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  • Ambuja Bose
  • Georgina Eason

Every week seems to bring news of another major retail chain in financial crisis. Ambuja Bose and Georgina Eason look at the practical impact on commercial landlords of having an insolvent or potentially insolvent tenant

Since the turn of the year, there has been a number of high-profile insolvencies, including Carillion, Toys R Us, Maplin and Jamie’s Italian. Worryingly for landlords, many businesses facing financial distress are in the retail, hospitality and leisure sectors, often occupying multiple sites, which can exacerbate the impact on landlords and the rental market in general.

In this article, we discuss the impact that tenant insolvency can have on landlords, and provide practical suggestions to help property solicitors advise their landlord clients in these trying times.

Insolvency legislation: the background

The law surrounding insolvency in England and Wales is complex. It is governed, in the main, by the Insolvency Act 1986 (as amended), and, since 6 April 2017, the Insolvency (England and Wales) Rules 2016. These two pieces of legislation apply to the vast majority of insolvencies, and we will focus on those insolvencies here. However, specialist insolvency legislation applies to certain sectors, industries and business types (including financial institutions, limited liability partnerships and charitable incorporated organisations), so when considering any insolvency situation, it is important to identify exactly which pieces of legislation are relevant.

What is insolvency?

A company is deemed insolvent if it fails either:

  • the balance sheet test: it does not have enough assets to cover its debts (ie the value of the company’s assets is less than the amount of its liabilities, including contingent and prospective liabilities) or
  • the cashflow test: it is unable to pay its debts as they fall due.

Types of insolvency

When advising landlord clients in relation to insolvent or potentially insolvent tenants, it is important to identify, at an early stage, both the type of insolvency process in place or being considered, and the stage that the particular insolvency has reached. This is because different insolvency processes bring with them varying rights, restrictions and measures.

There are three principal insolvency processes applicable to companies, outlined below.

Company voluntary arrangement (CVA)

This is a formal arrangement between a company and its creditors where the creditors agree to compromise an element of the debt owed to them, in order to enable the company to avoid insolvent liquidation or administration. The company can continue to trade under the management of its directors, but a licensed insolvency practitioner is appointed as supervisor of the CVA.

A CVA will be implemented if it is approved by 75 per cent (by value) of its creditors, unless more than 50 per cent (by value) of those who object to the CVA are unconnected to the company. Landlords should be aware that, once approved, a CVA binds all creditors, including creditors who voted against it and those who did not have notice of the CVA.

There is no automatic statutory moratorium in place in the period between the proposal of a CVA and its implementation, but ‘small’ companies (which satisfy at least two of the criteria set out in section 382(3) of the Companies Act 2006) may apply for an interim moratorium of up to 28 days by filing various documents in court at the time the CVA is proposed.

Administration

This is a formal insolvency process where, under the management of licensed insolvency practitioners (acting as administrators) rather than by its directors, a company is able to benefit from the protection of an automatic moratorium to achieve certain statutory purposes, including, if possible, the rescue of the company as a going concern. As the moratorium prevents creditors from taking action against the company without the express permission of the administrators or the court, creditors are unable to commence or continue legal action against the company, which means the administrators are not hindered from taking such steps as are necessary for the company’s rescue, its reorganisation, or realisation of its assets. The impact of the moratorium on landlord’s remedies is discussed further below.

Liquidation

This is a formal process where the company’s assets are realised and distributed to creditors (insofar as is possible) in satisfaction of the company’s debts, prior to the company being dissolved. Liquidation can also be referred to as a winding up, and a company can be wound up by the court in a process known as a compulsory liquidation, or alternatively following decisions made by the company’s shareholders and creditors in a process called creditors’ voluntary liquidation. A further type of liquidation, known as a members’ voluntary liquidation, is a solvent winding up process where creditors are paid in full.

The legal impact of insolvency on landlords’ rights

As readers will be aware, common landlord remedies for the non-payment of rent include forfeiture, issuing a money claim for arrears, and exercising commercial rent arrears recovery (CRAR).

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However, where your landlord client’s tenant is insolvent or approaching insolvency, it is possible that some, if not all, of those remedies are no longer legally available, due to the insolvency process the tenant is subject to or proposing. Further, even if a remedy is legally available, a landlord will want to consider, from a commercial point of view, whether exercising such a remedy is beneficial.

In the case of a company in administration, or a company in respect of which a notice of intention to appoint administrators has been filed in court, or an administration application issued and not yet dismissed, the automatic moratorium will prevent the landlord from exercising CRAR, issuing or continuing with a money claim, or forfeiting the lease by either peaceable re-entry or proceedings, unless express permission is obtained.

Where a company has proposed a CVA, if a ‘small companies moratorium’ has been applied for, the landlord is restricted from taking any enforcement action or exercising any remedy while the moratorium is in place. If there is no such moratorium, a landlord can continue to exercise its landlord remedies in the period prior to approval of the CVA. Once a CVA is approved, regardless of whether a small companies moratorium had been applied for or not, a landlord is prevented from exercising the usual remedies for pre-CVA breaches, unless the terms of the CVA are breached in themselves.

Lines of communication should be kept open with both the directors of the insolvent company prior to formal insolvency, and the insolvency practitioner once they are appointed

In the case of liquidations, close consideration must be given to whether the liquidation process is compulsory or voluntary. In general, in a voluntary liquidation, the landlord’s legal right to exercise remedies in relation to non-payment of rent is unfettered. In a compulsory liquidation, the position is a little more complex. Forfeiture by way of proceedings or the issuance of a money claim is not permitted unless the consent of the court or, if applicable, the liquidator, is obtained. Where CRAR has been commenced prior to the presentation of a winding up petition, it will be stayed in a compulsory liquidation, and if CRAR is commenced post-petition, it will be void. However, once a winding up order has been obtained, the landlord can then seek the permission of the court to exercise CRAR.

Landlords should also be aware that trustees in bankruptcies and liquidators (but not insolvency practitioners in administrations or CVAs) have the right to disclaim onerous property. Onerous property can be an unprofitable contract, or any other property of the company (including leasehold property) which is not easily or readily saleable, or property that may give rise to the liability to pay or perform onerous acts. A lease is often considered onerous property, and capable of disclaiming, due to not only the rent payment covenants within the lease, but also potentially any repair and decoration covenants. In addition, negative covenants within a lease may make it unsaleable, again making it potentially suitable for disclaiming. The effect of a disclaimer, which must relate to the whole of a piece of onerous property, is to determine the rights, interests and liabilities of the insolvent company in or in respect of the lease. Other than is necessary to release the company from any liability, a disclaimer does not operate to affect the rights and liabilities of any other person.

When should a landlord take enforcement action?

One of the most important considerations for landlords and their advisers is whether, even if certain landlord remedies are legally available, or if permission for those remedies can be sought, it is commercially beneficial to do so.

A premature or unfounded application to court could result in the landlord incurring hefty legal costs

A key factor, particularly when a landlord is considering forfeiture or taking back possession of a property, such as following disclaimer, is the state of the rental market at the time, and whether the landlord will be able to re-let the property quickly and easily. Prematurely ending a lease or taking back possession without a ready tenant could result in the landlord waiving its rights to the benefit of any third-party covenants (such as former tenants, guarantors or sureties), and also potentially becoming liable for business rates if the property sits empty for some time.

A landlord of an insolvent tenant should also consider how the property is being used during the course of the insolvency, and whether there is an argument to be made that the administrator or liquidator is liable to pay rent for any period of the insolvency, as an expense of the administration or liquidation.

Lines of communication should be kept open with both the directors of the insolvent company prior to formal insolvency, and the insolvency practitioner once they are appointed. Particularly in the case of an administration, the insolvency practitioner may be considering trading the business, and therefore utilising the property for a while, or may be seeking a sale of the insolvent company’s business, which could mean the new purchaser taking an assignment of the lease or entering into a new lease. Depending on parties’ respective bargaining positions, it may be that a new purchaser is willing to make a contribution towards the insolvent tenant’s rental arrears.

Similarly, when considering whether an application should be made to court to lift any statutory moratorium, the first step for a landlord would be to communicate with the administrators. This will help the landlord understand the administrators’ strategy to achieve the purposes of the administration, and evaluate how the landlord’s proposed actions following the lifting of the moratorium may balance against the interests of the creditors of the tenant generally, and the overall strategy for the administration. A premature or unfounded application to court could result in the landlord incurring hefty legal costs in relation to the application, and the landlord could also potentially be liable to pay the administrators’ costs if the application is unsuccessful.

Proper communication can lead to beneficial results for all

Proper communication can lead to beneficial results for all, as demonstrated by a recent matter in which one of the authors, Georgina Eason, was instructed by the directors of a business trading as an indoor soft play centre (SP Limited). SP Limited had fallen significantly behind with its rental payments, but the landlord had taken a view on these as they wanted the business to keep trading and attract people to the business park generally. The landlord had also loaned SP Limited monies towards the cost of new equipment. While the business was attracting custom, it was not profitable, and for that, and for various family reasons, the directors of SP Limited did not want to continue trading. The landlord was initially concerned with SP Limited’s proposal to surrender the lease and, being owed significant sums by SP Limited, in terms of both rental liabilities and the equipment loan, did not want its exposure to increase if SP Limited ceased trading before a new tenant was in place. While the previously amicable relationship between the landlord and the tenant had now broken down, the introduction of Georgina’s team as intermediaries helped establish a way forward. Following discussions with Georgina, the landlord recognised that it could not force the directors of SP Limited to trade while insolvent, and instead started exploring other avenues, such as exercising CRAR over the equipment, or pursuing the guarantors. Ultimately, a surrender was agreed which allowed the landlord to have its unit returned to it, fully equipped and ready for immediate re-letting to a new tenant, which had been sourced while negotiating the surrender. SP Limited was placed into liquidation, meaning the directors did not breach their fiduciary duties by trading while insolvent or to the deficit of creditors.

Retail CVAs – the new trend

It seems that every week brings more reports of retailers or restaurateurs considering restructuring proposals. At the time of writing this article, New Look, Prezzo, Byron, Select, and Carpetright have had CVAs approved, and Poundland is putting together proposals for presentation to landlords and creditors.

A CVA is not always a negative for landlords

CVAs allow companies to restructure the terms of their leases and their obligations, such as reducing rental payments, altering payment terms, or potentially removing a landlord’s right to forfeit in certain circumstances. A CVA proposal can treat different premises in different ways, so directors of retail companies can identify which units may be suitable for closure and which they are likely to continue to trade. As explained earlier, it may not be that every single landlord has agreed to approve the CVA (over 75 per cent in value of all those voting, including non-landlord creditors, is required to approve a CVA), but they will all be bound by the terms of the CVA nonetheless.

A CVA is not always a negative for landlords, particularly for a landlord of a unit which is to be kept open in a slow or flat market where the property may otherwise stand empty. There are positives, such as a higher return in a CVA than if the company otherwise went into liquidation or administration, plus if the tenant remains in occupation of the retail store or restaurant, it, rather than the landlord, will be responsible for paying rates. It will be a condition of the CVA that future rent for open stores will continue to be paid, although a number of recent CVAs have included terms reducing future rent by 20-50 per cent (though see also the recently reported case of Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd [2018] EWHC 402 (Ch), which relates to the insolvency of BHS, for limitations on such a reduction).

The impact of a CVA on landlords could be positive or negative, so landlords and their advisers must properly consider and understand the CVA’s provisions, including the effect if the CVA fails and the tenant is subsequently put into liquidation or administration, to properly understand their rights as landlord, including their rights to challenge the CVA if they feel it unfairly prejudices them.

Practical tips for landlords

  1. Regularly monitor rent and other sums due under the lease, to prevent significant arrears from arising.
  2. Be aware of indications of financial distress, such as late payments of rent, failure to comply with repair or decoration covenants, or requests to change payment terms to monthly or weekly rent rather than quarterly. Careful consideration should be given to any negotiations with the tenant in respect of these, to ensure the landlord does not inadvertently waive its long-term rights under the lease by agreeing to a temporary change in payment methods.
  3. Review the suitability and availability of security such as rent deposits, guarantors, authorised guarantee agreements etc,and the procedural requirements of relying on the same, including time limits.
  4. Consider whether notices can be served on any sub-tenant to pay rent directly.
  5. Maintain lines of communication.
  6. Properly read and understand any insolvency notices or proposals served.
  7. Take specialist advice at the earliest stage.

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