The Prudential Assurance Company Ltd v Ayres & Ors

The Claimants, the Prudential Assurance Company Limited (“the Prudential”), represented by Mr Trace QC leading Miss Harrison, is the lessee of substantial office premises in the City of London. It holds them of the Wardens and Society of the Mistery or Art of the Leathersellers of the City of London, whom I shall call “the Leathersellers”. The underlessee of the premises, replacing the Defendants, Messrs D.M. Ayres and C. Grew, (who had been the immediately preceding underlessee) came to be a firm of United States Attorneys, the Illinois partnership Altheimer & Gray (“A & G”). A & G moved into bankruptcy both in the United States and here, leaving, by now, some £1.5 million owing by way of unpaid obligations under the Underlease. The Prudential accordingly looked to recover from the Defendants, previous tenants of the premises, in their capacity as guarantors of A & G. But there exists a Supplemental Deed between the Prudential and A & G, supplemental to the Underlease, which contains a provision – clause 2 – which has been called a non-recourse provision, an unusual provision which arguably limits recovery by the Prudential to what might be called the Partnership assets of A & G to the exclusion of the personal assets of its individual partners. This judgment is concerned with the effect of that clause 2 upon recoverability from the Defendants as guarantors of A & G. The Defendants, represented by Mr Steinfeld QC leading Mr Ritchie, argue that the effect of clause 2 in the events which have happened, which I shall describe, is wholly to exonerate the Defendants from liability to the Prudential.

On the 12^th March 1997 the Prudential granted an Underlease of substantial office premises on two floors of Hasilwood House, Bishopsgate, London EC2. The underlessee, there described as “the Tenant”, then consisted of two individuals Mr D.J. Guiney and Mr D.M. Ayres. The term of the Underlease was to end on the 24^th December 2006. The reviewable rent, even unreviewed, was prescribed to be, from the 25^th December 2001, a little short of £400,000 per annum payable by equal quarterly payments in advance on the usual quarter days in every year. In addition there were service charges and other conventional provisions. The Underlease was described as a new tenancy within the meaning of section 1 of the Landlord and Tenant (Covenants) Act 1995. The underlessees covenanted to pay the rents reserved without deduction. The only permitted use was as high-class offices. There was a prohibition against assignment of the Underlease without the landlord’s, the Prudential’s, consent. Amongst the pre-conditions which the Prudential could insist upon, were the underlessee to wish to assign, was the execution by the underlessee and delivery to the Prudential prior to the assignment of an Authorised Guarantee Agreement, an instrument the nature of which is prescribed in the 1995 Act. Were rent to be paid late, interest was to fall due thereon under the provisions of the Underlease. The provisions of sections 24 to 28 inclusive of the Landlord and Tenant Act 1954 were duly excluded.

I have not seen the terms of the Headlease from the Leathersellers to the Prudential but it is plain, to judge from the Licence to Assign to Messrs Guiney and Ayres which the Prudential obtained from the Leathersellers on the 3^rd March 1997, that the Headlease required that the Prudential should obtain prior licence before assigning and that the Prudential bound itself not without the Leathersellers’ consent at any time expressly or by implication to waive any of the covenants contained in the Underlease which it granted to Messrs Guiney and Ayres.

Messrs Guiney and Ayres had been joined as underlessees as partners in the law firm of Brobeck Hale & Dorr International and, upon Mr Guiney retiring from that partnership in April 1997, he was shortly thereafter replaced by Mr Grew. On the 24^th September 1998 the Prudential joined in a Deed of Assignment, Covenant, Release and Licence of that date with Mr Guiney, Mr Ayres and Mr Grew. The Underlease was assigned to Messrs Ayres and Grew and Mr Grew covenanted with the Prudential with effect from the 24^th September 1998 and for the residue of the term to pay the rents reserved by the Underlease.

On the 8^th May 2001 Messrs Ayres and Grew, the Defendants, agreed with A & G that A & G should take over the Underlease. A term of the agreement between them was that in the prospective assignment A & G would separately covenant with the Defendants that A & G and its successors in title to the Underlease would, during the continuance of the term of the Underlease, pay all rents becoming due under the Underlease from the date of actual completion of the assignment.

On 8^th June 2001 a Licence to Assign the Underlease was granted by the Leathersellers to the Prudential. Both the Defendants and A & G were also parties to the licence. Both the Leathersellers and the Prudential agreed to the assignment by the Defendants to A & G. A & G covenanted with the Leathersellers and also with the Prudential. The covenant with the Prudential was that A & G would pay the rents “in the manner and at the respective times appointed for payment thereof and will perform and observe all the covenants on the part of the lessee and the covenants and provisions contained in the Underlease”. By clause 6 the Defendants covenanted with and guaranteed to the Prudential, inter alia, that if A & G, before any lawful assignment of the Underlease by it, made default in payment of the rents payable under the Underlease then the Defendants would pay the rents notwithstanding (clause 6.4.1) any time or indulgence granted by the Prudential to A & G, or any neglect or forbearance of the Prudential or (clause 6.4.2) any variation in the terms of the Underlease, or:

That is the background against which has to be construed the most important instrument for present purposes, namely the Supplemental Deed of the 21^st June 2001 made only between the Prudential and A & G. It was expressed to be supplemental to the Underlease. The Supplemental Deed has a definition of “Partnership” which was defined as meaning A & G “as constituted by the present and future partners thereof carrying on in partnership (with others) in the United States of America and elsewhere the professional practice of attorneys under the name or style of Altheimer & Gray and includes any successor body or firm carrying on the whole or a substantial part of the business of that Partnership from time to time in the United States of America and elsewhere and any successor firm, partnership or body following any merger, incorporation or otherwise”. It will be seen from that definition that it defines what is, so to speak, a legal personality; it does not in terms describe any particular body of assets or liabilities.

I shall come on later to the more crucial terms of clause 2 of the Supplemental Deed but, to continue a recital of the background facts, in October 2003 A & G’s creditors filed an petition against A & G under Chapter 7 of the US Bankruptcy Code. In November 2003 the case was converted to one under Chapter 11 of the US Bankruptcy Code and on the 21^st November 2003, by Order of the US Bankruptcy Court, A & G were authorised to reject the Underlease with effect from 30^th December 2003.

In May 2004 the Prudential began proceedings against the Defendants asking for a declaration that they, the Defendants, were obliged to accept a new Lease of the fourth and fifth floors of Hasilwood House, the premises described in the Underlease, and there then began to be served on the Defendants a series of notices under section 17 of the Landlord and Tenant (Covenants) Act 1995, none of which is contested as to its service or effect. In May 2005 the Prudential’s claim form was amended and there were later further amendments to it so as alternatively to claim from the Defendants as guarantors sums (then) of over £1.3 million and interest. It is that alternative claim which gives rise to the questions of construction with which I shall be concerned.

In May 2006 A & G as a partnership was wound up in England. In June 2006 its liquidator disclaimed the Underlease.

So far I have described, when speaking of proceedings, proceedings the number of which ends 1599. The Prudential has since issued separate proceedings, the ending of which is 4440, but I have not been concerned with such later proceedings.

No evidence other than documentary was led save for the witness statement of Mr C. Martin, the solicitor who, at the time of the Supplemental Deed, was at Berwin Leighton Paisner and had the conduct of conveyancing matters there on behalf of the Prudential. He wrote as to some surrounding circumstances but neither added to or subtracted from the matters required to be entertained in arriving at a true construction of the Supplemental Deed.

Only liability is in dispute before me. Subject to certain qualifications with which I need not, at this stage, deal, quantum is agreed at £1,534,416.88 of which over £1.289 million is for arrears of the reserved rent which, from March 2004, was at £143,250 per quarter.

Before going in detail to the important provisions of clause 2 of the Supplemental Deed I must describe a point which is quite deliberately not taken here. It might be thought that a guarantor who guarantees a tenant’s liability to pay rent to the landlord could expect that the tenant, unless the guarantor had otherwise expressly agreed to some restriction as to this, would be liable to the landlord to his uttermost farthing. A restriction limiting the landlord’s recovery to only some part of the tenant’s assets might be thought to represent an additional risk or burden upon the guarantor and hence, if not agreed by the guarantor, that it might serve to avoid the guarantee. That argument is expressly not taken here by Mr Steinfeld and Mr Ritchie.

That suffices as the background against which the questions as to the true construction of the Supplemental Deed are set.

The applicable principles of construction have not been in issue between the parties and I have been referred to Investor’s Compensation Scheme v West Bromwich Building Society [1998] 1 WLR 896 at 912f-913, BCCI v Ali [2002] 1 AC 251 at 259f and 269 and Rennie v Westbury Homes Holdings Ltd [2007] EWHC 164 (Ch), paras 37 and 38.

It is necessary to set out the whole of clause 2 of the Supplemental Deed which is as follows:-

Mr Trace notes, as I accept, that the provisions of clause 2 are temporary in the sense that they do not necessarily apply for the whole of the remnant of the term of the Underlease. They apply only “whilst the lease is vested in” A & G or in a related underlessee. Mr Trace relies on that as one of a number of features that point, contrary to Mr Steinfeld’s argument, to the rent under the Underlease remaining unchanged. If, for example, quarter by quarter, the rent reserved depended, Mr Trace says, on an examination of the “assets, income and accounts” of A & G then the rent would lose the certainty which is required as a characteristic of a rent and, even if those three ingredients were so well defined as to lead to an ascertainable sum, there would, even so, be a state of flux and of unknowing so uncommercial as to be improbable to have been intended. Depending on the law of partnership in Illinois (as to which no evidence was given), it could be that the Partnership assets could be reduced at will by the partners and its net income could effectively be reduced, in either case to thwart recovery of the reserved rent. Surely, says Mr Trace, that would be so uncommercial to be improbable to have been intended. Further, in the licence to assign A & G had covenanted to pay the Prudential the rents not as described in the Supplemental Deed but as contained in the Underlease. Moreover, the Prudential had licence from the Leathersellers only to permit assignment to A & G of an Underlease under which A & G were required to pay the rents described in the Underlease. Even after the execution of the Supplemental Deed, A & G, on giving notice to the Leathersellers, wrote:-

I accept that in these circumstances the rent reserved by the Underlease remained unchanged. But I do not see that as conflicting with the first part of clause 2.1 of the Supplemental Deed – “The liability of the Tenant under the Lease … shall be limited …”. It is open to a landlord to indicate to his tenant a willingness to accept less than the reserved rent. An example is to be found in the celebrated case Central London Property Trust Limited v High Trees House Limited [1947] KB 130. I thus read clause 2.1’s reference to the “liability” of the underlessee not as affecting the rent reserved but as indicating a binding willingness on the part of the Prudential in some circumstances to accept less than the reserved rent and thus to deny themselves also any remedy at law or in equity for the full reserved rent whilst those particular circumstances should apply. I can quite see the objections that it may have been unwise of the Prudential to have exposed their recovery to concepts as vague (if not further defined and regulated) as the Illinois partnership’s “assets income and accounts” and not to have obtained the Leathersellers’ consent to a partial waiver of the covenant as to rent in the Underlease but I cannot pretend that the first sentence of clause 2.1 is not there. In the result, as I see it, unless A & G should raise the inadequacy of the Partnership assets, the full reserved rent would be payable and accepted but, once that inadequacy is raised, whereas the obligation remains the same, there would be no remedy available to the Prudential beyond the extent of the described Partnership assets. The “liability” of the underlessee is limited, in other words, much as is the “liability” of a limited liability company; the extent of its obligations is unaffected but there are circumstances in which recovery from it will be restricted. Viewing liability in that way, the provisions of clause 2.1 beginning “Consequently” are, indeed, in part at least, a consequence of liability being treated as I have construed it to be; they are so consequential, at any rate so far as concerns recovery against A & G by the Prudential.

In reliance on the word “consequently” Mr Trace argues that its effect is to limit the sense of the words following so as to require that sense to be no other than such as is strictly consequential upon that which has preceded it. An alleviation of the burden on A & G, says Mr Trace, does not have, as an inescapable consequence, an alleviation of the burden on a previous tenant. I see the force of that but, if (as is the case) part of what immediately follows is truly so consequential, but part (as to recovery against “any previous tenant”) is not directly consequential, I do not see the word “consequently” as, of itself, to have sufficient force in such a context to deny effect to the part that is not. I cannot simply ignore the words “or any previous tenant” because their apparently intended effect would not be directly consequential upon the earlier restriction of recoverability against A & G. Nor is there any plea of rectification to delete them. Moreover, whilst an alleviation of the burden on a tenant does not have the inescapable consequence that the burden on the tenant’s guarantor is also alleviated, the implied process whereunder the guarantor is to be indemnified by the tenant leads to that consequence, though not inescapable, being at least usual.

Does such a reading thus far conflict with the phrase in clause 2.1 “recovery by [the Prudential] … for any such default”? The reference to “any such default” is at least inelegant as there is no prior reference to any kind of default but Mr Trace argues that any true construction has to give meaning to that phrase and thus has be such as to contemplate some sort of default being possible. He continues that, were there to be no complaint possible for non-payment of the unchanged reserved rent, then there never would be any “default”. I do not accept that. Even if the Prudential bindingly indicates that it will, in the described circumstances of an inadequacy of Partnership assets, accept a lesser sum as the payable rent, there could still be default on A & G’s part in its not paying even that reduced sum, either on time or at all. The need for a default to be possible is thus satisfied.

The words in clause 2.1 “or any previous tenant” plainly provide, as I have already touched upon, a real difficulty in the Prudential’s way when it seeks, as it does, to recover the unchanged full rent from the Defendants, a previous tenant. A natural and grammatical reading of the expression “any recovery by the Landlord against the Tenant or any previous tenant” is that what is there being described are two kinds of recovery by the landlord, one against the tenant and one against any previous tenant. Mr Trace, though, seeks first to say that it describes two kinds of recovery, one by the landlord and another by any previous tenant. I cannot accept that ungrammatical construction. The phrase is dealing with a claim against the “previous tenant” rather than by him. Its intent, as it seems to me, is to ensure, as it was put in argument, that, having shut the front door to keep out recovery from A & G going beyond the Partnership assets (by restricting the “liability” of A & G to the Prudential) the draftsman then wishes to shut the back door, whereby the Prudential might otherwise recover the full reserved rent from the previous tenant as guarantor, leaving the guarantor then to make a claim against A & G for indemnity, which, but for clause 2, could go beyond Partnership assets. The draftsman shuts the back door by providing that the landlord’s claim not only against the tenant but also against “any previous tenant” is limited as clause 2.1 prescribes.

But what commercial motive could there be, asks Mr Trace, for so limiting the recoverability against A & G or its guarantors? Mr Steinfeld, rightly in my view, says that it is not for the Court to explore motives and that, in any event, it has inadequate evidence to enable it to do so. It is plain that A & G insisted on a provision for limited recourse and plain, too, that ultimately the Prudential accepted and agreed that. It could be that the insolvency of a substantial American legal practice was thought to be so unlikely that it was regarded as a risk that could safely be borne; it could be that the full rent payable was high enough, in comparison with what was available from other prospective tenants, to justify the taking of whatever risk there was. It could be that a large American legal firm represented a prestigious tenant which it was worth acceptance of some risk to attract to the building. It is not for me to speculate on motives (and whatever I might do it could only be speculation) but I cannot say that plainly was there no possible commercial motive for the acceptance by the Prudential of clause 2.1 on the construction that I have given it. It is not, in my view, a construction so plainly improbable as not possibly to have been intended, nor to use Mr Trace’s word, so absurd as to require a departure from the ordinary meaning of the language used.

Mr Trace is entitled to take and does take the point that the last sentence of clause 2.1 – “Further, no partner ... shall be required by the Landlord at any time to loan or contribute personal money or property to the Tenant to enable it to discharge any obligation owed to the Landlord” – could be expected, by way of repetition of the words “or any previous tenant” earlier found, to add such words, after reference to “the Landlord”, at either or both of the two opportunities which that last sentence affords for their addition. That might have been expected so there is some force in that but not, in my view, force sufficient to override the plain intent of the earlier words “or any previous tenant”, which limit recovery as there provided.

It is true to say that the expression “any recovery by the Landlord against the Tenant or any previous tenant under the Lease … shall be limited to assets of the Partnership” is inept in the sense that recovery by the landlord against a previous tenant would not be “under the Lease” but it would be “by reference to” or “in relation to” the Lease and I do not regard the words “under the Lease” as so inept as to require some construction other than that which I have given.

The words “or any previous tenant” lead to such difficulties for the Prudential that Mr Trace even argued that they should be ignored. I have been unable to find any good reason for so extreme a construction. Looking at clause 2 as a whole and, indeed, the Supplemental Deed as a whole, one can see that it was very much concerned with limiting recourse to Partnership assets. The draftsman sees a number of ways in which attempt might be made to go beyond recovery of Partnership assets. There could be attempt to recover, in excess over Partnership assets, against the tenant, A & G, or individual partners. There could be recovery attempted by way of claim against the guarantor as previous tenant who, in turn, (as is common ground) could, but for clause 2, then recover by way of indemnity in such excess against A & G; and there could be recovery by the Prudential in the liquidation of A & G by way of a proof for the full unchanged reserved rent of the Underlease. The draftsman seeks to head off all forms of recovery beyond the loosely defined Partnership “assets, income and accounts” in all three circumstances. It is the commanding purpose of the Supplemental Deed to do so, but the question then becomes this: can the Defendants, not party to the Supplemental Deed, take advantage of the limitation of recovery against them which, if my construction is right, it confers?

To answer that question Mr Steinfeld relies on the Contracts (Rights of Third Parties) Act 1999 which came into force on the 11^th November 1999. Under the heading “Right of Third Party to Enforce Contractual Term” clause 1 provides, so far as material, as follows:

“Express” provision of a right to enforce is dealt with in section 1(1)(a) of the 1999 Act and what “appears” from a proper construction is dealt with in section 1(2), so it might be thought that the verb “purport” in 1(1)(b) is intended to deal with something that differs in some way from “express” provision and from the “appearance” of an intent. However, the first meaning given to the noun in the Oxford English Dictionary is;

The term or provision in question is clause 2.1, namely that recovery by the Prudential against “any previous tenant… shall be limited to assets of the Partnership”. It is, again, inelegant in the sense that one would not ordinarily expect recovery against A to be against assets other than those of A but I regard the sense as sufficiently clear, namely, that whilst the Prudential is fully entitled to recover in respect of the full reserved rent from Partnership assets, it was entitled to nothing more than that which was derived from those assets, either from A & G or from “any previous tenant”. To that extent, where, as here, the previous tenant is a guarantor, the sense of clause 2.1, in my view, manifestly confers a benefit, a cap as to recoverability, on the previous tenant. Accordingly I hold that the Defendants as previous tenants are entitled in their own right to enforce the provisions of clause 2.1 against the Prudential.

Miss Harrison, briefly following Mr Trace, argued that if clause 2.1 is given the construction which I have held to be the case and for which Mr Steinfeld argued then there are no circumstances in which the previous tenant’s guarantee would ever avail the Prudential; it would be a quite useless provision. I accept Mr Steinfeld’s answer that that is not so. There are circumstances, on such a construction, in which the Prudential might reasonably find it at least more convenient to go against the Defendants rather than against an American Partnership. There could, for example, be a case in which A & G failed to pay or punctually to pay the full reserved rent even though the Partnership assets did suffice to pay them. In such a case the Prudential might prefer to sue the Defendants under their guarantee rather than to chase an overseas defaulting debtor. I thus cannot describe the guarantees given by the Defendants as pointless, even on the construction of clause 2.1 coupled with the effect of the 1999 Act as I have taken it to be.

Mr Steinfeld argues that, in any event, the Defendants are not liable under their apparent guarantees to the Prudential contained within the Licence to Assign of June 2001 as, he says, those guarantees fall foul of the Landlord and Tenant (Covenants) Act 1995. The argument runs as follows. In that Licence to Assign the Defendants (there described as the undertenant) covenanted with the Prudential (there the tenant) to pay all rents and perform and observe all the covenants in respect of which A & G should be in default. Under section 5 of the 1995 Act the Defendants were released from the tenant’s covenants set out in the Underlease. That, though, - see section 16 – did not preclude the Defendants from entering into an “Authorised Guarantee Agreement” with respect to the performance of the covenants in the tenancy – section 16(1). But section 16 prescribes limits to what may be an Authorised Guarantee Agreement. Thus in section 16(5) one finds that, although an Authorised Guarantee Agreement may impose on the erstwhile tenant liabilities as guarantor in respect of the assignee’s performance of a particular covenant in the lease, the burdens of his covenants are not to be “more onerous than those to which he would be subject in the event of his being liable as a sole or principal debtor in respect of any obligation owed by the assignee under that covenant”. Mr Steinfeld’s argument here relies upon the rent payable by A & G, as he argued, having been reduced by way of clause 2.1 of the Supplemental Deed and, he continues, on that footing, unless the obligation on the previous tenant is correspondingly reduced, the obligation on the previous tenant would be more onerous than that applicable to the assignee. If, however, I am right in construing the reserved rent as continuing unchanged (but being subject to a binding indication from the Prudential that it will, in certain circumstances, accept less) then, so long as the recoverability against “any previous tenant” is correspondingly reduced by way of clause 2.1, in a comparison between the liabilities of the current tenant and the liabilities of the previous tenant as guarantor, neither is more onerous than that of the other and, accordingly, I do not see the 1995 Act as assisting the Defendants.

I have not been told what attempts at recovery of Partnership assets has been made by the Prudential nor what those attempts have led to by way of recovery but if my construction of clause 2 of the Supplemental Deed is correct and if I am right about the ability of the Defendants to rely on the 1999 Act, then, in practical terms, the Defendants are proof against any recovery against them under the guarantees given in clause 6 of the Licence to Assign of the 8^th June 2001 going beyond A & G Partnership assets. Mr Trace argues that clause 2.1 represents no more than an indulgence granted by the Prudential to A & G and hence, within clause 6.4.1 of the Licence to Assign, that it does not restrict the Prudential’s ability to go against the Defendants. But, in my view, if it is right to describe clause 2.1 as an indulgence at all, it is not merely an indulgence granted by the Prudential to A & G but an indulgence granted by the Prudential to “any previous tenant” and, in that sense, is outside the protection of clause 6.4.1. and can be relied on by the Defendants against the Claimant.

I have not understood it to be argued that the Prudential can now recover from the Defendants at least to the extent of an equivalent of what the Prudential might claim to recover from A & G Partnership assets, leaving the Defendants then to be subrogated to the Prudential in the A & G insolvency. That would plainly present difficulties and, as I say, has not been argued and may be rather pointless. For the reasons I have given, I hold that clause 2.1 of the Supplemental Deed protects the Defendants as I have indicated and I shall thus invite Counsel to discuss the particular form of relief to which the construction I have adopted should properly lead.