Clarence House Ltd v National Westminster Bank Plc

The issue in this case is whether by entering into a “virtual assignment” of leasehold office premises in Manchester the defendant tenant acted in breach of the standard-form alienation covenants contained in the lease under which the premises are held. A “virtual assignment” is an arrangement under which all the economic benefits and burdens of the relevant lease (including any management responsibilities) are transferred to a third party, but without any actual assignment of the leasehold interest or any change in the actual occupancy of the premises in question. It is typically employed where the relevant lease contains covenants against assigning or parting with the possession of the demised property without the consent of the landlord, and there are concerns either that the landlord may be unwilling to consent to a legal assignment of the lease because of perceived concerns about the financial standing of the assignee, or that the landlord’s consent may not be available in advance of the scheduled date for completion of the transaction. The VAT status of a virtual assignment has previously fallen to be considered by the Court of Appeal (May and Jonathan Parker LJJ and Sir Peter Gibson) in the case of Abbey National Plc v Commissioners of Revenue & Customs [2006] EWCA Civ 886; [2006] 3 EGLR 153; [2006] STC 1961, on appeal from a decision of the late Hart J the neutral citation number whereof is [2005] EWHC 831 (Ch). (It is reported at [2006] STC 852.) However, the researches of counsel have not revealed any case in which the courts have had to consider the implications of a virtual assignment in the context of a claim for the alleged breach of a tenant’s alienation covenants in a lease.

There is no dispute as to the relevant facts. By a lease (“the Lease”) made on 3^rd June 1986 between (1) Sun Life Assurance Company of Canada, the Claimant’s predecessor in title, as landlord and (2) County Bank Limited, the Defendant’s predecessor in title, as tenant, office premises on part of the ground and first floors of Clarence House, 4 Clarence Street, Manchester (“the Property”) were let for a period of 25 years commencing on 25^th December 1985. The Lease is registered at the Land Registry under Title Number GM414088. By Clause 4 and paragraph 30 of the 4^th Schedule, the Lease contained various common form restrictions against alienation on the part of the tenant. Since nothing turns on the precise terms of these restrictions, it is unnecessary for me to set them out in full. For present purposes, it is sufficient to record that they included covenants: (1) not to execute any declaration of trust with regard to the Property or any part thereof or the Lease: (2) not to share or permit sharing of possession or occupation of the Property or any part thereof or part with possession or occupation of the same; (3) not to underlet the whole of the Property or permit the creation of any derivative underlease without the landlord’s prior written consent; and (4) not to assign the Property without the landlord's prior written consent. No longer having any need to occupy the Property for its own business purposes, and pursuant to a licence granted by the Claimant’s predecessor in title, on 30^th January 2001 the Defendant underlet the whole of the Property to William M. Mercer Ltd (“Mercer”) for a term of years expiring on 21^st December 2010 (thus retaining a nominal reversion of 3 days). It is common ground that at no material time has the Defendant been in actual occupation of any part of the Property.

On 9^th June 2005 the Claimant’s parent company, The Royal Bank of Scotland Group plc (“RBS”), entered into a Master Agreement with New Liberty Property Holdings Ltd (“New Liberty”), an offshore company registered in Gibraltar. Pursuant to that agreement, and on the following day (10^th June 2005), the Defendant entered into a document termed a “Virtual Assignment” with New Liberty. That same day, the Defendant also granted a Power of Attorney to New Liberty enabling it to act in the name and on behalf of the Defendant in relation to the Property in accordance with the terms of the virtual assignment. It is common ground both that no approach was made to the Claimant to inform it of these arrangements, or to seek its consent to the virtual assignment, prior to the execution of these documents; and that the Claimant has never given its consent to the same.

It is unnecessary for me to recite the lengthy, and complex, provisions of the Master Agreement, the Virtual Assignment, and the Power of Attorney. This is because, subject to two differences, the virtual assignment scheme and documentation used by RBS and New Liberty were in all material respects identical to those which had been utilised in the Abbey National case. (Indeed, the documentation in the present case was drafted by Linklaters, acting for RBS, who had also acted for the virtual assignee (Mapeley) in relation to the documentation in the Abbey National case.) Anyone who wishes to consider the documentation in detail should consult the reports of the Abbey National case, where it is recorded at length and is subjected to a sustained and detailed examination. The first of the two changes in the drafting is that the Master Agreement no longer contains a provision (corresponding to paragraph 4.1 of Schedule 2 to the Master Agreement in the Abbey National case, and recited at paragraph 17 of Hart J’s decision) declaring that, until completion of the assignment of each lease, the seller should, where legally possible, hold the benefit of any sub-lease in trust for the buyer in all respects. The second of the changes relates to the terms of clause 2 of the Virtual Assignment from the Defendant to New Liberty. Headed (in bold) “Economic Benefit”, this merits reproduction in full: “The Intention of the Virtual Assignment is to pass to the Buyer all of the economic benefits and burdens of the Leases and Underleases in respect of the Properties, together with the obligation to manage all dealings with the Landlords and Undertenants as if the Properties had been assigned to the Buyer. Therefore any monies from any Undertenants pursuant to any Underleases, together with all proceeds for the surrender of any Underleases, shall belong to the Buyer.” In the Virtual Assignment in the Abbey National case, the first sentence of the equivalent provision (Clause 4, recited at paragraph 14 of the Court of Appeal’s decision, reproducing paragraph 18 of the decision of the VAT & Duties Tribunal) concluded with the additional words: “… but without this Virtual Assignment creating, vesting or granting any legal or equitable estate in the Premises to the Purchaser.” On behalf of the Defendant, it is said that the wording omitted from the instant Virtual Assignment is otiose.

It is unnecessary, for the purposes of this judgment, to relate the history of the events leading up to the issue, on 10^th April 2008, of the claim form herein by which the Claimant seeks a declaration that, by entering into the Virtual Assignment, the Defendant acted in breach of the Lease, and an inquiry into damages. It is also unnecessary for me to relate the procedural history of the present application. It is sufficient for me to record that, by an order made by Master Price on 19^th November 2008, it was, by consent, ordered that there should be the trial of the preliminary issue of liability only, with such further directions as to the quantification of any amount that may be due to the Claimant by way of damages to be given after that hearing as the judge should direct. In the event, the trial of that preliminary issue came on for hearing before me on Wednesday 21^st January 2009. After a full day’s argument from Mr Jonathan Gavaghan (of counsel) for the Claimant and Mr Simon Brilliant (of counsel) for the Defendant, at about 4.30pm I indicated that I would hand down judgment at 10.30am today, Friday 23^rd January 2009. The evidence before me comprised witness statements from the Claimant’s solicitor, Mr Brian Anthony Drewitt, dated 26^th September 2008, and from Mr Stephen Koehne, a solicitor and partner in the firm of Stephenson Harwood, the solicitors acting for New Liberty and (in this litigation) for the Defendant, dated 3^rd and 17^th October 2008. Since their evidence was non-contentious, I heard no live evidence. I had pre-read the trial bundle and the written skeleton arguments.

For the Claimant, it is submitted that the Defendant breached the alienation restrictions in the Lease by entering into the Virtual Assignment. It is said that it did so in one or more of the following respects: (1) by making a declaration of trust with regard to the Property or the Lease; (2) by sharing or parting with possession or (subject to any necessary amendment of the Particulars of Claim) occupation of the Property; (3) by assigning the Property without consent; and/or (4) by underletting the Property without consent. Indeed, Mr Gavaghan went so far as to submit that if the virtual assignment effected in the instant case achieved its objective, without involving any breach of the alienation restrictions in the Lease, it would tend to emasculate those restrictions.

The Defendant disputes that it has breached any of the alienation restrictions in the Lease. On its behalf, Mr Brilliant points out that a virtual assignment is only needed as a tool when the property which is being transferred is a lease which is subject to a covenant against alienation. The underlying concept of a virtual assignment is that the economic benefits and burdens of an interest in real property, including any management responsibilities under any lease, can be transferred separately from the underlying real property interests. It is said that the arrangement does not alter the relationship between the head-landlord and its tenant, each of which has the same rights and liabilities as before. It is just that, for practical purposes, the virtual assignee stands in the shoes of the tenant and acts as its agent. So far as any subtenant is concerned, as part of the arrangements, and to facilitate the working of the virtual assignment, a power of attorney is granted to the virtual assignee to enable it to do things in the name of the tenant. But this does not alter the underlying relationship between the tenant and its head landlord. He submits that, although the Virtual Assignment does bestow a considerable bundle of rights on New Liberty, that company is not given any right to occupy, let alone to possess, the Property. The law, he says, should be supportive of developments, such as the concept of the virtual assignment, which are designed to support commerce and the economy. He also emphasises that, under the terms of the Master Agreement, if there is a threatened forfeiture of any lease, the relevant property can be withdrawn from the arrangements without the whole transaction between the Defendant and New Liberty unravelling, so that the arrangement is not irrevocable.

Before I proceed to consider the merits of the parties’ respective submissions, it is necessary for me to say little about the Abbey National case. That case addressed two decisions of the VAT & Duties Tribunal. The first related to the situation where (unlike the present case) Abbey had remained in occupation of leasehold properties after the virtual assignment, paying a fee for that occupation to Mapeley, as its virtual assignee. The Tribunal had decided that the assignee made a standard-rated supply of agency and property letting services to Abbey regarding that part of the fee that exceeded the rents paid to the head landlords, and that this was not an exempt supply for VAT purposes because it did not constitute “the leasing or letting of immovable property” within the meaning of the relevant Council directive. Abbey's appeal against that decision was allowed by Hart J; but, on this point, his decision was reversed by the Court of Appeal. The second decision related to the situation where (as in the present case) leasehold properties were subject to underleases granted by Abbey, and where the effect of the virtual assignment between Abbey and the virtual assignee had been to transfer the economic benefit of those underleases to the latter. The issue was whether the rents due to Abbey under the underleases, when paid by the undertenant to the virtual assignee, as provided for by the virtual assignment, were exempt from VAT. Hart J upheld the Tribunal’s decision that they were exempt supplies on the further ground that, because of the express declaration of trust in respect of each underlease in favour of the virtual assignee, for the purposes of paragraph 8 (1) of Schedule 10 to the Value Added Tax Act 1994 the rents “accrued” to the virtual assignee, which was therefore to be treated as the person making the relevant grant. There was no appeal from this part of Hart J’s decision.

Delivering the Court of Appeal's decision, Jonathan Parker LJ started by considering the nature and effect under English law of the contractual arrangements contained in the master agreement and the virtual assignment in that case. At paragraph 50, he acknowledged that it was common ground that those contractual arrangements did not involve the transfer of any proprietary interest in the properties in question from Abbey to the virtual assignee, whether at law or in equity. He also recorded that it was “rightly accepted” by counsel for Abbey that they did not, and were not intended to, transfer to the virtual assignee “any contractual right to occupy the properties (for obvious reasons, given the existence of covenants against parting with possession without the consent of the landlord). In consequence, Abbey’s status as tenant remained the same after as before the execution of the virtual assignment: it continued to occupy the properties the subject of the virtual assignment in right of its status as tenant under the leases. It follows as night follows day that since Mapeley had itself no proprietary or contractual right to occupy the properties in question, it was not in a position to “lease back” (in the sense of retransfer) such a right to Abbey. As the tribunal rightly concluded… the contractual arrangements between Abbey and Mapeley were effective merely to regulate, as between the two of them, Abbey's exercise of its continuing right (qua tenant) to occupy the properties.” He then went on to consider the position under Community law, acknowledging (at paragraph 53) that the expression “leasing or letting”, when used in the directive, had a wider meaning than it did under English law.

For the Defendant, Mr Brilliant submits, in reliance upon these observations, that, although the Court of Appeal did not have to decide whether or not, when Mapeley received rent from an undertenant, the supply constituted the leasing or letting of immovable property within the meaning of Community law, the Court’s reasoning suggests that no legal or equitable assignment had taken place in English law.

For the claimant, Mr Gavaghan submits that the ruling does not affect the current case and does not assist the Defendant. He emphasises that this was a dispute between the tenant (as taxpayer) and the revenue. They were the only parties present and represented before the court. The head landlords were not represented and took no part in the proceedings. There was no one there to argue, or with any interest in arguing, that the Virtual Assignment had been a breach of any relevant lease. He also points to the inclusion, within the economic benefit clause of the virtual assignment in the Abbey National case, of the express disclaimer of the creation, vesting or grant of any legal or equitable estate in the premises in favour of the virtual assignee, a feature absent from the documentation in the present case. He submits that this disclaimer, and the fact that the case concerned VAT, shaped the presentation of the case in the Court of Appeal in that: (1) It was common ground that the virtual assignment did not involve the transfer of any proprietary interest. (2) It was not argued that the virtual assignment did not, and was not intended to, transfer any contractual right to occupy the properties. (3) For Abbey to have suggested that the virtual assignment had transferred any legal or equitable interest in the premises to Mapeley would have been directly contrary to the wording of the virtual assignment in that case. (4) Given the existence of the qualified covenants against parting with possession, it would have been contrary to Abbey's own interests to have contended for a result that might have justified the forfeiture of its leases. Mr Gavaghan also emphasised that the factual background to the virtual assignment being considered by the Court of Appeal was different to that in the present case in that Abbey remained the occupational tenant after the virtual assignment. Any attempt by the Defendant to take the decision in the Abbey National case out of context should be rejected.

I accept Mr Gavaghan’s submissions. Whilst the decision is a useful aid to understanding the concept of, and the commercial motivation for entering into, a virtual assignment, for the reasons that he gives I derive no assistance from the decisions of Hart J and the Court of Appeal in the Abbey National case in resolving the issues that I have to decide in the present litigation. The status of the virtual assignment, under English law, and as between the virtual assignor and its landlords, was not in issue in that litigation. I therefore turn to consider each of the ways in which the Claimant puts its case.

I can dispose of the assertion that there was a breach of the qualified covenant against underletting quite shortly. This was advanced by Mr Gavaghan very much by way of a makeweight; and for good reason. Neither in form nor in substance did the virtual assignment amount to an underletting. Perhaps the most formidable objection to treating it as such is the fact that it neither reserves, nor purports to reserve, any reversion to the Defendant. For this reason alone, I find it impossible to find any breach of the qualified covenant against underletting.

I also reject the submission that the virtual assignment was a breach of the qualified covenant against assignment. Although it was against him, very properly Mr Gavaghan drew my attention to the authority of the Court of Appeal’s decision in the case of Gentle v Faulkner [1900] 2 QB 267, and in particular to passages in the judgments of AL Smith and Romer LJJ at 273-4 and 276-7 respectively, as authority for the proposition that, in the absence of any context showing that the covenant is to have an extended meaning, a covenant in a lease against assigning the demised premises covers only a legal assignment. The actual decision in that case was that a declaration of trust did not amount to a breach of a covenant against assignment, thus necessitating the inclusion within any well-drafted lease (such as that in the instant case) of a covenant against executing any declaration of trust with regard to the demised premises or any part thereof. Here it is common ground that there has been no legal assignment of the Lease; and, in any event, the decision of the Court of Appeal in Brown & Root Technology Ltd v Sun Alliance & London Assurance Co Ltd (1996) 75 P & C R 223 establishes that the legal assignment of a registered leasehold title is only completed by registration.

Mr Gavaghan seeks to distinguish Gentle v Faulkner on the footing that the lease in that case contained no provision preventing any declaration of trust in respect of that lease. He submits that the inclusion of such a prohibition in the instant Lease gives the covenant against assignment a different context. Given that the parties prohibited any declaration of trust as well as an assignment, he submits that the word “assignment” in this Lease should be given a wider meaning than it was in the lease that was before the court in Gentle v Faulkner. In this Lease, the parties had intended to prevent a situation where the beneficial ownership and control of the Lease might be transferred even though the legal title might remain in the tenant: therefore, he submits, there is every reason to assume that the parties intended that the word “assignment”, when used in the current Lease, should not only cover a strict legal assignment, where both the legal and beneficial ownership had passed, but also an equitable assignment, where bare legal ownership remained but beneficial enjoyment had been assigned. The purpose of the prohibition was to ensure that the Lease remained, and to enable the landlord to deal, with the person who had a beneficial, and economic, interest in the Property. This should colour the court’s approach to the construction of the alienation restrictions in the Lease.

I reject this submission for two reasons: First, Mr Gavaghan's reasoning leads me to precisely the opposite conclusion. The fact that the alienation provisions in the Lease restrict several, specified forms of alienation leads me to the conclusion that the parties intended that only those forms of alienation should fall foul of the alienation restrictions: the express inclusion of several excludes the implication of other forms of alienation. Second, I endorse the characteristically common sense observations of Neuberger LJ (with whose judgment Mummery LJ agreed) in the case of Akici v L R Butlin Ltd [2005] EWCA Civ 1296; [2006] 1 WLR 201 at paragraph 24 that: “While interpretation of a word or phrase in a document must ultimately depend upon the documentary and factual circumstances in which it was agreed, it is desirable that the courts are as consistent as they properly can be when construing standard phrases in standard contexts.” Whilst those observations were expressly directed to a covenant against parting with possession, I have no doubt that they apply with equal force to a covenant against assignment.

I have had rather more difficulty with Mr Gavaghan's submission that the Virtual Assignment constituted a breach of the covenant not to execute any declaration of trust with regard to the Property or any part thereof or the Lease. He argues that the expressed intention of the Virtual Assignment was to transfer all of the economic benefits and burdens of the Lease and the Property (including Mercer’s underlease) from the Defendant to New Liberty. The Defendant merely remains the nominal owner of the leasehold interest following the Virtual Assignment. That, Mr Gavaghan submits, is the very nature of a trust, namely that one person in whom property is vested (the Defendant in this case being the trustee) is compelled to hold that property for the benefit of another person (New Liberty in this case being the beneficiary). In this connection, he refers me to paragraph 19-01 of Snell’s Principles of Equity, 31^st ed. (2005). While the Virtual assignment is not labelled a declaration of trust, he contends that its effect is to create and declare a trust because it is clear that, under its terms, the Defendant holds the lease totally for the benefit of New Liberty and not of itself. That, he submits, is a breach of the provision against any declaration of trust. To the Defendant’s objection that the Virtual Assignment is not in the form of the typical declaration of trust to be found in the standard precedents books, Mr Gavaghan points out that it is trite law that the label that the parties to it put upon a document or transaction is not determinative of its proper legal characterisation. In this connection, he refers me to the well-known observations of Lord Templeman in Street v Mountford [1985] AC 809 at 819E-G concerning forks and spades. To my suggested objection that paragraph 19-02 of Snell makes the point that, by virtue of his legal ownership, the trustee enjoys the full powers and duties of management which are incidental to the legal ownership of the trust property in question, and that these are denied to the Defendant by the terms of the Virtual Assignment, Mr Gavaghan replies that the trust in question here is a bare (or simple) trust of the kind referred to in paragraph 19-11 of Snell, in which the nature of the trust imposes no active duties or powers of management on the trustee.

Whilst recognising the force of Mr Gavaghan’s submissions, I should reject them. It does not seem to me that, by executing the Virtual Assignment, the Defendant has constituted itself a trustee of the Property for New Liberty. Whilst recognising that the same transaction may involve both legal relationships, contracts and trusts are in essence two distinct legal concepts. The relationship between the Defendant and New Liberty seems to me to be founded in contract rather than in equity. Any claim for breach would seem to me to give rise to a claim for damages at common-law rather than a claim for equitable compensation. As the editors of Snell observe (at paragraph 19-11),under a bare trust the trustee’s sole duties to the beneficiary are not only to allow him to enjoy the trust property, but also to obey any direction the beneficiary may give as to how the trust property should be disposed of by putting an end to the trust (in accordance with the rule in Saunders v Vautier (1841) Cr & Ph 240, affirming 4 Beav 115). This is not something which is available to New Liberty under the terms of the Virtual Assignment. With some hesitation, I therefore hold that there was no breach of the prohibition in the Lease against declaring any trust of the Property or the Lease.

I therefore turn finally to the submission that the Defendant is in breach of the restriction against sharing or permitting sharing of possession or occupation of the Property or any part thereof, or parting with possession or occupation of the same. So far as occupation is concerned, this is not presently pleaded as a breach, and rightly so: before the Virtual Assignment, Mercer was in occupation of the Property, and, so far as the evidence goes, it remains so to this day. What may happen in the three day interval between the expiry of its underlease and the expiry of the Lease by effluxion of time is a matter (1) for the future and (2) of speculation. Thus the question is whether, by entering into the Virtual Assignment, the Defendant has shared or permitted sharing of possession of the Property or has parted with possession of the same.

Mr Gavaghan submits that, in law, the possession of premises denotes an appropriate degree of physical control of those premises; and that the Virtual Assignment passed control of the Property, and Mercer’s underlease, from the Defendant to New Liberty. Alternatively, if the Defendant retained some form of control over the Property and Mercer’s underlease, it now shares such control (and thus possession) with New Liberty. For the Defendant, Mr Brilliant submits that New Liberty has no contractual or proprietary right to occupy the property, and it is therefore difficult to see how it can be said to be in possession. Moreover, in so far as it affects the Claimant, it is said that any activity carried out by New Liberty in relation to the Property and the Lease is in its capacity as agent for the Defendant and not as an activity of New Liberty in its own right.

I prefer Mr Gavaghan’s submissions. In my judgment, by executing the Virtual Assignment, the Defendant has either parted with possession of the Property to New Liberty or, at least, is sharing, or permitting the sharing of, possession of the Property with New Liberty. As I pointed out during the course of Mr Gavaghan’s oral submissions, the general definitions section of the Law of Property Act 1925 defines “possession” as including “receipt of rents and profits or the right to receive the same, if any”: see section 205 (1) (xix). Whilst that definition is provided for the purposes of a particular statute, and may be excluded where the context otherwise requires, in my judgment it encapsulates a concept well known to, and understood by, real property lawyers engaged in the drafting of leasehold documentation. Moreover, the alienation restrictions in the present Lease expressly differentiate between the concepts of “possession” and “occupation” which, contrary to Mr Brilliant’s submissions, should therefore not be conflated. The expressed intention and effect of Clause 2 of the Virtual Assignment is to “pass” to New Liberty “all of the economic benefits and burdens of” the Lease and Mercer’s underlease “together with the obligation to manage all dealings with” the Claimant and Mercer “as if the [Property] had been assigned to” New Liberty. “Therefore any monies from [Mercer] pursuant to [its underlease], together with all proceeds for the surrender of [its underlease] shall belong to [New Liberty].” On the footing that the entire Property is underlet to a third party, the effect of this arrangement is that New Liberty is to deal with the Property as the Defendant, as its head leasehold owner, would otherwise have been expected to deal with it, and the Defendant no longer has the right to do so. In my judgment, that amounts to a parting with or sharing of possession. As Mr Gavaghan pointed out, the fact that the rental income from Mercer now belongs beneficially to New Liberty is rightly a source of potential concern to the Claimant as it may impact upon the Defendant’s ability to pay the rent and to discharge its other obligations as tenant under the Lease.

Had I acceded to Mr Brilliant’s submissions, I have no doubt that the draftsmen of leases would have returned to their word processors and added a further restriction to the alienation provisions in their standard forms of lease prohibiting the “passing of the economic benefits and burdens of this Lease and any underlease of the demised premises by way of a virtual assignment or any similar concept or arrangement” just as, in an earlier age, and using less sophisticated materials, their predecessors did in the early days of the last century after the decision in Gentle v Faulkner. Subject to the outcome of any appeal, this decision saves them the trouble, and their clients the expense, of doing so.

I therefore determine that, by entering into the virtual assignment, the Defendant acted in breach of the alienation covenants contained in Clause 4 and paragraph 30 of the 4^th Schedule of and to the Lease. I shall direct an inquiry into damages; and I shall invite submissions from counsel as to the appropriate directions to be given in relation to the conduct of that inquiry, and also as to the costs of this litigation down to the date of my Order. In conclusion, I pay tribute to both counsel for the quality, clarity and length of their written and oral submissions.