Property Notepad - January 2010

4. VIRTUAL ASSIGNMENT BY A CORPORATE TENANT

In Clarence House Limited v National Westminster Bank Plc (2009), the Court of Appeal examined whether a tenant, Nat West, by entering into a ‘virtual assignment' of its lease to New Liberty Property Holdings Ltd (Liberty), had breached the alienation covenant in its lease (i.e. prohibiting assignment or parting with or sharing possession of the premises). In this case Nat West had not obtained the permission of its landlord, Clarence House Limited, for its arrangement.

A ‘virtual assignment' is where all economic benefits and burdens of a lease (including any management responsibilities the tenant has) are transferred to a third party, but without a formal assignment of the lease, and where the virtual assignee does not take up occupancy. It is often used by large corporate tenants for operational reasons. In this case Liberty collected the rents from an under tenant, William M. Mercer Ltd, as the agent for Nat West, and paid the head lease rents directly to the head landlord. Nat West was no longer, therefore, in occupation, collecting rent or paying rent.

Unsurprisingly, many head landlords are not comfortable with these sorts of arrangements, as they will not usually be consulted in advance. They can result in confusion and uncertainty as to the status and potential liability of both the named tenant and its virtual assignee, and a tenant's cash flow and solvency can of course be adversely affected if it no longer handles its own under lease rents.

The Court of Appeal decided that Nat West had not legally assigned its leasehold interest, but more crucially that it had not actually parted with possession of the property. There was therefore no breach of its lease covenants. The legal concept of possession is key to this case.

It differs from that of occupation, as it revolves instead around (a) the legal right to possess a property and exclude others from it, as opposed to merely occupying it from time to time, and (b) to collect rents and income from the property. As Liberty were given the right to collect the under lease rents, the Court recognised Liberty's status as an agent of Nat West, as opposed to that of a landlord, having a absolute right to retain those rents for its own use.

As a result of this decision, tenants involved in such arrangements will benefit from this clarification and it may encourage some to enter into similar arrangements if it makes operational sense to do so. Landlords are likely to remain uncomfortable with these, but may take some comfort from the clarification that their named tenant remains fully liable under the lease covenants. Landlords may also now consider adding more specific prohibitions to future leases, although they should first consider and discuss with their advisers the possible effect on marketability and rental value.

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