UK: Property & Insolvency - February 2010

INTRODUCTION

The coming months represent something of a journey into the unknown for us all. According to some analysts the market has bottomed out and 2010 will mark the start of the long road to recovery. For others the positive signs are nothing more than a false dawn prior to the economy entering the second cycle of a double dip recession.

Whatever 2010 brings one thing is certain: the effects of the last 18 months to 2 years are not going to disappear overnight. On the retail side, businesses will have been hanging on in order to capture the Christmas trade before taking the decision to restructure their affairs or cease trading. Also, insolvency situations typically lag several months behind the state of the economy as a whole, meaning that whilst there may be positive market indicators in abundance in 2010, for those at the coal face the impact of the economic downturn is almost certain to be felt throughout the coming year at least.

Topics covered in this edition of Bircham Dyson Bell's property and insolvency bulletin include offences under the Insolvency Act 1986, the recovery of rent as an administration expense, the role of a receiver appointed by mortgagees and disclosure obligations prior to a pre pack administration sale.

If having read this bulletin you would like to know more please do contact us.

IS RENT AN 'EXPENSE OF THE ADMINISTRATION'?

By Nitej Davda

Liquidation is the first step in the process of bringing the affairs of a company to an end. Administration, unlike liquidation, is intended to provide a breathing space to see whether the company can be saved, either in whole or in part. More often than not the rent stops coming in when a tenant company goes into administration; when a landlord asks the administrator what is happening it is often met with a wall of silence. The best that can be hoped for is a response that the company will pay rent when it can, but the landlord is just an unsecured creditor for any unpaid rent.

In this situation the landlord cannot forfeit, sue for the rent as a debt or take any other step to recover it without either consent of the administrator or permission of the Court. Ultimately however is the landlord required to suffer exposure to increasing rent arrears if the company maintains the status quo?

In law, once a company is placed into administration the Insolvency Rules provide a list of expenses of the administration which take precedence over other unsecured creditors, and their relative priority (Rule 2.67). Of relevance are the following, which are amongst a list of nine. Their order in the list of nine is in square brackets:

• expenses properly incurred by the administrator in performing his duties [1];
• any necessary disbursements incurred or to be paid in the course of the administration [6];
• the remuneration of the administrator [8].

It can be seen that it does not benefit the administrator if expenses of the company fall within category [1] or [6]. What then is the status of rent (assuming that the landlord is not secured by way of a charged rent deposit)? Arrears of rent prior to the placing of the company in administration are treated as unsecured debts. However, is it arguable that post administration arrears have a different status.

Exeter City Council v Bairstow & Others (2007)

This High Court decision concerned a company placed into administration and subsequently moved to liquidation. It was not in dispute that the Company traded from the premises during the period of administration. The question that arose was the status of business rates liability during the period of administration.

The judge found that Rule 2.67 was modelled on the equivalent rule governing priority in liquidation cases and that business rates did not fall within the definition of 'expenses properly incurred' for three reasons:

• this class of expense is intended to cover expenses which the administrator took positive steps to assume liability for;
• if this class of expense were to be interpreted as including those for which the administrator takes no positive steps to incur the liability, then the class of expenses that would fall within this category would make a mockery of the remaining categories of expense;
• not even authorities on interpreting the equivalent liquidation rule went so far as to classify business rates as an 'expense properly incurred'.

The judge did nevertheless find that business rates were a necessary disbursement. In so doing the judge based his decision squarely on the fact that the wording of Rule 2.67 was based upon its equivalent liquidation rule and Rule 2.67 was drafted after the House of Lords (as it then was) decision in Re Toshoku Finance UK plc (see below) which commented upon the interpretation of the liquidation equivalent. It would therefore be wrong not to apply the principles of this decision in interpreting Rule 2.67.

Re Toshoku Finance UK plc & Others v IRC (2002)

This case concerned the treatment of corporation tax as an expense of the liquidation. It was decided that as a post liquidation expense it fell within the category of a necessary disbursement. The leading opinion contained approval to the proposition that where a liquidator retained property for the purpose of advantageously disposing of it or otherwise continued to use it, rental payments that fall due after commencement of the administration could be considered as a post liquidation expense falling within the category of a necessary disbursement. The House of Lords was at pains to confirm that it was not stating that rent was an expense of liquidation; simply that it could.

Goldacre (Offices) Limited v Nortel Networks UK Limited (in administration) (2009)

This High Court decision was handed down in December 2009. The only issue for the Court to determine in this case was whether rent due in the course of an administration is payable as an expense of the administration under Rule 2.67. Nortel were in occupation of part of the premises in question during the course of the administration though it was conceded that they were only in occupation of a relatively small part of the premises demised (the majority of the remainder having been sublet). The judge held that rent fell within the class of necessary disbursements in an administration (though interestingly did not dismiss the suggestion that it may fall within 'expenses properly incurred') and that the rent should be payable in full by the tenant. In coming to this decision the judge distinguished the case from a recent Court of Appeal authority (Sunberry Properties Limited v Innovate Logistics Limited (2009) which provided that rent fell outside the scope of Rule 2.67), on three bases. First, the question of rent payment was just a side issue in the Sunberry case, arising because of eleventh hour submissions on the point. Second, the landlord conceded at the outset in Sunberry that it had no automatic right to receive rent during the administration. Finally, Toshoku was not cited to the Court of Appeal. The judge held that whilst the premises were occupied by Nortel (albeit in part), Nortel was liable for the entirety of the rent under Rule 2.67.

When faced with a tenant in administration landlords need to stand their ground and not accept at face value that they have no remedy to recover rent, particularly in circumstances where the company in administration appears to retain the premises either for the benefit of itself or a phoenix company.

LPA RECEIVERS – MAKING A COMEBACK?

By Simon Painter

In the last major recession in the early 1990s the appointment of LPA receivers over the property of secured debtors was commonplace. With difficult financial times continuing is it set to make a comeback?

Background

If a creditor has a fixed charge over property it can appoint a receiver. The receiver's powers are laid down by the express terms of the charge and the Law of Property Act 1925 (the LPA) which is why the receiver is usually known as an 'LPA Receiver'. The role of the receiver is to realise the debtor's assets in order to repay the debt to the creditor.

Appointment

The receiver's appointment needs to comply with the formalities required by the terms of the charge document or the LPA. The chargee must notify Companies House within 7 days of the receiver's appointment if the debtor is a company. All business correspondence from the debtor company must state that a receiver has been appointed.

Powers and Liabilities

The receivers' powers will depend upon the terms of the charge, but usually he has the power to do the following: demand and recover all rent due and owing at the property, take court proceedings, borrow money and give security, dispose of property, appoint solicitors and agents, take out insurance, carry on the business of the company debtor, and grant leases. The receiver does not have power to disclaim leases or other onerous contracts, nor does he have the power to absolve a tenant from contractual obligations entered into prior to the receivership. On the other hand, nor will a receiver be personally liable on pre-existing contracts, even if he decides not to honour them, unless the receiver has acted in bad faith or outside his authority.

In relation to new contracts entered into by the receiver on behalf of a company debtor after the receivership, the receiver can be personally liable unless the contract provides otherwise; it is therefore important for receivers to ensure that any fresh contracts contain exclusions of liability. The receiver should also try to negotiate with the creditor upon appointment for an express indemnity by the creditor against all liabilities that may be incurred by the receiver personally.

The receiver may also be liable for any acts of negligence or nuisance he commits in the course of his receivership and for certain statutory liabilities under the Insolvency Act 1986 if the company is in the course of being wound up. He may also be liable for criminal offences; for example, in one reported case for a failure to comply with health and safety requirements in the work place.

Duties

In managing and selling the debtor's business and assets, the receiver's duty is primarily to the charge holder with a secondary duty to the debtor. A duty is also owed to any guarantor of the tenant's obligations under the charge and to any other chargees of the property, but not to any unsecured creditors.

In practice, the duty includes a duty to obtain a fair market value when disposing of assets and to take reasonable care in exercising powers of management. Also any income and sums received from assets realised must be applied in a particular priority.

Landlord's Remedies

So what are the landlord's remedies if an LPA receiver is appointed over his tenant's premises? The appointment of a receiver does not affect the landlord's right to forfeit the lease, nor to distrain or sue for rent; any of these actions can be taken by the landlord without the permission of the court or the receiver.

WHAT HAPPENS TO LEASE RENEWAL PROCEEDINGS WHEN A LANDLORD ENTERS INTO ADMINISTRATION?

By David Vaughan

This difficult situation potentially placing the future of a tenant's business in jeopardy was recently considered by the Court.

Background Law

A tenant cannot proceed with a 1954 Act application for a new tenancy against a landlord that is in administration unless it obtains consent from the administrator or permission from the Court. The tenant's application would be caught under by the 'statutory moratorium' which protects companies which are in administration from creditors taking a step in any legal process.

Facts

In Somerfield Stores Limited v Spring (Sutton Coldfield) Limited, the High Court considered whether the defendant landlord could rely on its own administration to delay the lease renewal proceedings brought by the claimant tenant.

Somerfield Stores, the supermarket chain, was tenant of a store in Sutton Coldfield. It applied to the Court for a new tenancy of a supermarket. The landlord, Spring, opposed the application on the grounds that it intended to redevelop the supermarket site (section 30(1) (f) of the Landlord and Tenant Act 1954).

Spring subsequently entered into administration.

The tenant asked the administrator for consent to continue with its claim for a new lease. The administrator refused to provide consent, as it said that it wanted time to endeavour to put together a viable scheme pursuant to which it would satisfy the tests for redevelopment under section 30(1)(f) and sought a stay in the proceedings until such time as the scheme could be put together. A redeveloped site would have increased the market value of the property by £2m.

Somerfield Stores therefore applied to the Court for permission to continue with its claim for a new lease.

What Did the Court Decide?

Although the Court held that the tenant's application for a new lease was a 'legal process' and accordingly, caught by the 'statutory moratorium', it gave permission to the tenant to continue with its application for a new lease.

It was clear to the Court that the tenant was in a state of continuing uncertainty. It had the right to have its application heard without undue delay and the defendant had to prove an intention to redevelop.

The Court had to conduct a balancing exercise and consider the rights of the administrator to conduct an orderly administration in accordance with the statutory objectives against the right of the tenant to have its application heard. The Court held on the facts that it was wrong to withhold permission to continue the proceedings where it was virtually common ground that the defendant could not currently meet the test of intention to redevelop the premises. The Court had regard to the fact that the landlord was in administration as evidence that it did not intend to redevelop.

It would be interesting to know what the Court would decide if the landlord was not, as in Somerfield, opposing the tenant's right to renew its tenancy.

'PRE-PACK' ADMINISTRATIONS – THE NEW RULES

By Sinéad Lester

'Pre-pack' administrations have long had a bad name but have, given the current economic climate, recently been the focus of closer scrutiny. A pre-pack is where the sale of a company's business and/or assets is negotiated with a purchaser before the company is put into administration but the actual sale is effected by the administrator very shortly after his appointment.

Controversy stems primarily from the lack of transparency in the sale process, presenting unsecured creditors with a fait accompli rather than the opportunity to protect their own interests, coupled with the perception that pre-packs fail to maximise returns for unsecured creditors as the proposed administrator cannot properly test the market value of the company for risk of the company's financial difficulties being leaked. This is particularly so where the business is sold back to those who were in control of the vendor company.

By contrast, one of the beauties of pre-packs is that they allow a company to sell its business and/or assets speedily without attracting negative publicity from customers, staff and suppliers alike. Unlike most insolvency proceedings therefore, it may serve to preserve relationships. Even leaving these considerations aside, is the alternative of liquidation with the immediate cessation of the company's business any more attractive?

In an attempt to tackle some of the concerns raised by pre-packs, the Insolvency Service published Statement of Insolvency Practice 16 (SIP 16) which came into force on 1 January 2009. As a consequence, administrators now have to make extensive written disclosure to creditors in all cases where there is a pre-pack sale.

The recent case of Clydesdale Financial Services Limited v Smailes [2009] EWHC 1745 is interesting as it opens the doors to creditors asking the court to scrutinise transactions.

The Facts

Alexander Samuel LLP (LLP) carried on business as a solicitors' practice. LLP became insolvent and sought advice from Mr Smailes (S), an insolvency practitioner, who advised that LLP should resolve to enter into administration. S did not believe that it was possible to rescue LLP and instead believed that a better result would be achieved for LLP's creditors as a whole if an immediate sale of the business was agreed.

LLP engaged Mr Ling (L) to provide a valuation of the business. L carried out a desktop review of LLP's business without inspecting any of LLP's files, instead relying on the opinions of the partners of LLP as to the value of the firm's work-in-progress.

LLP then negotiated a sale of its business and assets to Jiva Solicitors LLP (J) with the close involvement of S who was subsequently appointed administrator of LLP. J agreed to pay substantially more than L's valuation of the business.

The major creditors of LLP were kept in the dark about the sale to J to ensure that they did not take any action which might jeopardise the deal. However, when the creditors were eventually told about the sale, Clydesdale Financial Services Limited and two other major creditors (C), issued an application for, inter alia, the removal of S as administrator as it was too late to stop the sale. The application was made on the basis that S had colluded in the sale of LLP to J at a gross undervalue, failed to consult with the creditors before the sale and failed to comply with SIP 16. C argued that S was so closely involved in negotiating the sale that he lacked impartiality and independence.

Decision

Whilst the court rejected all allegations of impropriety on S's part, the court agreed that it was appropriate for a review of the transaction to be conducted. The valuation evidence provided by L was of limited worth as it had not reviewed the assets of LLP but instead, relied solely on the opinions of the partners of LLP. There was no contemporaneous evidence about the process by which S agreed a sale price with J. Whilst the court accepted there was no clear evidence that a better deal had been possible, nor was there evidence that the sale to J was the best available.

S was not able to carry out the review of the deal as his involvement in the negotiations and the sale process meant that he lacked the necessary independence.

The court held that it was legitimate for S to keep the creditors in the dark to prevent the sale from falling through as long as this was an honestly held belief and therefore, was not a ground for S's removal as administrator.

Similarly, the non-compliance with SIP 16 in itself did not provide a ground for S's removal as administrator.

Conclusion

The case shows that where there is a legitimate case for the investigation of an administrator's conduct, there is strong reason for his removal, even late in the administration process. It is important therefore for administrators to obtain strong valuation evidence and keep contemporaneous records leading up to any pre-pack sale. In this case, the evidence was nothing more than a 'desktop review' based solely on information provided by the vendor. Reliance on such flimsy evidence is a high-risk strategy for administrators.

Whilst breaches of SIP 16 were not of itself determinative grounds for removal of an administrator, such non-compliance will be a relevant factor that the court will consider. This will come as welcome relief to administrators but the safest course for administrators is to ensure compliance as otherwise, the court may allow a review of a pre-pack sale.

INSOLVENCY – WHAT DIRECTORS MUST CONSIDER

By Sean Carolan

Two recent High Court decisions serve to highlight the range of directors' offences and liquidators' remedies that were created by the Insolvency Act 1986.

In the case of Bangla Television Limited (July 2009), Bangla Television's liquidator sought an order against its directors who, despite the Company being 'hopelessly insolvent', transferred its assets to another company (also now insolvent) for no consideration. In Phillips v McGregor (October 2009) the liquidator sought to recover from the Defendant director the value of transactions made before the making of a winding-up order. In both cases the liquidator applied for 'summary judgment'; applications that are based on the premise that there is no reasonable prospect of the directors successfully defending the claim and therefore the case should not proceed to a full blown trial.

Before continuing, it is worth revisiting the key offences of the Insolvency Act 1986 (the 1986 Act) relating to the protection of creditors.

Fraudulent Trading

The management of a business with the intention to defraud its creditors constitutes fraudulent trading. On application to the court by the liquidator, anyone knowingly party to fraudulent trading may be liable to make such contributions to the company's assets as the court sees fit.

Wrongful Trading

A director who knows (or should know) there is no reasonable prospect of a company avoiding liquidation must take all steps to minimise the potential loss to the company's creditors. Failure to do so constitutes wrongful trading. Again, on application to the court by the liquidator, the director may be liable to make such contributions to the company's assets as the court sees fit.

Misfeasance or Breach of Fiduciary Duty

Any person who has taken part in the running of a company and has become accountable for property or is guilty of misfeasance or breach of fiduciary duty may, on the application of the liquidator, be compelled to return the property or make such contributions to the company's assets as the court sees fit.

Transactions at Undervalue and Preferences

It can easily be envisaged that directors of a company on the verge of insolvency might seek to put assets beyond the reach of the liquidator. Consequently the 1986 Act also confers on liquidators the power to apply to the court to have transactions reversed in the following circumstances:

• If a transaction is made at a significant undervalue up to two years before the formal onset of insolvency in circumstances when at the time of the transaction, the company was technically insolvent within the meaning of the 1986 Act.
• If a transaction is made within six months of the formal onset of insolvency and is intended to put a creditor, surety or guarantor of the company in a better position than other such creditors. Where such 'preferences' are made with persons connected with the company this period may be extended to two years.

In Bangla Television the value of the company's assets that were transferred was stated to be £250,000, including almost £170,000 for goodwill. No consideration was paid by the purchaser to the company and the liquidator contended that the transaction constituted a transaction at undervalue and that the directors were wrongfully trading in the name of the company. There was no difficulty here in establishing that the directors had wrongfully traded and so the only question was to what extent were the directors liable to replenish the assets of the company. The liquidator sought to value the assets at £250,000, while the directors argued that the goodwill element of the now insolvent company should be discounted. The judge held that the liability was the amount that the company's assets were depleted by the directors' conduct, and ordered them to pay £250,000 plus interest.

In Phillips, the liquidator contended that the director of the company had committed a whole host of offences under the 1986 Act and had no realistic prospect of successfully defending the claims. These included transactions: (a) carried out after the presentation of a winding-up petition but without the agreement of the court; (b) repaying, before the presentation of the winding-up petition, loans from two of the Company's directors; and (c) repaying, from the Company's funds, a loan made to the Defendant by a third party.

The liquidators obtained judgment in the first instance. However the director successfully appealed the decision, not on the basis that he had not committed the offences alleged, but on the basis that a trial was necessary to determine a number of key issues, including: whether the Defendant's knowledge of the matter was sufficient to create liability for the transactions, and when the test of insolvency imposed by the 1986 Act was met.

In allowing the Defendant's appeal, Mr Justice Henderson was highly critical of the court's initial granting of summary judgment. Consequently, following Phillips it seems unlikely that summary judgment will be available to liquidators in any but the most straightforward of situations (such as were present in Bangla). As a result, obtaining orders against directors and the overturning of 'preferences' and 'transactions at undervalue' will in future be a lengthier and more costly process.

In the present economic climate directors must be increasingly careful in two respects. In the first place, to recognise when their companies might be said to be insolvent under the 1986 Act and secondly, to be aware of their obligations in the event that their company is technically insolvent within the meaning of that Act.

GET YOUR ORDER IN – IDENTIFYING JUDGMENT DEBTORS' PROPERTY

By Sarah Godfrey

Landlords owed money by defaulting tenants often have to resort to court proceedings to try and get it back. If however a tenant debtor still fails to pay once judgment is obtained it can be difficult for landlord creditors to identify assets owned by the debtor against which the judgment can be enforced.

The index of proprietors' names is a register kept by the Land Registry of all the registered properties held by individuals, joint owners and companies where these have been registered since 1 May 1972. This can therefore be a useful tool for out of pocket landlords to help trace tenants' properties.

A search of the index is simple and is conducted by sending a form PN1 to the Land Registry for a fee of £12. The form sets out the name to be searched, the applicant's details, the reason for the search and any accompanying documentary evidence.

The search is not however automatically available to creditors even if they have obtained a court judgment. Instead it is reserved for the following:

• Successors to the debtor or anyone who is required to deal with their estate (for example their executor or a trustee in bankruptcy);
• Regulatory bodies such as the Financial Services Authority; and
• Those with the specific permission of the court.

Landlords wishing to enforce debts against tenants therefore need to apply for a specific court order entitling them to conduct a PN1 search. A copy of that court order must be submitted to the Land Registry with their application. Where there is doubt about what assets a debtor may have to discharge a judgment debt, a creditor should consider applying for an order to search the index at the same time as applying for an order for costs at the end of the case.

The Index can therefore be a useful tool for landlords with a judgment against their tenant but as can be seen above the court's permission usually has to be obtained and, in the case of individuals, the Land Registry must be persuaded of the applicant's interest.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.