Commercial Property Focus - February 2009
Dealing with tenant default and the insolvent landlord
In today’s current financial climate thousands
of businesses are struggling to keep afloat as the “credit crunch”
shows no signs of ending. Every day, news comes of more
individuals and companies facing insolvency proceedings.
Nowhere is this more evident than in the commercial property field
and one area where this is having a major impact is that of
commercial lettings.
Not only are landlords finding that tenants
can no longer pay the rent for premises or, worse still, disappear
without trace leaving behind substantial rent arrears and
dilapidations, but tenants are also facing uncertainty and
vulnerability as many landlords are themselves struggling to
weather these financial storms. So where does this leave landlords
and tenants and what can they do to try and protect their
position?
The Struggling Tenant
The most notable sign that tenants are in
financial difficulties is the failure to pay rent or service charge
contributions. In considering the options available to them
the landlord will need to assess their aims and objectives and then
choose the most appropriate course of action in the circumstances
from a range of options available to them. The first question
that the landlord will need to consider is whether they want to
keep the tenant on the hook for the rent or try and end the
tenancy. The answer will depend on whether there are other
potential tenants available to take a new lease of the premises or
whether the landlord wants to take over the premises
themselves.
In the current market the landlord may be
unable to find suitable, alternative tenants. Similarly, they
may not wish to take new tenants if the current lease has many
years left to run and has favourable terms to the landlord, which
they would now be unable to negotiate with any new tenant. If
that is the case then the landlord will need to look for the best
way of recovering the arrears. Does the tenant have valuable
assets against which the landlord could seek to distrain for the
outstanding rent by seizing or taking walking possession of
items? If so, the landlord will need to be aware of the
limits on distress and be aware that this remedy is soon to be
abolished and be replaced with a new statutory scheme for the
recovery of commercial rent arrears which will reduce the powers
available to landlords.
If the tenant has other property then the
landlord may choose to seek a county court money judgement against
the tenant and seek to enforce it by a charging order over that
property. There may be guarantors or sureties that could be
pursued by the landlord for the arrears, rent deposits may be
capable of being used or arrears pursued from sub-tenants – subject
to compliance with the relevant contractual or statutory
procedures. It may also be possible to look back to former
tenants to recover arrears, although landlords need to be aware of
certain restrictions that may apply, particularly on more recent
leases. However, if the assignment to the current tenant was
unlawful or there is an authorised guarantee agreement (AGA) in
place then recovering arrears from former tenants may be an option
available to the landlord.
If the aim of the landlord is to retake the
premises, for example if the tenant has absconded and no details
are known as to their current whereabouts, then forfeiture or
acceptance of a surrender by operation of law may be options that
the landlord would want to consider. Forfeiture by peaceable
re-entry may be attractive as a fairly quick and cost effective
means of recovering possession, so that the landlord can limit
their loss although, again, care should be taken by the landlord to
ensure they comply with all necessary requirements.
However, the inability to pay rent or service
charge may be a sign of a more serious situation and the tenant may
in fact by facing insolvency because of their inability to pay
creditors. Indeed the landlord themselves may want to consider
taking insolvency proceedings themselves in respect of the unpaid
arrears. If such action is taken then the landlord’s options
to recover any arrears or take further legal action for other
breaches of the lease, such as failure to repair, are likely to be
greatly restricted.
If a tenant company is placed into
Administration a moratorium will exist preventing any form of legal
action against the tenant without the consent of the insolvency
practitioner or permission of the Court. This can place the
landlord in a difficult position as the tenant may have the benefit
of the premises even though no rent is being paid. Landlords
may find that they are being forced to apply to Court and incur the
time and cost of such an application to try and secure consent to
forfeit, etc. particularly as there is no guarantee that consent
will be granted. However, a recent case has suggested that in
the case of an administration, the unpaid rent should be paid as an
expense of the administration, where the premises have been used
during the administration for the continued needs of the business.
That provides some comfort – providing there is money realised into
the Administration.
Conversely, if the premises are seen as a
burden on the struggling tenant and are no longer required or
necessary for the business then a decision may be taken to disclaim
the lease leaving the landlord with empty premises that they cannot
let in the current market. Landlords should be aware that if a
lease is disclaimed then guarantors may not be released from
liability and they may be able to force the guarantor to take an
overriding lease of the premises in the event of disclaimer, in
accordance with the terms of the lease.
The Insolvent Landlord
Whereas a landlord will be alert from quite an
early stage that a tenant is in financial difficulties, owing to
the non-payment of rent, the position may not be as clear for
insolvent landlords and the tenant may only become aware of the
situation once the landlord has become the subject of formal
insolvency proceedings. However, there may be signs that the
landlord is struggling financially by their failure to comply with
their obligations under the lease. An example may be the
landlords’ failure to comply with their obligations to insure the
premises and the tenant may be well advised to take steps to
arrange their own insurance to protect themselves against the risk
of fire or flood damage, etc. Another example may be the landlord’s
failure to maintain the common / retained parts of the premises,
such as a properly functioning lift, or to ensure certain services
are provided, such as security cover. This may have a
detrimental effect on the tenant’s business and they may want to
consider taking action to address these issues
themselves.
Whilst the tenant may want to consider
carrying out any necessary repairs, for which the landlord is
liable, the tenant will need to ensure they have the right to take
such action. In addition, recovering the costs of such works
from the landlord is likely to be difficult if the landlord does
not have sufficient funds to pay. As indicated above, there
may also be limits on the legal action that can be taken if the
landlord is the subject of insolvency proceedings. If the tenant is
keen to end the Lease then the default of the landlord may give the
tenant an ability to end the tenancy in limited circumstances.
Where a landlord has entered into some form of
insolvency procedure then confusion can arise for the tenant as to
whom they should pay the rent for the premises. Should the
rent be paid to the landlord, an appointed insolvency practitioner
or a superior landlord who may be demanding that payment be made
direct to them? Tenants will need to ensure that they are
fully aware of the landlord’s position by making enquiries,
carrying out company searches and ascertaining who may have been
appointed to manage the landlord’s assets. The tenant needs
to be clear as to whom the rent should be paid to avoid remaining
liable for rent by inadvertently paying the wrong party.
The tenant’s rent deposit or sinking fund
contributions may also be at risk as such funds could form part of
the assets to be distributed amongst the landlord’s creditors.
These may be protected if they are being held on trust by the
landlord or if there are provisions in the lease that stipulate
that such funds are to be applied strictly in accordance with the
terms of the lease e.g. towards repair and maintenance costs, etc.
However, again tenants should try and safeguard these funds.
Where a landlord company enters into
Liquidation then the Liquidator appointed may decide to disclaim
the landlord’s superior lease. If this happens then the
tenant’s lease will also be brought to an end. Whilst the
tenant will have the right to apply for a vesting order for the
superior lease to be vested in them, allowing them to remain in the
premises, the tenant would only be entitled to take over the
superior lease rather than the previous underlease, the terms of
which may have been more favourable. Similarly, a superior
landlord may be entitled to forfeit the superior lease in the event
of insolvency and, if they opt to do so, then the tenant’s lease
will end albeit they will have a right to apply for relief from
forfeiture and a vesting order to take over the superior
lease.
What action should landlords and tenants take?
In light of the many problems that can arise
once the insolvency procedure commences, landlords and tenants
should ensure that they look out for signs that their landlord or
tenant may be in financial difficulties and to make sure they keep
the situation under review. If any signs of problems come to
light then enquiries should be made to confirm their financial
position as far as possible and if necessary steps taken to secure
payment of any arrears or recovery of premises (for landlords), or
securing their continued occupation / negotiating a surrender (for
tenants) before any formal insolvency process commences and their
ability to take action is restricted. If the insolvency process
occurs however then steps should be taken to liaise with the
appointed insolvency practitioner as soon as possible to ascertain
their intentions with regards to the premises. This will
enable plans to be put in place as soon as possible to deal with
the effect of the proposed course of action by the insolvency
practitioner. However, landlords should be careful not to
waive any right to forfeit in liaising or negotiating with the
insolvency practitioner.
Angela Penn, Solicitor
angela.penn@weightmans.com
For specific specialist insolvency
advice please contact Michael Green, Partner
michael.green@weightmans.com