Tindall Cobham 1 Ltd & Ors v Adda Hotels (An Unlimited Company) & Ors

The defendant companies are all associated companies in the Hilton Group (“the Group”). Hilton Worldwide Inc. is a Delaware corporation and a parent company in the Group. Adda Hotels (“Adda”) and Puckrup Hall Hotel Limited (“Puckrup”) were the original lessees of ten hotels in the UK under separate leases granted on 30 August 2002 by the claimants’ predecessors in title for terms expiring on 31 December 2029. The lease of the Tewskesbury Hotel was granted to Puckrup. The leases of the other nine hotels were granted to Adda. Each of the leases (which are in substantially the same terms) reserve significant base and turnover rents.

On 1 July 2014 Adda and Puckrup assigned each of the leases (separately) to the nine companies which have been joined as the 4^th to 12^th defendants. The name of each company indicates the location of the relevant hotels. The assignees are in each case £1 subsidiary companies in the Group which were formed for the purpose of taking the assignments.

We were told that the assignments were carried out as part of a Group re-organisation but they had the important consequence, if lawful, of releasing from further contractual liability under the various leases both Adda and Puckrup as original lessees and, more importantly, Hilton Worldwide Inc. as guarantor of those liabilities as a result of the operation of the provisions of ss. 5 and 24(2) of the Landlord and Tenant (Covenants) Act 1995 (“the 1995 Act”).

Those advising Adda and Puckrup took the view that it was not necessary to obtain the prior consent of the claimant landlord companies to the assignments. It is now conceded that this was wrong and in this Court Mr McGhee QC for the Hilton companies accepts that the assignments were not lawful and that under s.11 of the 1995 Act they were therefore ineffective to release the original tenants and their guarantor from their covenants under the leases. But the issue remains for the future whether a similar assignment or assignments to other associated companies in the Group would have the effect of achieving such release and whether the claimant landlords could lawfully prevent the assignments without at least the substitution of some suitable alternative guarantee.

These issues, which turn on the construction of the covenants against assignment in the leases and their interaction with the provisions of the 1995 Act, have led to litigation instituted by the claimants in the context of their own financial re-organisation. They are currently in the process of refinancing their group hotel business and a highly material factor in the negotiations for a new loan facility is the valuation of the hotels. This will obviously be affected by the continued existence or not of the Hilton parent company guarantee or some suitable alternative security for the rents due under the hotel leases. To this end, the claimants issued proceedings in the Chancery Division seeking inter alia a declaration that the assignments which took place on 1 July were unlawful as being in breach of clause 3.14 of the relevant hotel leases; and an order for the re-assignment of the leases to Adda and Puckrup as original tenants.

The claimants were given permission to apply for summary judgment on the claim and, as a result of expedited directions, the application was heard by Peter Smith J on 17 July: [2014] EWHC 2637 (Ch). He decided that the 1 July assignments had been carried out in breach of clause 3.14 of the leases so that they were excluded assignments within the meaning of s.11 of the 1995 Act. But he also made a declaration that under clause 3.14.6 the tenants were not permitted to assign the leases without first applying for the written consent of the landlords (such consent not to be unreasonably withheld) and that the landlords were entitled, as a condition of giving consent, to require compliance with the conditions set out in sub-clauses (a) and (b) of clause 3.14.6. His construction of sub-clause (b) was that this entitled the landlords to require the assigning tenants to procure a new guarantor (approved by the landlords) in place of Hilton Worldwide Inc. whose own guarantee would expire on the next lawful assignment of the leases.

The Hilton companies now appeal with the leave of the judge against this part of his order. As I explained earlier, it is now common ground that a request for consent must precede any assignment of the leases. But the issue between the parties is whether the judge was right to construe clause 3.14.6 in the way that he did and, if not, what are the contractual consequences for the parties of any future lawful assignments given the operation of the 1995 Act.

It is therefore convenient to begin by setting out the material provisions of the hotel leases.

Clause 1.1 contains various definitions. The relevant ones are “Guarantor” which means Hilton Worldwide Inc. (having replaced Hilton Group plc, the original guarantor, under a deed of release dated 24 February 2006) and “Tenant” which:

The terms of the guarantee are set out in the Sixth Schedule and include an obligation to pay the rents reserved by the lease and to perform the Tenant’s covenants.

The provisions governing assignment are contained in clause 3.14 and I set them out in full:

It is common ground that the references in sub-clauses 3.14.3 and 3.14.6 to s.19(1A) of the Landlord and Tenant (Covenants) Act 1995 are an error and should be read as references to s.19(1A) of the Landlord and Tenant Act 1927 (“the 1927 Act”).

The 1995 Act implemented the proposals contained in the Law Commission’s report, Landlord and Tenant Law: Privity of Contract and Estate (1988) (Law Com No. 174), which had recommended the reform of the position at common law under which the original parties to a lease continued to be bound contractually by their covenants (including those by way of guarantee) notwithstanding the assignment of the reversion or the term. The position of original tenants was dealt with by s.5 which provides:

The release of the tenant from his covenants triggers the automatic release of the existing guarantor. Section 24(2) provides:

To enforce these provisions s.25 also contains provisions which invalidate certain types of agreements in the lease. It states:

The only exception to the operation of ss. 5 and 24(2) is an authorised guarantee agreement (“AGA”) under s.16 (referred to in s.25(3)) under which the existing tenant whose covenants would be released under s.5 agrees to guarantee the performance of those covenants by the assignee only until any subsequent assignment of the lease: see s.16(4). In K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904; [2012] Ch 497 this Court decided that in a case where the existing tenant entered into an AGA in respect of the covenant liabilities of the assignee, it was permissible under s.25 for the tenant’s liabilities under the AGA to continue to be guaranteed by the existing guarantor. This was consistent with rather than a frustration of the provisions of s.24(2) which, as mentioned earlier, release the guarantor only where the tenant is himself released from his own covenants under the tenancy agreement. Beyond this limited exception, however, the provisions of s.25 are absolute in their effect and require an objective determination of what provisions of the relevant agreement fall within the scope of s.25(1)(a).

Section 19(1) of the 1927 Act has the effect of qualifying any covenant not to assign without the consent of the landlord with a proviso to the effect that such licence or consent is not to be unreasonably withheld. But the 1995 Act introduced a further provision in the form of s.19(1A) which benefits landlords by allowing them to set out in the lease the terms upon which consent will be given. It states:

The circumstances and conditions so specified are not therefore subject to any further overriding assessment of their reasonableness. The only exception to this is where they are framed by reference to a matter falling within the determination of the landlord or a third party. The power to make that determination has to be exercised reasonably and is therefore reviewable on those grounds: see s.19(1C).

As I have already explained, the judge’s decision that the 1 July assignments were unlawful under clause 3.14 of the leases because Adda and Puckrup had not made a prior request to the landlords for consent was sufficient to justify the declaration contained in paragraph 2 of his order that the leases had been assigned in breach of clause 3.14.6 and the consequential declarations in paragraphs 3 and 4 of the order. The relevant part of the order currently under appeal is the declaration contained in paragraph 1 and, in particular, paragraph 1c which encapsulates the judge’s construction of clause 3.14.6(b) as entitling the claimants to require the tenants to procure a new (and suitable) guarantor for the assignee’s liabilities under the leases in place of those of the existing guarantor which would be discharged under s.24(2) of the 1995 Act on a lawful assignment of the leases.

Before turning, however, to the appeal against that part of the order it is perhaps appropriate to mention by way of background a prior issue about construction which explains the judge’s concentration on clause 3.14.6 of the leases in his judgment and order. The hotel leases contain in clause 3.14 two covenants against assignment of the whole of the demised premises. The first is clause 3.14.3 which is general in its terms and enables the landlords to take advantage of s.19(1A) of the 1927 Act by withholding consent in any one of the four circumstances specified in clause 3.14.4 and by imposing as a condition of giving consent any one or more of the conditions set out in clause 3.14.5. The effect of those provisions is to entitle the landlords to limit any assignments to a company of sufficient financial standing and business competence with the benefit of a substantial new guarantee and/or an AGA by the outgoing tenant.

Clause 3.14.6, by contrast, is limited in terms to an assignment to an associated company of the tenant. Where this is what is proposed the landlord has limited itself to the right to impose only two possible conditions: the obligation to give notice of the completed assignment and the requirement in clause 3.14.6(b) that the tenant “shall procure that the Guarantor and any other guarantor of the Tenant” shall enter into a deed of covenant in the terms of the Sixth Schedule. Subject to compliance with those conditions (if imposed), the landlords must give consent to the assignment. This is in marked contrast to clause 3.14.3 under which the landlord could, at least in theory, refuse consent even if the proposed assignment otherwise met the circumstances and conditions permitted under clauses 3.14.4 and 3.14.5, provided that, in doing so, it would be acting reasonably. The landlord does not have this option under clause 3.14.6 and, as Mr McGhee emphasised, the conditions for assignment are very different.

It was therefore the defendants’ case before us (and I think before the judge) that, in the case of a proposed assignment to an associated company, the only applicable covenant was the one contained in clause 3.14.6. An assignment in compliance with those provisions could not, it was said, be in breach of the provisions of clause 3.14.3.

This issue of the precise limits of each covenant and their relationship to each other is not directly in point on this appeal because any future assignments are likely to be to an associated company within the Group and if consent is granted under clause 3.14.6 then it operates for all purposes. Conversely, if consent cannot be obtained under clause 3.14.6 then it could not be obtained under clause 3.14.3 if the landlords chose to rely upon all of the circumstances set out in clause 3.14.4. It is, I think, common ground that an associated company similar to the present assignees would not satisfy any of those criteria.

But my view is that Mr McGhee is in fact wrong in his submission that, as a matter of construction, clause 3.14.3 has no possible application to a proposed assignment to an associated company and that clause 3.14.6 provides what might be described as a complete code for assignments of that kind. Although the provisions of clauses 3.14.4 and 3.14.5 are much more extensive and potentially onerous than those contained in clause 3.14.6, this only serves to emphasise that clause 3.14.6 was designed to provide a more simple and streamlined process for the tenants to obtain consent for an assignment to other companies in the Group on the basis that the parent company would continue to guarantee their obligations under the lease. Clause 3.14.3 is general in its terms and clause 3.14.4.4 would, I think, be unnecessary if clause 3.14.3 was intended to have no possible application to any proposed assignment to an associated company. If therefore one possible effect of s.25 of the 1995 Act is, as the claimants contend in their respondents’ notice, to invalidate clause 3.14.6 in its entirety, then the provisions of clause 3.14.3 would in my view operate in respect of any proposed assignment to an associated company.

Against this background, it is easy to understand why the argument before the judge and before us concentrated for the most part on clause 3.14.6. The defendants’ primary case is that s.25 operates to invalidate not clause 3.14.6 itself or even clause 3.14.6(b) alone, but rather to prevent the landlords from exercising their contractual rights to impose condition (b) as a condition of their consent to the assignment. It is only when a landlord chooses to exercise its option to insist upon the 3^rd defendant (or other existing guarantor) entering into a guarantee in the terms of the Sixth Schedule that s.25 comes into operation. On this basis, no part of clause 3.14.6 requires to be excised and, except insofar as the landlord actually seeks to rely on condition (b), the clause continues to operate in relation to any assignment to an associated company and to provide the tenant with a mandatory consent to any such assignment.

Alternatively, Mr McGhee submits that if the effect of s.25 is to invalidate clause 3.14.6(b) itself (at least as between the present contracting parties) then a form of severance must take place with the result that the clause continues to govern any assignment to an associated company and can be taken advantage of by the tenant shorn of the provisions of sub-clause (b). This would, if correct, mean that the landlord would be required to consent to an assignment to an associated company even if it were only of very limited value without being able to impose any condition save that it should be notified of the completion of the assignment.

The judge regarded this outcome as wholly uncommercial. He said:

In his view there were two answers to the defendants’ argument. The first was to construe the reference in sub-clause (b) to “any other guarantor of the Tenant” as meaning “any other guarantor procured by the Tenant” so as to impose upon the assignor an obligation to provide an alternative guarantor to the Guarantor as defined. The second was to treat s.25 as invalidating not merely sub-clause (b), as the defendants have contended, but the entirety of the proviso to clause 3.14.6 so that one is left with a simple qualified covenant against assignment in the case of an assignment to an associated company. This is likely to enable the landlord faced with an assignment to a company of no substance to be able to insist upon the provision of a substantial guarantee.

The defendants’ appeal against the judge’s construction of clause 3.14.6 challenges two aspects of his reasoning. The first is his acceptance of the claimants’ argument that the commercial construction of the clause has to be driven by the consequences of the application of the 1995 Act. The second is the judge’s reliance in support of this on the principle sometimes expressed in terms of the maxim verba ita sunt intelligenda ut res magis valeat quam pereat which can be translated more pithily as “validate if possible”.

The principle that, as between possible constructions of an agreement, one should choose the construction which makes the instrument legally effective as opposed to ineffective is too obvious to require further explanation. It has a continuing echo in all the modern cases on construction which stress the need to opt for a meaning which will produce the most commercially workable version of the contract. But it is clear that the maxim or principle originated in that context and was not devised as a means of avoiding the consequences of legislation being applied to the contract which the parties had made. So in Hillas (WN) & Co Ltd v Arcos Ltd (1932) 147 L.T. 503 Lord Wright said:

It is also clear from this passage that it is not possible to apply the maxim in order to create an interpretation of the contract or other instrument which on ordinary principles of construction cannot be justified. An example of this is the decision of this Court in Re Baden's Deed Trusts [1969] 2 Ch 388 where Harman LJ said:

The starting point must therefore be to construe clause 3.14.6 in its proper contractual context in order to decide whether there are in fact realistic alternative constructions of the relevant words that may require the application of the “validate if possible” principle. As discussed earlier, the reference in sub-clause (b) to “and any other guarantor of the Tenant” appears as part of a composite condition which the landlord may impose as a condition of consent to an assignment to an associated company. It specifies what the landlord can insist should happen “on any such assignment” and it identifies whom the tenant is required to obtain the new guarantee from.

As a matter of ordinary language, the reference to “the Guarantor and any other guarantor of the Tenant” in my view denotes the persons who at the time of the assignment are the guarantors of the tenant’s obligations under the lease. The condition imposed on the tenant is no more than that he should procure a new guarantee from those persons. By contrast, the landlords’ construction of those words, which the judge accepted, is that they require the assigning tenant not merely to procure a new guarantee but also a new guarantor.

It seems to me that there are real difficulties about that construction of the clause. The first is that one has to read the words “and any other guarantor” as in some way imposing on the tenant an obligation to provide such a guarantor. The judge suggested that this could be achieved by reading the words “procured” or perhaps “to be procured” into the clause after “guarantor” but this would also require the substitution of “by” for “of” and, in my view, requires a significant re-formulation of the clause.

The other problem is that sub-clause (b) contains no provision which requires the new guarantor to be procured by the tenant to have any particular financial standing. The declaration in paragraph 1(d)(ii) of the judge’s order states that what the tenant must procure is “a person approved by the landlord as guarantor (such consent not to be unreasonably withheld)” but the judge does not explain in his judgment what is the basis of any such term and it is difficult to see how one could introduce such a requirement into clause 3.14.6 which expressly requires the landlord to give consent if the specified conditions are complied with. The conditions contained in sub-clauses (a) and (b) are intended to take advantage of s.19(1A) of the 1927 Act. But the consequence of this is that no question of reasonableness arises in their application. The landlord is free to stipulate the terms for his consent and the tenant must comply. Consistently with this, the conditions must specify what the tenant has to do in order to comply. Sub-clause (b) does not include a requirement for any new guarantor to be approved by the landlord and it is not obvious why one should be implied.

I therefore consider that the landlords’ construction of sub-clause (b) which the judge accepted is not correct and cannot be relied on as a realistic or equally plausible alternative to what the defendants say that it means. I think that the judge was wrong to allow his understandable hostility to what the defendants contend is the effect of s.25 upon the clause to produce a construction of the words which, on proper analysis, they cannot bear. In these circumstances, the “validate if possible” principle has no application and does not justify the landlords’ construction of the clause.

That therefore brings me to consider the alternative conclusion reached by the judge and a number of alternative arguments relied on by the landlords which the judge rejected but which are pursued on this appeal by way of respondents’ notice. All these arguments turn on the effect of s.25 on clause 3.14.6 of the lease. Mr McGhee included in his submissions an argument that clause 3.14.6 should be read as subject to an implied term that it would not be operated in breach of s.25. But since s.25 (by contrast to the cases he relied upon) is an anti-avoidance provision which invalidates any provision in the contract that would frustrate the operation of the 1995 Act, I can see no reason to imply a term simply to achieve the same effect.

As explained earlier, the defendants’ case is that s.25 invalidates the relevant agreement only to the extent that the contractual provisions would have the effect specified in s.25(1)(a). A minimalist approach is therefore called for and this, they say, can be achieved either by invalidating any actual reliance by the landlord on the clause 3.14.6(b) condition or at most by invalidating for the purpose of the next assignments the clause 3.14.6(b) condition itself.

Mr McGhee placed much reliance on the fact that the proviso to clause 3.14.6 is an option for the benefit of the landlords which it may choose not to exercise. Condition (b) is only objectionable, he says, if the landlords seek to rely upon it as a pre-condition to consent with the effect that under the concluding words of sub-clause 3.14.6 they are not required to give consent unless the condition is complied with.

The first of these two arguments was also relied on in part by Mr Reynolds QC for the landlords but with different alleged consequences. He accepts that it is possible to regard sub-clause (b) as not invalidated by s.25 on the basis that the section only avoids the assignor’s ability to comply with the condition. It would therefore invalidate any new guarantee which Hilton Worldwide chose to enter into in compliance with the condition but it would not, he submits, make it unlawful for the landlords to impose such a condition. Because the assignor could not (and therefore would not) have complied with the condition then the landlords would have no obligation to give consent under clause 3.14.6.

The argument that s.25 has no application to sub-clause (b) itself is based on the sub-clause not being an “agreement relating to the tenancy” within the meaning of s.25(1). It is simply a pre-condition that the tenant must comply with if it wishes to obtain the benefit of clause 3.14.6. In this way it is said to be analogous to the circumstances in Allnatt London Properties Ltd v Newton [1981] 41 P&CR 11 where the tenant under a lease protected by Part II of the Landlord and Tenant Act 1954 had first to offer to surrender the lease if he wished to assign it. Sir Robert Megarry V-C held that the offer, if accepted, would undoubtedly create a contract which was avoided by s.38(1) of the 1954 Act which applies to invalidate any “agreement relating to a tenancy” which has the effect of precluding the tenant from making an application for a new tenancy. But the clause in the lease which required the tenant to offer to surrender the lease was not itself invalidated because the requirement was to make an offer of surrender, not to agree to surrender; and the clause containing this requirement did not of itself prevent the tenant from making an application for a new tenancy.

The judge was not persuaded by either the landlords’ or the tenants’ arguments on this point and neither am I. In Allnatt the Vice-Chancellor did not decide that the covenant he was considering was not an “agreement relating to a tenancy” within the meaning of s.38(1). The tenant’s challenge to the validity of the covenant failed because it could not be said that it was an agreement which had the effect of precluding the tenant from applying for a new tenancy. The only effective bar to such an application was the separate agreement to surrender.

In this case s.25(1)(a) invalidates any agreement relating to a tenancy which would have the effect “to exclude, modify or otherwise frustrate the operation of the provisions of the Act”. Section 25(2) makes it expressly clear that s.25(1) can apply to a covenant in the lease against assignments insofar as it regulates the giving of consent for the assignment. It seems to me that a condition which requires the tenant to procure a continuing guarantee from an existing guarantor does have the effect identified in s.25(1)(a). Section 25(1) is concerned to invalidate agreements which would have the s.25(1)(a) consequences. It is not limited to the exercise of the rights which such agreements contain. The ability of the landlords to bring about one of the prohibited consequences by the exercise of those rights is enough in my view to bring the contractual provision conferring those rights within the ambit of the section. I do not therefore accept Mr McGhee’s first argument that s.25(1) is only engaged when the power to impose condition (b) is exercised.

Nor do I accept Mr Reynolds’ argument that the landlord can rely upon the invalidity of a guarantee of the kind contemplated by sub-clause (b) as constituting non-compliance by the tenant with that condition. That again limits the operation of s.25(1) to the exercise of the relevant contractual rights rather than the agreement itself. But it also raises the more fundamental question which applies to all the arguments about the effect of s.25 which is how far the section should be regarded as avoiding the contractual provisions in this case.

The arguments on s.25 which I have already outlined, the landlords’ argument that s.25(1) avoids the entirety of the proviso to clause 3.14.6 (which the judge accepted) and the further argument advanced by Mr Reynolds that it should be taken to avoid not only the proviso but the whole of clause 3.14.6 all turn on the words “to the extent that” in s.25(1). It is clear that s.25 was intended to provide a comprehensive anti-avoidance provision which, as Lord Nicholls said in London Diocesan Fund v Phithwa [2005] 1 WLR 3956, ought to be interpreted generously to ensure that the operation of the 1995 Act is not frustrated either directly or indirectly. Mr McGhee made the point that legislation which operates to avoid the whole or a part of a contract may produce consequences in terms of the legal position which the parties are left with that may be both capricious and uncommercial. I accept that. Any alteration of the contract will necessarily change the parties’ legal relationship from what they intended it to be and the actual impact upon them in terms of the remaining balance of liabilities and obligations may be fortuitous. But that should not be regarded as an invitation to assume that such will necessarily be the case, still less to attribute to Parliament an intention that the legislation should be interpreted and applied in that way when other alternatives are available.

Although the words “void to the extent that” indicate that Parliament did not intend to invalidate more of the relevant agreement than was necessary to safeguard the objectives of the Act in the context of the particular assignment under consideration, those words do not in my view preclude the Court from taking a balanced approach to invalidation which, whilst neutralising the offending parts of the contract, does not leave it emasculated and unworkable. The judge was referred in argument to the principles of severance under which the Court can enforce a contract containing provisions that are either illegal or against public policy provided that the unobjectionable provisions are severable. It seems to be generally accepted that the Court will not sever the terms of a contract for this purpose unless the unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording that remains; the remaining terms are supported by adequate consideration; and the removal of the unenforceable provisions does not alter the character of the contract: see Sadler v Imperial Life Assurance Co of Canada [1988] IRLR 388 at p. 393.

Neither party to this appeal relies upon the principles of severance as of direct application to what we have to decide. We are not concerned with whether the Court is able to sever an illegal contract on these common law principles because s.25 makes it clear in terms that it operates only to invalidate limited parts of the relevant agreement. The rules of severance are not therefore of much assistance even by analogy to a determination of how much of the contract the Court is required to treat as invalid or unenforceable for the purpose of s.25. But in carrying out that exercise I can see nothing in s.25(1) which prevents the Court from looking at the structure of the agreement in an objective and common sense way.

The difficulty I have with Mr McGhee’s argument that it is necessary only to remove sub-clause (b) of the proviso is that this would treat conditions (a) and (b) as independent and self-sufficient rather than as parts of a composite, interdependent proviso under which the landlords must consent to the assignment if the conditions are fulfilled. The removal from the proviso of the most important condition from the landlords’ point of view seems to me to call both logically and as a matter of drafting for the removal as well of the concluding two lines of the proviso which apply only if “such conditions” are complied with. Mr McGhee accepts that those words have to be changed but submits that his clients should remain entitled to the benefit of the requirement on the landlords to give consent. That is to create an inbalance in the contractual provisions which in my view the legislation was not intended to create unless unavoidable. The far more obvious solution which both respects the structure of the contract and gives effect to the provisions of s.25(1) is to regard, as the judge did, the whole of the proviso as being avoided by the legislation. This realistically treats the proviso as a complete term of the contract (which is what it is) and leaves clause 3.14.6 as a qualified covenant against assignment which can be operated according to its terms.

For the same reasons, I regard Mr Reynolds’ other argument that the whole of clause 3.14.6 should be regarded as invalidated as excessive and I reject it.

For these reasons, I would vary the judge’s order by deleting sub-paragraphs 1(b)-(e) but otherwise dismiss the appeal.

I agree.

I agree also.