Legal Briefing

Rent in administration proceedings: a headache for landlords

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Insurance | 01 May 2013

An important area of insolvency law – the liability of a company in administration to pay the rent under the lease of its premises – which until recently had been relatively clear and straight forward, is currently in an unsatisfactory state. This was not always the case, as, until quite recently, landlords and administrators could easily assess where they stood under the flexible approach that prevailed for many years. Unfortunately, as occasionally happens with insolvency law in the UK, a relatively minor change in the law leads to a re-examination of the position. The matter comes before the court, which feels constrained to interpret the law in a way 
that leads to an impractical result. There then follows a clamour for a change to the law. It is a pattern that we have seen several times before. 


BACKGROUND: THE FLEXIBLE APPROACH

Until the case of Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2009] the law was easy to understand and, this writer would suggest, practical and reasonably fair to both landlords and tenants. If a tenant went into administration and the administrators intended to use the leasehold premises, they expected to pay the rent for the period of their use and occupation apportioned on a daily basis, as an expense in the administration. In simple terms, that means it has priority over most other claims, including the administrators’ own remuneration and expenses, except claims under a fixed charge. If rent accruing due up to the day of the appointment of the administrators was unpaid then the landlords had to accept that the arrears were an unsecured claim against the tenant in administration ranking equally along with all the other unsecured creditors of the administration company. The administrators would not expect to pay rent for a period longer than the actual occupation of the premises by the company in administration and nor would the landlord expect to receive rent in that respect. The rent payable under the lease was apportioned on a daily basis according to the period of occupation for the benefit of the administration, which meant that if the administrators stored stock, goods or furniture at the premises then they would have to pay the rent for the period of such storage use. Equally, if the lease had a value and the administrators marketed the premises with a view to selling the lease for the benefit of the administration, then they had to pay the apportioned rent for the period of the marketing until a sale of the lease. This pay-as-you-go approach was perhaps not so popular with landlords who often felt that the tenant in administration was gaining an excessive benefit at their expense. They felt that it was all very well to be paid rent for the period of the administrators’ use of the premises, but it was unfair that the administration moratorium prevented the landlord from retaking possession of the premises for breach of the lease constituted by unpaid arrears of rent.

The law says that the landlord can only forfeit the lease of a company in administration with the consent of the administrators or with the permission of the court. ‘Administration expenses’ were not defined as such under the old law, but s19 of the Insolvency Act 1986 (effectively repealed in relation to most cases by the Enterprise Act in 2003) referred to debts or liabilities incurred by the administrators which were to be paid ahead of their own remuneration out of the floating charge assets. The balancing exercise which the court was obliged to carry out between the competing interests of the landlord and the creditors as a whole was established in the Court of Appeal’s decision in Re Atlantic Computer Systems plc [1992]. That case concerned equipment leases rather than a lease of land, but the principle of the balancing exercise was applicable to leases of land. The balancing of the landlord’s interest as a creditor against the interests of the administration and the other creditors as a whole was at the heart of the flexible approach. If the administrators could show that retention of the premises was necessary for achieving the purpose of the administration, then the court would usually allow the administrators to retain possession, usually (but not always) on condition that the administrators caused the rent to be paid as an expense in the administration for the period of the administration company’s occupation and/or use. The court could exercise its discretion in another way: by ordering rent to be payable out of the proceeds of sale of the business and assets of the administration company, the court could affect the timing of the payment of rent to give a breathing space to the administration company.

The law was thus clear but also flexible depending on the circumstances and was easily applied in practice, so that disputes over the amount of rent to be paid were rare. The Re Atlantic Computers approach could also be applied to service charge and dilapidations as well as to rent. However, landlords were concerned that this flexible approach worked against them and in favour of the administrators in two main ways: firstly, the rent accrued and owing on the date of the appointment was an unsecured claim and secondly, the administrators were only prepared to pay an apportioned rent in relation to the space they occupied if that was less than the whole premises demised by the lease. It was this issue which caused the landlord in Goldacre to seek an order that the administrators should pay the rent due in respect of the whole of the premises comprised in the lease, although they were in occupation of only a part of the premises.

CHANGES TO THE LAW

In 2003, the Enterprise Act introduced a number of changes to the Insolvency Act 1986 and the Insolvency Rules 1986, including one important change to the issue of rent: it introduced for the first time an order of priority for payment of ‘expenses in the administration’ contained in Rule 2.67 of the Insolvency Rules, which closely tracked the existing priority of ‘liquidation expenses’ contained in Rule 4.218 of the Insolvency Rules. This has brought its own problems as there is much debate as to whether the liabilities listed in Rule 2.67 are exhaustive and it is therefore unclear which liabilities fall within it. However, there is little debate that rent under a lease in relation to the period of the administrators’ use of the premises falls within either Rule 2.67(1)(a) ‘expenses properly incurred by the administrator in performing his functions’ or Rule 2.67(1)(f) ‘necessary disbursements by the administrator in the course of the administration…’

THE TOSHOKU CASE 
FOLLOWED IN GOLDACRE

Into the mix came the House of Lords decision in Re Toshoku Finance UK plc [2002], requiring an analysis of the true meaning and effect of ‘liquidation expenses’. Toshoku had nothing to do with rent under leases – it was a liquidation case concerning the ranking of debts due to the Inland Revenue. The decision of the House of Lords inToshoku reviewed the law as applied under some old nineteenth-century liquidation cases, including the concept known as the Lundy Granite, or salvage, principle, which states that where, as a consequence of liquidation, assets belonging to a third party are retained by the liquidating company for the benefit of creditors, the cost of their use was an expense in the liquidation. In 2009 Toshoku was applied to a case of rent due in administration – Goldacre, as referred to above – because the Court’s analysis of Rule 2.67 apparently compelled it to follow the equivalent law on liquidation expenses and the Lundy Granite principle. The application of the Toshoku decision to the interpretation of the liability of a company in administration to pay rent under a lease of premises had, in summary, the following results in Goldacre:

  • firstly and crucially, there was no 
scope for the application of the 
flexible approach adopted by the 
Court of Appeal in Re Atlantic Computers, meaning, of course, that the previous regime for determining payment of rent by administrators 
had to be scrapped;
  • following the Lundy Granite principle, the tenant company in administration had to pay the rent falling due under the lease during the course of the administration;
  • this meant that if the rent payment day fell just before the appointment of the administrators, and assuming the rent was payable quarterly in advance, the rent for the quarter would not be payable as an administration expense, resulting in a rent-free period;
  • rent which was accrued but unpaid at the date of the administrators’ appointment would be an unsecured debt; and
  • since the company in administration was contractually bound by the lease, its terms applied strictly and the full amount of the relevant quarter’s rent was to be paid, despite the fact that the administrators of Nortel Networks retained only part of the premises. Thus, another part of the flexible Re Atlantic Computers approach was jettisoned.

LEISURE (NORWICH) II LTD V 
LUMINAR LAVA IGNITE LTD [2012]

The tenant company, Luminar, operated numerous nightclubs and the case relates to four leasehold premises. Luminar faced financial difficulties and went into administration after the September quarter day, without paying rent for that quarter. The terms of the relevant leases held by Luminar provided that rent was payable quarterly in advance. After going into administration, Luminar continued to trade from the various leasehold premises, while the administrators marketed its business and assets for sale.

Apparently, the landlords of these 
premises were hoping to extend the principle in Goldacre so as to allow the recovery of the rent accruing due as at the date of the administrators’ appointment as an expense in the administration. The landlords made an application to Court1 claiming that the conduct of Luminar’s administrators was unfairly harmful to its interests. In particular, the landlord complained that Luminar was effectively occupying the premises rent free and that, because of the statutory moratorium benefiting the tenant company in administration, the landlord was unable 
to forfeit the leases for non-payment of rent. The landlord sought an order compelling the administrators of Luminar to pay all the rent that was outstanding under the leases, as 
an expense of Luminar’s administration.

The landlord argued the fact that the obligation to pay the rent for the quarter that had fallen due before Luminar went into administration was irrelevant. The landlord relied on an old case called Re Silkstone & Dosworth Coal & Iron Co [1881], to argue that the Court could require the payment of rent that had accrued due pre-administration as an expense of an administration.

THE LUMINAR DECISION

The landlords’ application backfired. The Court held that the Lundy Granite principle only applied to obligations that fell due in the course of the insolvency process, which meant that a liability that had fallen due for payment before the start of the administration could not be within the category of administration expenses.

The Court did not accept the landlord’s argument that Silkstone was an authority for the proposition that rent that fell due pre-insolvency could subsequently rank as an expense. Silkstone was crucially different because the rent was payable in arrears. The Court suggested that Silkstone might not be decided in the same way if it came for hearing today, and since it is now rare for leases to provide for payment in arrears, the point is not of widespread interest anyway.

The decision followed Goldacre and produced the absurd result that administrators appointed after a rent payment day will have the benefit of a rent-free period for the remaining part of the quarter. Unfortunately for the landlord, the attempt to extend the effect of Goldacre has only resulted in confirmation that pre-appointment rent is an unsecured claim, not an expense of the administration. However, the decision does help landlords to the extent that it states that, if the administration continues beyond the next quarterly payment date, then that quarter’s rent would be payable in full as an administration expense, whether or not the administrators retained the premises for the full period of the quarter.

LAZARI GP LTD V JERVIS [2012]

Another court decision in May 2012 was better news for landlords and confirms that the courts will be prepared to grant the right to forfeit the lease, in certain cases where the administrators refuse to give consent to the landlord retaking possession. The Re Atlantic Computers principle still has application and, in this 
case, the administrators failed to demonstrate that forfeiture of the lease by the landlord would be detrimental to the purpose of the administration. The administrators sold the business of the company on a pre-pack basis and gave a licence to the buyer to occupy the premises of the business pending the landlord granting a formal consent to the assignment of the lease. The landlord had found a new tenant for the premises at a higher rent and also argued that the buyer of the business in occupation had an insufficient covenant entitling the landlord to refuse consent to the proposed assignment. The Court accepted the landlord’s evidence that the buyer’s covenant was insufficient and, given the lack of evidence that the purpose of the administration would be adversely affected, the Court ordered that the landlord could 
re-enter the premises.

SUNBERRY

The outcome in this case was different from Innovate Logistics Ltd (in administration) v Sunberry Peoperties Ltd[2008], in which the Court of Appeal refused to give the landlord permission to forfeit the lease. The reason was that in Sunberry, the buyers of the business of the administration company were collecting book debts for the benefit of the administration creditors and needed to operate from the premises to be able to do so effectively.

SUMMARY

The logic of Goldacre and Luminar suits neither administrators nor landlords. The Luminar decision means that landlords 
can lose out entirely on the majority 
of a quarter’s rent as a result of the deliberate timing of the appointment 
of the administrators to take place the 
day after the rent falls due. If the administration continues beyond the 
next quarterly rent day, the administrators will have to pay the full quarter’s rent 
even if they intend to vacate the 
premises within a short period. They 
also have to pay the full rent under the lease even when occupying only part 
of the premises.

The law in relation to the wider issue of expenses in liquidation and administration is currently in disarray, although it is understood that the Supreme Court 
may give a ruling on aspects of that wider issue when deciding the Nortel pension case set for hearing shortly. The narrower point regarding rent in administration is unsatisfactory. It can be prejudicial to both landlords and administrators, in comparison to the flexible approach under Re Atlantic Computers. However, it has not gone unnoticed that the Court of Appeal in Sunberry in 2008 applied the flexible approach, ordering the administrators to pay rent on an apportioned basis for the period of their occupation. Apparently, 
the judges in Goldacre and Luminar considered that they were not bound 
to follow the Sunberrydecision, albeit 
for sound legal reasons. Two things are clear – the Goldacre/Luminar approach 
is unsatisfactory and the law in this area 
is crying out for legislative reform.

 

Note

  1. Under paragraph 74 of Schedule B1 to The Insolvency Act 1986.