Legal Briefing

Administrators, landlords and tenants: three key cases

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Finance | 01 June 2010

Since the introduction of the Insolvency Act 1986 (the 1986 Act), there has been a standard way of dealing with the leasehold premises of a company in administration as part of the sale of the business. Typically, the business sale agreement provides for the purchaser to occupy the leased premises on the basis of an informal licence.

The sale agreement places the onus on the purchaser to obtain the landlord’s consent to the assignment of the lease. It also provides that the consequence of this formal breach of the lease is to be at the risk of the purchaser alone.

In the majority of cases, this method of dealing with the company’s leased business premises is effective because the landlord will prefer to have the purchaser or assignee in occupation paying the rent and will usually work with the purchaser to formalise the assignment of the lease.

In the days before the prevalence of pre-pack sales, administrators would usually have time to contact the landlord and explain their plans for the premises. However, when the sale is a pre-pack the landlord is sometimes left in the dark. Consequently, landlords can be taken by surprise in discovering that their tenant is in administration, its business has already been sold and that the purchaser is in occupation of the premises under an informal licence granted by the administrator.

Innovate Logistics Ltd v Sunberry Properties Ltd [2008]

This was the situation confronting Sunberry Properties Ltd, the landlords of several acres of cold store warehouse premises let on a 30-year lease at a substantial annual rent, following an administration order made in relation to their tenant, Innovate Logistics. A pre-packaged sale of the frozen food, warehousing and distribution business to the purchaser was completed immediately after the making of the administration order. The landlords’ reaction was to apply to the same judge who had made the administration order, seeking permission to start proceedings for immediate termination of the licence granted to the purchaser. The judge gave the landlords permission under paragraph 43(6) of Schedule B1 of the 1986 Act to start legal proceedings. The administrators then applied to the Court of Appeal.

It was surprising that the first instance judge gave leave to the landlords to bring these proceedings because it seemed to undermine the purpose of the administration order, which was to preserve the business by its sale as a going concern and the collection of its book debts, which had been retained by the company and excluded from the sale. Because the purchaser had taken over the premises, it was able to continue to provide services (in the storage and distribution of frozen food) to the customers of the business, which would enable the administrators to continue to collect outstanding book debts of about £8m. Without those arrangements, the book debts would be uncollectable and there would be a detriment to the majority of the company’s creditors. Apparently, owing to a misunderstanding, these facts were not before the first instance judge when he gave permission to the landlord to sue the company in administration.

When dealing with this type of conflict between one particular creditor and the body of the creditors, the court is supposed to carry out a balancing exercise, as referred to in the leading case of Re Atlantic Computer Systems plc [1990]. In Atlantic Computer Systems the burden should have been on the landlords to make out their case that it would be inequitable for them to be prevented from commencing the intended proceedings. In carrying out the balancing exercise, the court would be expected to compare the financial loss suffered by the landlords if permission to commence the proceedings were refused, with the loss that would be suffered by the body of the creditors if permission were given.

In Innovate the Court of Appeal noted that, unlike Atlantic Computer Systems, the landlords were not seeking to repossess the premises because of non-payment of rent. The landlords wanted the purchaser to remain in possession as their tenant under an assigned or new lease rather than being in occupation under the informal licence. However, the landlords were being paid the monthly passing rent and were also in a position to grant a formal licence to occupy. In other words, there was no significant detriment to the landlords compared to the detriment to the body of creditors. On the other hand, if the landlords had been allowed to start proceedings to terminate the licence, this would have disrupted the business under the management of the purchaser with the result that there would have been great difficulty in collecting the outstanding debts owed to the company. That would be detrimental to the body of the creditors.

The Court of Appeal allowed the administrators’ appeal and dismissed the landlords’ application. This decision was practical because it enabled the administrators to achieve the purpose of the administration, and permitted the sale of business and the transfer of premises to the buyer in the short time period required by the insolvency of the seller. Despite this decision by the Court of Appeal, in Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2009] HHJ Purle QC took an approach that is much less helpful to administrators in selling businesses.

Goldacre

The facts in Goldacre were that the company in administration had two long leases on its premises, both of which pre-dated the administration. The administrators were using a relatively small part of the premises, in respect of both of the leases, for the conduct of the administration. The administrators had paid rent and accepted that they owed interest on late payment of rent. The main issue before the court was the question of future rent. The landlord’s counsel submitted that an established line of case law meant that, because of their continued use of the premises, the administrators were liable to pay the rent as it fell due as an administration expense. Most of the cases cited in support of this argument concerned companies in liquidation. HHJ Purle QC noted the similarity of the wording relating to the priority of expenses of Rule 2.67 and Rule 4.218 of the Insolvency Rules 1986 (the 1986 Rules), which apply to administrations and liquidations respectively. The House of Lords considered Rule 4.218 in Re Toshoku Finance UK plc [2002], holding that the expenses regime set out in the 1986 Rules is mandatory and applies to both administrations and liquidations. The House of Lords’ decision in Toshoku concerned corporation tax and considered the liquidation expenses principle, which is sometimes referred to as the Lundy Granite principle or the salvage principle.1 Submissions in Goldacre also included references to case law on whether a liquidator who retains property for the purpose of disposing of it has to pay rent as an expense in the liquidation.

In Goldacre HHJ Purle QC took the view that the rent for the two long leases fell within Rule 2.67(1) of the 1986 Rules under either (a) as ‘expenses properly incurred by the administrator in performing his functions in the administration of a company’ or (f) as a ‘necessary disbursement by the administrator in the course of the administration’. HHJ Purle QC was not impressed by the argument of the administrators that the company in administration should pay a proportionate rent based on the small part of the premises that they were occupying for the purposes of the administration. He considered the decision of the Court of Appeal in Innovate, noting that it gave a clear indication that the issue of what the administrators should pay should be approached flexibly. However, he said that this approach was adopted as a result of a concession and, therefore, the Court of Appeal’s decision did not strictly bind him to a similar approach. HHJ Purle QC also pointed out that in Innovate the Court of Appeal did not consider the judgment in Toshoku or the case law relating to the Lundy Granite principle. He also pointed out that the decision in Toshoku had rejected the application of the Atlantic Computers Systems approach in other cases.

In summary, the Goldacre judgment is complex and delves back into various cases concerning liquidation expenses. There is a respectable view that HHJ Purle QC did not place enough emphasis on the Atlantic Computer Systems approach, as adopted in Innovate. HHJ Purle QC held that rent under both long leases would continue to be payable as an administration expense, quarterly in advance, under the terms of the two leases for so long as the administrators retained or used any part of the premises for the benefit of the administration. The only way that the administrators could get out of this liability as an expense of the administration would be to vacate the demised property entirely.

This decision clearly leaves a very large question mark over the ability of administrators to retain premises and will cause significant difficulties in the planning of business rescues using the administration procedure. Landlords as an interest group might regard this decision as a good one, but this would be a short-sighted view to take as a less flexible mechanism for business rescue will result in more businesses going to the wall.

Good Harvest Partnership LLP v Centaur Services Ltd [2010]

A parent company will often give a guarantee in relation to a subsidiary’s liabilities as tenant under a lease. It is fairly standard practice for leases to incorporate guarantor provisions, under which the guarantor agrees to guarantee all the liabilities and obligations of the tenant under the lease, including the authorised guarantee agreement (AGA). Good Harvest Partnership LLP v Centaur Services Ltd [2010] raised the question of whether the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act) precludes a guarantor of a tenant’s obligations under a lease from being required to give a further guarantee in respect of an assignee of the lease.

The landlord granted an underlease to the tenant for a term of ten years. The tenant’s guarantor, Centaur Services (Centaur) was also a party to the underlease. In September 2004 the tenant assigned the underlease to Total Home Entertainment Distribution Ltd (the assignee). The same day, the landlord, the tenant and Centaur entered into an authorised guarantee agreement (AGA). The AGA recited that the landlord had agreed to grant the tenant a licence to effect the assignment to the assignee, subject to the tenant and the assignee entering into a formal licence, and the tenant and Centaur entering into the guarantee agreement. The guarantee agreement contained a provision under which the tenant and Centaur each covenanted with the landlord that the assignee would pay rent and perform the lessee covenants ‘from the date of the assignment to the assignee until the next lawful assignment of the underlease’.

Subsequently, Good Harvest acquired the freehold and became the assignee’s direct landlord. Good Harvest commenced proceedings in June 2009 against Centaur under the guarantee agreement to recover rent due for the period 25 December 2008 to 25 March 2009. If found liable, Centaur as guarantor would be liable for the rent and other liabilities to the expiry of the lease in July 2011.

Newey J decided that s25 of the 1995 Act prohibited Good Harvest’s claim against Centaur. Among his reasons were as follows:

  1. parliament intended that the guarantor should be relieved of any liability on the assignment of the lease;
  2. the requirement that the guarantor enter into a further guarantee on the assignment of the lease would ‘frustrate the operation of the 1995 Act’; and
  3. there was no indication in s16 of the 1995 Act that an AGA can include a guarantee from anyone other than the tenant.

It follows from this decision that any attempt by a landlord to withhold a licence to assign to a proposed assignee, on the condition the existing guarantor is required to guarantee the AGA, will be unlawful and ineffective. However, landlords are still entitled to require the proposed assignee to provide a satisfactory guarantor and, if one is not forthcoming and the assignee appears to be of doubtful financial standing, to withhold licence to assign.

Conclusion

The result of these three recent cases could be summarised as: Administrators 2 – Landlords 1, although a more sophisticated analysis would be that the courts have tended to uphold the rescue culture. Goldacre is the exception, although it appears to be open to challenge on the basis that the flexible approach set out in Atlantic Computer Systems is more appropriate to the payment of rent by companies in administration. Arguably, and with respect, HHJ Purle QC should have given more recognition to the fact that administration is intended to be a business rescue mechanism rather than a procedure for winding-up the business. It remains to be seen whether the difficulties anticipated to result from the decision in Goldacre will be put right in subsequent cases or whether the issue will be regarded as serious enough to require legislative intervention.