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Virtual Lease Assignments - Tenants Beware

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In the recent case of Clarence House Limited v. National Westminster Bank PLC, the court reviewed the status of "virtual lease assignments" and considered whether they could constitute a breach of the terms of a lease prohibiting assignments without landlord's consent.

The majority of commercial leases will generally permit assignments of the leasehold interest by the tenant, involving sharing or parting with possession of the property, subject to obtaining landlord's consent. Where time is critical, or the parties do not believe consent will be forthcoming, a virtual assignment of the lease can take place whereby the economic benefit and burden of the lease transfer to the buyer without the leasehold interest actually transferring.

Applying this principle to the facts of the case, the landlord Clarence House had granted a 25 year lease to Natwest Bank, containing a standard assignment clause requiring landlord's consent. In turn Natwest Bank granted an underlease to William M. Mercer Limited ("Mercer") as the bank no longer needed to occupy the property. Natwest therefore became the intermediate landlord to Mercer, collecting rent from them, and paying the rent due under their own lease to Clarence House. In 2005, as part of a wider commercial transaction, Natwest entered into a virtual assignment with a buyer for the purpose of passing the benefits, burdens and management obligations of the underlease to the buyer as they were no longer of any relevance to Natwest.

Clarence House was not informed of the new arrangement, nor were they approached for consent to properly assign the lease to the buyer. Once they became aware of it they issued proceedings for damages against their tenant Natwest Bank claiming that the virtual assignment breached various terms of Natwest's lease.

The main lease terms in question were:

Interestingly, the landlord did not succeed with its claim in relation to point (a). The court ruled, on a strict interpretation of the term "assignment", that what had taken place was not technically a legal assignment, but only a virtual one, therefore no breach had occurred.

However, the landlord did succeed in its claim that Natwest had parted with possession of the property under point (b). Of course it was the undertenant, Mercer, that was actually occupying the property and this remained constant. What did change however was the level of control over the property that Natwest could exercise after the virtual assignment, which, the court ruled, was clearly less than that which they could exercise before the assignment. Thus, by parting with this control over the property they were deemed to have parted with possession of it, and a breach of the lease had thereby occurred.

This is clearly good news for landlords concerned about their tenants disposing of management control over their own undertenants without their knowledge or consent. It remains to be seen whether this case encourages a raft of applications for retrospective landlord's consent from tenants who have carried out virtual assignments in the past and now wish to avoid a similar fate.

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