Landlords - fasten your seat belts

Posted: 25/07/2012

Whether rent due should be treated as an insolvency expense (paid in preference to unsecured creditors and the insolvency practitioner's fees/expenses) remains controversially topical. With the economic recovery being more of a marathon than a sprint, and more insolvencies anticipated, both landlords and insolvency practitioners (IP) are calling for greater clarity over when rent is an insolvency expense and over what period.

Property Week recently reported that a consortium of high profile landlords, including the UK’s four biggest property companies, plan to bring a class action to challenge the law in this regard. It is against this backdrop that the recent decision of MK Airlines Property Limited (in administration) v Katz [2012] is worthy of mention.

The case

MK Airlines Limited (MK) leased premises to operate its cargo airline business. They went into administration in June 2008, provisional liquidation on 22 June 2010 and compulsorily liquidation in October 2010.

The provisional liquidators (appointed two days before the June 2010 quarter day), took steps to secure the property (which contained substantial airline equipment) but did nothing further. They eventually decided to retain the premises to avoid the cost and risk of relocating the stored equipment. The equipment remained at the premises when the liquidators finally disclaimed the lease.

The court was asked to decide two issues:

• was the rent that fell due during the provisional liquidation to be treated as an expense of the liquidation?
• was the disclaimer of the lease invalidated by a lack of intention to give vacant possession (given the continued storage of equipment on the premises)?

The decision

The key elements of the decision are as follows:

• the Lundy Granite principle applies to a provisional liquidation, in the same way as it applies to administrations and liquidations. In essence, the principle is that where an insolvent company uses a third party's asset for the benefit of the company's creditors, the company should pay for that use from the realisation of the company's assets. In other words, landlords of tenants in provisional liquidation are able to claim rent as an insolvency expense where the provisional liquidator 'uses' the premises for the purposes of the provisional liquidation;
• merely retaining the premises and securing equipment did not amount to 'use' within the Lundy Granite principle. Given that there was only a period of two days between the IP's appointment and the rent quarter day, the court felt that the IPs could not have decided (before the rental payment became due) to use the premises for the purposes of the provisional liquidation. It followed that as there was no 'use' by the IPs, the June quarter's rent could not to be treated as an insolvency expense;
• the notice of the disclaimer was not invalidated by a lack of intention and failure to give vacant possession;
• the tenant was liable for damages for trespass.

Comment

Recent case law (Leisure (Norwich) II Limited v Luminar Lava Ignite Limited (in administration), 28 March 2012) has moved away from the pre 2009 practice of 'pay as you go'. Post Goldacre (Goldacre (Offices) Limited v Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch)), it is the timing of an IP's appointment that is key. Where rent is payable in advance and the premises are used for the purposes of the insolvency:

• if the IP's appointment is made before a rent due date, the full rental payment falling due will rank as an insolvency expense. The IP cannot apportion the rent even where the premises are used only for part of the period for which rent is due;
• if the IP's appointment is made after a rent due date, rental payments which fell due before the date of appointment will be treated as an unsecured claim. This is the case in relation to the whole amount of rent due, even where the IP uses the premises after the appointment.

Depending on the timing of the insolvency the law, as it currently stands, unfairly favours either landlords or administrators. To make matters worse, the MK decision has now introduced an element of subjectivity into the mix. Rental payments may not automatically be treated as an insolvency expense, even if the appointment was before the rent due date. According to MK, it seems that a positive decision to use the premises for the purpose of the insolvency is necessary. In MK, two days was insufficient time to make that decision. What about larger portfolios? How long will an IP need where there are a number of properties to consider? In relation to the insolvency of a large retailer, the question of 'use' is likely to be fairly clear, the IP is either trading from the premises or not. The issue will be less clear cut for non-retail tenants.

Landlords will also feel aggrieved by the court's decision on the disclaimer point. The judge in MK was sympathetic to the liquidators; the lease was effectively disclaimed even though equipment was left in situ. This means that landlords faced with tenant insolvency may be left with premises that are, in practice, unlettable in the short term. The tenant in MK was liable for damages for trespass, but this may be of no real help to landlords; the case did not decide whether the damages should be treated as an insolvency expense or not.

What can a landlord do?

Until the law is clarified, we are stuck with the current unsatisfactory position. So what should a landlord do to help itself in an insolvency situation?

In addition to our previous advice to be open minded towards monthly rental payments (see 'Administrators get use of property rent free'), landlords need to act quickly and proactively where there is any hint of financial difficulty. Early dialogue with the relevant IP is advisable; they should be pressed for a timely decision about the use of the premises and whether rent is to be paid as an expense.

As far as any proposed disclaimer is concerned, landlords should be wary of dealing with equipment left on the premises. Even if the disclaimer is authorised, a landlord cannot simply remove the goods; doing so (without following the correct procedure) could leave the landlord open to a claim either under common law or for wrongful interference with goods under the Torts (Interference with Goods) Act 1977.

The 1977 Act provides a notification scheme by which a landlord can dispose of equipment without liability. Embarking on the scheme will obviously take time and money, but a landlord may have no other option if it is to avoid a claim. As a first step when faced with equipment left on the premises, a landlord should prepare an inventory of the equipment and get a professional appraisal. Where equipment is evidently leased or does not belong to the tenant, details of the owner should be obtained, where possible, and contacted in order to notify them that the equipment should be collected.

The future

The MK case certainly provides more turbulence for landlords in these financially bumpy times. One hopes that given the particularly individual circumstances of the case, it will not be followed. However, the decision does represent a continued attack on the treatment of rent as an insolvency expense. The outcome of any class action bought by landlords will be closely watched. Will we see a return to the pre-Goldacre ‘pay as you go’ approach? One thing is for certain; the current position is unsatisfactory. Perhaps now is the time for the Government to legislate to provide certainty and clarity.

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