Tenant Insolvency and Landlords Remedies

by Emma Harwood - Solicitor

In the current difficult financial times, the issue of tenant insolvency and its impact on landlords is becoming increasingly important. This guide advises landlords on the steps to take when a tenant has become insolvent.

When a landlord grants a commercial lease to a tenant, there is always a risk that the tenant might breach the terms of the lease and that risk should be catered for in both the drafting of the lease terms (such as ato include additional security by rent deposit or guarantor) and by the use of a number of different remedies open to a landlord.

Where the tenant fails to pay any rents due under the lease (which in most commercial leases will include service charge and insurance premiums), the landlord may threaten and ultimately take one of a number of possible courses of action:

• Bring the lease to an end by court proceedings or peaceable re-entry;
• Issue debt recovery proceedings in the County Court;
• Seize the tenant’s goods – and ultimately sell them to re-coup his/her losses;
• Draw on a Rent Deposit;
• Serve a notice on any sub-tenant requiring him/her to pay the sub-rent directly to the landlord;
• Seek to recover the sums from a guarantor or former tenant.

In today’s economic climate, the threat of tenant insolvency is now a very real prospect.

What, if anything, can the landlord do where the tenant becomes insolvent and is in breach of one or more of the covenants under the lease?

Landlord Remedies

The general remedies available to landlords of commercial premises where a tenant falls into arrears are set out in more detail below.

Forfeiture of the Lease – bringing the lease to an end – either by court action or by peaceable re-entry

The Landlord may elect to forfeit a tenancy by:-

• Court Proceedings; or
• Peaceable re-entry.

Court proceedings are more costly and time consuming but may have advantages should there be an application for ‘Relief Form Forfeiture’by the tenant.

Peaceable re-entry is quicker and cheaper and arguably more effective. It is effected by entering the premises (when empty), changing the locks, posting a notice of re-entry on the premises and notifying the tenant and his Solicitors. Any re-entry must be peaceable otherwise the re-entry will be unlawful. Simply securing the property is not re-entry.

Forfeiture can be a very useful remedy if the landlord wishes to recover possession of the property, although the ability to re-let the premises will obviously influence a landlord’s decision as to whether to pursue this option. However, consideration needs to be given at the outset as to whether this remedy is likely to be used because some remedies for recovering arrears of rent will waive the right to forfeit. Waiver will prevent this remedy from being pursued unless and until further arrears of rent become due.

It is important to note that forfeiture terminates the tenancy; the landlord would need to consider the prospects of re-letting the premises.

Alternatives to Forfeiture

Levying distress against certain goods on the tenant's premises

This is an effective remedy, provided that there are appropriate goods on the premises to make it worthwhile and/or the business is such that attendance by a bailiff at certain times will cause maximum commercial embarrassment for the tenant.

This remedy allows a landlord to seize goods from leasehold premises and to sell them to realise money to cover arrears of rent due in respect of those premises. Rather than remove the goods on which distress has been levied, the bailiff may decide to impound them on the premises until the debt has been paid. Ultimately, the goods can be removed from the premises and sold if the debt is not paid.

Issuing court proceedings

It can be costly and time consuming to pursue court proceedings, particularly as there is the possibility that the tenant will seek to defend a claim for rent arrears by putting forward a spurious counterclaim (for example, claiming the landlord's  failure to make repairs to the property) in order to drag out proceedings and prevent the landlord from obtaining judgment.

Service of a statutory demand or presentation of a winding-up petition

The threat of bankruptcy or winding-up proceedings is becoming more common to secure the payment of rent. The service of a Ssatutory demand is more of an indirect route to recovery, but can be extremely effective for getting the rent paid. This is because of the risk that, unless payment is made within 21 days of the date of service, the landlord can initiate bankruptcy or winding-up proceedings against the tenant.

It is often unnecessary to pursue the full process. Indeed, if service of the statutory demand does not result in payment of the rent, then it may be unwise to take further action because of the substantial costs often involved in bringing a bankruptcy or winding-up petition.

Using any rent deposit

When granting or assigning a lease, the landlord can request additional security from the tenant to encourage proper performance of the tenant covenants contained in the lease (i.e. payment of rent or failure to repair or maintain the property), in the form of a rent deposit.

If there is a rent deposit, it is usually a quick and simple process for a landlord to use it to settle arrears owed by the tenant. Of course, any withdrawal means there is less money available to safeguard arrears in the future. Although there will almost certainly be an obligation on the tenant in the rent deposit deed to repay the funds withdrawn from the rent deposit, the tenant may well be unable to do so if it is experiencing financial difficulties.

Pursuing any guarantor

This is a useful means of obtaining settlement of arrears from a third party. Unlike a withdrawal from a rent deposit, there is no limit on the number of times a landlord can seek redress from a guarantor under the terms of the lease. However, if the guarantor is closely connected with the tenant, such as a director of the tenant company, then a failing tenant may also mean a failing guarantor who is unable to pay the sums demanded.

Pursuing any former tenant as guarantor

Under the provisions of the Landlord & Tenant Covenants Act 1995 (‘1995 Act’), where a lease granted on or after 1 January 1996 is assigned, the original tenant or any assignor is released from its liability under the tenants covenants contained in the lease ,unless it enters into an Authorised Guarantee Agreement, which is lawfully required as a condition of the assignment.

Where the lease was granted prior to 1 January 1996, this will not apply and the original tenant and any original guarantor will remain liable throughout the term of the lease, through ‘Privity of Contract’. Subsequent tenants and guarantors usually also have continuing liability through covenants given in the Licence to Assign.

Whichever of the two regimes of liability applies, pursuing former tenants and guarantors can be a useful remedy. However, there are time limits for bringing the claim: before pursuing a former tenant and/or guarantor for arrears of fixed charges, the landlord must have served notice under Section 17 of the 1995 Act on the former tenant and/or guarantor within six months of the fixed charge falling due. Any tenant or guarantor which settles the arrears in full is entitled to call for an overriding lease to be granted to it.

Pursuing any sub-tenant under Section 6 of the Law of Distress (Amendment) Act 1908

If there are arrears owing, notice can be served under Section 6 requiring the tenant to pay rent directly to the superior landlord.

This can be a very helpful remedy for landlords, since it enables them to serve notice on any subtenant requiring them to divert rent to the landlord that would otherwise be payable to the tenant. This notice can be served whenever there are arrears of rent due from the intermediate tenant. It is a simple process which can often assist cash flow, although fresh notices need to be served if further arrears accrue.

Insolvency Regimes

There are a number of insolvency regimes for use in different circumstances and for different purposes (having regard to the value of the property to the landlord and the insolvent tenant) under the Insolvency Act 1986.

Corporate insolvency:-

• Company Voluntary Arrangements (CVA)
• Administration
• Pre-pack Administration
• Receivership
• Winding-Up or Liquidation
• Voluntary Winding-Up
• Compulsory Winding-Up

Individual tenant insolvency:-

• Individual Voluntary Arrangement (IVA)
• Bankruptcy

Terminating the tenancy of an insolvent tenant

Where the tenant is struggling to pay rent and/or is subject to an insolvency regime, the landlord will often want to consider terminating the tenancy. This route needs to be assessed carefully in a difficult market, since it may benefit the landlord to keep the tenancy in place until such time as a new tenant has been found.

In a good market, the landlord will often be confident of re-letting the premises in the near future or it may be interested in recovering possession for the purpose of re-development etc. Where the tenancy is protected by the Landlord and Tenant Act 1954, the tenant’s insolvency may give the landlord an opportunity to regain possession, without having to satisfy the hurdles of that Act and/or pay statutory compensation.

A summary of the main options for terminating tenancies is set out below.

• Disclaimer

This is not a method of termination which can be used directly by a landlord, since it is the renunciation of a liability by a liquidator (voluntary or compulsory winding-up) or a trustee in bankruptcy.

Such parties are entitled to ‘disclaim’ any onerous property of an insolvent party, which can include leases. Notice of the disclaimer must be given to the landlord and any other ‘interested persons’ such as mortgagees or subtenants.

A landlord may give notice under the Insolvency Rules to require a liquidator or trustee in bankruptcy to decide whether or not to disclaim. The liquidator or trustee in bankruptcy then has 28 days in which to disclaim, unless the Court allows a longer period.

• Forfeiture

Depending on the terms of the lease, a tenant’s insolvency will often give the landlord a right of forfeiture after service of a notice under Section 146 of the Law of Property Act 1925. There may also be a separate ground of forfeiture if the tenant owes arrears of rent, for which a Section 146 Notice is not required. However, forfeiture clauses usually allow a tenant a grace period of 7-21 days for the payment of rent before allowing the landlord to exercise its right to forfeit.

• Surrender

The terms for ‘surrender’ of the lease by the tenant are a matter of negotiation between the parties.

Landlords may try to seek the payment of any arrears as a condition of accepting surrender, but this is commonly rejected by insolvency practitioners acting for tenant companies. Very often, insolvency practitioners prefer to minimise costs by seeking surrender through operation of law (i.e. by returning the keys and the original lease) rather than via legal documentation. The risk here is that there may be charges or other interests created by the tenant which would survive the surrender and the Llndlord’s legal advisers therefore need to undertake appropriate investigations before any surrender is accepted.