UK: Tenant Insolvency: Beware The Surrender

Last Updated: 10 April 2013
Article by Richard Flenley

In these times of high street failure and intensely difficult trading conditions, the incidence of tenant insolvency is on the rise. It is a sign of the times that HMV, Jessops and Blockbuster rank as three of many examples of failure within a list of approaching 250 businesses that have failed since 2007 affecting in excess of 23,000 properties.

Against this backdrop it is inevitable that commercial landlords will seek to minimise their losses by negotiating with liquidators and administrators with a view to securing a commercial resolution that both secures payment of some of the liabilities whilst also freeing up property for onward letting. Many would rather do this than run the risk of a potentially far worse deal by waiting for the insolvency to be completed.

However, landlords need to tread carefully and make sure that the settlement reached reflects the deal that they think has been struck. By contrast, insolvency practitioners also need to be clear as to the liabilities that are being compromised and those that remain.

Failure to give these issues proper regard can be costly, as the landlord found out in the case of Re Teathers Ltd (in Liquidation), also known as Baroque Investments Limited v Heis [2012] EWHC 2886 (Ch).

In that case, Baroque Investments Limited (“Baroque”) was the owner of freehold property known as Beaufort House, 15 St Botolph Street, London, EC3. The fifth floor was let to Teathers Ltd (“Teathers”) on the terms of four leases dated 31 July 1991, 7 May 1996, 30 July 1997 and 14 December 2005. Each lease was for a term of years expiring on 30 March 2014 and each contained a tenant covenant on the following terms (or at least of the same effect):

“to keep the demised premises … in good and substantial repair and condition … and in such repair and condition … to yield up the same at the expiration or sooner determination of the term”.

Then, on 14 December 2005, Teathers entered into two licences for alterations with Baroque (the alterations in question involving alterations to the 5th floor including the infill of an atrium area) that provided, amongst other things, that:

“Before the end of the Lease the Tenant is to dismantle and remove the Works and reinstate the Premises to the same plan and design as before the carrying out of the Works and as if the Works had not been carried out (unless and to the extent that the Landlord requests that it does not do so)”.

On 23 October 2008, Richard Heis and Samantha Rae Bewick (“the Liquidators”) were appointed as administrators of Teathers and then later appointed as joint liquidators on 8 October 2009. On 13 November 2009, Teathers, acting via the Liquidators, surrendered each of the leases (“the Surrenders”) on terms that included the following provision:

“[Baroque] and [Teathers] respectively release each other from the rights and obligations contained in the Lease and from all liability in respect of any breach of those rights andobligations whether arising on or after, but not before, the date of this Surrender”.

On the same day Baroque relet the 5th floor to Instant Offices Management LLP for a term of four years at an annual rent of £706,550 with an initial rent free period of 19 months.

Following the surrender, Baroque sought to claim various sums via the liquidation, the majority of which were accepted by the Liquidators following negotiation save for, in the main, a dilapidations claim totalling £1,212,395. That claim was essentially based on the provisions of the leases and licence for alterations referred to above with the essential issue between the parties being whether or not Teathers’ liability for those claims had been released by the terms of the Surrenders set out above.

This issue was heard as a preliminary issue by the then Chancellor of the High Court, Sir Andrew Morritt (“the Chancellor”).

Reinstatement

In his Judgment, the Chancellor first considered the issue of the reinstatement liability and the question of when the obligation to reinstate the premises arose. Baroque contended that the liability was such that it must have arisen before the completion of the Surrenders and, on this basis, that the terms of the Surrenders did not release Teathers from this element of the dilapidations liability. The rationale for this view was that the liability was one that required reinstatement “before the end of the Lease” and the Surrenders themselves marked the end of the Lease.

The Liquidators, on the other hand, maintained that cannot have arisen before completion of the Surrenders on the true construction of the obligations. The Liquidators stated that, without the words “before the end of the Lease”, Teathers would have had a reasonable time after termination of the Lease to carry out the reinstatement works (Matthey v Curling [1922] 2 AC 180,240 refers in this regard) and that that the words in question had at their core the intention of limiting the time available to Teathers completing this work. Further, because the term of the leases did not expire until 30 March 2014, there cannot have been any breach of the reinstatement obligation at the time of the Surrenders on 13 November 2009.

The Chancellor agreed with the Liquidators and stated:

“The licences gave to the tenant the full period of the term created by the leases within which to carry out the requisite reinstatement. Accordingly, as at 13 November 2009, there was no breach of the obligations to reinstate. … In my view the inescapable consequence is that that potential liability was released by the surrenders”.

The claim for reinstatement therefore failed.

Repair

The Chancellor then went on to consider the case for Teathers continuing to be bound by its repairing obligations.

At Trial, both parties concurred (as supported by the decision in Ebbetts v Conquest (1900) 82 LT 560) that the repairing covenant in question contained two obligations:

1. To keep the demised premises in good repair during the term; and

2. To yield up the demised premises in good repair at the expiration or sooner determination of the term.

It was not in dispute that obligation 2 was released by the Surrenders. However, there was dispute as to whether or not obligation 1 was so released and central to this claim was the terms of section 18(1) Landlord and Tenant Act 1927 (“s.18(1)”). S.18(1) states (so far as is relevant to this case):

“Damages for a breach of a covenant or agreement to keep … premises in repair during the currency of a lease, … shall in no case exceed the amount (if any) by which the value of the reversion (whether immediate or not) in the premises is diminished owing to the breach of such covenant or agreement as aforesaid; …”.

The position put forward by Baroque was that (i) whilst the normal date for the assessment of damages is the date of the breach (i.e. the day before the Surrenders on 13 November 2009) the Court was not bound to assume the continuation of the leases when assessing the amount of damage to the reversion but was bound to have regard to the subsequent events of surrender and reletting; and (ii) taking this position into account, the level of the claim pursuant to s.18(1) should be 15 of the 19 months’ rent free that had to be offered to the incoming tenant in addition to the rent reduction that Baroque had to agree in order to speedily re-let the premises and in so doing mitigate its losses.

The Liquidators disputed both the method of calculation of the purported claim as well as the proposition that for the purposes of a valuation under s.18(1) in circumstances where the term of the lease has not expired by effluxion of time it was not a pre-requisite that there be an assumption made that the lease to which the reversion is subject is continuing.

On that basis, the Liquidators relied on the decision of the Court Appeal in Hanson v Newman [1934] CH 298, 306 and, more specifically, to the statement by Romer LJ that:

“Whatever may be the strict meaning at law of the word “reversion” there can, I think, be no doubt as to the meaning that that word bears in the section of the Landlord and Tenant Act, 1927, with which we are concerned here. The reversion in that section, if it be a freehold reversion, means the freehold subject to the lease, and valuing the reversion for the purposes of the section you must value the freehold subject to so much, if any, of the term of the lease as remains in existence”.

The Liquidators therefore, taking this formulation into account, contended that in this case the claim as made out by Baroque was inconsistent with both the fact of the release of the covenant to yield up in good repair and the terms of s.18(1). In this context, the Liquidators adopted the view that what the claim needed to do was to compare the value of the reversion with the property in its actual state with its repaired state, not simply to suggest that the claim should be formulated on the basis of the costs that Baroque had to incur to secure a speedy re-letting of the unit.

The Chancellor agreed with the Liquidators when he stated that:

“It is clear from Mr Grey’s [Baroque’s key witness] description of how he arrived at the figure … that he did not following the processes required by s.18(1). He made no attempt to value the reversion … in either its actual or repaired state but assumed that the difference between those valuations would be equal to the loss sustained by Baroque on reletting … It may or not be. Accordingly, the Liquidators were right to reject the proof of debt so calculated”.

The Chancellor went on to conclude that, taking the above into account, whilst technically meaning that a claim for damage to the reversion pursuant to s.18(1) is possible in this or a similar case, the circumstances within which such a claim would be available are limited as under no circumstances can the requirements imposed by s.18(1) be altered and, accordingly, “it may be difficult to prove that the effect of the disrepair has been to cause any diminution in the value of the reversion”.

Conclusion

As indicated at the outset of this article, the consequences of failing to accurately record the terms of a surrender so that they take into account all of the claims that are anticipated can be costly.

In this case, Baroque thought that it would be able to recover in excess of £1million over and above the specific terms agreed. However, by leaving this element outside of the express terms of the surrenders (or at least not fully particularised within those terms), Baroque ran the risk of being unable to recover its full losses on re-letting. Given that the re-letting completed on the same day as the Surrenders, Baroque should, one would have thought, have been in a position to fully particularise these losses and negotiate a far more robust resolution than the one reached.

Ultimately the risk that Barqoue ran failed to pay off.

What this result should do therefore is bring into sharper focus the need to ensure that, whilst such Surrenders can be an effective way of drawing an end to leasehold obligations in the case of tenant insolvency, they are treated with caution, carefully negotiated and meticulously prepared.

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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