The insolvency merry-go-round

Posted: 07/02/2017

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The past 12-18 months have seen some of the biggest changes to established insolvency law and practice in England and Wales since the Insolvency Act 1986 and Insolvency Rules 1986 (the old Rules) came into force. These have culminated with the new Insolvency Rules 2016 (the new Rules), which become effective on 6 April 2017 and are intended to consolidate the old Rules (including all 28 subsequent sets of amendments to them). More changes could also be afoot: the Insolvency Service recently consulted on whether our insolvency regime might benefit from a new standalone moratorium procedure – something that could have a considerable effect on the real estate industry.

Legislative update

The new Rules set out how recent legislative changes will be applied in practice, for example:

Creditors’ involvement in decision-making

Something that landlords and other creditors should be aware of is that changes introduced by the Small Business, Enterprise and Employment Act 2015 (SBEEA) and incorporated into the new Rules create an entirely new decision-making regime once a company insolvency procedure has been commenced. Key elements are:

• physical creditors’ meetings are being phased out;
• decisions made by insolvency practitioners are now deemed to be approved by creditors with only limited exceptions.

For the uninitiated creditor, these changes could make it far more difficult to hold delinquent tenants and insolvency practitioners to account. The phasing out of physical meetings includes the first meeting of creditors – often where landlords and creditors take the opportunity to raise issues as to the conduct of the tenant company (or director) in the period leading up to insolvency.

What the new Rules have not formalised

In 2014, the Court of Appeal’s decision in Jervis and others v Pillar Denton Ltd and others [2014] EWCA Civ 180; [2014] 2 EGLR 9 arising out of the administration of the Game retail group (Game) addressed the treatment of rent payable by an insolvent tenant so as to avoid either the landlord or the administrator from being disproportionately burdened with the liability for an entire quarter’s rent, depending on when the rent payment date fell (which became the law following the decision in Goldacre (Offices) Ltd v Nortel Networks UK Ltd (in administration) [2009] EWHC 3389 (Ch); [2009] 1 EGLR 25).

Game tells us that the administrator must pay as an expense of the administration such rent arising during the period that the administrator holds the property for the ‘purposes of administration’, with the liability for rent accruing daily rather than, for example, in quarterly increments.

Many in the real estate sector had hoped the new Rules might codify the decision in Game, to provide a little more certainty as to when rent will be payable as an expense of the administration and when it will simply be a debt that the landlord must claim as an unsecured creditor. Unfortunately, the new Rules do not do this. We must, therefore, continue to rely on current case law unless or until Parliament sees fit to legislate (or indeed if Game is overturned).

Should it provide some comfort, Game has, effectively, reinstated the position as it was prior to Goldacre (and consistent with the Court of Appeal’s earlier decision in AIB Capital Markets plc and another v Atlantic Computer Systems plc and others [1990] EWCA Civ 20). Accordingly, it is considered unlikely to be overturned anytime soon. From a landlord perspective therefore, it will feel more like having moved full circle than forward.

Update on proposed changes

During 2016, the Insolvency Service consulted on four potential changes to the insolvency regime and went on to seek the views of industry by way of a consultation.

The British Property Federation responded on this, raising concerns with one of the proposed changes in particular – an extended moratorium for insolvent companies prior to any formal insolvency process being entered into.

The specific proposal is for a company in financial difficulty to benefit from an entirely new ‘moratorium’ procedure lasting three months (where it would be protected from its creditors, including enforcement procedures by landlords) but still remain outside any formal insolvency process.

It is currently unclear but reasonably anticipated that, if introduced, there would be nothing stopping a tenant company benefiting from the interim moratorium and then simply entering administration anyway (which then has its own moratorium).

Any such moratorium then raises its own Game-related questions, most particularly, what is the position on rent during the new moratorium period and from what source of funds is rent accruing during this period to be paid? At least with an administration landlords can take some comfort that the insolvency practitioners appointed will have to pay rent accruing as ‘an expense of the administration’ (at least for the period when the property is used). What happens if the tenant has no money to pay the rent three months after the new moratorium period has expired?

While such a moratorium does, in theory, help to alleviate the difficulties of a distressed business, it could potentially be open to abuse and the proposed length of three months might only draw out a process that is already uncertain for landlords. Given the evolving case law over the past 30 years on the payment of rent during an administration, it is also entirely possible that landlords will have to endure another decade of uncertainty as the effects of the new moratorium on rent payments are clarified through the courts.

The Insolvency Service is currently analysing the feedback from the consultation process. There are competing issues at play, with political pressure to find ways to help companies in difficulty. Two-thirds of respondents to the consultation agreed that a standalone moratorium would, in theory, facilitate business rescue. Interestingly, however, the insolvency industry trade body, R3, takes the view that the proposed length of three months is too long and recommends instead a 21-day period (with oversight by an insolvency practitioner).

If the proposed new moratorium was not enough to trouble landlords, the Insolvency Service consultation also invited views as to the following possible changes (all available in the US Chapter 11 procedure on which the current consultation is clearly based):

• the ‘cram-down’ of creditors (whereby non-consenting creditors can be bound by a prescribed majority of consenting creditors of the same class – similar to that under the current ‘CVA’ or ‘scheme of arrangement’ procedures in the UK);
• protection of ‘essential contracts’ – while this applies in the UK in relation to certain contracts, such as utilities, it is much more limited than the Chapter 11 equivalent (it is unclear how far such principle is to be extended and its impact on landlords’ ability to forfeit);
• ‘super-senior’ or ‘rescue finance’ – not previously seen in the UK (but common in the US) whereby new finance provided during the rescue period will rank in priority to certain existing creditor claims including, at a minimum, unsecured creditors (in the US such lending can rank above prior secured lending). This again highlights the need for landlords to know where their rent claims and proprietary rights will rank.

From a landlord perspective, the proposals in their current form present a very real concern. In addition to the issues as to payment of rent, landlords might not be able to exercise their rights of distraint or commence forfeiture proceedings against a non-paying tenant during the moratorium period.

On 22 November 2016, the European Commission published a proposal for a new directive which effectively repeats (mostly) the Insolvency Service proposals (as well as certain other procedures already incorporated into UK law). If passed, the directive will need to be adopted into local law by all member states within two years. It is no comfort that such a directive might not be binding in the UK if Article 50 is triggered early this year (although our European friends may be less enamoured by our parting gift to them) as, Brexit or no Brexit, it appears likely that some incarnation of these proposals will become law in a further round of amendments quite soon.

Whatever is finally introduced, whether landlords are looking at: a new 21-day or three-month moratorium; supervised or unsupervised by an insolvency practitioner; with or without the introduction of ‘rescue finance’ or new ‘cram-down’ procedures, it would not seem unreasonable for commercial landlords to ask that (this time around) they should be entitled to see clear and express provisions on the treatment of rent during any such moratorium period and the priority of such claims in the insolvent estate.

Those affected would be well advised to keep themselves abreast of the proposed changes (both in the UK and the EU). The next stage in the process is for the Insolvency Service to put forward its revised proposals. Watch this space.

This article was published in Estates Gazette in February 2017.

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