Insolvent tenants – how do they impact landlords?

Corporate entities are increasingly succumbing to the pressures of creditors and excessive debt levels, and we are seeing a spike in the number of corporate clients approaching us for insolvency advice – these include property owners.

Commercial lawyer DEAN FRITH is aware that agents want to know where property owners stand when their tenant enters administration or liquidation.

Corporate insolvency has massive consequences for landlords, including:

• their ability to ensure rent is paid on time;
• that any arrears are brought up to date;
• to recover possession of the leased premises; and
• to commence legal proceedings in relation to any breaches of the lease.

Voluntary Administration versus Liquidation – what’s the difference?

Voluntary administration includes the appointment of an insolvency practitioner (administrator) to take control of a company in order to maximise the company’s chances of continuing to trade or providing a better return to shareholders and creditors.

Conversely, the purpose of liquidation of an insolvent company is to have an independent person appointed to wind up the company’s affairs in an orderly and equitable way, for the benefit of all creditors.

What does it mean for Landlords?

The consequences of having an insolvent tenant will depend on whether the landlord’s tenant is entering administration or being liquidated:

Administration

1. Under the Corporations Act 2001 (Cth) (“the Act”), an administrator is not required to pay rent for 5 business days after the commencement of a company’s administration. After the 5 day grace period has ended, the administrator is liable for rent for as long as the tenant “uses, occupies or is in possession of the premises”.
2. Most commercial leases contain clauses which allow the landlord to immediately terminate the lease and re-enter the premises once the tenant becomes insolvent; however, under the Act, the landlord cannot recover possession of premises during a period of administration without a court order or the administrator’s written consent.
3. A landlord is unable to continue any existing action, or commence any new action, against a company that has entered administration for the period that the administration is in effect.
4. Landlords should be very careful if considering calling upon a bank guarantee or security deposit provided by a corporate tenant who has entered a period of administration. It is possible that doing so may give rise to an unfair preference claim, and we therefore strongly advise that landlords seek advice prior to calling on any security offered pursuant to a lease.

Liquidation

1. A liquidator is not personally liable for rent during the liquidation, nor is a liquidator responsible for arrears of rent; however, if the liquidator remains in occupation of leased premises, the rent for this period of occupation will be the liquidator’s expense.
2. If the lease allows the landlord to do so, the landlord may terminate the lease and re-enter the premises if the tenant goes into liquidation. Similarly, the liquidator is entitled to vacate the premises at any time.
3. Under the Act, a landlord cannot commence or continue legal action against a company that has entered liquidation without the permission of the court.
4. A liquidator has the ability to ‘disclaim’ a lease, which terminates the tenant’s rights, interests and obligations in relation to the lease. Disclaimer also means that the landlord is entitled to re-enter the premises and take possession.
5. As with an administration, landlords should be very careful if they seek to call upon security offered under the lease, and should seek legal advice before attempting to do so.

Practical Tips to Protect Landlords

Unfortunately even the best lease in the world and a thorough knowledge of the Act and corporate insolvency practice will not save a landlord in every situation.

However, landlords can help themselves to reduce their risk by ensuring they have timely and efficient procedures in place. Loss can be minimised by:

• Being diligent in following up with tenants if there is news or other indications that they may be in financial difficulty, such as consistently paying rent late – do not wait to receive a notice from an administrator or liquidator.
• Making sure lease documents are up to date and effective – old documents can lead to interpretation problems.
• Taking advantage of all possible security options when negotiating the terms of the lease at the outset – unlimited personal guarantees, bank guarantees, etc.
• Ensuring that the Lease has as many safe guards as possible to best protect the Landlord’s interests as against a liquidator in the event of the insolvency of the Tenant. For example – a clause in the Lease that gives the Landlord an automatic legal interest in the Tenant’s fixture, fittings, plant, equipment and stock upon the liquidation or administration of the Tenant, with such interest registered on the Personal Property Security register.
• Being realistic about prospects to recover rent and other moneys payable under a lease from an insolvent tenant, and taking steps to mitigate loss as early as possible.
• Opening the lines of communication with an administrator or liquidator as early as possible – often, they’re prepared to give a general indication of where the company is headed.

The implications for a landlord of an insolvent tenant can be significant and complicated. As soon as a landlord becomes aware of insolvency (or potential insolvency) they should seek professional advice to ensure their position is as protected as possible.

 

Baker Love Lawyers’ leasing team has over many years developed a standard commercial Lease document. Our Lease contains all of the safe guards referenced in this article. Please contact one of our leasing team if you would like further information or assistance with preparing Lease documents.