knowledge | 27 April 2020 |
COVID-19: Tenant Insolvency in Commercial Leases
Landlord and tenant relationships are likely to come under strain as tenants experience financial difficulties due to the COVID-19 pandemic. For tenant companies such financial difficulties may result in a tenant being placed in examinership, or ultimately in the appointment of a liquidator or receiver. An insolvency event generally constitutes an event of default in a commercial lease. However, a landlord’s ability to enforce its obligations will differ depending on a number of factors, most notably: the terms of the lease, the terms of any guarantee in place and which of these three forms of insolvency a tenant is facing.
Businesses will experience the economic shock caused by COVID-19 differently. For some, it will be a short-term shock so that, while potentially damaging to the business, examinership can provide a route back to economic health. Examinership is a statutory scheme for the rescue of companies governed by Part 10 of the Companies Act 2014 (the “Act”). Where there is a reasonable prospect of the survival of a company as a going concern, examinership facilitates this by placing it under the protection of the Court (High or Circuit) for up to 100 days (subject to extension in specific circumstances). During the protection period the company’s affairs are explored by the Court appointed “examiner” to see if it is capable of being rescued and, if so, to formulate proposals for that rescue (referred to as a “scheme of arrangement”). The liabilities of the company are frozen at the commencement of an examinership and the scheme of arrangement can cram down those liabilities, which include liabilities arising under a lease.
During the protection period, the exercise of all contractual rights against the company in examinership are suspended so that no action can be taken by a landlord against a tenant company to re-possess the property as would otherwise be the case. An examiner does not displace the powers of the directors so the responsibility to pay rent remains with the tenant company.
In terms of how lease rights and obligations may be treated in any scheme which is approved and adopted for the rescue of the company:
- Rent arrears accrued under a lease may be reduced in any scheme of arrangement. However, the landlord can request the examiner, at their discretion, to “certify” rent arising during the protection period, under s529 of the Act, as an expense necessary for the survival of the company, giving it priority over other unsecured claims and floating charges. An examiner does not have the power to vary the terms of a lease (for example the term or rent payable), unless a landlord consents in writing to its inclusion.
- Examinership does however provide the company with the power to repudiate onerous contracts (including leases) in their entirety by making an application to Court. In order to succeed in obtaining an order to repudiate a particular lease, the tenant company must demonstrate to the Court that the business operating from the subject premises is not profitable and that it is therefore jeopardising the overall viability of the company. In this way, the risks and rewards of examinership and the potential successful repudiation of a lease must be carefully weighed up by both landlords and tenants in any early discussions between them.
Liquidation is the procedure used where a company will cease to exist. Once appointed, broadly speaking, the primary obligation of a liquidator is to take control of all of the insolvent company’s assets, realise those assets and to distribute them to the creditors of the company in accordance with the statutory order of priorities.
In terms of prioritising payments, a liquidator must first pay the liquidator’s fees and expenses of the winding up, followed by any preferential payments1, before addressing the claims of floating charge holders, and thereafter unsecured creditors. Secured creditors will get paid from the realisations of the charged assets.
In terms of how lease rights and obligations may be treated when a liquidator is appointed to an insolvent tenant company:
- A landlord’s claim for outstanding rent and service charge payments, relating to the period prior to the commencement of the winding up, and any claim for dilapidations will have the status of an unsecured creditor.
- Rates due for the 12 month period prior to liquidation rank as a preferential claim.
- In circumstances where a liquidator, for commercial reasons, chooses to occupy the premises after the commencement of the winding up, rent and service charge payments incurred by the liquidator in occupying the premises are fully recoverable by the landlord, and are treated as an expense of the liquidation (ranking in priority above all creditors’ claims).
- In relation to forfeiture, notwithstanding the existence of a carefully worded forfeiture clause, provided the liquidator complies with the covenants of the lease, a landlord cannot act upon any forfeiture rights arising on the appointment of the liquidator under the lease within the first year of a liquidation.2 However, a landlord’s right to forfeit a lease for non-payment of rent remains intact, although the usual statutory protections afforded to tenants requiring service of a forfeiture notice equally apply to a liquidator. Furthermore, a liquidator can apply to Court for relief against forfeiture for non-payment of rent.
A liquidator can apply to Court for leave to disclaim the lease if it considers it to be “onerous property”.3 However this is a costly and time consuming process for a liquidator and therefore it is likely that any liquidator would seek to surrender the lease voluntarily before bringing an application to disclaim a lease. Whether or not a landlord accepts a surrender of the lease is a commercial decision for the landlord to make but in practical terms, landlords often do so in order to seek to mitigate their loss by re-letting the premises.
As outlined above, the majority of commercial leases contain a clause providing for the forfeiture of the lease in the event that a receiver is appointed to a tenant. A receiver is appointed to a company or to the property of a company by a lender under a mortgage or charge or other security. The main function of a receiver is to realise the best price reasonably obtainable from the secured assets to pay off the debt due to the lender. Unlike with examinership and liquidation, unless a landlord has postponed its right to forfeit the lease for the benefit of the lender (by agreement in the lease or in a separate direct agreement with the tenant’s lender) a landlord will be entitled to re-enter the premises and terminate the lease on the appointment of a receiver to the tenant. The primary benefit to a landlord in doing so is to recover possession of the premises, allowing it to be re-let. In practical terms, any arrears of rent that accrued prior to the appointment of the receiver will usually be difficult to recover, as the debt owed to the lender will be paid to the lender ahead of any rent arrears owed to the landlord. Where a landlord has postponed its right to forfeit, this would likely only continue on terms where the receiver pays the rent and/or the lease is assigned to a third party acceptable to the landlord.
Understanding the insolvency regimes available is just one step towards equipping both landlords and tenants to make their best business decisions in what is an extremely challenging time for everyone. Recognising the challenges that each face and early communication and engagement will also be the key to moving positively forward.
Also contributed by Alice Ward, Darragh Murray and Lisa Leonard.
- As set out in s621 of the Act.
- See s2 of the Conveyancing and Law of Property Act 1892 and s14 of the Conveyancing Act 1881.
- The liquidator has 12 months from the date of the commencement of the winding up to take this step. However, where the existence of onerous property has not come to the knowledge of the liquidator within 1 month after the date of the commencement of the winding up, the power under this section of disclaiming the property may be exercised at any time within 12 months after the date on which the liquidator has become aware thereof or such extended period as may be allowed by the Court.
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.