UK: Commercial Leases And The Disclaimer Process - A Brief Guide

Last Updated: 29 October 2008
Article by Kenny Friday

One of the effects of the current economic climate has been a marked increase in the number of tenants going into liquidation. Consequently, many landlords have found themselves on the receiving end of a notice of disclaimer from liquidators relating to their property.

What follows is a brief guide to the disclaimer process in the context of leasehold premises and company tenants.

Power to Disclaim

According to s.178 of the Insolvency Act 1986 ("IA"), a liquidator has the power, without the leave of the court, to disclaim 'onerous property'. 'Onerous property' includes property that 'may give rise to a liability to pay money or perform any other onerous act'. As a lease imposes liabilities on a tenant, including the payment of rent and the performance of covenants, it can clearly be classified as onerous property.

By giving the prescribed notice, a liquidator can disclaim onerous property even though he may have taken possession of it, endeavoured to sell it or exercised any other rights of ownership.

The Disclaimer Procedure

Liquidators must follow a strict procedure when disclaiming a property. First, a notice of disclaimer, and a copy, must be filed with the court in the prescribed form. This must contain enough detail to make the property easily identifiable and it must be signed by the liquidator. The court will then ensure that both the notice and the copy are sealed and endorsed with the date of filing and will return the copy to the liquidator to serve.

Within seven days of the notice to disclaim being returned by the court, the liquidator must send or give copies of the notice to every person who, to his knowledge:-

  • claims under the company as underlessee or mortgagee;

  • claims an interest in the disclaimed property;

  • is under any liability in respect of the property, not being a liability discharged by the disclaimer; or

  • if the disclaimer is of an unprofitable contract, is a party to the contract or has an interest under it.

A failure by the liquidator to serve notice on a person whom he is aware of will invalidate the disclaimer. In addition, the liquidator must immediately send a copy of the notice to anyone who they subsequently learn has a relevant interest in the property, otherwise the notice will be invalidated. The exceptions to this are if the liquidator knows that the person has already been made aware of the disclaimer, or the court (on the liquidator's application) orders that compliance is not required.

The disclaimer comes into effect once the notice has been served on all parties claiming under the company as underlessee or mortgagee, and if no application for a vesting order has been made within 14 days of the date upon which the last notice of disclaimer was served.

Notice to Elect

If a person interested in a lease is aware that a tenant has gone into liquidation and wants to establish the liquidator's intentions concerning the lease, they can bring the matter to a head by serving a notice to elect. This forces a liquidator to decide whether or not to disclaim the specified property. If a notice to elect is served on a liquidator (or his predecessor), and a notice of disclaimer is not served within 28 days (beginning on the day the application is made) or such longer period as the court may allow, then a notice of disclaimer cannot be served in respect of that lease.

The notice must be delivered to the liquidator personally or by registered post and must be made in the form known as 'notice to elect' or a substantially similar form.

What is the effect of a disclaimer of a lease?

An effective disclaimer will, from its effective date, determine the rights, interests and liabilities of the tenant company in relation to the lease. However, it does not (except so far as is necessary for the purpose of releasing the company from any liability) affect the rights and liabilities of any other person.

The rights and obligations of both the tenant and the landlord under the lease will, therefore, be terminated immediately. Consequently, the insolvent tenant will no longer be required to pay rent, which is an obvious disadvantage to the landlord, although there may be a surety for the insolvent tenant. In the current depressed market, even if the landlord is able to find a new tenant to occupy the property, they are unlikely to receive an equivalent rent to that previously paid by the insolvent tenant.

As regards third parties, the House of Lords in Hindcastle Ltd v Barbara Attenborough Associates [1997] AC 70 firmly established that the effect of a disclaimer was to release the insolvent tenant but not others who had liabilities in respect of the lease.

It is essential to appreciate, therefore, that if no application for a vesting order is made and a landlord does not choose to take possession, then despite the lease having been disclaimed and the tenant's obligations having been brought to an end, third parties with an interest in the lease could potentially remain financially exposed.

The implications of disclaimer are different for the various parties, but some common examples are as follows:

  • Original Tenant / Assignee(s) – if the original tenant is not the insolvent tenant then they will continue to be liable under the lease, and will lose any right of indemnity they have against the insolvent tenant. The position is the same for an assignee of the lease.

  • Subtenant – a subtenant's rights against the insolvent tenant end if the lease is disclaimed. If the subtenant continues to perform the insolvent tenant's obligations under the disclaimed lease, then the landlord cannot eject the subtenant from the property.

  • Guarantor for the Insolvent Tenant – the guarantor will continue to be liable even though the tenant has been released from their liabilities and will lose any right of indemnity they have against the insolvent tenant. Additionally, depending on the terms of the guarantee, it is also possible that the landlord could require the guarantor to take on a lease of the premises.

  • Mortgagee – A legal charge will survive a disclaimer but in order to prevent the security being forfeited, the mortgagee should pay the insolvent tenant's rent and continue to perform its obligations under the lease.

Right to compensation

Following the disclaimer of a lease, any person suffering loss or damage as a result may claim in the winding up for such loss or damage.

Conclusion

For the foreseeable future then, it seems that the disclaimer procedure will certainly continue to provide an attractive solution for liquidators looking to dispose of onerous leases. This will leave landlords to pursue alternative parties to recover arrears and will force third parties to pay out for liabilities that they may ultimately be unable to recover from the insolvent tenant.

Although the process of disclaiming a lease is, itself, relatively straightforward, the implications for third parties are not always so clear and the matter can quickly become complicated, particularly if a number of parties are involved.

In such situations, all parties that have, or may have had, an interest in the leasehold property will need to give careful consideration to their possible exposure. Additionally, prompt decisions will need to be made about what action, should be taken to minimise any potential liability.

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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