When CVAs aren’t always clear cut

This year, landlords have increasingly had to deal with the issues posed by insolvent tenants. In order to address mounting tenant arrears, one of the first solutions a landlord might reach for is the rent deposit. But is it safe to do so when your tenant is insolvent? In this article, we explore different insolvency scenarios and give some practical tips for what landlords should be thinking about. What is a rent deposit and what forms can it take? A rent deposit can take many forms. It will usually involve a sum of money provided by the tenant to the landlord which can be drawn on by the landlord in the event of the tenant’s breach of obligations in the lease. Typically, a landlord will be looking to the deposit where there is a shortfall of sums relating to rent, service charge, or insurance. Some of the more common ways in which a rent deposit will be structured include: A. money which is paid and belongs to the landlord and is held in a separate account; B. money which is paid to the landlord, but continues to belong to the tenant, who charges it in favour of the landlord; and C. money which is paid to the landlord who holds it on trust for the tenant. A rent deposit may also be classified as a “financial collateral arrangement” under the Financial Collateral Arrangements (No 2) Regulations 2003, for example, if the rent deposit creates a charge and the landlord has control of the rent deposit account. My tenant is insolvent. Do I have the right to drawdown on the rent deposit? The way in which the deposit is structured is key to how the landlord can access the money on the tenant’s insolvency. The starting point for the landlord is always to look at the specific terms of its rent deposit deed with the tenant. These terms should be considered in light of the insolvency process that the tenant is undergoing, which will normally be one of the following: company voluntary arrangements; administration; and liquidation (compulsory or voluntary). (A) Where the rent deposit monies clearly belong to the landlord and not the tenant In this scenario, generally the tenant’s insolvency will not affect the landlord’s rights to drawdown on the deposit. The key exception is where the deposit is held as stakeholder by a third party, in which case a legal analysis should be undertaken to assess the extent to which the tenant can assert it has a beneficial interest in the deposit money. (B) Where the rent deposit belongs to the tenant, but the deposit is charged to the landlord The landlord’s rights depend on which insolvency regime applies: CVAs: as a secured creditor, the landlord will be able to drawdown on the deposit despite a CVA being proposed or passed, unless the landlord specifically agrees that it cannot via the terms of the CVA. Administration: on administration, an automatic statutory moratorium under the Insolvency Act 1986 applies to actions taken against the insolvent tenant company. Therefore, unless the landlord holds the deposit monies as part of its general funds, a landlord will generally need either the administrator’s consent (which is often forthcoming) or court permission before drawing down on the deposit. However, if FCAR applies, the landlord will not need consent before drawing down. Liquidation: unlike administration, there is no prohibition on a secured creditor from exercising its security in the case of a voluntary or compulsory liquidation, so it is free to drawdown on the deposit. However, if it’s necessary for the landlord to commence proceedings against the tenant company in order to effect that drawdown, the landlord will need to apply to court for permission to do so. (C) Where the rent deposit is held by the landlord as trustee on behalf of the tenant In this case, the position is not so clear although it is generally thought that a landlord can make deductions from the deposit despite the tenant’s insolvency. There is an argument that the deposit money forms part of the tenant’s insolvent estate, and that therefore an insolvency practitioner has a right to claim against the landlord for the full rent deposit. However, even if the insolvency practitioner exercised that right, if the tenant is in arrears, the landlord should be able to raise a defence of equitable set-off to avoid having to pay the rent deposit back to the insolvent tenant. Closing thoughts Landlords should not underestimate the power of rent deposits. Often, a well-timed drawdown can make the difference in recovering thousands of pounds worth of arrears. Whether it is a good idea to do so can be very fact-specific, so landlords are well advised to seek expert advice as soon as they learn that a tenant may be entering into an insolvency process. Common questions raised by landlords regarding rent deposits when faced with an insolvent tenant 1. My tenant has proposed a CVA. Should I drawdown on the rent deposit? In a tenant CVA scenario, a landlord should strongly consider drawing down on any rent deposit prior to the CVA coming into effect. Tenant CVAs are increasingly imposing on landlords a release of all outstanding tenant’s arrears. For example, even if the landlord has a claim against the tenant for £100,000 of rent arrears, once the CVA is approved this will typically be written off as part of the CVA’s terms. A landlord should look first to any notice period that may be required, in case it runs out of time to give sufficient notice prior to the CVA being approved. If the landlord can drawdown on the deposit before the CVA is approved – often there is a window of around 14 days between the proposal being made and the vote to approve the CVA – the landlord could avoid its claim for the arrears being extinguished. A landlord will need to seek advice and act quickly given that it will typically have around 14 days to consider and vote on the CVA proposal. 2. My tenant is entering into administration. Should I drawdown on the rent deposit? The headline point for landlords with a tenant facing administration is that ordinarily they should not drawdown on any rent deposit, unless there are good fact-specific reasons for doing so. This is because a landlord will usually be entitled to be paid rent by the company in administration if the administrators are “beneficially occupying” the property for the benefit of the administration. A lesson in how a landlord should not proceed can be gleaned from Re London Bridge Entertainment Partners LLP (in administration) [2019] EWHC 2932 (Ch). In that case, the landlord held a tenant’s deposit of more than £2m, which was placed into a separate account in the landlord’s name. The tenant company went into administration, continued to use the premises and failed to pay a month’s rent. The landlord drew on the rent deposit to settle these arrears, but the tenant company failed to replenish the rent deposit. The High Court ruled that the tenant’s obligation to top up the rent deposit was not payable as an expense of the administration, even though the property was generally being used for the benefit of the administration. This means that the landlord would have been better off had it held onto the rent deposit and used this for other sums (eg dilapidations) while simply claiming rent from the administrators as an administration expense in the normal way. 3. My tenant was undergoing liquidation, but has now disclaimed the lease. What can I do with the rent deposit? In this scenario, a landlord can still generally recoup all of its existing arrears from the rent deposit. If there is a balance remaining in the deposit after the landlord draws down to cover the tenant’s arrears, the terms of the rent deposit deed may also say that the landlord can keep some or all of the remainder to cover its costs. However, landlords should be aware that the liquidators can challenge this on the basis that it is a “contractual penalty”. Jordan Walsh is an associate at Ashurst Picture © Isopix/Shutterstock