Landlord Insolvency

What happens when a landlord’s liquidity is in question? If you suspect that your landlord may be in financial difficulty you can find out by checking the Companies House website. This article sets out a brief guide to what tenants can do to protect their tenancy.

What can tenants do?

Most well drafted commercial leases contain a provision which allows a landlord to forfeit the lease in the event of a tenant’s insolvency. Although it is rare, there is no reason why there should not be a provision which allows the tenant to terminate the lease on a landlord’s insolvency. Unfortunately very few lease documents deal with this point.

Freehold interests

If the landlord’s freehold interest is disclaimed, it is extinguished and the ownership of the land itself reverts to the Crown. Generally the Crown would not assume the landlord’s obligations under the lease. A tenant faced with such a situation should seek advice immediately.

Leasehold interests

If you are a subtenant and the superior lease has been disclaimed as a result of the superior landlord’s liquidation, then generally your lease (the sublease) will also fall away. In these circumstances, you can apply for a court order vesting the lease in you. This new lease will be on the same terms as the disclaimed superior lease. This may not necessarily be an attractive prospect particularly if your old lease was only lease of part of the property. However, this at least maintains and regulates a landlord and tenant relationship.

Disclaimer

A landlord’s insolvency would not affect the tenant’s rights under the lease but a liquidator or trustee in bankruptcy may disclaim the debtor’s “onerous property” which frequently includes a debtor’s interest in a lease.

Landlords seeking to terminate a lease may require the liquidator or trustee to decide whether he wishes to disclaim the property in which event the disclaimer may not be made more than 28 days after that notice to disclaim.

If the insolvent landlord’s superior lease provides for forfeiture on insolvency, the superior landlord may forfeit the lease. They will need consent of the administrator or liquidator or permission from the court. Any subtenant can apply for relief from forfeiture in these circumstances which takes the form of a vesting order (see above).

When a liquidator is appointed, any rent should be paid directly to the liquidator. Until then, the tenant should continue to pay the Landlord in the usual way as the tenant will not want to be in breach of its covenants.

If you are a subtenant and your landlord is insolvent, the superior landlord may serve a notice on you requiring the rent under your lease to be paid directly to it until the arrears are covered. If such a notice is served on you, advice should be sought immediately as to its validity. Essentially such a notice creates a landlord and tenant relationship between you (as the subtenant) and the superior landlord. This means that should you default, the superior landlord can take direct action against you for the sums due. For a superior landlord this is a cheap and quick way to maintain some rental income.

Monies held by the Landlord

As a tenant who faces the prospect of an insolvent landlord, you will be concerned with what happens to the monies held by the landlord such as rent deposits, advanced contributions to service charges including sinking funds.

In the case of rent deposits, all creditors have a claim to the monies in that account. If you want to ensure that you have a right to the monies, they should be placed in a separate account so that they remain identifiable. So long as the rent deposit deed is properly drafted so that the monies are held on trust by the landlord to meet lease obligations or that the deposit belongs to the tenant but is charged to the landlord, then the creditors should be not be able to access the funds. The trust approach is preferable for both the landlord and the tenant. Solicitors acting in the best interest of the tenant should ensure that the rent deposit deed adequately protects the tenant’s position in this way.

Advance payments of service charge and sinking funds are more problematic as unless the monies are held on trust as recommended by the RICS service charge code, you may become an unsecured creditor of an insolvent landlord.

Unless a lease states otherwise, the payment of service charge will form part of the landlord’s general funds which are to be applied in accordance with the lease.

Landlord not performing its duties

There may be situations where the Landlord does not keep up with its lease obligations such as the upkeep of common parts and insurance. If you find yourself in this situation, it is not advisable to withhold paying the rent and service charge payments. If you do so, the landlord can rightfully forfeit your lease or exercise distraint. As discussed in Part 1 of this article on tenant insolvency distraint will no longer be possible when the commercial recovery of rent arrears arrangements comes into force.

In exceptional cases, the tenant can repudiate the contract by claiming derogation of grant if the Landlord’s breach of covenants substantially deprives the tenant of its enjoyment of the premises.

Steps to minimize risk

When a property is a valuable asset and continues to produce a healthy income stream, the insolvency practitioner will be keen to maintain a good relationship with the tenants especially those in administration. However, if the property is economically unsound and tainted with problems, then a disclaimer is likely (see above).

There are certain things a tenant can do to minimise risk. The main concern for a tenant will be insurance of the premises where an insolvent landlord does not insure. The tenant should insure the premises to avoid potentially uninsured losses. Caution should be taken so as to avoid double insurance. In this situation, the tenant should notify the landlord (and potentially other tenants in the building) that he has stepped in to insure the premises. The tenant should also advise the landlord that he intends to recover those parts of insurance cost to be paid by the other tenants in the building.

The maintenance of the common parts and/or structure of the building will also be a concern to the tenant. The best course of action may be for the tenant to carry out any essential works of repair. In any event, professional advice should be sought before any works are carried out as they are likely to lead to the tenant breaching covenants in the lease and/or committing tortuous acts. The tenant will need to bear in mind that the likelihood of recovery from an insolvent landlord the full amount of expenditure is remote. It is best to obtain consent of the landlord through its insolvency practitioner before any works are commenced.

Finally, seek advice early with a view to approaching the insolvency practitioner and if necessary other tenants to ensure that their occupation of the premises can continue as smoothly as possible.