Author - Michael Lower
The lease / licence distinction and why it matters
If a landowner agrees to allow someone else to occupy his or her property, the occupier is either a tenant or a licensee. Whether a contract creates a lease or a licence can have very important legal and regulatory consequences.
Private sector leases in the United Kingdom, for example, are likely to be assured shorthold tenancies and to be regulated by the Housing Act 1988. The Landlord and Tenant Act 1985 imposes a number of significant obligations on landlords of dwelling houses in the United Kingdom. Neither of these statutory codes apply to licences.
There is a large amount of case law about how a lease is to be distinguished from a licence. In broad terms, tenants have the high degree of control over the property that is consistent with a form of property ownership.
This blog post explains the tests developed by the courts to distinguish the lease from the licence. In this post I use ‘landowner’ for the person who is either landlord or licensor and ‘occupier’ for the person who is either tenant or licensee.
Street v Mountford
In Street v Mountford Lord Templeman said that the test for whether an agreement creates a lease is to ask whether it: (a) gives the occupier exclusive possession of the property; and (b) does so for a certain term. These criteria are the litmus test for the existence of a lease. The tests appear simple, but appearances are deceptive.
Exclusive possession
Gray and Gray (Elements of Land Law (5th ed), Oxford: Oxford University Press [4.1.61] – [4.1.62]) suggest that ‘exclusive possession has two emanations: territorial control and immunity from supervisory control.
Territorial control is about who makes the decisions as to who can enter the property. If the landowner can come and go freely (perhaps because of a duty to provide services such as cleaning) then there is a licence.
In Parkins v Westminster City Council ((1998) 30 HLR 894) the English Court of Appeal held that occupiers did not have exclusive possession when the agreement said that the landowner could allow additional people to occupy the property.
A landowner exercises supervisory control when the agreement gives them the power to intensively regulate the occupier’s activities in the property.
In Westminster City Council v Clarke the council and Mr Clarke entered into an agreement that gave Mr. Clarke the right to occupy a room in a hostel for homeless, single men. Some of the occupants had personality disorders or physical disabilities.
The council could change the accommodation or require Mr. Clarke to share his room. He had to be back in his room by 11 pm. Any visitors had to leave by then and he had to comply with the directions of the warden or his staff.
Lord Templeman said: ‘These limitations confirmed that the council retained possession of all the rooms of the hostel in order to supervise and control the activities of the occupiers, including Mr. Clarke. Although Mr. Clarke physically occupied room E he did not enjoy possession exclusively of the council’ ([1992] 2 AC 288 at 301 – 02).
Intention is an aspect of exclusive possession
In the English Court of Appeal decision in The Manchester Ship Canal Company Limited v Vauxhall Motors Ltd Lewison LJ said that: ‘There are two elements to the concept of possession: (1) a sufficient degree of physical custody and control (‘factual possession’); (2) an intention to exercise such custody and control on one’s own behalf and for one’s own benefit (‘intention to possess’)’([2018] EWCA Civ 1100 (The Manchester Ship Canal Company Limited v Vauxhall Motors Ltd at [59]).
This was approved by the UK Supreme Court in the same case ([2019] UKSC 46 at [42] per Lord Briggs) and corroborates the statement in Gray & Gray that ‘some kind of conscious will to control [the] occupancy and to defend it against all comers’ is a requirement for exclusive possession (Gray & Gray [4.1.63]).
A search for the legal substance of the agreement
Whether an agreement confers exclusive possession for a certain term is a question of contractual interpretation, a search for the objective common contractual intention of the parties.
Purchas LJ said that ‘the effect in law of the agreement must depend upon its construction in accordance with the normal rules in the context of its factual matrix and genesis.’ (Crancour Ltd v Da Silvaesa at [56]).
In Crancour Ltd v Da Silvaesa , Purchas LJ usefully summarised the guidance offered by Lord Templeman in Street as to factors that the courts should ignore in reaching their decision:
the description of the agreement chosen by the parties;
the actual subjective intention of the parties;
the effects of the Rent Acts; and
the exercise or failure to exercise rights provided by the agreement by one, either or both the parties to the agreement is not of decisive importance.
That it makes sense to produce this guidance is testimony both to the ingenuity of lawyers in trying to avoid categorisation as a lease and the difficulties that the courts face in trying to decide on which side of the lease / licence divide an arrangement might fall.
‘Control’ provisions
Echoing Lord Templeman in Street, Purchas LJ also said that the court should not draw up a ‘shopping list’ of clauses that can be taken to indicate a licence rather than a lease and that the court should not award marks for drafting.
It is only natural that lawyers who want to avoid agreements that confer exclusive possession on occupiers should include in agreements clauses that confer territorial and supervisory control on the landowner rather than the occupier.
Include enough of such clauses, drawn from a ‘shopping list’ of helpful provisions and the courts might be persuaded that the occupier lacks exclusive possession. This is linked to the idea of courts giving ‘marks for drafting’, rewarding lawyers who have remembered to include the right clauses in their agreement with a finding of a licence.
Discouraging a ‘shopping list’ approach and refusing to awards marks for drafting imply that the courts are prepared to ignore, or downplay the significance of, any control provisions included in the agreement.
There is a difficulty, however, because the courts cannot normally ignore the presence of clauses dealing with issues of control. They are, after all, terms in a written agreement and would normally be understood as the surest manifestation of the parties’ contractual intentions.
So, ‘a skilful draftsman must, in appropriate circumstances, be allowed to succeed’ (Crancour Ltd v Da Silvaesa ((1986) 52 P & CR 204 at 289 per Purchas LJ). Control provisions can only be disregarded if the court decides that they are sham terms.
‘Control provisions’ as sham terms
Landowners keen to avoid the regulatory consequences of creating a lease have a clear incentive to include control provisions in the lease. It may be that the clauses have been included to mislead the court as to the true nature of the agreement.
Lord Templeman warned of this possibility and said that the court should be ‘be astute to detect and frustrate sham devices and artificial transactions whose only object is to disguise the grant of a tenancy and to evade the Rent Acts’ (Street v Mountford [1985] AC 809 at 826). The court ignores sham terms and interprets the agreement as if they had not been included in it.
In Snook v London and West Riding Investments Ltd. Diplock LJ explained that ‘sham’ ‘means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create’ ([1967] 2 Q.B. 786 at 802).
Diplock LJ goes on to explain, in the same passage, that in a sham arrangement the parties have a common intention that the sham terms ‘are not to create the legal rights and obligations which they give the appearance of creating’. This is an extreme case where contractual interpretation requires the court to disregard written terms.
The parties have consciously agreed to include written terms which do not reflect their true bargain. Sham terms are mere ‘dressing up’ (Antoniades v Villiers 1997] 1 AC 417 at 475, Lord Jauncey of Tullichettle).
In Antoniades v Villiers the owner of a flat allowed a couple into occupation. The owner was keen to avoid creating a lease which would be subject to the Rent Acts and insisted that the couple each sign individual ‘licence’ agreements to create the impression that neither of them had exclusive possession since they were sharing possession with each other. The agreement allowed the owner to allow others into occupation of the flat and even to live there himself.
If these terms recorded what the parties’ contractual intention the couple would not have enjoyed exclusive possession. The owner would be in control of the flat and could decide who could live there.
The House of Lords had no difficulty in deciding that these arrangements were sham. The ‘substance and reality’ was that there was a single agreement giving the co-habitees exclusive possession of the flat.
‘Sham’ needs to be proved
Just because a term has the convenient (for the landowner) effect of leading to the conclusion that the agreement is a licence does not mean that it is a sham:
‘The exercise of construction must be carried out on the basis that the provisions of the agreement are genuine unless, from their very terms, they appear to be consistent with a sham agreement as defined in the speech of Lord Diplock in Snook v. London and West Riding Investments Ltd’ (Crancour Ltd v Da Silvaesa ((1986) 52 P & CR 204 at 290 per Purchas LJ).
In the case of a sham arrangement, the parties ‘have no intention of honouring their respective obligations, or enjoying their respective rights, under the provision or agreement’ (National Westminster Bank v Jones No HC 1999 14155 at [45]).
When considering whether a control provision is a sham, the court is entitled to look at the acts of the parties after the agreement. If the landowner never relied on the suspect control provision this is a sign that the clause may be a sham (Antoniades v Villiers ([1997] 1 AC 417 at 475, Lord Jauncey of Tullichettle).
On the other hand, in Camelot Guardian Management Ltd v Khoo Butcher J. observed that:
‘it has to be borne in mind that not every departure from the terms of a contract and how it is operated indicates that the relevant agreement was a pretence when entered into. Furthermore, the fact that a contractual right is not exercised does not of itself mean that it ceases to exist. The relevant party may be entitled subsequently to insist on its performance nevertheless’ ([33]).
There was no sham here in that case even though the landowner refrained from exercising in full the control rights in the agreement.
How ready should the court be to find that control provisions are sham terms?
We have already seen that Lord Templeman in Street said that the courts should be ‘astute’ to detect and frustrate sham terms. This seems to imply a readiness on their part to find that control provisions are shams.
In fact, however, there is ‘a strong presumption that the parties to what appears to be perfectly proper agreements, intend them to be effective, and that they intend to honour and enjoy their respective obligations and rights’ (National Westminster Bank v Jones No HC 1999 14155 at [46] per Neuberger J.). The court ‘is slow to find a sham’ (at [65]).
There needs to be something about the terms to suggest that they might be sham.
In Crancour Ltd v Da Silvaesa , Purchas LJ said that ‘[t]he exercise of construction must be carried out on the basis that the provisions of the agreement are genuine unless, from their very terms, they appear to be consistent with a sham agreement as defined in the speech of Lord Diplock in Snook v London & West Riding Investments Ltd’ (at [60]).
In the same case, Nicholls LJ suggested that the idea of a sham arises where a clause is so extraordinary that it calls for an explanation’ (at [45]).
In Antoniades v Villiers, Lord Oliver of Aylmerton spoke of ‘an air of total unreality about these documents’ ([1997] 1 AC 417 at 467). In National Westminster Bank v Jones said that a finding of sham connotes ‘a degree of dishonesty’ (at [40]). The fact that a transaction is ‘palpably artificial’ is relevant but not decisive (National Westminster Bank v Jones at [33]).
Is exclusive possession a test or a label applied after the event?
In Shell-Mex and BP Ltd v Manchester Garages Ltd, Lord Denning said:
‘At one time it used to be thought that exclusive possession was a decisive factor. But that is not so. It depends on broader considerations altogether. Primarily on whether it is personal in its nature or not.’ ([1971] 1 WLR 612 at 617).
In Street, Lord Templeman responded: ‘If exclusive possession at a rent for a term does not constitute a tenancy then the distinction between a contractual tenancy and a contractual licence becomes wholly unidentifiable’ (at 825).
In Shell-Mex and BP Ltd v Manchester Garages Ltd, the fact that the occupation agreement was ancillary to a broader commercial arrangement under which Manchester Garages were to buy petrol exclusively from Shell-Mex was relevant. So too was the fact that the agreement was not assignable.
Manchester Garages precedes Street with its much greater emphasis on the centrality of exclusive possession as the hallmark of the lease. It may be, though, that the courts sometimes have to make an intuitive call as to the quality of the rights enjoyed by the occupier and whether the arrangement is proprietary or purely personal.
In marginal cases, a finding of exclusive possession may be a label applied by the courts after they have decided that the arrangement belongs on one side or the other of the lease / licence divide.
It is as well to bear in mind the words of Richard Southwell in Mehta v Royal Bank of Scotland ((2000) 32 H.L.R. 45) that: ‘there is no simple all-embracing test’ for whether an occupier enjoys exclusive possession and that ‘the search for such a test would be a search for a chimera’.
Michael Lower