Commercial leases and liquidators’ rights

Despite recent improvements in rent collections, Remit Consulting reports a remaining £7bn shortfall in commercial rent collection. When rent and forfeiture relief measures expire this spring, distressed assets may increase. Should that happen, what are the disclaimer powers of liquidators for insolvent tenants, and the consequences for commercial leasing transactions? The power A liquidator undertaking either a voluntary or compulsory liquidation of a corporate tenant (or the trustee in bankruptcy of an individual tenant) has the power to disclaim the tenant’s onerous property by giving notice (in statutory form). The disclaimer powers and rules are prescribed by the Insolvency Act 1986 and the Insolvency Rules 2016. If property is disclaimed, the rights, interests and liabilities of the insolvent entity in, or in respect of, that property are brought to an end from the date of the disclaimer. Even if a liquidator or trustee has taken possession of the property, or already tried to sell it, they can still decide to disclaim that property. This power of disclaimer can create uncertainty for those interested in that property. Therefore, the Act allows those interested parties to serve notice requiring a disclaimer decision within a fixed period of 28 days from receipt of notice. The liquidator or trustee can seek a court-sanctioned extension of the 28-day period. The focus The power to disclaim applies to any property within the insolvent tenant’s ownership that has no value, and for which there is an obligation to perform some onerous task. Leases, licences and agreements for lease fall firmly within the definition of “onerous property” in the Act as a consequence of tenant covenants to maintain and repair the property and to pay rents. However, any disclaimer must relate to the whole of the property. Leases may be disclaimed even if they have been terminated – whether by expiry of the lease term or forfeiture – in order to extinguish any contingent or continuing liabilities under them. The liquidator or trustee will need to establish whether the property is onerous or capable of being realised to provide funds for creditors, but also to assess whether any imminent liability is likely to accrue to the insolvent estate, or to them personally, if they delay disclaimer. Decisions and restrictions The decision to disclaim property results from exercise of the liquidator’s powers of management and administration of the estate. Within seven business days from the disclaimer, the liquidator or trustee must serve a disclaimer notice on: anyone claiming a proprietary interest in the property; anyone (eg, a guarantor) who would remain liable notwithstanding disclaimer; for leasehold property, anyone claiming under the company or bankrupt as a subtenant or mortgagee; and for a dwelling house, anyone in residential occupation. A court will not usually intervene once the liquidator has decided to disclaim. However, once a disclaimer notice has been issued, a party may, in certain circumstances, apply to the court for an order vesting the property in them if they fall within one of the above categories. This application must be made within three months or the earlier of: (i) the date that the applicant received a copy of the disclaimer notice from the liquidator or trustee; or (ii) the date it became aware of the disclaimer. A vesting order usually puts the disclaimed lease into the hands of the relevant party on the same terms as those to which the insolvent tenant was subject, at the time of the winding-up. That relevant party would remain liable for antecedent breaches of covenant and payment of rent arrears under the vested lease. The effect Disclaimer brings the tenant’s liability under the lease to an end. However, the rights and liabilities of any other party are not affected, except as might be necessary to release the insolvent estate and the insolvent entity. Therefore, although the lease no longer exists between the landlord and tenant, the relationship is theoretically preserved as a notional lease in order to keep any obligations on the part of a guarantor or other relevant third parties alive. This means that, notwithstanding disclaimer, the rights and liabilities of: any unreleased guarantors; the original tenant (if not the insolvent party) under an “old” (pre-1996) lease; (subject to statutory notice requirements) former tenants subject to AGAs; and (subject as above) sub-guarantors of those former tenants remain in place as though the lease had continued and not been determined. Additionally, if the lease is held by joint tenants, the disclaimer will not discontinue the liability of any remaining solvent joint tenant. And, depending on its terms, the landlord may still have recourse under any collateral rent deposit arrangement for financial losses incurred as a result of the disclaimer. Consequently, disclaimer can have significant, adverse implications for a guarantor who will, in all likelihood and in the absence of express exclusion drafting, remain on the hook for the financial impact of the disclaimer and/or will be subject to obligations to take up a new lease. Leases and lease guarantors On disclaimer, if a disclaimer is unchallenged and no vesting order is made, the lease determines and the landlord becomes entitled to immediate possession. If the tenant stays in the property after disclaimer, it will be a trespasser. The landlord should pause for consideration before deciding to take possession. If the landlord does not take possession, the notional lease referred to above will continue, as will the landlord’s right to claim under it. However, when the landlord takes possession, that notional lease comes to an end, as do the third-party liabilities that it preserved. From that point the landlord can no longer claim against any guarantors or other third parties for unpaid rent or other tenant breaches, or require any guarantor to take up a new lease under the terms of its guarantee. The landlord will suffer loss or damage following disclaimer, most likely from outstanding and/or future rent. And so, statute deems the landlord (and anyone else suffering loss or damage as a result of the disclaimer) a creditor of the insolvent estate, to the extent of that loss or damage. A lease guarantor remains liable under the terms of the guarantee. Where the landlord has served notice under section 17 of the Landlord and Tenant (Covenants) Act 1995, this liability will include the payment of rent and service charge under the determined lease until the landlord physically takes possession. The landlord is under no duty to exercise its right to possession. Authorised guarantee agreements A former tenant of a post-1996 tenancy who has provided an AGA remains liable for ongoing obligations to pay rent and observe tenant covenants under the disclaimed lease. In Doleman v Shaw [2009] EWCA Civ 279; [2009] 2 EGLR 35, the AGA was expressed to remain in force only for “the period during which [the company] is bound by the tenant covenants in the Lease”. Although the AGA tried to limit the guarantor’s liability to coincide with the tenant’s liability, the court held that the guarantor under an AGA remains obliged to perform the tenant’s covenants following disclaimer. Modern AGAs usually contain a landlord’s put option to require the former tenant to take a new lease. Following disclaimer, the landlord will retain its put option against any guarantor, even if it enters the premises to carry out inspections and begins to market the premises. Where the guarantor takes up a new lease of the premises, the remaining term of the disclaimed lease will vest in the guarantor. Business rates liability mitigation will be a key factor in the landlord’s exercise of the put option, which will remove any suggestion that the landlord has re-taken occupation. Additionally, a property with no lease in place, subject to guarantee payments instead of rent, may not be a very marketable investment. Right for guarantor to call for a new lease Unlike the landlord, the guarantor does not have an immediate right to possession of the premises on lease disclaimer. It can, however, exercise its statutory right under section 19 of the 1995 Act to call for an overriding lease, giving it an immediate right to possession. Exercise of this right does not by itself relieve the guarantor from liability for tenant’s default. Relief will require the guarantor to make full payment of all amounts, which it has been duly required to pay in accordance with section 17 of the 1995 Act (including rent, service charge and interest under the determined lease until physical possession). However, it does allow the guarantor to take control of the premises, and limit future exposure to liability by onward alienation of the lease. Any such call by the guarantor must be made within 12 months of the date of payment pursuant to section 17 of the 1995 Act. Rent deposits The landlord of a disclaimed lease will be strenuously seeking to secure financial recovery, and will turn to existing rent deposit arrangements. Landlords need to exercise caution where the rent deposit is based within the lease itself – disclaimer of the lease may automatically result in a disclaimer of the rent deposit. However, a liquidator may not disclaim a rent deposit if contained in a separate deed. A guarantor joined as a party to the lease and rent deposit deed will be contractually bound, following disclaimer, to support the tenant’s liability under the rent deposit deed (including the obligation to top up the deposit balance following drawdown). Sub-tenants Following disclaimer, any sub-tenant will remain entitled to possession of the premises under its sub-lease if (and so long as) it pays the rent and performs the tenant covenants in the disclaimed lease. That may mean complying with more onerous covenants in order to remain entitled to possession. If the subtenant continues to comply only with different or less onerous sub-tenant covenants, the landlord will be entitled to forfeit. If the landlord brings forfeiture proceedings, the sub-tenant can apply for a vesting order. Beware! Surety obligations should be entered into with full appreciation of potential ongoing liability beyond the lease’s existence. If the parties intend guarantor liability to determine on lease disclaimer, this must be agreed and documented. Landlords should also beware. Rights against guarantors can provide a lifeline, but require accurate and timely exercise of notices. Failure to heed statutory timelines could have dire financial consequences. Anna George is an associate in the real estate department and Chloe Potter is an associate in the banking and finance department at Baker McKenzie