UK: Property & Insolvency - September 2010

Last Updated: 28 September 2010

Article by Simon Painter and Nitej Davda

INTRODUCTION

At the time of going to press the future for construction giant and FTSE 250 company Connaught remains uncertain. In all probability by the time this bulletin is received its social housing arm will have been placed into administration putting around 10,000 employees at risk and causing an inevitable ripple effect which will be felt across the sector.

Whilst certain subsidiaries within the Connaught group appear safe for now the reason for the apparent demise of what it is best known for is a combination of holding loss making contracts, public spending cuts, mounting debt and an inability to secure a refinancing package from the banks.

The end for Connaught as we know it (a company that at its peak was worth over half a billion pounds) follows on the heels of a very high profile casualty in the legal sector. The law firm Halliwells LLP was placed into administration in July and its assets are now in the process of being acquired by other law firms. At its peak, like Connaught, it was one of the largest businesses in its sector in the UK. The Lawyer, a weekly publication aimed at the legal sector, ranked Halliwells at the end of 2009 as the 39th largest law firm in England and Wales, with a turnover of £83m and net profits over just under £12m.

The reasons cited by Halliwells for its demise were high property costs, exacerbated by the effect of the economic downturn as the reason for their plight. Halliwells took a lease of premises in Manchester at the height of the property market.

Both Connaught and Halliwells were seen as big players in their respective markets and unlike Woolworths and Zavvi (whose market shares could clearly be seen to be squeezed by a combination of their competitors on the high street and on-line) their demise (in the case of Connaught, apparent demise) has taken many by surprise. They are illustrations however of the fact that the effect of the economic downturn and Government spending cuts will continue to be felt for many months to come, and that insolvency based issues such as those covered in this bulletin and previous editions of it will continue to be relevant to those involved in the property sector.

If, having read this bulletin, you would like more information in relation to the matters covered please do contact us.

A MATTER OF PRINCIPLE – THE ANTI-DEPRIVATION RULE

By Lynsey McIntyre

The underlying policy of the Insolvency Act 1986 is that all assets of an insolvent organisation must be made available for distribution amongst its creditors. However, the courts also have the power to prevent parties from contracting out of the statutory regime. This long established common law principle known as the anti-deprivation principle has been used by the courts over the years to strike down contractual provisions which attempt to do just that. The principle has received an airing in two recent High Court decisions.

Mayhew v King & Another (2010) concerned the scope of 'assets' covered by the principle. M engaged an insurance broker, T, to arrange insurance cover through C in connection with M's haulage activities. The scope of the cover was found to be potentially inadequate (when M was sued by Mr Mayhew for substantial damages and C initially refused to provide cover) and this led to M suing T for negligence. The negligence claim was settled by M and T entering into an agreement under which T would be responsible for reimbursing to M 85% of any sums to be paid to Mr Mayhew The settlement agreement contained a termination clause with the effect that T would be released from its obligation to indemnify M, if M became insolvent.

M subsequently went into administration and M's administrators assigned the benefit of the settlement agreement with T to C so that C could recover directly, on behalf of M, 85% of any sums payable on M's behalf. C sought to enforce the settlement agreement against T but T relied upon the termination clause, the effect of which would be that the settlement agreement would come to an end, M would lose the benefit of the indemnity and M's unsecured creditors would have to meet any shortfall rather than T.

C's response was that the termination provision was unenforceable under the anti-deprivation principle. C claimed that the clause operated to permanently deprive M's creditors of a valuable asset for distribution.

In response T argued that the anti-deprivation principle does not apply to a right to enforce an interest, in this case the indemnity, particularly in circumstances where the parties had negotiated the terms of the agreement themselves. The court however agreed with C and found that the termination provision in the settlement agreement offended against the anti-deprivation principle and was void as a result. The judge held that the principle could be applied to such rights created by a contract, even where the contracting parties had agreed limits to the duration of those rights. If the effect of the limitation essentially deprives an organisation's creditors of the benefits of the indemnity on the organisation's insolvency, then the limitation will be void.

This is a salient reminder that contractual limitations (for example in any guarantee) relating to insolvent events in any form of contract (particularly indemnities or other contracts which give rise to a right of legal action) are vulnerable to being struck down if the court considers that the intention and effect of the limitation is to deprive the insolvent company and its unsecured creditors of a valuable asset.

The anti deprivation principle has recently had a second airing, in the somewhat more high profile dispute concerning the Portsmouth City Football Club (and its administrators) and HMRC. At a recent high court hearing in which HMRC sought to have a company voluntary arrangement entered into by the club set aside, concerns were raised by HMRC that the so-called 'football creditor's rule' fell foul of the anti deprivation principle. The football creditor's rule (provided for within both the Premier League and Football League's own rules) provides that when a football club is moved to administration, broadcast and league revenues that would otherwise be due to the club during that period are ring fenced for creditors of the club that are involved in the game itself, thereby depriving 'non-industry' unsecured creditors of the opportunity to derive any benefit from such revenue. The judge declined to make any ruling in relation to the compatibility of the football creditor's rule with the anti deprivation policy but it is perhaps only a matter of time before such a challenge does materialise, in which case there may be further clarification or guidance of the extent to which the principle can be circumvented.

IT'S ALL IN THE FIGURES: FINANCIAL CONSIDERATIONS ON APPLICATIONS FOR CONSENT TO ASSIGN

By Nitej Davda

Whether it be due to economic factors or otherwise, applications received by landlords for consent to assign a lease of office or retail premises are regular occurrences. The financial standing of the proposed assignee is usually the most important factor for consideration by the landlord, especially where the assignor is a blue chip tenant.

Typically the landlord (or the landlord's agent) will receive a request for consent to assign together with the last three years filed accounts for the assignee. References may also be provided. The lease will ordinarily contain a qualified covenant against assignment (that the consent of the landlord to any assignment is required, such consent not to be unreasonably withheld).

It was historically thought that one way of forming a view on financial standing was just to consider the pre tax profits of the proposed assignee. The decision in British Bakeries v Testler (1986) was seen as authority for the proposition that if the pre tax profits of the proposed assignee were less than three times the annual rent then the landlord would be justified in withholding consent. Of course this is not a test that could ever be rigidly applied (consider the example of a proposed assignee with exceptional items in its last accounts that has the effect of reducing pre tax profits) and has since been frowned upon as setting any standard test for considering the financial standing of a proposed assignee. The landlord must take a considered view of the accounts information provided and not rely solely upon the 'three times' principle.

Just as a landlord would instruct an accountant to prepare its own accounts, the analysis of the accounts of a proposed assignee should similarly be considered by an accountant. Accounts which appear strong on their face may have hidden messages contained within. The same may apply to accounts which appear weak on their face. The duty on a landlord when considering an application for consent to assign is to act reasonably. Is it acting reasonably to consider the financial strength of a proposed assignee without the assistance of an accountant? It may be if the person reviewing the accounts knows and understands accounting procedures and is able to properly interpret the accounts, but in the majority of cases this will not be so. Also remember that in a worst case scenario a landlord's decision will be the subject of a legal challenge. This means that the landlord has to demonstrate that he acted reasonably in refusing consent. It does not matter that others might have accepted the proposed assignee if it can be shown that the landlord was reasonable in refusing consent. It is going to be easier for a landlord to do this if he can show that he relied upon an independent professional to review the proposed assignee's financial information and that independent reviewer raised concerns over the content of the same.

Landlords should be wary of placing reliance upon management accounts and credit reports. Management accounts can provide up to date information since the last filed accounts, but of course these are unaudited documents prepared for internal use only and should be viewed with caution. Credit reports can be useful cross checks but it would be wrong for a landlord to rely upon them to the exclusion of any analysis of the accounts provided. Publicly available credit reports not volunteered by the tenant are (1) not part of the application for consent (2) not prepared by or on behalf of the landlord and (3) not prepared in response to an application for consent to assign. Consequently reliance upon them in favour of the documents produced by the tenant to support the application (or documents prepared on behalf of the landlord in considering the specific request for consent) does leave a landlord exposed in the event that a refusal to grant consent is challenged.

Landlords can sometimes be concerned over the effect on capital value of a proposed assignee. There are two points to make here. The first is that reduction in capital value should only be raised as a basis for refusing consent where the landlord is likely to either sell, mortgage or re-mortgage the asset in question in the near future or where capital value impacts upon the business of the landlord. If the landlord is not intending to realise the capital value of the tenanted asset (or if capital value is of no relevance to the business of the landlord) then why would any possible negative impact on capital value caused by the assignment be of relevance? The second is that in order to rely upon capital value as a basis for refusing consent, the landlord must demonstrate diminution in that capital value with the use of independent valuation evidence.

A proposed assignee with poor accounting records (or indeed no accounting records in the case of a start up) will often be put forward together with a guarantor. In these circumstances the role of the guarantor should always be remembered. It is for the guarantor to meet the obligations of the tenant to the extent that the tenant is unable to meet them itself. Consequently it is always prudent for the landlord to consider the collective financial position of the assignee and guarantor.

The obligations on a landlord when considering the financial standing of a proposed assignee and formulating a response to a request for consent to assign can be onerous. The landlord also has to remember that not only does he have to act reasonably in coming to a decision, he also has to act within a reasonable amount of time. Time starts to run when the application for consent to assign is received and ends when the landlord communicates his decision tin writing together with (if refusing consent or imposing conditions on the granting of consent) reasons. What is a reasonable amount of time depends on the facts of an individual case. It may depend upon whether the tenant provides information in a timely fashion or at all. As a general rule of thumb however, assuming the application is accompanied with all relevant information a landlord should be aiming to produce a written response within three weeks. The Court of Appeal held, in NCR v Riverland Portfolio (No.1) Limited (2005) that 'in the absence of special exceptional circumstances a period of less than three weeks (particularly in the holiday period) cannot ... be categorised as inherently unreasonable'. This was said in the context of an application for consent to sublet but was justified on grounds equally applicable to an application for consent to assign; namely that the landlord, upon receipt of the application, has to consider the financial and legal implications of the disposal (or a refusal) and to report to management. There may of course be circumstances where a period of three weeks is in itself too long.

WITHOUT A REMEDY

By Sinéad Lester

The law has for years tried to grapple with the Gordian Knot between protecting a debtor's assets for realisation and distribution to his creditors and protecting third parties who enter into transactions with the debtor after the bankruptcy process has been initiated, completely unaware of that process.

In the case of land, where a third party purchaser takes the land without notice of the pending bankruptcy action, the purchaser takes the land free from any interest of any subsequently appointed trustee in bankruptcy. By contrast, where a third party purchaser takes the land, with notice of the pending bankruptcy action, the purchaser takes the property subject to the rights of any subsequently appointed trustee in bankruptcy.

Poulton v Ministry of Justice and Rule 6.13

It is with this backdrop in mind that the importance of Rule 6.13 of the Insolvency Rules 1986 (Rule 6.13) and the case of The Trustee in Bankruptcy of Louise St John Poulton v Ministry of Justice (2010) should be considered. In this case, a bankruptcy petition was presented against Louise Poulton (P) in the Guildford County Court.

Pursuant to Rule 6.13, the court is required to 'as soon as reasonably practicable send to the Chief Land Register notice of the petition with a request that it may be registered in the register of pending actions.' Following receipt of the notification, the Land Registry registers a bankruptcy petition against the name of the debtor in the register of pending actions. To the extent that the debtor is the registered proprietor of any registered estate in land, the Land Registry is required to register a notice in respect of the pending action against the relevant property's title as soon as practicable after the registration of the petition as a pending action. In this way, any subsequent purchaser who decides to purchase property owned by the debtor takes his interest in the property subject to the power of any subsequently appointed trustee in bankruptcy to overturn the transaction. In practice, therefore, a purchaser will not purchase a property from a debtor whose Land Registry title is subject to notice of a pending bankruptcy action for fear of the sale being subsequently overturned.

In this case, however, the court failed to notify the Land Registry of the issue of a bankruptcy petition in breach of Rule 6.13. P therefore sold a property owned by her to a third party who did not have notice of the pending bankruptcy action. The net equity in the property, totalling approximately £45,000, was therefore not available for the benefit of the creditors as P's trustee in bankruptcy could not have the sale set aside.

P's trustee in bankruptcy sought damages from the Court Service to compensate P's bankrupt estate for the loss resulting from the sale of the property following the Court's failure to comply with Rule 6.13. The High Court held that Rule 6.13 gave the trustee in bankruptcy a right of action for breach of statutory duty against the Court Service but the Court of Appeal disagreed, overturning the lower court's decision.

The Court of Appeal held that there was no private law right of action against a court for failing to comply with Rule 6.13. This means that where the court fails to comply with its obligations under Rule 6.13, the trustee in bankruptcy has no remedy even where the court's failure has caused a loss to the bankrupt's estate.

In conclusion, this is unwelcome news for creditors. In light of this decision, creditors would be well advised to check with the Land Registry themselves whether the court has complied with its obligations under Rule 6.13 and if it has not, to register the bankruptcy petition themselves. Indeed, this route was sanctioned by the Court of Appeal and appears to be the best way to avoid being left in the unenviable position of having no remedy.

GOOD HARVEST – BAD DECISION?

By David Vaughan

Under the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act) tenants and any guarantor are both released from liability under a lease following a lawful assignment. The 1995 Act has introduced the ability for landlords on any assignment to require the outgoing tenant to enter into an authorised guarantee agreement (or AGA) in support of the incoming tenant. However the 1995 Act is silent as to whether an existing guarantor can be required to join in any or AGA or give a fresh guarantee. It is not possible to enter into a contract which has the effect of avoiding the effect of the 1995 Act.

Many leases require, as a precondition to the grant, that the guarantor will continue to guarantee a tenant's chosen assignee.

The Two Methods

In practice, there are two common methods that a landlord may adopt to keep a tenant's guarantor on the hook following an assignment by the tenant:

  1. it may require the guarantor to guarantee the obligations of the assignee by entering into a new AGA; or
  2. it may require the guarantor to guarantee the tenant's obligations under the AGA it gives to the landlord (a sub-guarantee).

Facts of the Good Harvest case

The facts of Good Harvest Partnership LLP v Centaur Services Limited (2010) are as follows. A tenancy was entered into on 5 October 2001, with the defendant (Centaur Services) standing as guarantor to the tenant. The original tenant assigned the Lease in 2004, at which point the tenant and defendant entered into an AGA to guarantee performance of the lease obligations by the assignee until such time as a further lawful assignment took place (ie in accordance with method no.1 above). The assignee failed to pay the rent and the claimant landlord (Good Harvest) claimed against the defendant, as contractual guarantor.

Decision

The High Court held that a tenant's guarantor is released on a permitted assignment of a lease and because the 1995 Act does not provide that a landlord can call for the guarantor of the assignee to remain a guarantor of the assignor, the landlord cannot call for it. The decision does not create a binding precedent. It was due to be appealed on 29 June 2010 but settled on the eve of the hearing. It had been hoped that the appeal (which would create a binding legal precedent) would overturn the decision or, if upholding the decision, at least to also provide some guidance on position in relation to sub-guarantees. Unfortunately we are now left with uncertainty in relation to the position of the guarantor and it is also difficult to structure new leases where the landlord wants a guarantor to have continuing liability.

Practical Implications

Given the current uncertainty the practical point to take away is that landlords cannot assume that guarantors will be available to underpin an assignee's obligations under an AGA (or to provide a sub-guarantee) and that may affect applications for consent to assign and freehold values. Landlords may require additional security from the assignee because of the weakness of an unsupported AGA. It is likely that the Good Harvest case will make landlords more inclined to limit tenants' rights to assign leases by using restrictive alienation covenants in leases.

MAKING CLAIMS IN ADMINISTRATION/LIQUIDATION AS AN UNSECURED CREDITOR: THE PROCESS OF PROVING DEBTS OWED BY THE COMPANY

By Rita Sarkar

Insolvency procedures involving companies are complex and generally take a long time to complete. There is plenty of jargon which adds to the confusion, whereas all that an unsecured creditor usually wants to know is how to make a claim for the monies owed to him by the company, to whom the claim should be made, how long it will take to decide the claim and whether there is a possibility of recovering any monies from a company which is obviously experiencing financial difficulties.

Administration is a process under which a company that is in financial trouble will either be reorganised, or have its assets sold for the benefit of the creditors. The principal aim of the administrator (who takes over the control of the company from its directors) is to try to rescue the company so that it may continue to trade, although, in practice, such an outcome is rare. Liquidation, on the other hand, will always end in the dissolution of the ailing company – it is a process under which the assets of the company are sold and distributed to the creditors.

Administrators and liquidators are obliged to send a notice of their appointment to every creditor of the company of whom they are aware. However, there may well be creditors of whom the administrator or liquidator will not be aware and this may particularly be the case where unsecured creditors are involved, ie creditors who do not hold any security for the monies owed by the company.

Receiving a notice of appointment from the administrator or liquidator does not mean that the debt has been acknowledged or accepted – a creditor is required to complete what is known as a 'Proof of Debt' form to make a formal claim against the company (see below).

How to Make a Claim

Proof of Debt forms can be obtained from the administrator or liquidator. The unsecured creditor should complete the form to provide the required information in writing, including:

  • the creditor's name and address;
  • the total amount of the claim, including any VAT and any outstanding interest as at the date the company went into administration/liquidation;
  • details of any documents supporting the debt - it is not necessary to attach these documents with the Proof of Debt form but the administrator/liquidator may ask for these (at a later stage) to substantiate the claim; and
  • details of how and when the debt was incurred.

To Whom the Claim Should be Made

An unsecured creditor must send the completed Proof of Debt form to the administrator or liquidator, who will then proceed to consider the merits of the claim.

How Long it Will Take to Decide the Claim

This is difficult to predict as much will depend upon the particular circumstances of the company in administration/liquidation and the nature of the claim. A complex claim for a significant amount of money might be hotly disputed. A dilapidations claim might be the subject of lengthy negotiations.

From the creditor's point of view, it is important that a continuous dialogue is maintained with the administrator or liquidator so that the existence of the claim is known and it is not simply forgotten. Never assume that silence means that a claim is being considered!

Whether There is a Possibility of Recovering Any Monies

Once all claims have been considered, the question that the administrator or liquidator has to consider is what assets are available (if any) to pay the unsecured creditors of the company.

In an administration or liquidation, funds are paid in the following order of priority:

  1. debts secured over the company's assets or by fixed charges;
  2. the fees and expenses of the administration/liquidation;
  3. preferential debts;
  4. floating charges;
  5. unsecured creditors; and
  6. shareholders (if there is any surplus).

As can be seen from the above, unsecured creditors rank relatively low in priority in the order of distribution in an administration or liquidation. It is therefore not unusual for unsecured creditors to be paid on a pro-rata basis and if there are too few assets, unsecured creditors might not receive any monies at all.

If you are a creditor who has concerns about the financial situation of the debtor company, you should, as a first step, contact Companies House (www.companieshouse.gov.uk) to establish whether insolvency proceedings have commenced in respect of the company and if so, obtain the contact details of the administrator or liquidator who has been appointed.

DISCLAIMER: THE NEW RULES

By Helen Matthews

In the continuing uncertainty of the current economic climate, and with a tough financial regime introduced by the new government, landlords may still find themselves faced with an insolvent tenant.

A liquidator or trustee in bankruptcy, or 'office holders', may disclaim any onerous property belonging to an insolvent company or a bankrupt individual. Disclaimer is most commonly used to free an insolvent company or bankrupt from their lease obligations. A disclaimer has the effect of releasing an insolvent company or bankrupt individual from any further liability under the lease of their property.

On 6 April 2010 new rules came into force simplifying the procedure whereby office holders can disclaim leases, or indeed any other onerous property. The Insolvency (Amendment) Rules 2010 (SI 2010/686) (2010 Rules) removed the need for the court to seal a notice of disclaimer. Instead, the disclaimer notice is effective as soon as an office holder authenticates it.

Following the introduction of the 2010 Rules, office holders can disclaim leases by:

  • preparing a notice of disclaimer. This must include enough detail on the relevant form to enable ready identification of the property being disclaimed;
  • authenticating and dating the notice of disclaimer, which will be effective from that date; there is no longer any requirement to lodge the notice at court or for the court to seal the notice for it to become effective;
  • sending a copy of the notice to the Land Registry, if the property being disclaimed is a registered interest in land;
  • in the case of a liquidator of an insolvent company, sending a copy of the notice to the registrar of companies;
  • sending a copy of the notice within seven business days of the date of the notice to every person;
    • who claims an interest in the disclaimed property; or
    • is under any liability in respect of the disclaimed property (other than an obligation that the disclaimer brings to an end).

Notice to Elect

Any person with an interest in property, usually landlords, in which a company in liquidation or a bankrupt also has an interest, may require the office holder to decide whether to disclaim the property in question. The interested party must serve the office holder with a notice to that effect (a notice to elect). Once served with a notice to elect, the office holder must issue a notice of disclaimer within 28 days of the request, failing which he loses the ability to do so.

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.

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Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.