Issues for commercial tenants where the landlord has become insolvent

This article deals with the issues that may arise for commercial tenants (the Tenant) if their landlord becomes insolvent (the Insolvent Landlord), in particular where the Insolvent Landlord is an intermediate landlord, such as a headtenant, and where the Tenant is a subtenant.

By way of background, the main types of insolvency proceedings are:

• Bankruptcy: the process under which an individual is declared bankrupt by the court
• Individual Voluntary Arrangement (IVA): the process by which an individual comes to an agreement with its creditors to repay its debts
• Administration: the process by which an administrator is appointed to ‘rescue’ the company as a going concern
• Compulsory Liquidation: the winding up of a company as a result of a court order
• Creditors Voluntary Liquidation: the process by which the shareholders of a company agree to wind up the company without the need for a court order
• Company Voluntary Arrangement (CVA): the process by which a company comes to an agreement with its creditors to repay its debts.

This article focusses on the implications of corporate insolvency on commercial leases.

Administration

Administration of the Landlord or headtenant/ intermediate landlord will have less of an impact on a tenant than liquidation, as the property will be managed as a going concern and the lease will usually continue. If an intermediate landlord goes into administration, that landlord will be treated as using the property for the purposes of the landlord’s business and the liabilities of that company will be treated as expenses of the administration. However, an administration very often leads to a liquidation, so it is worth the Tenant seeking early discussions with the superior landlord for a new lease and for an agreement for surrender of the lease with the company in administration.

Liquidation

Risk of forfeiture
An Insolvent Landlord generally will not be able to forfeit a lease. However, most leases give a landlord the right to forfeit on the insolvency of a tenant, so where the Insolvent Landlord is an intermediate landlord, the superior landlord may be able to rely on a right to peaceably reenter the property if the intermediate Insolvent Landlord fails to pay its rent. If the superior landlord does not have the right to peaceably re-enter the property, then it will be required to request permission from the Court or the liquidator before it can forfeit the lease.

If a superior landlord forfeits the lease with an Insolvent Landlord, the Tenant’s lease will end automatically. A Tenant will be able to apply to the Court for relief from forfeiture but the Tenant would have to apply for relief in respect of the Insolvent Landlord’s lease, not its own lease and the terms of the Insolvent Landlord’s lease could be more onerous for the Tenant. In particular this could be an issue for a Tenant of part of premises who may be required to take on a lease of the whole premises. Also a subtenant’s right to relief of what is in effect its landlord’s lease, is not as strong as a tenant’s right to apply for relief of its own lease.

Disclaimer
A lease is usually a valuable asset in a liquidation which a liquidator would be looking to dispose of as part of the liquidator’s task of realising assets. Nevertheless, where an Insolvent Landlord goes into liquidation there may be some cases where the liabilities under that landlord’s own lease may give the liquidator the right to disclaim that lease as ‘onerous property’. This will terminate the Insolvent Landlord’s rights and obligations towards both the superior landlord and the Tenant.

Unlike forfeiture, a disclaimer of a headlease does not automatically end the Tenant’s interest in the property in the same way that forfeiture does, although the sublease itself is in effect determined. The Tenant will retain the right to occupy the premises if it complies with the obligations of the headlease and starts paying rent to the superior landlord. The right to remain in occupation is an assignable right.

The Tenant has the right to ask the liquidator of the Insolvent Landlord whether the lease will be disclaimed and a response is required within 28 days. This can be a welcome comfort for a Tenant that is concerned about eviction. The Tenant can also make an application to the Court to have the disclaimed headlease vested in the Tenant or to be excluded from all interest in the property.

If the Insolvent Landlord is also the freeholder of the property then the freehold will belong to the Insolvent Landlord’s estate.

If the freehold is disclaimed it passes by escheat to the Crown and the Tenant will then owe the obligations under the lease or headlease to the Crown until the expiry of the term. As with other cases of disclaimer, the Crown will not similarly assume the Insolvent Landlord’s duties towards the Tenant.

A Tenant of part of the property may also apply for a vesting order, but it will mean that the Tenant assumes the Insolvent Landlord’s responsibilities for the whole of the property which may be an unattractive prospect.

Rent
A Tenant will be required to pay the rent due under its lease to the liquidator as normal. If the Tenant fails to do so, it would be in breach of its lease.

A superior landlord may serve a Section 6 notice under the Law of Distress Act 1908, known as a ‘rent diversion notice’, which will entitle the superior landlord to receive rent directly from the Tenant rather than the Insolvent Landlord.

Rent Deposit
The right to the money in the rent deposit depends on the structure of the rent deposit arrangement. If the rent deposit is held in a separate account, or rent deposit scheme, then it is most likely to be the Tenant’s property and will not form part of the Insolvent Landlord’s estate for the purposes of the liquidation.

Where the rent deposit is not held in a separate account, the Tenant will need to show that the money is held on Trust for it by the Insolvent Landlord. If the deposit is held as stakeholder it will usually be held on trust for both parties and although the money will not be mingled with the Insolvent Landlord’s funds, it may be shared between them unless there has been some breach of the contract by one of the parties.

On a surrender of the headlease the Tenant will have a direct relationship with the superior landlord on the terms of the sublease and the superior landlord will step into the Insolvent Landlord’s shoes. It would be prudent for a tenant to ask the superior landlord to require an express clause in the deed of surrender which deals with the repayment of the rent deposit monies, so that a new rent deposit arrangement can be established.

On a disclaimer, it is arguable that a liquidator asserting a right to disclaim cannot retain a right to the rent deposit.

For more information on rent deposits please see: Commercial rent deposits: what happens on insolvency of landlord or tenant article – Edwin Coe Newsletter – Summer Edition 2017 (page 10).

Repairs
If the Insolvent Landlord is in default of its repairing obligations then the Tenant cannot usually withhold rent as most leases do not permit deduction or set off, so this would put the Tenant in breach of its lease. In extreme cases a Tenant may be able to repudiate the lease, if the breach interferes with its enjoyment of the premises to the extent that the failure to repair amounts to derogation from grant.

Unfortunately the sums collected from the Tenant through the service charge are not held on trust for the Tenant, unless specifically stated, and will form part of the Insolvent Landlord’s estate in the liquidation. A liquidator may ringfence the fund for the purposes of affecting the repairs but it is unlikely that there will be sufficient funds in the reserve to fulfil the Insolvent Landlord’s obligations.

If the Tenant wants to recover its service charge payments, or carries out repairs and seeks to recover the cost from the Insolvent Landlord, it will be an unsecured creditor. Unsecured creditors are last in the list of creditors to be paid out in a liquidation and are not guaranteed repayment in full.

Company Voluntary Arrangement (CVA)
A CVA is where a company enters into a contract with its creditors in order to avoid liquidation. The company proposing the CVA often has the potential to be a viable ongoing business. The directors usually circulate a proposal to creditors and shareholders for approval, which will involve the creditors agreeing to accept reduced payment terms. The proposal has to be approved by 75% of the creditors and 50% of the shareholders. Once approved, the CVA binds all people entitled to vote, save for secured creditors. CVAs do not require court intervention and are becoming much more widely used. Very often CVAs are heavily dependent on reducing rental payments on expensive leases.

A subtenant is unlikely to have much of a share in the vote and therefore early discussions should be entered into with the superior landlord to establish a direct leasehold arrangement.

Conclusion
Any insolvent process creates greater uncertainty and leads to wasted costs and management time.

Tenants are advised to seek professional advice as soon as possible to avoid the undesirable consequences of landlord insolvency outlined above.

For further information regarding this topic or any other property and construction dispute, please contact Joanna Osborne – Head of Property Litigation, or any member of Edwin Coe Property Litigation team.

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