Property and Insolvency Briefing - November 2011 - Landlord & Tenant - Leases

It looks like there is another hard winter ahead. With the Eurozone in crisis and UK consumer confidence at an all time low insolvency is still very much on the agenda for those in the world of property.

No sector appears untouched. Take as an example the formerly buoyant care homes sector. In late May this year the future of 750 care homes hung in the balance after the UK's biggest care home operator Southern Cross warned that it may not have enough funds to stay in business beyond June. The company came close to administration after falling occupancy rates left it unable to meet rising rental bills. Southern Cross arranged for its care homes to be transferred to landlords. This should be completed in the next few weeks ahead of a full windingup of the company, expected before the end of the year. Banks and landlords still owed money by Southern Cross are likely to be left with a shortfall as a result. Just this month Aberdeen-based Argus Care Group, a care home company with more than 780 staff and 500 residents in its 12 nursing and residential homes has gone into administration. At the time of writing, 73 care home companies have failed in 2011.

There have been many interesting legal developments in the area of property and insolvency law since our last bulletin. We hope those we have covered in this issue are of interest.

Where does a commercial landlord stand when its tenant becomes insolvent?

By Simon Painter

A common issue facing landlords of commercial premises is to decide what to do if one of its tenants has stopped paying the rent and has entered into one of the types of insolvency prescribed by statute. In the case of companies, these can include company voluntary arrangements, administration, administrative receivership, Law of Property Act receivership or liquidation. In the case of individuals, they might include individual voluntary arrangements or bankruptcy.

In theory, the landlord is in a stronger position than some other creditors because of the extra remedies available to it under the law relating to landlord and tenant. Provided the lease contains standard provisions, a landlord (absent insolvency) would normally be able to forfeit the lease, either by court action or by peaceable re-entry, to distrain for the rent against certain goods of the tenant at the premises or sue for the rent by court action.

In most types of insolvency, the landlord's ability to take the sort of action set out above is curtailed by the insolvency rules, so that any such action will be stayed or require permission of the court. However, there are some exceptions to this rule, as set out below.

Liquidation

In the case of a winding up (or liquidation), the landlord's remedies depend upon whether there is a voluntary or compulsory winding up. A voluntary winding up may be either a shareholders' voluntary winding up or a creditors' voluntary winding up. In such cases there is no moratorium on the actions of a landlord as such, however, another creditor or the liquidator may apply to the court for an order to restrain any action or proceedings by the landlord. In the case of a compulsory winding up, permission of the court will be needed if a landlord wishes to take enforcement action.

Receivership

In the case of receivership, which may refer either to an administrative receivership or a receivership under the Law of Property Act 1925, the appointment of a receiver does not affect the landlord's enforcement remedies, although the landlord may find it has to deal with the receiver rather than the tenant.

Company Voluntary Arrangements (CVAs)

In the case of CVAs, there is a difference between 'small' companies and other companies. A small company is one that satisfies two or more of the following criteria: A turnover no greater than £6.5m; balance sheet assets no greater than £3.26m; no more than 50 employees. If a tenant company comes within those criteria, it may file at court for a moratorium preventing enforcement of remedies by the landlord.

In relation to companies not deemed to be small companies, there is no moratorium on landlord action and enforcement remedies depend on the terms of the CVA, the default position being that the landlord may enforce its remedies unless the CVA specifically removes this right.

Individual Voluntary Arrangements (IVAs)

In the case of individuals who have entered into IVAs, the right of the landlord to distrain will depend upon the terms of the particular IVA. However, a landlord will need leave of the court to take court action to recover arrears of rent and/or to forfeit.

Bankruptcy

In the case of bankruptcy, the landlord may distrain for up to six months rent that has accrued prior to the bankruptcy order being made; however, leave of the court is needed to begin any court proceedings for recovery of the rent. The landlord does not need permission to forfeit the lease. In summary, if the landlord finds itself with an insolvent tenant who owes rent, there are various options available, albeit in some cases limited ones, depending on the type of insolvency involved.

Bankruptcy v Wife's right to occupy

By Katie Hamilton

In Re Ruiz (a bankrupt) [2011] EWHC 913 (Fam) the High Court ruled that a wife's right to occupy the matrimonial home did not prevent her husband's trustee in bankruptcy (TiB) gaining and enforcing a proprietary interest in the property.

The Facts

M and G married in 2001 and moved into a house purchased by M and registered in his sole name. In 2006 divorce proceedings were initiated, following which G obtained a freezing order over M's assets and an occupation order over the marital home.

During 2006/7 M ran up large debts (some in breach of the freezing order). In December 2007, unable to make his repayments, M petitioned for his own bankruptcy. M disclosed that he was in the midst of divorce proceedings but did not disclose the freezing or occupation orders. He declared assets of £300,000 and debts of £66,000. Although M was not balance sheet insolvent, the court accepted that he could not pay his debts as they fell due, and duly made a bankruptcy order.

In November 2008, the financial order on divorce was made; G was to receive a lump sum equal to the entire surplus after the bankruptcy debts and costs were cleared (the Divorce Order). An offer of £270,000 had been received on the property and the amount required to discharge the bankruptcy was some £132,000.

Unfortunately, property prices then crashed and the prospective purchasers reduced their offer. G stopped cooperating with the sale and refused to relinquish her occupation rights. The TiB then applied for an order for possession and G made an application to appeal out of time against the Divorce Order. Permission to appeal was granted and in September 2009 (nearly two years after the bankruptcy order had been made), G also applied for M's bankruptcy to be annulled. A hearing to consider both issues was eventually referred to the High Court and set for March 2011. Throughout this period the assets had been haemorrhaging and by March 2011 the overall amount required to clear the bankruptcy had risen to £260,000.

The Arguments and Decision

Under section 282 of the Insolvency Act 1986 (IA) a bankruptcy order may be annulled if it appears to the court that "on any grounds existing at the time the order was made, the order ought not to have been made". In an earlier case (Paulin) there is authority for the proposition that, as the husband was balance sheet solvent at the date of the bankruptcy order, the burden was on him to justify why the court should not annul the bankruptcy. The judge rejected this argument; while he accepted that the husband's petition may have been "unnecessary" and the freezing and occupation orders should have been disclosed, this was distinguished from the "tactical" bankruptcy manufactured by the husband in the Paulin case. It was dishonesty, not balance sheet solvency, which shifted the burden of proof.

Further arguments were raised in relation to the appeal of the Divorce Order:

that the effect of section 336(2) IA ("Where a spouse's or civil partner's home rights...are a charge on the estate or interest of the other spouse...and the other spouse is adjudged bankrupt...the charge... binds the trustee of the bankrupt's estate and persons deriving title under the trustee") was to prevent the TiB from acquiring any proprietary interest in the marital home;
the TiB could only disturb the wife's rights via a possession order through the bankruptcy court (not under the Divorce Order); and/or
the wife's rights to the property had priority over the TiB's, so the property should have been disclaimed as onerous.

The judge rejected all three arguments. He considered argument (a) amounted to giving the wife a right to remain in the property in perpetuity regardless of anyone else's interest, which was "absurd". The intention behind section 336(2) was to ensure that "where a wife's home rights are concerned, a TiB is in no better short-term position than the husband would have been. The rights endure until they are brought to an end by an order of the court, whether in the divorce proceedings or by an order in the bankruptcy proceedings." Accordingly, argument (b) failed as at the time the Divorce Order was made, the wife agreed to the sale and the trustee had no reason to apply to the bankruptcy court for an order for possession.

Onerous property is defined as "property comprised in the bankrupt's estate which is...not readily saleable". The judge rejected the argument that the wife's rights to occupy the home meant that the property was not readily saleable (and therefore onerous) as it was open to the TiB to apply under section 336 IA for an order for possession.

The wife's appeal therefore failed, meaning that the bankruptcy and Divorce Order remained in effect.

Comment

The case clarifies the relative priority of occupational rights in the context of bankruptcy; the practical effect of section 336(2) is to allow a spouse to remain in occupation of the matrimonial home pending a final order in divorce proceedings (or a possession order through bankruptcy proceedings). The section does not act to grant the spouse of a bankrupt debtor any form of proprietary interest superior to that of the TiB.

The judge suggested that even had the wife's argument in respect of the annulment had been accepted, as the application had been made so late, the bankruptcy debts were such as to make it virtually pointless for the court to annul. Making an annulment application early on in the proceedings is therefore vital.

Finally, it was suggested that in situations where the debtor bringing a bankruptcy petition is also going through divorce proceedings, courts should consider adjourning the hearing to allow the debtor's spouse to receive notice of the petitions and make representations to the court. Whether this will, in future, become common practice or help avoid situations similar to this, remains to be seen.

Landlords and Tenants - The balance of power and Authorised Guarantee Agreements

By Sarah Godfrey

Many in the property industry have kept a keen interest in the development of the law relating to Authorised Guarantee Agreements ('AGAs'), particularly in the wake of the case Good Harvest Partnership v Centaur Services Limited 2010 EWHC (Ch). The recent case of KS Victoria v House of Fraser (Stores Management) Ltd and others 2011 EWCA Civ 904 has clarified and reframed the law on AGAs.

The story began on 1st January 1996 with the advent of the Landlord and Tenant (Covenants) Act 1995 ('the 1995 Act'). Before the 1995 Act came into force landlords very much had the upper hand as they could pursue any former tenant of a lease for a breach of a lease by a subsequent tenant. The 1995 Act sought to redress the balance of power by legislating that once a tenant had assigned their lease, their liability ended.

However, so that landlords were still protected to a certain extent, the 1995 Act allowed Landlords to require assigning tenants to guarantee the immediate assignee's performance of the lease covenants. So if tenant A assigned to B, A would guarantee B's performance of the tenant's covenants in the lease, but once B assigned to C, A was off the hook. These guarantees are commonly known as AGAs.

What was not entirely clear though was whether the 1995 Act also prevented a tenant's guarantor from having continuing liability to the landlord for the performance of subsequent tenants. The 1995 Act contains strong 'antiavoidance' provisions which prevent any arrangements which are not true AGAs from being valid.

Good Harvest

Property professionals got very excited about the case Good Harvest Partnership v Centaur Services Limited. In that case the court ruled that a tenant's guarantor cannot be required to enter an AGA directly guaranteeing the assignee's performance of the tenant's covenants in a lease.

There was still a question mark however as to:

Whether it would be acceptable if a tenant's guarantor entered into such an AGA voluntarily. This happens frequently for example where a company assigns a lease to a group company and the parent company stands as a repeat guarantor; and
Whether as an alternative to a guarantor directly guaranteeing an incoming tenant in an AGA, they could guarantee the outgoing tenant's covenants in the AGA (commonly known as a 'subguarantee'). It was hoped that the Court of Appeal would clear up the ambiguity in the law. However on 29 June 2010 the parties settled out of court leaving these questions unanswered.

KS Victoria

KS Victoria – which centred on a sale and leaseback agreement which required a tenant's guarantor to stand as a direct guarantor for the assignee - has brought some welcome clarification to the law in this area, albeit not necessarily to the satisfaction of either landlords or tenants.

Firstly the case upheld the Good Harvest decision: a landlord cannot require a tenant's guarantor to enter an AGA to directly guarantee the performance by the assignee of the tenant's covenants in the lease. The case also addressed the unanswered questions above:

To the chagrin of landlords and some tenants the case went further than Good Harvest and ruled that a guarantor cannot even enter such an arrangement voluntarily ; and
On the other hand the case brought some welcome news for landlords and confirmed that the subguarantee arrangement will be valid.

Implications going forwards

Certainly those hardest hit by the decision are those landlords who have already granted leases which permit intra-group assignments without requiring landlords consent, on the proviso that the tenant's guarantor gives a repeat guarantee in an AGA.

A recent example of a deal that has faltered because of the change in law is that of the Citi Tower in Canary Wharf, where potential investors have been put off buying the property as the lease is assigned to a subsidiary of Citi bank and there is uncertainty as to the validity of the guarantee.

The judgment isn't necessarily in tenants' interests either. For example, a repeat parent guarantee can often be a desirable mechanism for the parent company as it facilitates an assignment that a landlord might otherwise be unwilling to consent to (on the basis that often the tenant company may be a shell company without any financial standing). There are of course other options that the parties can look at such as using the sub-guarantee structure (but this will only work for the first assignment with a repeat guarantor) and rent deposits, but overall it is true to say that KS Victoria has fettered the ability of both landlords and tenants to make commercial bargains that are in many cases mutually advantageous.

Can a Trustee in Bankruptcy be liable for costs following assignment of a cause of action to a third party?

By Helen Matthews

TiBs frequently assign the right to recover debts due to the bankrupt's estate. The advantage to the TiB is that he receives a lump sum or a share of the proceeds of a successful claim for the benefit of the bankrupt's creditors without having to fund and pursue litigation himself. In most cases, once a TiB has assigned the right to recover the debt that will be the end of the matter; he just has to wait for the litigation to be concluded when payment of the agreed share will be made. A recent Court of Appeal decision means that this will not always be the case. In Hunt v Harb and another [2011] EWCA Civ 1239 (27 October 2011), the Court of Appeal has confirmed that if a TiB assigns a cause of action to a third party in return for a share of the proceeds of any future litigation the TiB can be found liable for the costs of the parties to the litigation.

The court has a wide discretion regarding costs orders and may, if it considers it appropriate, order that someone who is not a party to the litigation should pay some of the costs incurred by one or more of the parties in the course of the proceedings.

Under the Insolvency Act 1986, on the appointment of a TiB, the assets of a bankrupt generally vest in the TiB. These assets are known as the bankrupt's estate. Included within that estate are most rights of action held by the bankrupt; a bankrupt cannot himself pursue a claim that vests in his TiB.

If a TiB chooses to litigate one of the bankrupt's rights of action that vest in him, he must bring the claim in his own name. As in any litigation, the TiB has potential liability for the costs of any other party to the litigation; if he loses he can expect to pay. Generally, he can indemnify himself against this from the assets in the bankrupt's estate, but this may be of little worth if the estate does not have sufficient assets to meet those costs. By assigning causes of action to third parties, in return for a lump sum payment or a share of the proceeds from the litigation this can generally be avoided.

It has however been held previously in Hamilton v Official Receiver [1998] BPIR 602 that where a TiB has assigned a cause of action in return for a share of the ultimate proceeds of the litigation, it may be appropriate to make a nonparty costs order against the TiB if the claim fails. In Hamilton the court held that the risk of a third party costs award justified a TiB's decision not to assign a claim.

A TiB cannot however be subjected to a non party costs order where he has assigned a cause of action in return for a single lump sum payment.

In the Harb case, Mrs Harb was a bankrupt claiming to be the ex-wife of the King of Saudi Arabia and also claimed that the King's son had agreed to transfer to her a sum of money and two high value London properties. As this apparent agreement had vested in her TiB following her bankruptcy he issued proceedings so that the claim would not become time-barred under the Limitation Act 1980. In due course the TiB discontinued the proceedings as there were insufficient funds in the estate to continue funding them.

Mrs Harb obtained an order from the High Court setting aside the TiB's notice of discontinuance on the basis that, before discontinuing, he should have tried to assign the cause of action. A timetable was set for the TiB to offer an assignment of the claim and, if an acceptable offer could not be found, for the TiB then to discontinue the claim. The order expressly allowed the TiB to reject any offer giving the TiB a share of the proceeds of the litigation. The TiB sought this specifically so that he would not be obliged to assign the claim on the basis that he might face a non-party costs order in due course. Mrs Harb appealed against that provision in the order.

In the Court of Appeal, Mrs Harb argued that Hamilton was wrongly decided and that, once a TiB assigned a cause of action, he could not be liable for the costs of any of the parties to the litigation. She argued that there was no reason why there should be any difference between an assignment of a cause of action in return for a lump sum payment, from which the TiB was exonerated from any future costs liability, and an assignment in return for a share of the litigation proceeds. Mrs Harb also argued that the order risked stifling a legitimate claim, contrary to the settled policy of the courts that such claims should not be prevented from coming to court simply because of the bankruptcy of the claimant.

Whilst the Court of Appeal did not accept Mrs Harb's arguments it deleted the provision in the High Court about which she complained. It was held that the court's discretion to order costs against a non-party to litigation was wide; it was inappropriate to limit that discretion in all cases involving bankruptcy. The decision of the High Court in Hamilton was therefore upheld; the TiB stood to benefit from the outcome of the litigation and this was a consideration which could justify a non-party costs order.

Importantly, the Court of Appeal did not however rule out the possibility that, in appropriate cases, a court might make an order exonerating the TiB from any future costs liability. It did not consider that there were such grounds in this case as the TiB had not yet reached an agreement on the terms of an assignment. The High Court was therefore wrong to grant express permission to reject an offer to take an assignment on the basis that a non-party costs order was possible in due course.

What can a TiB do to protect himself when assigning a cause of action? Following Harb, he could seek an order exonerating him from any potential non-party costs liability early in the litigation. Alternatively, he could seek an indemnity against the third party taking the assignment, or from the bankrupt's creditors who stand to benefit from the litigation.

Foreign assets: overseas but over here in a bankruptcy

By Rita Sarkar

Earlier this year, the High Court gave judgment in a case involving a bankrupt who owned property in Morocco (Saunders v Donovan, unreported). The bankrupt had also granted someone a power of attorney in respect of the Moroccan property. The question that fell to be decided by the High Court was four-fold:

which law applied to the bankruptcy proceedings?
which law applied to the power of attorney granted by the bankrupt?
did the power of attorney have any effect on the TiB's claim to the bankrupt's property?
did the Moroccan property vest in the TiB in English law?

The High Court's decision sets down important principles which need to be borne in mind when dealing with bankruptcy proceedings involving foreign assets.

Facts of Saunders v Donovan

In 1995, a bankruptcy order was made against DCD in England. Under normal circumstances, DCD would have been a discharged bankrupt after a year. However, by reason of his noncooperation, the discharge of DCD's bankruptcy was suspended i.e. he remained a bankrupt.

In 2006, following discovery of the fact that DCD owned 16.7 hectares of land in Morocco, the TiB commenced court proceedings in Morocco to realise that property. In the Moroccan court proceedings, an individual (DD) challenged the TiB's claim on the basis that DCD had granted him a power of attorney in respect of the Moroccan property.

The power of attorney (which was written in French) gave DD the power to sell the Moroccan property, sign any contract of sale relating to that property, receive the sums due from that sale and "generally [do] everything necessary to complete [the] said sale."

The Moroccan courts recognised the English bankruptcy and the role of the TiB in relation to DCD's estate. The proceedings eventually reached the Supreme Court of Morocco, which asked the TiB to obtain an order from the English courts as to the effect of the power of attorney on his claim to the Moroccan property.

The decision of the High Court

The High Court gave its answer in the following way.

Which law applied to the bankruptcy proceedings?

The law which applied to the bankruptcy proceedings was English law and, therefore, the relevant provisions of the Insolvency Act 1986 had to be considered.

Which law applied to the power of attorney?

The power of attorney was made by an English donor in favour of an English attorney and was executed (i.e. signed) in England. No evidence or proof of an applicable foreign law was put forward by DD or DCD.

It followed, therefore, that English law applied to the power of attorney also.

Did the power of attorney have any effect on the TiB's claim to DCD's property?

A power of attorney is described as 'a document by which one person (donor) gives another person (attorney) the power to act on his behalf and in his name' – generally speaking, therefore, it does not create any proprietary interest.

Section 284 of the Insolvency Act 1986 provides that when a person is made bankrupt, any disposition of property made by him in the period between the presentation of the bankruptcy petition and the vesting of his estate in the TiB will be void unless it is made with the consent of the courts.

In DCD's case, the power of attorney was granted after the presentation of the bankruptcy petition and before his estate vested in the TiB, which meant that it was caught by the relevant period specified in Section 284 of the Insolvency Act 1986. Therefore, the High Court held that the power of attorney did not create or give rise to any valid disposition of DCD's property.

In any event, in English law, the bankruptcy of a donor automatically revokes any power of attorney he may have granted prior to the bankruptcy. Hence, in that respect, the timing of the power of attorney granted by DCD was immaterial. Accordingly, it was held that the power of attorney stood revoked and had no effect on the TiB's claim to DCD's property.

Did the Moroccan property vest in the TiB in English law?

The Insolvency Act 1986 provides that the bankrupt's estate vests in the TiB immediately upon the latter's appointment. The bankrupt's estate is defined as 'all property belonging to or vested in the bankrupt' and property is defined as 'money, goods...land and every description of property wherever situated...'.

Given the clear wording of the legislation, the High Court had no hesitation in holding that the property in DCD's estate which vested in the TiB included 'land wherever situated' which, in turn, included the property in Morocco.

Accordingly, the TiB was entitled to realise the property in Morocco for the benefit of DCD's creditors and the power of attorney granted to DD had no effect in respect of the assets in DCD's estate.

Conclusion

In an increasingly globalised world, it is no longer uncommon to encounter foreign assets in bankruptcy proceedings and the decision in Saunders v Donovan is likely to be of assistance to insolvency practitioners when dealing with assets situated overseas.

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.

UK: Property and Insolvency Briefing - November 2011