TENANT DEFAULT – PROTECTING THE INVESTMENT

Key issues
Forfeiture is not the only alternative…
Monthly payment plans/lease re-gears are useful negotiating tools
Forfeiture- consider long term costs…
Existence of third parties against whom a claim can be made
Guarantees – are they enforceable?
Administration/liquidation

A bumpy ride
What are the options for property investors seeking to maximise revenue from their property portfolios, particularly when faced with an occupier in financial difficulty?

A property investor will look to protect its income stream but the recent economic fragility has altered perception of what tools investors should use to protect their investment.

Forfeiture
Prior to the economic downturn forfeiture or the threat of forfeiture was usually enough to ensure prompt payment of arrears.

In better times, with the confidence of knowing the property could be quickly re-let, often at a higher rent, landlords were able to terminate the lease quickly and with little cost by instructing bailiffs to 'effect peaceful re-entry' meaning that the lease was brought to an end by the locks being changed, and the tenant being excluded from the property. Unless the tenant could pay the overdue rent, that was the end of the tenancy.

The market
In a healthy market it can still usually take a number of months to re-let. In a fragile market it will invariably take much longer. There is no guarantee that a landlord will secure the same rental for a particular premises and is likely to have to resolve any disrepair issues with the property and to offer incentives to the incoming tenant.

Empty rate relief
Following forfeiture, a landlord will not only suffer an interruption to its income stream but changes to empty rate relief in April 2008 mean that landlords now have to pay for the privilege of keeping commercial property vacant. Although there are schemes available to mitigate the impact such action needs to be considered in the context of whether a remedy such as forfeiture is a proportionate and cost effective response to a tenant's financial difficulty.

Distraint
This ancient right allows a landlord to instruct a bailiff to visit the premises and 'levy' against the tenant's goods that are on the premises. Ultimately if payment is not made, then the bailiff can sell those goods to pay the rent and any bailiff's costs incurred in taking the action. There are specific rules on what a bailiff can take, so care needs to be exercised to decide when this is an appropriate remedy.

Monthly payments
By maintaining an open dialogue with the tenant, there are occasions where the landlord realises that without help, the tenant is likely to default. There are several options that might allow the landlord to assist in keeping the tenant trading in the short term until the situation improves.

A tenant might simply need an opportunity to manage its cash flow. Most commercial leases include a tenant covenant requiring the tenant to pay the rent quarterly in advance. During a downturn, tying up cash for such a period can add to the financial burden on a pressed tenant. Negotiating a monthly rental payment plan might enable the tenant breathing space while the landlord suffers no more than the administrative cost of setting up the plan.

It is important to agree with the tenant that any such concession would operate only for a limited period and thereafter subject to review depending on financial performance of the tenant.

Instalment plan
If the situation is worse, then it might be that a longer instalment plan is necessary but the landlord needs to be convinced that the tenant has a real hope of recovery. Taking security or a guarantee in consideration for the delay in payment might be appropriate.

Reducing the rent
This involves negotiating with the tenant to 're-gear' the lease. Commonly this requires the parties entering into a deed of variation to reduce rental or other periodical payments in the lease. This might be for a limited period or for the duration of the term depending on how long there is left to run.

It goes without saying that the landlord gets less money. There are also inevitably professional costs in documenting such an arrangement; legal costs in drafting, negotiating and completing a deed of variation, agent's costs in negotiating the amount and length during which any discount is to operate.

The landlord will need to balance carefully these items against the cost of having a vacant unit. No doubt, in certain circumstances, the landlord could forfeit the lease but if it maintains an income stream (albeit reduced) in such cases the parties might have more to gain through negotiation.

A deed of variation is usually a comparatively simple document to negotiate but special care needs to be taken where a guarantor is joined as a party to a lease.

Statutory demand
Where the landlord considers the tenant has got the money available to pay the rent, or is prioritising other creditors, then it needs to act swiftly, and ensure any threat made is followed through.

One method is serving a statutory demand, which formally demands payment within 21 days, against the threat that if payment is not made, then the landlord will issue a winding up petition. This can be useful to assess the tenant’s financial problems.

Is the lease an "old lease"?
If the lease was completed prior to 1 January 1996 original tenant liability is preserved. This means the landlord can ask the original tenant to pay the rent, so long as a notice is served within 6 months of any liability becoming due.

Where there has been an assignment of an old lease and the current tenant is in financial difficulty the landlord might consider serving a notice on the original tenant to cover these liabilities.

What about guarantors?
If the landlord had concerns about the covenant strength or financial security of the tenant prior to completion of the lease it might well have insisted on the tenant providing a guarantor.

If this is the case the landlord can make a claim against the guarantor.

There are however a couple of issues landlords should consider that have particular significance in terms of enforcing guarantees.

The much publicised case of Good Harvest has raised doubts about the ability of landlords to be able to enforce a guarantee that is given by a guarantor in an authorised guarantee agreement (AGA). In circumstances where a tenant is looking to assign a new lease and the landlord is contractually entitled to insist that the guarantor enter into the AGA, the Court held that the landlord could not enforce the AGA against the guarantor.

Simply because a lease says that a guarantor must give a guarantee on assignment does not mean that the landlord will be able to enforce it. Therefore advice should be taken as soon as it is apparent that a guarantor may be called upon to pay any sums under the lease.

Enforceability
Enforceability also arises in the context of variation of a lease, for example, as a result of agreeing a 're-gear' with the tenant. It is established law that unilaterally varying a lease (and the underlying obligations of the guarantor) without the consent of the guarantor may well result in the guarantor being inadvertently released from its obligations.

A well drafted guarantee clause in a lease will invariably include a saving provision that purports to keep the guarantee alive notwithstanding any variation that is entered into by the tenant. It is far safer however to ensure that the guarantor is made a party to any deed of variation. This should not pose a problem in the case of a re-gear of the lease as any such deed will be for the benefit of the tenant and potentially reduce any guarantor's liability.

Insolvency
Changes that have been made to the insolvency regime have been designed to bring in a regime that saves more businesses. The price for this is a shift in the balance of power between the landlord and tenant. No longer is the only choice for the tenant to liquidate the company and in so doing, lose any value attaching to the trading goodwill.

Administration
With the modern form of administration, the tenant company can continue to trade, but have protection from its creditors while it either tries to trade through the current difficulties or looks for a buyer.

This period is known as a moratorium, and prevents forfeiture, distraint and legal proceedings, amongst other actions. As soon as the landlord receives notice of the administration of a tenant it should not take any action until it has taken legal advice. It would also be well advised to open a dialogue with the administrator to ascertain its intentions for the company and the particular property.

If the property is being used for the benefit of the creditors in the administration then the landlord should receive payment of rent and other charges as what is known as an expense of the administration. This does need to be dealt with promptly to ensure it is clear what is to be paid and when.

Liquidation
Where a liquidator has been appointed it has the power to disclaim the lease. There is a risk for an investor that a disclaimer may adversely affect its income stream particularly if there are subleases. If the investor receives notice of a disclaimer, this is another instance where it should take immediate legal advice.

Simon Pickett
spickett@beachcroft.com
+44(0)117 918 2036