"Virtual assignments": strange new beasts in the forest

A recent case (Clarence House Ltd v National Westminster Bank Plc 8 December 2009) looked at virtual assignments and provides useful guidance to the industry on the extent to which they amount to a breach of normal rack rent lease alienation provisions.

First of all, what is a virtual assignment? This is an arrangement under which all the economic benefits and burdens of a lease are transferred to a third party without any actual assignment or change in the physical occupancy of the premises. Virtual assignments are often used as a mechanism where it is believed a landlord’s consent to an assignment of a lease may not be obtained or will not be available in the timeframe required and have been used to facilitate large portfolio transactions.

In the recent Court of Appeal case, the premises in question were underlet to and occupied by a subtenant, with the landlord’s consent. The lease contained standard covenants against alienation. The tenant entered into a virtual assignment of the lease, whereby it transferred to a third party all the economic benefits and burdens of the lease and underlease, including management responsibilities, but without assigning the leasehold interest or changing the actual occupancy of the premises. The assignee was to pay the rent and perform all tenant covenants contained in the lease and the landlord’s covenants in the underlease. The tenant also appointed the assignee as its agent to collect the rent from the undertenant. The tenant also granted a power of attorney to the assignee enabling it to act in the name of and on behalf of the tenant in respect of the premises. The landlord was not informed of those arrangements and its consent was not obtained.

The landlord sought a declaration that by entering into the virtual assignment the tenant had breached the alienation provisions in the lease.

The Court of Appeal considered the various alienation restrictions. Firstly the Court found that the tenant had not shared or parted with possession of the premises. The characteristic of the right to possession was the right to exclude all others from the property in question. At the time of the virtual assignment the tenant was not (and had not been) in possession of the premises; the occupier and party in possession was the undertenant. The virtual assignment did not alter that situation and therefore the tenant could not be said to have parted with possession to the assignee or to have shared possession by entering into the virtual assignment.

Even if parting with possession was interpreted more widely to include the right to receive rents as in some real estate contexts it can (which the Court considered was the wrong approach here) there was still no breach. By collecting rent as agent for the tenant (in the tenant’s name), the assignee did not receive that rent for itself in the sense of putting it into possession of the premises. There was a purely contractual arrangement between the tenant and the assignee, which did not result in a transfer to the virtual assignee of the right to receive rents and profits.

The Court furthermore held that a virtual assignment was not a declaration of trust. The relationship between the tenant and the virtual assignee was a contractual one only. They considered that “virtual assignments are strange new beasts in the forest; that one must circle around them suspiciously and cautiously; but the moment one gets close and has a good sniff, the overwhelming smell is of contract, not of trust”.

Finally the Court determined that a virtual assignment was not an assignment or underletting. Therefore all in all the Court did not believe there had been a breach of the lease covenants.

It is not yet clear whether the decision will be appealed. However, the case is likely to boost the confidence of tenants, now that the legality of virtual assignments has been confirmed. It may also ease landlords’ concerns about the effect of virtual assignments, as the Court of Appeal ruled that a virtual assignment did not alter the underlying relationship between the landlord and tenant.