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Monday, 30 April 2012

Record Insolvencies, Pressure on Lenders & Lease Guarantees

The outlook for the remainder of 2012 is grim as insolvencies rocket to levels not seen since the 1990s, according to a spring report by the Ernst & Young Item Club.

The report also comments that commercial real estate (CRE) portfolios represent a continuing drag on bank profitability.

The sharp drop in property values and downward pressure on rental income have seen many lenders giving “forebearance” to customers by waiving loan-to-value and debt-service covenants, offering payment holidays and extending debt maturities.

Lenders are trying to sit it out in the hope that loan recovery rates will be higher when property prices and incomes eventually recover.

They are also wary of offloading large volumes of distressed sales on to the market, as prices would be hit even further, creating a spiral.

Not surprisingly, the report concludes, banks also remain cautious about extending additional credit to the CRE sector.

The Bank of England recently reported that the amount of bank credit made available in the CRE sector had seen a further decline in the first quarter of 2012, and was expected to fall “significantly” during the second quarter.

All this is happening of course against the backdrop of a double-dip recession.

In this climate, anyone in the business of granting new leases needs to take whatever additional security they can get.

That might mean insisting on a guarantee from a parent or group company.

With smaller companies, often the only available guarantee will be a personal one from a director of the company.

Take great care when accepting personal guarantees.

They may be unenforceable if the guarantor can show he didn’t know what he was signing, or that he was put under pressure to sign a guarantee unwillingly (see my post What Can You Do if Your Tenant Stops Paying or Goes Bust? for more details of a recent case).

At the very least, you need to get written confirmation from the guarantor that he is aware of the risks and was given an opportunity to take legal and financial advice.

You also need to know if the guarantor is financially sound, otherwise the guarantee won’t be worth the paper it’s written on.

You can do an online insolvency search for free. Also, carry out a credit check and get a reference from a bank or accountant.

What are the most common alternatives to a director’s guarantee?

·         Corporate guarantee from another company (not necessarily related). You would still need to carry out financial checks, but they might be easier to do and the guarantee would be less vulnerable to challenge.

·         Instead of getting a guarantee from a director, make him a joint tenant instead, with “joint and several” liability, so he steps into the company’s shoes if the company stops paying. You still need to check his financial soundness though.

·         Rent deposit. If documented in the right way, these give you a fixed (albeit limited) pot of money on which you can draw in the event of a default.

·         Bank guarantee. Arguably the best of the lot, but given the banks’ reluctance to take on more exposure, how willing will they be to give one?

Of course, a guarantor might look a good bet when the guarantee is given, but by the time of the default he might be worthless too, especially if his fortunes have gone down with the company he’s guaranteeing – which is quite likely.

Sometimes, there's simply no protection against failure and that’s the dilemma banks and many investors find themselves in today.

Monday, 23 April 2012

Taking the Profit: BPF Slams Pre-Pack Administration for Ripping Off Pensioners

The British Property Federation (BPF) has launched a campaign, called Taking the Profit, seeking retail insolvency reforms to restore fairness to pensioners, especially with regard to pre-pack administrations.

Pre-pack administration is 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 (IP) before the company goes into administration and is then completed immediately after the start of the administration.

A company can even be bought out of administration by its directors or other people closely connected with the company that failed – a so-called “Phoenix pre-pack”.

Representing landlords, the BPF argues that “tens of millions of pounds” is being siphoned out of pensioners’ savings into the pockets of private investors profiting from retail failure.

The BPF has highlighted what it sees as “the growing underhand practice”, mainly in relation to pre-pack administrations, where the terms of the sale are kept deliberately vague, and at the same time landlords are pressurised by an agent of the buyer of the company, with or without the knowledge of the IP, to extract concessions on existing leases of profitable stores.

The BPF alleges this is often under threat that if concessions are not given then that landlord’s property will not feature in the sale – meaning the landlord’s store will end up being one of the ones dumped when the business is transferred to a new concern, leaving it empty and potentially vulnerable to rates liability if a new tenant can’t be found before the concession period expires.

The result, says the BPF, on profitable stores is simply to transfer profits from pensioners’ savings in property to the new buyers of the business, often private investors. It says tens of millions of pounds of pensioners’ saving have been lost in this way.

Another consequence, argues the BPF, is that it puts rival successful retailers at a disadvantage. This reinforces failure, rather than promoting more successful retailers.

Unsecured creditors are particularly vulnerable in the insolvency process and landlords are also at risk of missing out, earlier in the process, on a quarter’s rent if the IP is appointed just after the quarter day (see Free Quarter For Administrators Strengthens Case for Monthly Rents).

As I mentioned in Phoenix From the Flames: Pre-Pack Administrations Live On, earlier this year the government scrapped plans to reform the pre-pack administration process, despite the criticisms of it concerning the lack of clarity, lack of accountability and perceived short-termism.

Defenders of the process will point out it is quick; has lower costs; enables minimum erosion of supplier, customer and employee confidence; and saves jobs.

The latter is a particularly powerful argument, especially as, if the company goes bust, the landlord probably wouldn’t have got anything anyway.

It may seem emotive to pitch this argument, as the BPF has done, as a defence of pensioners’ savings; and those advocating the contrary position could just as powerfully argue for the need to stand up for jobs for the young.

But the use of pre-pack raises difficult questions of moral hazard too.

Liz peace, Chief executive of the BPF, says:

“An enterprise economy works first and foremost on trust and written contracts. If both become worthless that has serious implications for enterprise and economic efficiency.”

And what is the prime role of the IP?

Liz Peace argues it to secure the best result for creditors, not to maximise the profits of the new company.

“We are becoming increasingly concerned that Insolvency Practitioners are acting more in the interests of the buyers than creditors.”

The BPF stresses it is supportive of the rescue culture and has made the following proposals for reform:

·         Amend the IPs’ guidance notes, known as SIP16, so that an IP must be clear which assets are part of the sale, on which it is seeking to negotiate, and which it does not want.

·         Amend SIP16 so that it “frowns on” any collusion between the IP and the buyer or his agent to extract concessions on leases that are part of the sale.

·         Speed up the process of achieving better regulation of the insolvency sector, including a single contact point for making complaints and one that doesn’t involve having to go to court. It is now nearly two years since the OFT called for such measures.

·         Tighten up the rules on advertising by IPs.

These proposals, if enacted, might bring more confidence and transparency to the process.

Meanwhile, if you're an unsecured creditor involved in a retail insolvency, the BPF wants to hear from you.

And for more comment, here is an article from Pinsent Masons.

Wednesday, 18 April 2012

When the Music Stops – How Late Rent Reviews Can Strike a Note of Discord


When your landlord seeks to implement a rent review long after the last review date has been and gone, it can come as a nasty surprise for you as a business tenant.

If you’re a tenant that’s become used to paying rent at a certain rate, the fact that your landlord seems to have ignored the last review date might well have lulled you into a false sense of security.

During a recession or, more euphemistically, a downturn landlords will want to wait for more favourable comparable rents before triggering a review.

Where the lease provides for open market “upwards only” rent reviews, the flexible nature of the vast majority of  those rent review clauses allows landlords to delay the review until it suits them – they are only prevented from doing so if the clause makes time “of the essence”, which is rare these days.

Commercial leases also usually provide for the difference between the old rent and the new rent (the “uplift”) to be paid when the review takes place, and backdated to the review date specified in the lease.

Most leases also go a step further and require interest to be paid on the uplift as well (usually at base rate but sometimes higher).

If the parties are unable to agree on a new rent, the lease will normally provide for the rent to be settled either by arbitration or by an expert.

Horgan Lovells have recently produced a useful summary of the more detailed consequences of late review and I also looked at a case last year in Don’t Bury Your Head in the Sand and at rent reviews generally in The Only Way is Up.

One feature of late review to bear in mind is that liability to pay the whole of the uplift comes at the point at which the new rent is either agreed between the parties, or determined by an expert or arbitrator.

So, to borrow Horgan Lovells’ analogy, settlement of a rent review is comparable to the music stopping in a game of pass the parcel – the tenant left holding the tenancy is liable to pay the whole uplift backdated to the review date, which could be a long time ago and might even be before you acquired the lease (if you took an assignment of the lease from a previous tenant).

It doesn’t matter how long you have held the lease.

Meanwhile, the landlord who holds the reversion of your lease when the rent is agreed or determined receives the whole uplift, even if it has only recently acquired the reversion (although in reality a well advised seller of the reversion would usually make sure it’s entitled to receive its share of the uplift in the contract for sale).

The principle is likely to apply in reverse if there were a downwards rent review (so as current tenant you would be entitled to the whole credit and the current landlord would be obliged to pay it) – but “upwards or downwards” rent reviews are still rare, despite it being an option suggested in the Commercial Lease Code.

What practical steps can you take as a tenant?

·         If you’re negotiating a new lease, try to include a long stop date in the rent review clause, such as the next rent review date, or earlier.

·         If you’re taking an assignment of an existing lease and there’s an outstanding rent review, try to get a retention and indemnity from the outgoing tenant to protect you against any uplift if the review is subsequently triggered by the landlord.

·         If you’re unlucky enough to be faced with a late rent review, look for evidence that the landlord has waived the review or is “estopped” from triggering it (see the Horgan Lovells article and my post last year for more about these technical points).

·         If the review is being settled by arbitration, make sure you get involved, along with your advisors, in the arbitration process to argue your case.

·         If the review is being determined by an expert, use any powers given to you in the lease to make your representations to the expert.

This list isn’t exhaustive; what’s important is that when your landlord tells you it’s going to implement the review, you contact your rent review advisors straight away.

Don’t bury your head in the sand.