COVENANT STRENGTH

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					                         COVENANT STRENGTH
                                    Paul Roberts
                                        Forsters


1.   Introduction

     Covenant strength means the financial worth of a tenant or potential tenant. The
     assessment of financial worth is intended to determine the current and potential ability
     of an individual or company to observe and perform the covenants of a tenant. Put
     another way, when considering covenant strength what you are doing is assessing the
     potential risk of a tenant defaulting on its obligations within the lease – principally the
     obligation to pay rent.

     This paper considers why and when the determination of covenant strength is relevant
     and the ways in which the covenant strength of a prospective tenant or assignee can be
     assessed. It also will look at recent developments including the way in which practice
     is developing under the regime of the Landlord & Tenant (Covenants) Act 1995.

2.   The Importance of Covenant Strength

     The importance of a tenant's covenant strength should be self evident. It is important
     to different people, at different times, and for different reasons. We need to determine
     covenant strength for:

     §   landlords in terms of the rental income they will receive and can expect to receive
         in the future. The assessment of covenant strength is essential in establishing the
         value of their investment.

     §   lenders whose loans are secured on property in terms of the security that is
         offered by the income flow from the property

     §   assignees who may be liable either under the rules of privity of contract or under
         an authorised guarantee agreement.

3.   How Does Covenant Strength Affect Value?

     Covenant strength is fundamental to the value of an investment in property. The
     valuer will take account of a number of different factors, one of which will be the
     quality of the tenant's covenant. The tenant's covenant strength is relevant to the
     probability of the landlord receiving the reserved rent during the term of the lease.
     This factor, along with many others; such as the location of the property, its age and
     condition, the length of the lease and the market generally will determine the value of
     the landlord's interest.

     The impact of the tenant's covenant can be illustrated by comparing the approach that
     a valuer may take when valuing two identical units. Unit 1 let to a local sole trader
     with no "track record" at a rent of £100,000 p.a. and Unit 2 let to a successful
     national operator who has been able to negotiate a lower rent of £95,000 p.a. Both


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     leases are for a term of ten years and apart from rent their terms are identical. Which
     unit is more valuable?

     The valuer is likely to decide that the investment offered by the national operator is
     more attractive; its business is well established; it has a record of consistent profit and
     its business has substantial assets. Compare this with the local sole trader who has
     only just started business and has no record to offer. Which business is more likely to
     succeed? Which tenant has the greater covenant strength? Which property is the more
     valuable investment?

     Having deciding this what would a purchaser pay for each investment. The valuer
     might decide that a purchaser would be concerned that there is a risk that the tenant of
     Unit 1 may default. The unit could then be relet but there is a danger of a rental void.
     Reflecting this he may decide that a purchaser would offer a sum on the basis of say 11
     "years purchase" or a yield of 9%. A purchaser of Unit 2 can be more certain of its
     rental income; even if the tenant assigns a new lease an AGA can be required. In view
     of this, the purchaser of Unit 2 is likely to have to pay more to secure this unit, say 12
     "years purchase" or a yield of 8%. On this basis even though Unit 1 commands a
     higher rent by £5,000 p.a. the value of Unit 2 will be more than £75,000 higher.

     This demonstrates the significance for the landlord in securing a strong tenant's
     covenant even, in this case, at the cost of a slightly lower rent.

4.   Other Examples of the Impact of Covenant Strength

     Similar considerations will apply when valuing a property as security for a loan. When
     acting for a bank taking security over property that is let, you will consider not only
     the terms of the lease but also the identity of the tenant. Will the tenant be likely to
     pay the rent and any projected increases in rent for the term of the loan? If not, the
     potential for reletting the property will be more important and the valuation may well
     be reduced.

     Assignors often omit to apply the same considerations when assigning their lease. If
     the assignee defaults liability will usually revert either to the assignor under a new
     lease or, in the case of an old lease, to one or more previous tenants. Usually the
     tenant most likely to be paid will be pursued. The last thing most assignors want to
     face is a claim from a previous landlord and the problem of taking a lease back of the
     property.

     The moral is that covenant strength is always important and is often vital.

5.   When is Covenant Strength Considered

     There are a number of occasions when covenant strength will be considered. The
     obvious ones include:

     §   an application for licence to assign or licence to underlet

     §   the grant of a new lease

     §   taking security over let property

     §   one tenant assigning a lease to another


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     Similar issues apply in each case and the relevant enquiries and assessment of
     information need to carried out. In the first example, the determination is subject to
     statutory or contractual control whereas in other cases, for example when a new lease
     is being granted or a loan is being considered, no such controls apply. This paper
     concentrates on determining covenant strength in the case of an application for licence
     to assign. The landlord will need to consider the lease and any other relevant
     documents (for e.g. licences or deeds) and must take into account various statutory
     provisions when reaching its decision. The determination of whether or not to grant
     consent gives a landlord an opportunity to preserve the value of its investment
     provided the right steps are taken.

6.   Covenant Strength is Still Important - Privity or Not

     Before 1996 the rule of privity of contract meant that the original tenant would be
     liable for the whole of the lease term. Whilst the strength of the original tenant
     covenant was essential, the covenant of the actual tenant in occupation was still a
     major factor in determining the value of the landlord's interest. Even under pre -1996
     leases it is not always possible to recover against an original tenant for a variety of
     reasons, perhaps due to the insolvency of the original tenant. As a result the courts
     have taken the view that even though an original tenant will remain liable the landlord
     may reasonably refuse consent if the market would take the view that the assignment
     would lower the value of the landlord's reversion and the landlord wishes to sell the
     reversion

     Ponderosa International Development v. Pengap Securities (Bristol) [1986] 1
     EGLR 66

     Covenant strength on assignment is therefore important even though original tenant
     liability remains by virtue of privity under an old lease.

     Leases post-1996 fall under a different regime (see below) and when the lease is
     assigned the tenant's covenant will be released. As a result, it has become even more
     vital for the landlord that he should be able to check and control the covenant strength
     of an incoming tenant.

7.   Statutory Rules

     It is not proposed to provide an exhaustive summary of the various rules and
     requirements concerning lease covenants against alienation but a brief review of the
     key provisions is helpful to ensure that these are keep in mind.

     If there is no express restriction in the lease a tenant may deal with the premises
     demised to him either by assigning the lease or sub-letting the premises without
     reference to his landlord. Almost every lease, however, will contain a restriction
     against dealing, which usually takes the form of a tenant's covenants imposing
     prohibitions against dealing with the premises. This consent can be either absolute or
     qualified.

     Statute plays an important role in defining the rules applicable to covenants against the
     assignment or underletting of the premises. These rules tend to limit the scope of the
     landlord to refuse consent to an assignment on the grounds of covenant strength. Key
     statutory provisions to bear in mind are:


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Landlord and Tenant Act 1927 Section 19(1)

This provides that:

"a covenant condition or agreement against assigning, underletting, charging or parting with the possession of
demised premises or any part thereof without licence or consent [of the landlord] …….. shall notwithstanding
any express condition to the contrary be deemed to be subject to a proviso that such licence or consent is not to be
unreasonably withheld".

Section 19(1)(a)

The relevance of this provision will be seen later. As a result of this proviso, implying
an obligation to act reasonably (which is often found set out in the lease itself) the
landlord's discretion when determining covenant strength will be constrained by the
requirement that it must act reasonably.

Landlord and Tenant Act 1988

This Act provides a statutory duty upon a landlord to give consent within a reasonable
time after service of the tenant's application for consent unless it is reasonable for the
landlord to withhold it. This is important in terms of the mechanics of responding to
an application for consent, considering the application and providing an answer.

Key points to note here are that:

(a)         a breach of duty arises as soon as there has been unreasonable delay. The
            landlord cannot avoid liability by saying he has not had sufficient information
            if no information has been requested;

(b)         if the landlord has refused consent he can only justify that refusal upon
            matters at which he was then aware;

            Footwear Corporation Limited v Amplight Properties Limited 1999 1
            WLR 555.

(c)         the landlord's duty is to give to the tenant a written notice of his decision
            within a reasonable time specifying any conditions which should be attached
            to a consent or the reasons withholding consent.

            Section 1 (3) Landlord and Tenant Act 1988

(d)         reasons for refusing consent given orally rather than in writing will not satisfy
            the landlord's obligation.

            Footwear Corporation Limited v Amplight Properties Limited 1999 1
            WLR 555.

(e)         The Landlord can require an undertaking to pay his costs before proceeding
            but those costs must be reasonable.

            Dong Bang Minerva (UK) Limited v Divina Limited 1996 73 P&CR 253.




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     (f)        The landlord bears the onus of proof and must show that the time within
                which consent was given or response provided was reasonable; that any
                condition attached to consent was reasonable and if consent was refused it
                was reasonable not to give consent. If the landlord fails to discharge its
                obligation a claim may be brought for breach of statutory duty and the
                landlord may be liable in damages.

                Section 1(b) Landlord and Tenant Act 1988

8.   New Leases - Landlord and Tenant (Covenants) Act 1995 ("the 1995 Act")

     The 1995 Act applies to all leases granted after 1 January 1996 except those granted
     pursuant to a pre 1 January 1996 agreement for lease. Upon the assignment of a lease
     to which the 1995 Act applies a tenant will be released from its "tenant covenants".
     The release applies to assignment in accordance with the terms of the lease so that
     assignment in breach of covenant will not bring liability to an end. The 1995 Act has
     led to key changes to the procedure upon assignments:

     §     The outgoing tenant may be required to enter into an authorised guarantee
           agreement – these agreements are now the norm on assignment.

                Section 16 (2) Landlord and Tenant (Covenants) Act 1995

     §     Conditions to assignment may be imposed by a landlord under a qualified
           covenant.

                Section 22 Landlord and Tenant (Covenants) Act 1995

     §     In a new lease there is now likely to be a proviso to the effect that:

                "For the purposes of Section 19(1A) of the Landlord and Tenant Act 1927 the Landlord shall
                be entitled to withhold consent to a proposed assignment if any of the Circumstances apply and the
                Landlord shall be entitled to grant its consent subject to all or any of the Conditions for assignment."

     The proviso allows the landlord to dictate more clearly who will be an acceptable
     assignee and to set out pre-conditions to the completion of an assignment. In this way
     the landlord can spell out how covenant strength is to be assessed and, indeed, in
     some cases may attempt to define specific tests that must be satisfied.

     Although the 1995 Act allows such circumstances to be spelt out if there is any
     judgement to be reached, for example an assessment as to the strength of the tenant's
     covenant, the assessment must be a reasonable one or there must be a mechanism for
     a third party to determine. (Section 19(1C) Landlord and Tenant Act 1927 (inserted
     by Landlord and Tenant (Covenants) Act 1995 Section 22). It is usual to adopt the
     former approach as it is better for a landlord to be required to exercise a judgement in
     their "reasonable" opinion than to have someone else decide what is reasonable. This
     decision is also influenced by the question of speed since neither the landlord or the
     tenant wants a third party involved if it can be avoided.

     As a result of the 1995 Act the lease may state clearly what covenant strength means.
     Originally landlords thought their interests would be served by setting out specific
     financial tests measuring covenant strength. As a result in leases granted in or around
     1996, tests based on the assignee's profits, gearing or net assets were regularly seen.


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     These tests are now rare. They have proved to be inflexible and do not necessarily
     ensure that an accurate assessment of true covenant strength could be made.

     It is now more common to find the following provisions relevant to covenant strength
     entitling a landlord to refuse consent:

     §   The assignment to the assignee would in the reasonable opinion of the landlord
         detrimentally affect the value of the landlord's interest. This goes to the very heart
         of the question of covenant strength.

     §   The assignee will not in the reasonable opinion of the landlord be of sufficient
         financial standing comply with the rent and other obligations of the tenant under
         the lease. Again this requires an assessment of covenant strength.

     §   Where the proposed assignee is not resident in the United Kingdom. The concern
         here is that it may be difficult to enforce judgements in a foreign jurisdiction.

     §   Where the proposed assignee is a group company of the tenant. This can be
         contentious for tenants since it would impact upon the ability to reorganise the
         ownership of leasehold properties on a company reconstruction regardless of the
         strength of the covenant of the proposed new tenant. From a landlord's point of
         view, however, there will be a concern that the original tenant's liability can be
         removed by switching the property between group companies where the quality of
         the covenant may be diminished.

     New leases will also contain conditions precedent that must be met prior to
     assignment. These conditions include:

     •   that the proposed assignee gives direct covenants with the landlord (in order to
         enforce covenants against the new tenant) and that the outgoing tenant enters into
         an Authorised Guarantee Agreement ("AGA").

     •   In the case of a corporate body if the landlord requires a guarantor or some other
         form of collateral security may be required.

     •   The provision of a rent deposit may be required if reasonable.

9.   How Do You Ascertain Covenant Strength?

     Determining covenant strength requires an appraisal of the financial standing of the
     potential tenant. This paper concentrates on the steps to be taken where the potential
     tenant is a UK limited company and the observations regarding the process of
     determining covenant strength focuses almost exclusively on this type of potential
     tenant. The tenant might, however, be an individual, or a partnership or a UK body or
     organisation or might be a foreign company. Different issues will arise and different
     enquiries will be needed. There are dealt with briefly in this paper.

     Before considering how to ascertain the covenant strength of a potential tenant we
     should address who should carry out the determination. The audience today
     comprises lawyers and property managers, some of whom will have financial training
     but some who will not. Our clients will expect us to advise them on the covenant
     strength of a potential tenant and it is vital to know what information is available,


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      what that information means and when to get specialist advice. Surveyors or lawyers
      are not accountants but they should be able to interpret the accounts of a company.
      They should also know when to call for the advice of an accountant or some other
      specialist but could be ready to understand and act on the accountant's advice.

      A word of warning about liability. Remember that those of you offering professional
      advice are at risk of incurring liability if inadequate advice is given negligently.

      §   What is the scope of your retainer from your client?

      §   Are you responsible for determining the covenant strength of a potential tenant?

      §   Do you have the necessary skill and expertise to reach that decision?

      §   Might it be necessary to obtain specialist advice and if so will you be able to
          interpret such advice?

      Make sure that you think about these issues and whatever conclusion you reach about
      the scope of your responsibility this should be recorded in an written agreement with
      your client. This is for your protection and at the same time should help your client to
      identify what specialist advice may be required.

10.   Information Regarding Covenant Strength

      Determining covenant strength will require a consideration of as much information as
      possible regarding the potential tenant. The information you obtain should include
      some or all of the following:

      §   Company Accounts – usually copies of the company's accounts will be provided
          by the company or its agents. For larger companies annual accounts may be
          contained in glossy annual reports or obtained from the company's own website.
          Accounts must be filed at Companies House and are available from there. If copy
          accounts have not been received you should request company accounts for the last
          three completed accounting years. If audited accounts are not available
          "management accounts" may be available. If unaudited accounts are proffered as
          evidence of the company's covenant check to see who produced them. Can an
          accountant verify their accuracy? Why have the accounts not been audited yet?
          Have the accounts been filed at Companies House and, if not, why not? A refusal
          to provide company accounts has been held to justify a refusal of consent

               Evans v. Dawkins [1968] CLY 2162

      §   Referees – the subject of references is referred to below.

      §   Company Information and/or Business Plan – this should be used to find out
          as much as possible about the company. Various sources of information will
          contain details such as statements about the direction the company is taking and
          an explanations for the company's published. Does the company have plans for
          expansion or restructuring? Who are its directors, principal officers and
          shareholders (this may be contained in the accounts and will also be revealed by
          searches)? When was the company formed and what is its history – look for
          significant developments in the company's history – for example a change of



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          ownership or a change of purpose? What is its business and from where does it
          operate? For what purpose will the property be used?

      §   If there are inter-group loans or loans from directors, ask for details in order to
          discover the true indebtedness of the company. In addition, the landlord may want
          to investigate and consider the degree of exposure of a prospective assignee to
          adverse market conditions, it's health and safety record of assignee company and
          potential claims and indeed any other matters which an accountant would consider
          appropriate when carrying out a due diligence exercise. Whatever information is
          obtained should be used to build up as complete a picture as possible about the
          company and its activities.

      It is important to remember that when dealing with an application for consent it is the
      landlord's right to request relevant information and until the tenant provides it the
      landlord is not obliged to give its decision. The landlord must however make the
      request for information – see comments on Landlord & Tenant Act 1988 contained
      above. Even though not governed by statute, where you are acting for a landlord
      granting a new lease the need to obtain information is just as important.

      The following paragraphs refer entirely to the consideration of information regarding
      the covenant strength of a company. Similar considerations apply where the
      prospective tenant is an individual, a partnership or some other type of body. In each
      case you will need to assess covenant strength. Will the prospective tenant be able to
      pay the rent. Much of the information referred to below will still be relevant. For
      example:

      §   A sole trader or a partnership may be able to provide trading accounts

      §   Charities and unincorporated associations will almost always have trading
          accounts, sometimes published and often audited

      §   References should certainly be available in almost every case

      §   Credit rating searches may be made against some organisations

      §   Searches regarding individuals can still be carried out.

      Remember to think carefully about who is the tenant. In the case of a partnership this
      will usually be the partners but if there are many partners it may be decided to accept a
      number of partners as the tenant. What will be the liability of the other partners?
      What if the partnership proposes a "service company" as tenant? What type of
      guarantees does the landlord need?

11.   Company Accounts – What Do They Tell You?

      Whether a company has limited or unlimited liability it must keep accounting records,
      even when it is not trading. In addition, all limited and public limited companies must
      send their accounts to the Registrar at Companies House. These accounts will include
      a profit and loss account, or an income and expenditure account if the company is not
      trading for profit and a balance sheet. The accounts should contain a report signed by
      the directors of the company and a separate report from the auditor report verifying
      the validity of the accounts. Independent auditing of a company's accounts is a
      fundamental requirement which applies to all companies except very small ones. It is

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      a requirement much in the news recently concerning certain spectacular corporate
      collapses.

      The profit and loss account contains details of trading during the financial year, and
      will include details of the company’s turnover which is defined as :

      the amounts derived from the provision of goods and services falling within the company's ordinary trading
      activities after deduction of trade discounts, VAT, and any other taxes based on this revenue.

      Companies Act 1985 – section 262(1)

      This account will state the profit of the Company which will be an important indicator
      of the "health" or covenant strength of the Company. Profit may be stated in a variety
      of different ways:

      §    Operating Profit - the total value of sales (or turnover) less costs incurred, including
           salaries and rent.

      §    Pre-tax profit - Operating profit less interest payable on company debts.

      §    Profit after tax –profit after tax will be available to pay dividends to shareholders. If
           there are any retained profit these will be added to the reserves in the balance
           sheet.

      In addition to the profit and loss account, the accounts will contain a balance sheet
      which must be signed by a director of the Company. What should you find in the
      balance sheet:

      §    Fixed assets of the company, which are long-term assets held for business use and
           which are not expected to be converted to cash in the current or forthcoming fiscal
           year. Fixed assets include tangible assets such as property, plant and machinery,
           and intangible assets which are typically something of value that cannot be
           physically touched such as goodwill, intellectual rights, or trademarks.

      §    Current assets which can be converted to cash in less than one year. They might
           include stocks of goods (not just raw materials but also work in progress) sums
           owed by debtors and cash balances.

      §    Current liabilities which are debts which must be paid within 12 months.

      §    Long-term liabilities not required to be paid within 12 months and may include
           mortgages on land and buildings.

12.   Accounting Standards

      In considering the covenant strength of the company it is important to know how the
      company accounts for its liabilities and, in particular, liability to landlords.
      Traditionally, property leases have been regarded as operating leases and currently
      under SSAP21 a tenant is only required to show a finance lease and not an operating
      lease on its balance sheet. A finance lease is one where the tenant treats the lease
      asset as if he had owned it so that the value of this asset will be shown on the balance
      sheet and there will be a corresponding entry with a liability equal to the present value



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      of the rental payments over the term of the lease. The cost of the finance lease is
      therefore shown as if it were a debt due from the company.

      Operating leases, such as leases of property occupied by a company, typically do not
      transfer the risk in rewards of ownership and they are treated an asset of the landlord
      and merely any revenue expense of the tenant.

      In the case of a tenant with numerous occupational leases, for example a retail
      company with a large chain of leasehold shops, the treatment of those leases will have
      significant implications for the levels of indebtedness, gearing ra tios, return on assets
      and other financial analysis. If a landlord is presented with a set of accounts prepared
      for this type of tenant according to current practice it makes it very difficult for the
      landlord to judge the true covenant strength of the prospective tenant.

      This accounting treatment of operating leases is likely following the publication in
      December 1999 of proposals by the Accounting Standards Board dealing with the
      treatment of leases. This Discussion Paper was entitled 'Leases: Implementation of a
      New Approach'. It recommends that all leases should be reflected in financial
      statements in a consistent manner and it explores the principles that should determine
      the extent of the assets and liabilities that lessees and lessors would recognise under
      leases.

      Under the recommended approach, at the beginning of a lease the lessee would
      recognise an asset and a liability equivalent to the fair value of the rights and
      obligations that are conveyed by the lease (usually the present value of the minimum
      payments required by the lease); thereafter, the accounting for the lease asset and
      liability would follow the normal requirements for accounting for fixed assets and debt.
      The lessor would report financial assets (representing amounts receivable from the
      lessee) and residual interests as separate assets.

      The Position Paper also examines the principles for accounting for more complex
      features of lease contracts. These include renewal options, contingent rentals, residual
      value guarantees and sale and leaseback transactions.

      Comments on the Discussion Paper were requested by April 2000. The website of
      the ASB states that it "is considering the issues raised by respondents to the Paper,
      and is continuing to exchange views and information with other members of the
      G4+1. Due to the complexity of the issues involved, it is expected to take some time
      to fully consider them". It seems unlikely therefore that a Financial Reporting
      Exposure Draft (the next stage in the process of change) will be published in the near
      future.

      In general it is thought that these changes will make it easier for landlords to assess
      covenant strength, but clearly the significant impact such changes will bring about will
      lead to a re-definition of the rules that are to be applied.

13.   Company Searches and Credit Reference Searches

      Once you have received copies of the company's accounts what should you do with
      them? The first question (already touched on above) is whether specialist advice is
      required. It may be sensible to obtain the advice of an accountant who may be better
      qualified to review complicated financial information.


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Generally speaking, the process of researching and analysing detailed financial
information can often be a time consuming process, especially when having to trawl
through the past three years' accounts. It may be necessary to obtain more information
in order to ensure that you have a complete picture. Requesting information inevitably
means delay. Although the onus is on the applicant to provide information, delay may
not suit the landlord either.

One alternative, which is regularly used, is to obtain an analysis of the company's
financial standing from a provider of financial information and credit-ratings. T hese
services are available (usually by subscription) from company's such as ICC, Dun &
Bradstreet and FAME (Financial Analysis Made Easy), to name just three. These
organisations will produce a report on any company for a relatively modest fee which,
in any event, can be properly recovered from the applicant.

These organisations will use information derived from accounts filed at Companies
House and from other registers and records. Standard credit rating tests are used and
the result will be a detailed critique on the company in a user-friendly form which
should cut through a lot of the detail.

Dun & Bradstreet which is probably the "market leader" boasts that database has details
on over 3.5 million companies in the UK alone. It produces a rating based on both financial
strength and risk - in terms of a company extending credit. The search result also
provides key financial data – a potted version of the company's audited accounts
focussing on key business indicators. This data includes:

§   Date of incorporation

§   Number of employees

§   Capital structure

§   Directors and principal officers

§   Associated companies

§   Profit and Loss

§   Net Worth

§   Public notice information, for example court judgements, mortgages and charges,
    filing requirements.

Dun & Bradstreet's website explains that its rating system uses a "combination of
mathematical modelling, expert rules, skilled Business Analysts and many years
experience in insolvency trends". Their analysts aim to identify events which are most
"significant and predictive in nature and which affect the status of a business". The
D&B rating is reviewed on the basis of information collected on a daily basis from a
variety of sources. Whilst the rating system is fundamentally "credit risk" based the
criteria will be almost entirely as relevant when assessing covenant strength.

The search can be carried out on line and the result will be available within a matter of
a few minutes. The search result will need to be reviewed carefully. What is it telling



                                       11
      you about the company? If in doubt ask for more information or obtain advice from a
      specialist.

      Although it may sound obvious, it is worth pointing out that it is essential that you
      ensure that the information provided and the credit searches are made against the right
      company. Although two companies may not have the same name, similar names may
      be found. Name changes can also lead to confusion. This is particularly true in
      relation to group companies. In a large group there may be countless companies with
      similar names. Some of these companies may be worthless whilst the assets and
      profits are in another group company.

      The best way to check is to look at the company number which is unique. Its number
      should be found on the company's accounts. Ask for the number to be confirmed and
      check that the number is correct. This information is readily available from
      Companies House where on line searches can be made. Alternatively various
      companies offer search services.

      Remember also that there are other sources of information. Information is maintained
      at H M Land Charges Registry. Searches can be made to discover what litigation may
      be pending. Usually this will be covered as part of a credit rating search.

14.   References

      The usual requirement will be for the assignee to produce refere nces, for example from
      its bank, a current landlord and several trade or professional referees. It is preferable
      for the applicant to be required to give the names and addresses of the referees so that
      the landlord's solicitor or agent can apply for the reference. This allows the landlord to
      ensure that the referee is aware of and is asked to address specifically the tenant’s
      covenants that will be undertaken by the assignee. This information alone will often
      not be sufficient and the landlord should also consider making requests for further
      information including the names of business contacts so that verbal references can be
      obtained about the applicant and its business.

      Most of you will know from your own experience that written references are hardly
      ever illuminating. Bankers are constrained in terms of the information that they are
      entitled to provide. Usually a bank reference will be provided "bank to bank" so you
      may need to get your own bank to request the information. The reference will usually
      be limited to stating that the company has and maintains an account.

      References from current landlords may be helpful, particularly in the case of a bad
      tenant as you may be told about previous problems but you cannot rely on this. Other
      references in the form of testimonials may be very helpful, however, this is rare. More
      often than not the reference will either be far too favourable or so vague as to be
      worthless. References will frequently contain "exclusions" seeking to remove any
      liability from the giver of the reference !

      What weight should be placed on reference replies? Where references cast doubt upon
      the ability of the assignee to pay the rent and perform the other obligations of the
      tenant, the landlord will normally be entitled to refuse consent:

      Shanly v. Ward (1913) TLR 714.



                                             12
It has been held that references given by persons who exclude liability for their
statements are of less weight than references given by persons who do not exclude
liability:

British Bakeries – see above

Less weight will be given to a reference where the standing of the referee is uncertain
or where the terms of the request for the reference are not disclosed:

Ponderosa International Development v. Pengap Securities (Bristol) [1986] 1
EGLR 66

If a referee is providing information about the income of a person it should be made
clear whether the income is before or after tax:

Ponderosa International Development v. Pengap Securities (Bristol) [1986] 1
EGLR 66

What is the liability of the giver of the reference? The reference must not be
misleading. If you are giving a reference care should be taken to ensure that the
information provided is true or at the least that the referee reasonably believes it to be
true. If a referee deliberately or negligently misleads the recipient of the reference into
thinking that the subject of the reference is better than he really is the referee leaves
himself open to liability.

Whether you can be sued for a misleading reference will turn upon the reference itself.
As a general rule a clear indication of the limits of the reference should be made but
"exclusions" may not be foolproof if a reference is intentionally misleading. Be careful
with the statements given. Unequivocal statements regarding the subject's ability to
do something, for example its ability to pay rent, may be unwise. Do you have enough
information about the subject? How can you know whether or not it has and will have
the resources top pay rent throughout the term of a lease? It is better to limit your
comments to what you know and to what is within your direct experience. Accurate
reporting of the subject's past performance is in any event of more assistance than
speculative assertions about the future.

The Court of Appeal has recently considered liability for a misleading reference given
by accountants:

HIT Finance Limited v. Cohen Arnold & Co LTL 14/10/99 (unreported)

The accountants provided a reference regarding the net worth of a company
"according to the information supplied to us". The reference proved misleading. It
was admitted that the accountants had obtained no verification of the information
provided by the company which went into liquidation. The court decided that whilst
the statement was misleading it was not an unqualified statement as to the company's
net worth. As a result the court held that there had been no assumption of
responsibility by the accountants and no duty of care had been assumed as between
the accountants and a lender who had seen the reference and relied on it.

The conclusion must be that it will be difficult to sue successfully upon most
references. To succeed it will be necessary to show that the referee has provided an
unqualified statement regarding an applicant which is intentionally misleading knowing

                                        13
      that the recipient will rely upon the reference to reach a decision regarding the
      assignment of a lease. If it can be shown that the landlord suffers loss as a result, a
      claim may be brought. Remember that under data protection legislation the subject of
      a reference may require a copy of the reference to be provided.

15.   When is it lawful to refuse consent on the basis of Covenant Strength?

      When deciding whether incoming tenant’s is of "satisfactory" covenant strength a
      landlord will want to make a commercial judgement. Generally speaking the landlord
      will be entitled to have regard to the affect that the proposed new tenant will have on
      the landlord's interest. Non-lawyers may be relieved to note the words of Mr Justice
      Warner who made it clear that the landlord was perfectly entitled to take into account
      the attitude of the market to the assignee's covenant:

      " the tenant [had] …… to live in the real world and to take the market as it finds it, not as lawyers might
      wish it to be".

      Pondesrosa International Development Inc v. Pengap Securities (Bristol) Limited
      [1986] 1 EGLR 66

      The question of the covenant strength of the tenant was specifically dealt with by the
      Court of Appeal when it set down seven guideline points which it then regarded as
      principles to be followed in determining whether a refusal of consent would be
      justifiable.

      International Drilling Fluids Limited v. Louisville Investments (Uxbridge) Limited
      [1986] Ch 513

      These guidelines are:

      §   The landlord is not entitled to refuse consent to obtain a collateral advantage.

      §   A reasonable belief of suspicions is required – the landlord must reach proper
          conclusions acting objectively but does not have to prove the accuracy of the
          information relied on.

      §   The burden is on the landlord to prove he has acted reasonably.

      §   The proposed user by the assignee may be relevant even though it is not prohibited
          under the lease.

      §   The landlord may be entitled to refuse consent to prevent the property being used
          in an undesirable way or by an undesirable tenant.

      §   The affect upon the value of the landlord's interest will often be relevant but the
          courts is entitled to decide whether the landlord or tenant will suffer the greater
          prejudice.

      §   Every case will be decided on merit in the light of all the circumstances.

      In International Drilling the Court of Appeal decided that the fact that expert
      evidence suggested that the effect of the occupation of the proposed assignee would
      likely be that the value of the property would be reduced it was equally relevant that


                                                     14
      there was no immediate prospect of the landlord's interest being offered for sale. The
      court decided that this theoretical loss to the landlord was far outweighed by the
      actual detriment to the tenant if the tenant could not assign its lease. Taking this into
      account it was not reasonable for consent to be refused.

      Where, however, there was a prospect and indeed a need for the landlord to sell its
      interest the landlord was entitled to weigh up the impact in the market of the proposed
      assignee and guarantor. On the facts presented to the court it was held that the
      landlord's reservations concerning the assignee's capitalisation and debt position and
      the references provided as to the guarantor's financial standing were perfectly
      justifiable.

16.   Rules of Thumb?

      An analysis of the covenant strength of a limited company will focus upon the audited
      profit and loss accounts and balance sheet of that company. Consideration will be
      given to the profits of the company amongst other financial indicators. The approach
      to be taken was considered in

      British Bakeries (Midlands) Limited v. Michael Testler & Co. Limited [1986] 1
      EGLR 64

      Based on the information provided to the landlord there was a real doubt regarding the
      proposed financial ability of proposed assignee to meet the obligations under the lease.
      References related to a previous business and premises of the assignee; they were now
      embarking on an entirely new venture in premises with a much higher rental. Certain
      property valuations were found to be unreliable and various unaided accounts cast
      reasonable doubt about the finances of the assignee.

      Sometimes it is said that the rule of thumb requirement is that the company should
      have profits before tax over a three year period equal to a specific multiple of the rent.
      This notion has recently been dismissed by Mr Justice Neuberger:

      "Mention is made of the existence of a rule of thumb that a proposed tenant should have profits after tax equal
      to three times the rent before it would be regarded as a satisfactory prospective tenant. I am not satisfied that
      there is such a test"

      Footwear Corporation Limited v Amplight Properties Limited 1999 1 WLR 555.

      Notwithstanding these comments landlord's and their advisors will continue to look at
      a prospective assignee's accounts and may well apply there own "rules of thumb" that
      an assignee without profits at least three times the annual rent will not be acceptable.
      There is no guarantee however that the court will agree with the landlord's judgement.

17.   Guarantees and Rent Deposits

      The covenant strength of an assignee may be "supplemented by a surety's covenant or
      by a rent deposit. Leases granted post 1995 may contain a specific requirement for
      these to be provided; whether this will be enforceable has not been tested. Old leases
      have contained provisions entitling the landlord to call for one or more persons to
      guarantee an assignee's covenants, usually where it is reasonable to do so according to
      the covenant strength of the assignee.



                                                        15
When the landlord is considering covenant strength it is relevant to consider the
covenant of both the tenant and any surety that is being offered. It has been held
however that where there is a grave doubt concerning a tenant's ability to pay the rent
the offer of a guarantor will not necessarily be a satisfactory substitute for a suitable
tenant.

Warren v. Marketing Exchange for Africa [1998] 2 EGLR 247

Rent deposits involve a sum of money being deposited into an account, which may be
held by the landlord's solicitor or agent or may be held in joint names. A deed should
be entered into regulating the operation of the account. Normally it will be intended
that the landlord is entitled to draw down from the account rent and any other
monetary amount due to the landlord under the terms of the lease where the tenant
fails to make payment according to the lease provisions. Where the landlord properly
draws from the deposit the tenant will be required to make up the deposit to the
original amount.

Remember that the terms of the rent deposit deed will determine whether the money
held as the deposit belongs to the landlord or to the tenant. It is suggested that the
deposit should remain the property of the tenant; from the tenant's point of view if it
does not it may be impossible to recover the money in accordance with the deed for
example in the case of a liquidation of the landlord. Landlords must remember that
where the deposit contains a charge over the deposited sum, if the tenant is a
company, notice must be given within 21 days at Companies House.




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