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Insolvency and Unpaid Rent: Closing of a Loophole

About The Author

Thomas Horton (Former Writer)

Thomas studied Law at the University of Birmingham, and graduated with a 2:1 in July 2013. In the elapsed time, Thomas has worked for law firm HowardKennedyFsi LLP as a paralegal in the property department. Thomas has also been awarded a Major Scholarship by the Honourable Society of the Inner Temple and will begin the BPTC with City Law School in September 2014.

The Court of Appeal recently decided on an area of concern for commercial landlords, namely the continued enjoyment of the landlord’s premises during the tenant’s administration, and the determination of who should be liable for rent during the administrator’s occupation of the premises.

Commercial Context

Pre-pack administrations are arrangements where the sale of all or parts of a company’s business or assets are negotiated with a purchaser prior to the appointment of an administrator. Once appointed, the administrator immediately actions this sale to the purchaser.

In light of popular high street names going into administration during the recession (Woolworths, Game Station, Comet, Jessops, Blockbuster), pre-pack administrations have become extremely popular, creating what is known as a “rescue culture”. The use of a pre-pack administration is advantageous to the company as it allows trade operations to continue up until the point of administration, with the profitable parts of the company then being transferred to the selected purchaser. There are several benefits to this method, as it ensures a good price is paid for the company going into administration (which is good news for creditors) in addition to maintaining good business and securing jobs. It will often be the intent of the new purchaser to take on the profitable stores, and close down stores weaker in financial performance.  For further information on the standards required for pre-pack administrations, please refer to the Statement of Insolvency Practice 16.

The Problems and Legal Analysis

Pre-pack administrations have caused areas of concern for commercial landlords, mainly because the process does not fit with commercial leases. Firstly, the new purchaser, when in occupation of the premises, is likely to be in breach of covenant contained in the lease, as there would not have been an executed licence to assign for their occupation. However, in such instances the landlord is unable to forfeit the lease, in accordance with Schedule B1 Paragraph 43(4) of the Insolvency Act 1986.

Secondly, a further problem has developed from the decision in Leisure (Norwich) II Ltd v Luminar Lava Ignite Ltd, which decided that the rent payable in advance on retail premises occurring prior to the administration is not recoverable by the landlord as an administration expense, i.e. an expense that is payable by the appointed administrator (see Schedule B1 Paragraph 99 of the Insolvency Act 1986 and Rule 2.67 of the Insolvency Rules 1986). In summary, HHJ Pelling QC held in Luminar (paragraph 24):

The outcome of the issue I have to resolve depends upon the application of the fundamental distinction to be drawn between an obligation to pay rent that arises while the lease is being retained by a liquidator or administrator for the purposes of the insolvency procedure and an obligation that arises prior to the commencement of the insolvency process. In this case, since rent was in each case payable in advance and had fallen due for payment before the commencement of the administration, it is not recoverable as an administration expense.

Is it fair, therefore, that if a company, paying rent quarterly, goes into administration on 26th March, when rent is due payable (some £10 million) on the 25th March, that the landlord would not be able to recover that rent? By waiting a number of days (until after the rent was payable), based on the previous authorities, administrators are able to avoid the cost of the payment of rent in advance. This, therefore, would mean that the administrator would be receiving the benefit of the premises for three months without rent. This was the factual scenario seen in the Court of Appeal’s decision of Jarvis v Pillar Denton Ltd (Game Station), and what a collection of commercial landlords were appealing against.

HHJ Pelling QC’s decision in Luminar was made in application of the decision in Goldacre (Offices) Ltd v Nortel Networks UK Ltd. The landlord in this case (Goldacre) brought an action against the respondent company for the rent of business premises to be paid as an administration expense. This case differed to Jarvis and Luminar, as it referred to the administrator’s liability to pay rent due during the period of administration as an administration expense. There were two long leases, pre-dating the administration. The company went into administration, and upon their appointment, the administrators used part of the business premises for efficient conduct of the administration. The parts not being used by the administrators were receiving rent payments from sub-tenants, which were accordingly passed onto the landlord. The issue, therefore, was whether rent for the part occupied by the administrators for the purpose of the administration should be paid as an administration expense. HHJ Purle QC held that the administrators should be liable for the payment of the rent as an administration expense in application of the Lundy Granite principle (a full explanation of which is available from this informative article from Tanfield Chambers). The Lundy Granite principle is, as James LJ held in the case from 1871 (citation: 1870-1871 LR 6 Ch App 462):

… [I]f the company for its own purposes, and with a view to the realisation of the property to better advantage, remains in possession of the estate, which the lessor is therefore not able to obtain possession of, common sense and ordinary justice require the court to see that the landlord receives the full value of the property.

HHJ Purle QC also went on to decide, in the same judgment, that any rent payments that became payable during the administrator’s continued occupation would result in their liability for full payment as an administration expense:

… [A] liquidator electing to hold leasehold premises can do so only on the terms and conditions contained in the lease, and that any liability incurred while the lease is being enjoyed or retained for the benefit of the liquidation is payable in full as a liquidation expense. The same principle in my judgment applies in an administration.

Accordingly, the premise of the Lundy Granite principle was determined; if the rent falls due before the appointment of the administrator, then the rent will not be payable as an administration expense, even though the administrator can proceed to use the premises for administration purposes. If the rents falls due after the appointment of the administrator, then the rent for the entire time period it covers is payable as an administration expense.

The appeal in Jarvis challenged this standing of the law; the landlord on appeal in Jarvis wanted the Lundy Granite principle to extend to the rent that fell payable prior to the appointment of the administrator to be payable as an administration expense, rather than being a debt in the administration.

The appeal and cross-appeal were allowed. Returning to the equitable basis of James LJ’s formulation of the Lundy Granite principle Lewison LJ held that [at paragraph 82]:

… [C]ommon sense and ordinary justice require the court to see that the landlord is paid. What he is to be paid is again not described by reference to the days on which rent falls due for payment. What he is to receive is the “full value” of the property. Where the property is held under the terms of a lease the full value will be taken to be the rate of rent reserved by the lease. I cannot see why common sense or ordinary justice should be defeated by the happenstance that a rent day occurs immediately before the date of entry into administration if the rent falling due on that day covers a period during which the administrator retains possession of the property or the benefit of the administration.

The Lundy Granite principle informed the court’s interpretation of the Insolvency Rules 1986, which contains a complete list of what ranks as an expense of the insolvency process (for which the rent payments would fall into either Rule 2.67(1)(a) or (f)) (see Lewison LJ at paragraph 77). The equitable finding of the Lundy Granite principle, correctly applied (with common sense and ordinary justice) would determine the administrator liable for the rent payment. The comments of Lord Hoffman in Re Toshoku Finance UK Plc. (at paragraph 29) were affirmed:

The principle ... is thus one which permits, on equitable grounds, the concept of a liability incurred as an expense of the liquidation to be expanded to include liabilities incurred before the liquidation in respect of property afterwards retained by the liquidator for the benefit of the insolvent estate.

Accordingly, the Lundy Granite principle was not formulated in a manner dependent upon what dates rent payments fell due, but it was formulated in reference to the period of which the landlord’s premises was used to the occupant’s advantage (see paragraph 44 of Lewison LJ’s judgment). Lewison LJ went on to state at paragraph 101:

The true extent of the principle, in my judgment, is that the office holder must make payments at the rate of the rent for the duration of any period during which he retains possession of the demised property for the benefit of the winding up or administration (as the case may be). The rent will be treated as accruing from day to day. Those payments are payable as expenses of the winding up or administration. The duration of the period is a question of fact and is not determined merely by reference to which rent days occur before, during or after that period.

The decision of the Court of Appeal has remedied an area of law that was left in an unsatisfactory state following the decisions of Goldacre and Luminar. The common sense and ordinary justice of the court has determined that landlords will, quite rightly, be paid rent for the duration of beneficial occupation by the administrator of the commercial premises used for administration purposes.

Admittedly, this deal is not as sweet for administrators who were previously able to have beneficial use of the premises free of charge. Yet with continued economic growth being seen in the United Kingdom, the decision is perhaps another signal of the end of a bleak financial crisis. Further, the calculation of the rent on a day to day basis is an application of ‘common sense’ to the benefit of the administrators, which is particularly advantageous where rent payments were originally agreed to be paid quarterly.

The effect that the decision is likely to have upon the use of pre pack administrations is yet to be seen; however, it is difficult to see how one can argue against the payment of premises they have had the benefit of occupying. It is hoped that, if further high street names are to go into administration, the use of pre-pack administrations is not deterred from, following the Court of Appeal’s decision. The effect of holding administrators liable for the payment of the rent during their beneficial occupation is likely to have the financial implications of resulting in additional stores of the rescued brand being closed, and in turn, more jobs and profitability lost.

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Tagged: Commercial Law, Property Law

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