Most commentators are agreed that 2012 will be an extremely difficult year for business globally and particularly in the eurozone. In the UK, both landlords and tenants are going to have to be acutely aware of their legal rights in a climate where many more business failures are predicted. The law relating to the insolvency of tenants and the effect on landlord and tenant relationships around the UK has inevitably developed in these tough times and, as a result, recent case law provides some helpful guidelines for well-advised landlords and tenants.
AGAS – POSITION OF GUARANTORS
Under the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act), a tenant that assigns a lease is usually required to enter into an authorised guarantee agreement (AGA). The 1995 Act applies to all leases entered into from and including 1 January 1996 (unless the lease was dated after this date but entered into pursuant to an agreement for lease dated before 1 January 1996).
An AGA is a guarantee from the outgoing tenant that the incoming tenant will comply with its obligations under the lease. It is made between the landlord and tenant and must conform to the requirements of the 1995 Act to be valid and enforceable. The general purpose of the 1995 Act is to relieve the outgoing tenant from its obligations under the lease once it has assigned it to the incoming tenant. Crucially, s24(2)(b) of the 1995 Act provides that, once a tenant is released, ‘another person’ bound by a covenant of the tenancy will be released to the same extent as the tenant.
The very useful decision in K/S Victoria Street v House of Fraser (Stores Management) Ltd & ors [2011] clarifies the meaning of the key provisions of the 1995 Act, giving Court of Appeal approval to the decision of the High Court in Good Harvest Partnership LLP v Centaur Services Ltd [2010] (see IHL181, p50) and also clearing up some of the uncertainty surrounding the validity of sub-guarantees.
K/S VICTORIA STREET V HOUSE OF FRASER
Facts
A freehold department store was acquired and transferred from one subsidiary of House of Fraser Ltd (the parent) to another subsidiary within its group. The freehold was then sold to K/S under a sale and leaseback agreement by which the parent guaranteed its subsidiary’s tenant obligations under the lease. For tax reasons the lease was completed in the name of one subsidiary company, subject to being assigned to another group company within three months.
The assignment did not take place within the agreed timeframe and K/S sought to enforce a term of the agreement to the effect that, in this event, the lease had to be assigned to a named group company (with a much stronger balance sheet) with the existing guarantor (the parent) acting as guarantor of the assignee. The parent argued that this term was unenforceable under the terms of the 1995 Act. The most significant issue before the Court of Appeal was whether the requirement for the parent to act as guarantor for the assignee was void under s25(1) of the 1995 Act, that states that ‘any agreement is void to the extent that it restricts the operation of the Act’.
Decision
The Court of Appeal confirmed that if, in a situation where an outgoing tenant’s liabilities ceased, a landlord could impose an obligation that the existing guarantor must guarantee the incoming tenant’s obligations, it would frustrate the clear purpose of the 1995 Act.
On completion of the assignment from original tenant to the assignee, the assignor would be released from its obligations as tenant under the lease (s5(2)). Section 24(2) of the 1995 Act requires that the parent, as the assignor’s guarantor, must be released to the same extent. If this were not the case, landlords would be entitled to ensure that guarantors would be in precisely the same position they would have been in prior to the commencement of the 1995 Act by creating a ‘renewal obligation’, meaning that landlords, when granting leases, could require guarantors to guarantee the liability of every successive assignee throughout the term of the lease.
Section 25 is clear that any agreement (whether it is created in the lease or in a prior agreement) is void to the extent that it would exclude, modify or frustrate the operation of the 1995 Act. This means that any term of the assignment seeking to impose on the guarantor an obligation to take on a liability from which it would have been released on assignment, would be void under s25 of the Act because it would frustrate the operation of s24 of the Act. Therefore, K/S could not require the parent to act as a guarantor of the assignee.
Leasehold commitments are often part of a group restructuring (particularly in the retail sector) and, as a consequence, landlords, tenants and administrators must be aware that the Court, in adopting this approach, has limited the commercial freedom of the parties. Section 25 of the 1995 Act is concerned with the ‘effect’ of any agreement, not the purpose behind it. For that reason, it does not matter if, in the particular case, the guarantee is freely offered by the existing guarantor: if taken contrary to the 1995 Act, it will be unenforceable against the guarantor, as in K/S Victoria Street itself.
Decision on sub-guarantees
However, landlords may be able to find a way around this issue based on the Court’s ruling on sub-guarantees. Good Harvest cast some doubt on the subject, but the Court of Appeal concluded that the tenant’s guarantor can validly guarantee the assignor’s obligations under an AGA by means of a sub-guarantee, provided that the terms of s16 of the 1995 Act (provisions relating to AGAs) are observed. In addition, the Court went further than Good Harvest by indicating that the assignor’s guarantor could act as guarantor for the liability of subsequent assignees on further assignments, that is, assignments taking place after the assignment in question.
In summary, landlords are in a stronger position than originally thought post Good Harvest, given the Court’s indication that sub-guarantees under AGAs are valid. These should achieve roughly the same effect as having the assignor’s guarantor give a guarantee in relation to the assignee’s liability for the tenant covenants under the lease.
GUARANTOR’S POSITION ON DISCLAIMER OF LEASE BY LIQUIDATOR
The facts of another Court of Appeal decision, Shaw v Doleman [2009], are fairly typical of the situations arising frequently in the current UK property market: it considers where the loss lies on the insolvency of a corporate tenant. In outline, the facts were that the landlord required the original tenant to enter into an AGA of the performance of the tenant’s covenants under the lease. The AGA was entered into in the pre-agreed form set out in a schedule to the lease. The covenant was to be effective throughout the period during which the assignee was bound by the tenant covenants in the lease.
Two years down the line, the tenant company suffered severe financial difficulties. It fell into arrears with the rent, had judgment entered against it, vacated the premises and eventually went into liquidation following a winding up order. The liquidator then disclaimed the lease.
A liquidator has a power to disclaim ‘onerous property’ under s178 of the Insolvency Act 1986 (the 1986 Act) (a trustee in bankruptcy has similar rights under s315). Section 178(4) of the 1986 Act provides:
‘(4) A disclaimer under this section – (a) operates so as to determine, as from the date of the disclaimer, the rights, interests and liabilities of the company in or in respect of the property disclaimed; but (b) does not, except so far as is necessary for the purpose of releasing the company from any liability, affect the rights or liabilities of any other person.’
The landlord sought to make the guarantor liable under the AGA. The guarantor contested liability on the grounds that the guarantee liability under the AGA terminated with the disclaimer, as the disclaimer terminated the lease.
The landlord’s case was that the guarantor’s liability was unaffected by the liquidator’s disclaimer in accordance with the express terms of s178(4)(b) of the 1986 Act. The House of Lords construed the provisions of s178 in the leading authority Hindcastle Ltd v Barbara Attenborough Ltd [1997]. It held that s178(4) meant that the disclaimer operated to determine the interest of the tenant in the disclaimed property, but not so as to affect the rights or liabilities of any other person. Therefore, even though the tenant’s interest in the property had been determined, in applyingHindcastle to a post-1995 Act lease, the Court of Appeal held that a guarantor would still be liable, as the rights and liabilities of third parties are to remain as though the lease had continued without being determined. The right of the landlord to require the guarantor pay the rent arrears and/or take a new lease therefore remained under the terms of the AGA.
Tenants in financial difficulty are likely to be in breach of covenants under the lease some time before the occurrence of any formal liquidation process. The result will be that former tenants might be liable under their AGAs to perform tenant obligations, which might not be limited to rent arrears but may also include repairing covenants. While it is theoretically possible to have specific wording in the AGA to provide that the guarantor’s liabilities will end on the disclaimer of a lease, most tenants will have pre-agreed the form of AGA by reference to a schedule in the original lease. Of course, insolvency and disclaimer are the main risks a landlord will be seeking to guard against. It is therefore unlikely that any well-advised landlord would agree to include such a proviso, although tenants might seek to have them included in negotiating the terms of the lease and related form of AGA.
SURRENDER OF THE LEASE ON TENANT’S INSOLVENCY
Yet another Court of Appeal decision – QFS Scaffolding Ltd v Sable [2010] – concerns the insolvency of the tenant and whether the lease can be treated as terminated as a result. The tenant company was struggling and administrative receivers were appointed to it. Prior to the appointment, another company (QFS) was formed with a view to taking over the scaffolding element of the tenant’s business. QFS moved into the property and commenced lengthy negotiations with the landlord for a new lease. These turned out to be abortive and no new lease was granted to QFS. Subsequently, QFS approached the administrative receiver of the tenant who executed a deed assigning the existing lease to QFS.
The landlord argued that the lease was surrendered by operation of law, that QFS had occupied the property as a tenant at will during the lease negotiations and that this tenancy had been determined by the landlord.
A lease can be surrendered by way of deed or (more informally) by operation of law. In QFS the Court of Appeal set out its interpretation of the legal principle of surrender by operation of law, which is to be inferred from the conduct of the landlord and tenant. Based on the doctrine of estoppel rather than the actual intention of the parties, the conduct must show both a handing back of the property by the tenant and an acceptance by the landlord. The Court of Appeal referred to the authorities showing that:
‘… there is no estoppel by mere verbal agreement; there must in addition be some act which is inconsistent with the continuance of the tenancy.’
The Court had to analyse the conduct of the parties and considered in evidence the following facts: the tenant had stopped using the property; QFS had been left in occupation; the tenant had not offered to pay any rent; the tenant had not acknowledged any liability for rent; the tenant had not referred to the lease in any way (including in the receivers’ report to creditors) despite being aware that the landlord was attempting to negotiate a new lease of the property with QFS.
The Court, in considering unequivocal conduct, also referred to the case of Bellcourt Estates Ltd v Adesina [2005] where the requirement that the conduct of the parties must be inconsistent with the continuation of the lease was described as a ‘high threshold’. Based on all of the factors above, the Court found that the conduct was not unequivocal. Further, in the absence of unequivocal conduct implying that the lease had been surrendered, there could be no implied tenancy at will between the landlord and QFS, as the original lease was still in existence. The landlord on this occasion was under the mistaken belief that the appointment of the receivers had resulted in the lease being forfeited and that the receivers were unable to assign the lease. On a practical note, the only sure way for landlords to have certainty is to require the tenant (acting by its receiver/administrator) to enter into a deed of surrender. However, if the tenant is in liquidation, the liquidator should be formally requested to disclaim the lease.
RENT AS AN ADMINISTRATION EXPENSE
Whether or not rent under a lease can be an expense in the administration is the difference between the landlords’ claim being paid in full, ahead of most other creditors, or remaining just an unsecured claim to be dealt with much later by the liquidator once the administration process is complete. As returns to unsecured creditors are most often in the 10-15% region or less, there is clearly an incentive for landlords to establish that they are entitled to be paid the rent under the lease as an expense in the administration and to receive the rent in full during the period of occupation of the administration company.
The High Court decided in Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2010] that the rent issue must be determined simply by whether the company in administration uses the premises for the benefit of the administration (see IHL181, p50). This means that the administrators’ calculations would have to assume payment of the full amount of the rent falling due under the lease while the company in administration uses the premises. This is the case even if only a small part of the premises are being used. In Goldacre the court did not follow Atlantic Computer Systems Plc[1991] that decided (albeit, in a case about equipment leases) that the landlords’ claim to rent has to be balanced against the interests of the creditors as a whole.
However, administrators will not necessarily accept the Goldacre approach. There is a respectable argument that Goldacre was incorrectly decided and the precedent in Atlantic Computershould have been followed: some administrators will be alive to this point. It follows that there is a real possibility that the ‘rent in administration’ issue may come before the courts again, and there are quite a few experts who believe that if it does, it might well be decided differently. That would put landlords in a worse position on their tenants’ administration: the position should therefore be treated with caution.
CLAIMING RENT AS AN ADMINISTRATION EXPENSE
In the Woolworths administration (Re WW Realisation 1 Ltd (In Administration) [2010]), a significant percentage of private landlords and local authority landlords failed to contact the administrators in order to claim rent due under their leases. As a result, the administrators applied to the court and obtained an order permitting them to impose a cut-off date for the landlords’ claims. The court allowed the administrators to make a final distribution to creditors after allowing 28 days from the sending of a final letter to the potential ‘rent as expense’ claimants notifying them of the court order. Those claiming rent as an expense after the cut-off date lost their entitlement. The court was prepared to make the order, noting that the potential claimants were commercial landlords who could be expected to look after their own commercial interests and understand insolvency procedures.
CONCLUSION
Clearly, this is a complex and developing area and going forward, issues relating to the insolvency of tenants will be cropping up frequently in the retail and other sectors. It will be essential for all involved – landlords, tenants and administrators – to fully understand their legal position.