Insolvent Tenants By Madeleine Perrignon | July 2009 Area of Expertise | Business & Property
Summary The unsettled economic climate may lead to increased tenant insolvencies. It is important for landlords to understand basic insolvency law and its effect on leases so that they can make better informed decisions if their tenants are threatened by insolvency, or if an administrator, receiver or liquidator is appointed to a tenant’s business.
Who Does This Impact? Landlords
What Action Should Be Taken? Landlords should be aware of warning signs of imminent retail failure and communicate with the tenant so that they can take pre-emptive action. Landlords should also obtain maximum security from tenants when negotiating a new lease.
Warning Signs A landlord needs to identify warning signs of imminent retail failure. Indicators may include: •
Strained relationships with key suppliers and customers;
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Legal threats;
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Request for extension of trading terms and delay in paying creditors;
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Inadequate cash reserves to meet immediate liabilities;
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Poor banking relationships and no access to finance, due to poor credit rating;
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Suppliers requiring cash on delivery; and
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Post-dated cheques.
One of the clearest indicators of financial difficulty is when a retailer owes tax to the ATO. When a company is facing cash flow shortages, the creditors that complain loudest will be the creditors that are paid first. At such a time, debts due to the ATO are generally of no urgency. Instead, the retailer will concentrate on paying its suppliers so it can continue to trade. If a landlord identifies that there are outstanding debts to the ATO, then it needs to protect itself by taking action. Obviously, a landlord may not be aware of outstanding ATO debts, or the other indicators of financial difficulty. However, it will assist the landlord to at least possess an awareness of what might indicate financial instability.
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Insolvency Terminology If a tenant has been declared insolvent, it is important to understand insolvency terminology.
Receiver and Manager A receiver is usually appointed by a charge holder if there is an event of default pursuant to a charge. They can also be appointed by a Court. The receiver attempts to maximise the return for the charge holder. This appointment can occur simultaneously with the appointment of an administrator or a liquidator. Subsequent to their appointment, the business will either be sold, continue its operations, or be administered or liquidated. Receivers are custodians of the business until further decisions are made concerning its continued operations. Unlike voluntary administration or liquidation, a landlord can terminate a lease during the period that a business is in receivership. Section 419A of the Corporations Act provides that the receiver is not liable to pay rent for seven days after its appointment. If, during this period, it vacates the property, then it will not be liable to pay rent after the initial seven day period.
Voluntary Administration A liquidator, charge holder (holding an enforceable charge over the whole or substantially the whole of the company’s assets), or a director resolution can lead to the appointment of an administrator. If the administration is successful, the company can trade its way out of difficulty. If it is an unsuccessful administration, then the company will generally be liquidated. The administrator’s role is to take control of the company’s affairs from the directors, carry on business, investigate the company’s affairs and make recommendations to the creditors. The administrator’s powers include commencing legal proceedings, executing company documents and disposing of company assets. Section 440C of the Corporations Act prevents the landlord from taking possession of the leased premises during voluntary administration, other than with the administrator’s consent or with the Court’s leave – unless (prior to the commencement of the administration) the landlord has already exercised a power to recover the property. (Although, if the Court believes that the landlord is protected without repossession of the property, it might veto this right.) The protection of Section 440C ceases at the end of administration. Section 443B of the Corporations Act provides that the administrator is not liable to pay rent for five business days after the administration begins. If, during this period, it vacates the property, then it will not be liable to pay rent after the initial five day period. The intention of the legislation is to give creditors the opportunity to consider their options and to prevent the landlord from preempting that position, by disturbing the company’s possession of the premises during the voluntary administration.
Liquidation Liquidation is when a liquidator is appointed to a company (either by Court order or voluntarily), in order to collect and dispose of a company’s assets and repay liabilities owing to creditors. It results in the company being wound up and ultimately deregistered. A
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solvent voluntary winding up is referred to as a ‘members’ winding up. However, most voluntary liquidations are ‘insolvent’ and are commenced by creditors. A provisional liquidator may be appointed in order to preserve the status quo of a company and to enable the Court to decide, after a further examination, whether the company should be wound up. Their role is to ‘receive’ rent income and other proceeds. They gather in and realise the assets and pay debts to the satisfaction of the charge holders. Their powers may include the ability to conduct the company’s business. Whilst provisional liquidators are appointed, legal proceedings and enforcement proceedings are stayed except with the Court’s leave. The company continues to exist, but the internal management functions are taken over by the provisional liquidator. The appointment is said to therefore paralyse the company and it usually only happens in urgent situations. Pursuant to Section 568 of the Corporations Act Act, a liquidator can disclaim a lease – and a landlord can serve notice on the liquidator to ascertain whether or not the lease will be disclaimed. If the liquidator does not disclaim the lease within twenty eight days, then the lease will continue. If the liquidator serves a Section 568 Notice and disclaims the lease, then the landlord can recover possession of the premises. Obviously, it is in the landlord’s interests to ascertain as soon as possible what is happening with the lease, so that it can seek to locate a new tenant and mitigate losses.
Rental Arrears Secured creditors hold security over assets, which entitle them to realise the asset, if a debtor falls behind in payments. For example, pursuant to a mortgage, banks can exercise a power of sale and sell a house. Finance companies with a bill of sale over a car can repossess the vehicle and sell it. Unless secured by way of formal mortgage or charge, landlords are grouped in with other unsecured creditors. Their only chance of arrears recovery is to lodge a Proof of Debt and hope that sufficient assets remain once the company is wound up. The Corporations Act details the priority order for payments. This provides that the administrator is to be paid, followed by employees, secured creditors and then unsecured creditors. In respect of the period prior to receivership, the landlord is not entitled to recover rental arrears from the receiver. Again, the landlord must lodge a Proof of Debt and hope that there are sufficient assets.
Effect of an Insolvency Event on the Lease Typically, commercial leases will contain a term that an insolvency event will be deemed a default by a tenant pursuant to the lease. Therefore, the appointment of an administrator, liquidator, or receiver and manager would be considered an insolvency event, meaning that the landlord had the immediate right to terminate the lease. However, if an administrator has been appointed, there is a moratorium affecting all creditors. If a landlord had commenced proceedings prior to the appointment of the administrator, pursuant to Section 441F of the Corporations Act Act, the landlord is still entitled to continue this action. This is why it is important for landlords to try and ascertain the solvency of their tenants, so that they can choose whether or not to terminate a lease, rather than wait for an administrator to decide whether it wants to continue the lease.
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Section 129 Notices If a tenant breaches the lease, the landlord may be required to serve a notice pursuant to Section 129 of the Conveyancing Act (‘Breach Notice’) which provides that the notice must specify the breach, and (if it is capable of remedy), require the tenant to remedy the breach. Once the period specified has passed, then the landlord can exercise its right of re-entry or forfeiture. If there is an insolvency appointment, there is conflicting advice as to whether or not the landlord must still serve a Breach Notice. For safety, a landlord probably should. If the landlord does seek to terminate the lease based on an ‘insolvency event’, the liquidator may be able to seek relief against forfeiture (although it will need to weigh up the cost of doing so in terms of what assets remain to pay creditors).
Assignment of Leases A liquidator will often be motivated by the increased sale price if it can sell the business as a going concern. In this case, an assignment will be required and the landlord should reach agreement that the liquidator can continue occupation, provided it pays all post liquidation rent.
Bank Guarantees and Security Deposits – Can a Landlord Still Call on Them? A landlord is still entitled to call up a bank guarantee or other security bond that it holds to reimburse it for rent, or other costs owed by the tenant. The landlord is also entitled to sue under any personal guarantee. However, it should be remembered that personal guarantees may not be easily enforceable when the tenant is insolvent, as the landlord may not be the only creditor for a tenant. Also remember that a security deposit belongs to a tenant and any payment from it would be considered a payment by the tenant to the landlord. This may be found to be an unfair preferential payment which a liquidator could claw back. A bank guarantee is a guaranteed payment from a bank (who is a third party), so it will not be considered an unfair preferential payment, as the tenant is not making the payment. A bank guarantee is therefore the preferred option for a landlord.
How Can a Landlord Minimise Loss? •
Obtain maximum security when negotiating a new lease.
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Communicate with tenants to try and ascertain financial solvency. Prior to appointment of an administrator or a liquidator, commence action for recovery of a debt, including terminating a lease.
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Call up a bank guarantee or security bond soon after default.
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Communicate with the administrator or a liquidator to ascertain the status of the insolvent tenant and to ascertain whether or not the administrator or liquidator wishes to disclaim the lease.
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Attempt to locate a new tenant quickly and mitigate loss because it may prove difficult to recover all outstanding moneys from the administrator or liquidator.
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Lodge a Proof of Debt with the administrator or liquidator in respect of outstanding monies owed by the tenant.
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For more information, please contact: Madeleine Perrignon Partner T: 02 8257 5710 madeleine.perrignon@turkslegal.com.au
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