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Tuesday, 31 January 2012

There’s Too Much Confusion – I Can’t Get No Relief

The second line of Dylan’s much-covered All Along the Watchtower may not have been inspired by landlord and tenant law, but it serves as a good accompaniment to a recent case on forfeiture of a commercial lease.

Most commercial leases give the landlord the right to forfeit (take back) the lease from the tenant if it doesn’t comply with its terms.

The right will usually be set out in the lease and normally arises if the tenant fails to pay the rent, breaches a covenant or (unless the lease is to be used as security for a mortgage) becomes insolvent.

The landlord can forfeit the lease by peaceably re-entering” the premises and changing the locks; or by issuing proceedings for forfeiture, usually in the County Court.

Forfeiture however can be something of a pyrrhic victory for a landlord in a recession; after all, getting back empty premises is not much use if there’s no one else out there to take them on instead. It might just result in the landlord being left with an empty rates liability.

Equally, a tenant might welcome forfeiture and consider itself well rid of the lease burden.

But what if the tenant wants to stay?

Tenants are usually able to apply to the court for relief from forfeiture if they are able to show they can comply with the lease obligations. If the tenant succeeds, it gets the lease back, although it will usually have to pay the landlord’s legal costs.

What if the landlord, especially if there’s no one else on the horizon, is persuaded it should allow the tenant to stay?

Can the landlord itself grant relief?

Not if it wants the old lease back.

In Zestcrest Limited –v- County Hall Green Ventures Limited (reported in the Estates Gazette for 17th December 2011) the County Court confirmed that a private deal done after forfeiture has taken place without going back to the court is treated as a new lease. 

What’s wrong with that?

Well, unfortunately it can have some unwelcome knock-on effects for you as a landlord.

For example, if the lease that has just been forfeited was excluded from the security of tenure provisions of the Landlord and Tenant Act 1954 (1954 Act) (which otherwise gives business tenants rights to renew their lease at the end of the term), the implied new lease would not be.

Avid readers of Digging the Dirt may recall this is similar to the situation where a tenant serves a break notice, then changes its mind and decides to stay with the landlord’s blessing – in which case the law implies a new lease has come into effect.

For more about the dangers of unintended consequences when new leases are implied in circumstances like these, see my post of a year ago – Lease Break Clauses: What If You Change Your Mind?

So, even if both parties decide to set the forfeiture aside, there has to be an application by consent to the court for relief.

Once the court makes the order, the lease is treated as though it had never been forfeited in the first place and it carries on as before – so if it was excluded from the 1954 Act, for example, it stays excluded.

As it happens, in the Zestcrest case, the tenant did make an application to the court for relief (because the landlord insisted) but then said that it was unreasonable to have been forced to do so by the landlord and that the landlord should reimburse the tenant’s costs. 

The tenant failed with that argument and the court said it was essential for the landlord, in view of the fact that the original lease had been excluded from the 1954 Act, to have formal relief from forfeiture.

Now, there must be some way out of here...

Friday, 27 January 2012

Phoenix from the Flames – Pre-Pack Administrations Live On

The government has scrapped plans to reform the controversial practice of “pre-pack” administrations, causing fury with landlords.

Administration has become the predominant process for dealing with insolvent companies where there is a prospect of keeping the business of the company alive.

“Pre-pack” administrations are a fast-track insolvency procedure that avoids a failing business being sold on the open market; instead the sale of the company’s assets is set up by an insolvency practitioner before the company goes into administration and is then completed immediately after the start of the administration.

It’s become a practice frequently adopted by failing retail organisations.

Recent examples of pre-packs are Bonmarche, Peacocks and Blacks Leisure.

Pre-pack sales to connected parties, such as company directors, can be done at great speed and presented to creditors as a fait accompli. 

This is similar in effect to the outlawed practice of creating so-called “phoenix companies”; which used to involve liquidating a failed company, with the same business re-emerging immediately afterwards as a new company without the debts of the old one.

Some landlords, as major creditors, have been losing out as the new organisations created out of pre-packs pick and choose which stores to continue trading from.

The British Property Federation (BPF) has criticised the scrapping of reforms first suggested 18 months ago by Business Innovations & Skills minister, Ed Davey, which would have required insolvency practitioners to notify creditors in advance of a pre-pack and allow them three days to scrutinise the proposals to ensure they represented the best deal for creditors, and to give them time object if they wish. 

The BPF had in fact argued that three days would be insufficient and wanted a longer notice period, but now will get nothing because yesterday, reports the Telegraph, Ed Davey said the reform would not go ahead at all, saying the government is not convinced the benefit of a change in regulations "outweighs the overall benefit to business of adhering to the moratorium on regulations affecting micro-business", which the BPF say the government has known about all along.

The Telegraph reports that the Association of British Insurers has also criticised pre-packs extensively. It claimed in a submission to Parliament that they are being actively marketed by insolvency advisers as a way of dumping debt and casting off troublesome creditors.

Other criticisms of pre-packs include:

·         Lack of transparency – unsecured creditors often don’t know what’s about to happen.
·         Lack of accountability – no approval of the court or creditors is required.
·         The return for creditors may not be maximised because there is limited marketing of the business compared with an open market disposal.
·         It’s a short term fix which may not necessarily subject the company to the restructuring it needs to survive long term.

There are two sides to this story though.

Landlords may not like this but there are pragmatic reasons why pre-packs often represent the best outcome going in today’s tough world, whatever you may think about moral hazard.

Benefits of pre-packs include:

·         They are quick and the lower costs may result in better returns for creditors.
·         Minimum erosion of supplier, customer and employee confidence, which in a “people” business like retail is vital.
·         The opportunity to save jobs – clearly of paramount importance.
·         It might be the only realistic alternative to liquidation, which would benefit no one.
·         Unsecured creditors probably wouldn’t have got anything anyway.

Landlords also need to bear in mind that if a company is liquidated, the liquidator can disclaim the lease and walk away, leaving the landlord with nothing but a looming empty rates liability.

It’s a thorny issue morally though; and if you are one of the landlords that loses out it will seem very unfair.

Accountancy Age says the regulator of the profession, the Insolvency Service, is going to review existing pre-pack legislation to see how more confidence and transparency could be injected into the process.

The phoenix may yet have its wings clipped.

Photo by Velo Steve via flickr

Tuesday, 17 January 2012

Lease Break Clauses: Skating on Thin Ice


Break clauses can leave you skating on thin ice.

Two recent cases from mid-winter once again show the importance of scrutinising the detail of a break clause and scrupulously keeping up to date with payments of rent and interest, if that is what the clause requires.

The first case, from 23 November 2011, is Quirkco Investments Ltd –v- Aspray Transport Ltd [2011] EWHC 3060 (Ch).

The break clause was conditional on there being no arrears of rent and no other outstanding breaches of covenant on the break date, which was 18 December 2010. 

In November 2010 the landlord sent an invoice for the insurance premium for the next year. 

The tenant was required to pay such sums as the landlord may “from time to time expend in insuring”. 

The tenant refused to pay the insurance premium because it covered the period after it was due to vacate under the break clause. 

As it happened, the landlord’s cheque to the insurance broker went missing so the landlord’s broker paid the premium on behalf of the landlord, but before the break date.

The court decided that the landlord could not demand payment for the insurance when it had not yet “expended” the amount itself (the broker had). 

There may be other reasons why the break clause had not been validly exercised (as it required the tenant not to be in material outstanding breach of covenant), but this was not one of them.

The second case, from 19 December 2011, is Avocet Industrial Estates LLP –v- Merol Ltd [2011] EWHC 3422 (Ch).

This time the tenant was not so lucky.

The tenant had a right to break on a certain date. 

The break was conditional on all payments due under the lease being paid. 

During the lease term the tenant had paid its rent by cheque and had often been a bit late with its payments. 

The day before the break date, the tenant gave a cheque to the landlord for six months’ rent and said it had paid all outstanding charges and was not aware of any breach. 

The landlord argued that payment had not been made because it had not received cleared funds. 

The landlord also said there were other payments still outstanding because the tenant had not paid interest that was due under the lease for payments of rent that had been paid late in the past, even though the landlord had not issued any demands for payment of that interest. 

In this case the court decided that because the landlord had consistently agreed to accept cheques as payment for the rent, there was therefore an implied agreement that the landlord would accept payment by cheque of sums due under the lease; so the landlord could not object to receiving a cheque immediately before the break date.

However, it was the matter of the missed interest payments that saw the tenant plunge through the metaphorical thin ice.

The court said the tenant had owed interest because of the late payments of rent. The lease did not qualify the landlord’s entitlement to interest by requiring the landlord to serve a prior demand for it and the tenant would have been able to calculate the interest due without any difficulty. 

The judge acknowledged that this was something of a “trap” for the tenant.

Because the tenant had not paid the interest that was due, even though it had not been demanded, a payment due under the lease had not been paid and so the break clause condition had not been satisfied.

The tenant, as a result, was not able to end its lease and remained in the hook.

The fact that the amount of interest outstanding was only £130 made no difference – which led the judge to conclude:

“However, it was not suggested that the size of the amount allowed one to ignore non-compliance... I consider that the result in this case is a harsh one but, applying legal principle, it is one which I am obliged to reach.”

For more about break clauses generally, here is a link to my other posts last year.

As well as highlighting the point made in previous posts about the need to exercise extreme care when exercising break rights, the Avocet case also demonstrates the need to scrutinise carefully your records of payment to see if any interest payments are due to the landlord.

Thursday, 5 January 2012

Locked Out: How Effective are Exclusivity Agreements?

Exclusivity – or lock-out – agreements are sometimes entered into between parties in commercial property transactions, usually where the buyer wants to stop the seller from dealing with anyone else for a fixed period.

The buyer might want time, for example, to conclude its survey and detailed site investigations and arrange funding without fear of the seller selling the property to someone else in the meantime.

This can be an important consideration in England & Wales because, unlike in other jurisdictions, there is no obligation on the seller to sell to the buyer when it has accepted its offer unless and until formal written contracts have been exchanged, which won’t usually happen until the buyer has concluded its due diligence.

A lock-out agreement will buy a bit of breathing space.

There’s a difference, however, between lock-out agreements and lock-in agreements.

Lock-in agreements, where parties expressly agree to negotiate with each other, are unenforceable because they are "agreements to agree", and so lack certainty.

Lock-out agreements on the other hand can be binding contracts, although they are negative in nature in that they bind the seller not to negotiate with someone else, rather than compelling the seller to do a deal with a particular buyer.

To be enforceable, a lock-out agreement must be for a fixed period, or it will be void for uncertainty. So, for example, it won’t work if it says it’s to last for a “reasonable period”.

If contracts have not been exchanged by the end of the fixed period, then the seller is free to deal with someone else if it wants to.

If you want a lock-out agreement, you will normally need to make it a condition of your offer. The lock-out agreement can then be drawn up quickly after your offer has been accepted “subject to contract”.

Technically a lock-out agreement doesn’t have to be in writing, as it’s not a contract for the sale of land, but obviously it should be in writing in order to avoid disputes.

How effective is a lock out agreement if the seller ignores it?

The short answer is, probably not as effective as the buyer would like it to be.

The buyer is very unlikely to get an injunction stopping the seller from selling the property to someone else during the exclusivity period.

The buyer’s remedies are more likely to be limited to recovering its wasted costs, such as legal and surveying fees – which at least is better than nothing, which is what the buyer is likely to get in this situation without a lock-out agreement.

It may mean, however, that if the seller gets a much better offer from someone else during the exclusivity period, it might decide to breach the lock-out agreement, proceed with the better offer and pay the limited damages arising out of the breach.

If you try and get round this by specifying punitive damages in the lock-out agreement, you run the risk they will be deemed an unenforceable “penalty”.

Are lock-out agreements still being used in such a difficult market?

Yes. One of the odd things about the current market is that it is fragmented. Some areas might still be competitive “micro markets” and there are still some cash-rich buyers competing for particular, maybe unusual, properties.

Alternatively, you might be a buyer surprised by having your very low offer accepted which you worry might be withdrawn if a better offer materialises before you have concluded the deal.

In these situations lock-out agreements can be useful, but beware their limitations.