Virtual assignments: A leasing pitfall

In recent years, the use of virtual assignments in respect of portfolio transactions has become increasingly common. As well as being a clever device developed by solicitors, a virtual assignment transfers all the economic benefits and burdens of a lease to a third party, but without any actual assignment of the leasehold interest or a change in the actual occupancy of the premises. Such arrangements are attractive for tenants as they are able to remove lease liabilities from the balance sheet and property risks can be transferred to a third party.

Most commercial leases contain restrictions preventing any form of alienation without the landlord’s consent. Landlords will therefore be concerned that their tenants may be able to circumvent these standard restrictions.

The recent Court of Appeal ruling in the case of Clarence House Limited v National Westminster Bank Plc (2009) will not provide any extra comfort for commercial landlords.

Case background
National Westminster Bank Plc (NatWest) held a lease of offices in Clarence House, Manchester, which contained the following alienation restrictions:
- no underletting of the whole of the premises without the landlord’s prior written consent;
- no assignment of the premises without the landlord’s prior written consent;
- no execution of any declaration of trust in relation to the premises or the lease; and
- no sharing of possession or occupation of the premises or part thereof and no parting with possession or occupation of the premises
    or part thereof.

In 2001, NatWest sublet the premises to William M. Mercer Ltd (Mercer) with the landlord’s consent. On 10 June 2005, NatWest executed a virtual assignment of a portfolio of properties to New Liberty Property Holdings Limited (New Liberty) and which included the offices at Clarence House. The agreement between NatWest and New Liberty passed all the economic benefits and burdens and managerial obligations associated with the premises. New Liberty would be responsible for
the collection of the rent from Mercer and the payment of the rent to NatWest’s landlord.

When the landlord became aware of this arrangement, the rent was already in arrears and was not happy to have to deal with the Gibraltar-based New Liberty rather than NatWest. The landlord’s concerns were not without foundation as provisional liquidators of New Liberty were subsequently appointed.

First instance
The trial judge held that NatWest had not breached the covenant against assignment because that covenant covered only a legal assignment. It was also held that there was no declaration of trust as the relationship between NatWest and New Liberty was founded in contract rather than equity.
 
NatWest were however found to have either parted with possession of the premises or at least been guilty of sharing or permitting the sharing of possession with New Liberty. The definition of “possession”, the trial judge concluded, was to be found in the meaning ascribed to it in s.205(1) (xix) of the Law of Property Act 1925, being the “receipt of rents and profits or the right to receive the same, if any”. In addition, the trial judge held that as the premises were underlet to Mercer, the effect was that New Liberty was able to deal with the premises as NatWest, being the head leasehold owner, would otherwise have been expected to deal with them. As NatWest no longer had the right to deal with the premises, that amounted to a parting or sharing of possession.

Court of Appeal
Both the landlord and NatWest appealed against the trial judge’s verdict. The landlord appealed on the grounds that NatWest had breached the terms of the lease by executing a declaration of trust and/or assigning or subletting without consent.

Ward LJ explained that “the hallmark of the right to possession is the right to exclude all others from the property in question. That is the ordinary and normal sense of the word and that is the meaning which it should be given in this covenant.” In order to have parted with possession, NatWest must have “wholly ousted itself or completely excluded itself from the legal possession of the demised premises for all purposes”.

The Court of Appeal held that, as a result of the underlease to Mercer, the virtual assignment did not alter the position that NatWest was not in possession of the premises and therefore could not have parted with possession to or shared possession with New Liberty.
Furthermore, it was held that at the moment of receiving the rent, New Liberty holds it as agent for NatWest and then immediately thereafter it becomes money received to the account of New Liberty. The virtual assignment is therefore purely a contractual arrangement and does not result in a transfer to New Liberty of the right to receive the rents and the profits. On this basis, if there are any arrears, NatWest would have to sue as it is the party to the underlease entitled to receive the rent and any action brought by New Liberty in its own name would be defeated.

Ward LJ found similarities between a virtual assignment and a landlord assigning the right to receive the rent without assigning its reversion. This interpretation follows Kataria v Safeland plc (1998) in which it was held that such an assignment treats the rent as a chose in action and the assignee acquires no interest in the reversion. In such a case, whilst the assignee can recover rent as a debt, it cannot forfeit the lease for non-payment.

NatWest’s appeal was allowed on the basis that the virtual assignment therefore did not transfer a legal interest. It did not purport to share or part with possession for the benefit of New Liberty, nor did it assign any possessive rights to receive the rent (though, even if it had, there would still be no sharing or parting with possession in this regard).

In addition, the Court of Appeal found that there was no declaration of trust or unlawful assignment or underletting.

Implications
The collective sigh of relief from large corporations with a substantial property portfolio could probably have been heard throughout the City. Unless a subsequent ruling departs from this case, it is likely that virtual assignments will become a more popular tool to avoid the usual prohibitions on assignment, declarations of trust and parting with or sharing possession which are contained in most commercial leases. It is a mechanism that enables tenants to dispose of the various economic benefits and burdens attached to a lease without the need to wait for landlord’s consent. Such a transaction will no doubt be particularly appealing to those businesses wishing to raise capital and relinquish managerial and administrative obligations, as well as shifting balance sheet liabilities and making their portfolios more efficient.

Conversely, practitioners acting for landlords will be expected to create tighter alienation provisions within such leases, thereby preventing virtual assignments. As ever, the winner in relation to any such clause will simply be a reflection of the true bargaining power of the landlord and the tenant.

Jamie Hyams is an associate at Hogan & Hartson