Insolvency update: rent as an insolvency expense

When companies fail, landlords are often one of the largest creditors. Not only that but they may be unable to re-let in the short term or, worse, prevented from re-letting their premises while office holders seek a buyer for or wind down the business.

Before the judgment in Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2009] EWHC 3389 (Ch), it had long been considered that the payment of rent by administrators was a matter within the discretion of the court, usually considered in the context of an application for permission to forfeit a lease. The fact that the payment of rent falling due, while premises are being used for the purpose of an administration, is not discretionary was put beyond doubt in Goldacre. However, Goldacre did not determine all questions relating to such payment of rent and the courts continue to clarify the position in cases such as MK Airlines Property Ltd (In Administration) v Katz [2012] EWHC 1018 (Ch), which was decided in May.

In Goldacre, the administrators of the company had been using a relatively small part of the leased premises for the more efficient conduct of the administration. Other parts were occupied by sub-tenants, and rent was being paid by the sub-tenants directly to the landlord, such that the court was not concerned with the administrators' occupation of those parts of the premises.

Rent had been paid for the period of the administration but the landlord sought the court's direction as to whether future rent fell to be paid by the administrators as an expense of the administration under rule 2.67 of the Insolvency Rules 1986. This would have the effect of giving rent payments priority over (among other claims in the administration) the administrators' own remuneration.

The Lundy Granite principle had developed in relation to liquidations, following the 1871 case of that name, which provided that, where property is retained for the purpose of advantageously disposing of it or it continues to be used in a liquidation, rent ought to be regarded as if it was a debt incurred for the purpose of that process, even though it was incurred pursuant to an obligation entered into by the company before the process commenced and ought to be paid as an expense of the liquidation. Since rule 4.218 of the Insolvency Rules 1986 came into force, which sets out categories of liquidation expenses, it has been considered by the courts to have the same effect.

In Goldacre, the court found that this principle applied equally in administrations, notwithstanding that the Insolvency Rules contain less clear wording in relation to administration expenses.

The court went further and found that, once an administrator makes use of or decides to retain rented premises, rent falling due on the next quarter date (and indeed any other contractual payment date) would be payable by the administrators as an expense, in full and without apportionment where such use or retention comes to an end before the end of the quarter.

The court did not consider itself bound to follow the approach of the Court of Appeal in Sunberry Properties Ltd v Innovate Logistics Ltd [2008] EWCA Civ 1321, in which it had thought that such matters were within the discretion of the court, affording it flexibility in its approach to achieve a fair outcome. The court in Goldacre considered that this was not a matter of discretion but a matter prescribed by the Insolvency Rules and rent for each payment period would be payable with no regard to the amount recovered through the use of the property, for example, under the terms of any licence to occupy the premises granted by the administrators.

In Goldacre, the court acknowledged that there was no immediate right to payment since the administrators must first determine that there are sufficient funds available for payment to be made, having regard to other claims with the same or greater priority. The court did not, however, clarify where, in the order of priority determined by insolvency rule 2.67 (a) to (j), the expense fell to be paid, saying that if it was not under sub-paragraph (a) then it fell to be paid under sub-paragraph (f).

Since Goldacre, administrators have to factor into their strategy for an administration the effect of using the company premises and ensure that there are sufficient funds available to pay all expenses of the administration, including rent, so that they do not risk having insufficient funds available to pay their own remuneration at the end of the administration. They may time the administration appointment to fall after a rent payment date to give them time to decide on strategy, finish off contracts that can be completed quickly, and, if appropriate, vacate the premises before the next rent payment date. Where the purchaser of the business and assets of a company in administration is allowed to continue to trade from the premises, for example under the terms of a licence, then administrators should ensure that the terms of the licence require payment, in advance of occupation, of at least rent due in any quarter during which the licence will continue. Administrators should also inform the landlord once the use or retention of the premises has come to an end and make it clear to the landlord that consent will be given to forfeiture of the lease or a surrender will be agreed.

Open door

Landlords have taken every opportunity to use Goldacre to their advantage. Unfortunately, not all matters relevant to any such entitlement were decided in Goldacre, leaving the door open for claims that may go beyond what was intended and leading to disputes between landlords and administrators.

Some of those disputes have recently come before the court. In Leisure (Norwich) II Ltd v Luminar Lava Ignite Ltd [2012] EWHC 951 (Ch), decided in March, the court confirmed that, where rent fell due for payment before the administration, it would not be payable as an expense even if the administrators were using the premises for the purpose of the administration during the rent period. Where rent for a period fell due for payment, in advance, after the administrators had elected to use the premises, then rent would be payable as an expense for the whole period. However, where rent is payable in arrears, it is payable only for the time during which the premises are being used.

In May, the court handed down judgment in MK Airlines. MK Airlines had been subject to several insolvency processes, including a provisional liquidation. The court had to determine whether rent payable during the period of the provisional liquidation should be treated as an expense of the liquidation. Further, if it did, the court needed to determine the point in time from which rent would be so payable.

Provisional liquidators are appointed before there is any winding-up in relation to a company to look after the company's assets and no more. It was therefore argued that a provisional liquidator could not be motivated to retain or use the premises for the convenience of the winding-up. The court considered that rent was payable as an expense on the grounds that: it would be anomalous if the position differed between an administration, liquidation and provisional liquidation; expenses incurred by a provisional liquidator are an expense in the liquidation under the Insolvency Rules; and the circumstances would determine in each case whether rent was an expense based upon whether the provisional liquidator had retained the premises for the purpose of advantageous realisation or its continued use.

The court made it clear that, if the provisional liquidators had done nothing in relation to the premises, neither using them nor retaining them for the purpose described, then rent would not fall to be payable as an expense.

In MK Airlines, the provisional liquidators had been appointed two days before a rent quarter date. They had then considered what urgent action they needed to take to protect the assets, having determined that they were in jeopardy and that immediate action was required to protect them. The assets were therefore secured at the company's rented premises. At a later date the provisional liquidator had considered whether to remove the assets from the premises. However, removal would be expensive (they included aircraft and a flight simulator) so it was concluded that the assets should be left at the premises until the liquidation of the company.

Following the authority of Re Oak Pits Colliery [1882], the court decided that merely retaining and securing property situated on the premises was not a use sufficient to engage the principle that rent should be paid as an expense. Accordingly, rent falling due on the first quarter day after the appointment of the provisional liquidators was not payable as an expense. However, it was considered that at some later date, before the next quarter date, the provisional liquidators had made a decision to retain the premises and not seek to disclaim the lease, to the benefit of the liquidation. The court said that it was possible to treat each quarter differently depending upon the motivation of the provisional liquidator as at the rent payment date. However, the court did not consider that it would be appropriate to apportion the rent between the time before and after the decision to retain the premises had been made.

Establishing intention

Landlords that have premises occupied by companies that go into an insolvency process should open a dialogue with the office holder immediately, in writing, to ascertain the administrator's intention. If it is the intention that the premises be used or retained for some purpose then landlords should seek confirmation that rent will be paid for that period as an expense.

At such time the office holder notifies the landlord that the premises are no longer required there will no obligation upon the landlord to take back possession of the premises, though the landlord may wish to seek a surrender or consent to forfeiture or find out if a liquidator intends to disclaim the lease. Landlords may be able to avoid paying rates, if the premises are empty, and may not wish to retain possession for this reason but merely to obtain access for the purpose of marketing the property.

Landlords may wish to consider granting (or amending) leases to provide that rent is payable more frequently than quarterly so that they do not have to wait so long before rent becomes an expense of an insolvency process.