Two’s company when it comes to debt funding. Surely, three makes things a little crowded? It doesn’t have to be that way.
The recent closure of a national hardware chain of stores, and continued demand from investors for businesses in sectors such as retail, healthcare and childcare, has many thinking about the action a tenant's financier could take to maintain existing leases if the tenant's business had debt funding and it goes into default. This is also a sensitive issue for landlords given that in such circumstances they would face uncertainty in relation to their rental income. If there’s one thing we can learn from financing these businesses it’s that an express agreement of rights between a landlord, tenant and the tenant’s financier has the potential to alleviate future disputes.
When a borrower defaults under its debt financing arrangements, its financier may want to continue the existing leasing arrangements of the borrower. This may be to sell the tenant’s business as a going concern or access leased premises to sell assets located on them.
Hence, the rise of the tripartite relationship.
Financiers often require borrowers and their landlords to enter into a three-way agreement commonly referred to as a landlord waiver or right of entry agreement. This governs the interplay of rights between the financier, the tenant and the landlord.
Crucially, it allows the financier to step into the shoes of the tenant following a default. As you’d imagine, there are some challenges around this.
If the financier does not obtain a right of entry agreement, it may need permission from the landlord prior to entering the property. This may prove problematic, as the borrower is likely to be in default under its debt financing arrangements at this particular time.
Negotiations in respect of the rights covered by the tripartite agreement can often become unnecessarily protracted. This is particularly true where there is an existing lease in place and there is little incentive for an existing landlord to agree to enter into such a document. So, it’s essential that a financier limits their requests in such an agreement to the items that are important to the protection of the secured assets.
We’ve identified five key commercial issues the three parties need to agree on to most efficiently and effectively settle the common challenges each faces.
Consent to security
The financier wants to ensure that the grant of security does not constitute a breach of the lease terms. This can be addressed by the landlord consenting to the existence of that security in the tripartite agreement. This isn’t usually a problem for a landlord.
Entry for select purposes
A financier will usually request the right to enter the leased premises. It will want to be able to inspect, repair or maintain the leased premises or any assets over which it has taken security.
It will also require the ability to remove such assets upon a borrower default.
The landlord may agree to this request provided it receives reasonable notice prior to entry, entry is during business hours, any removal takes place within a certain period of time and any damage caused by the removal is made good by the financier.
If the assets aren’t removed within that period of time, then the landlord will require the tenant and financier to agree that the landlord can treat the assets as abandoned and the property of the landlord.
Financiers are likely to agree to such a compromise, provided the agreed timeframe is sufficient and it’s physically practicable to remove the assets. For example, if the assets include construction or mining equipment or other heavy machinery, then the financier might prefer to have the right to conduct an auction on the premises.
This is usually an area of significant negotiation.
A financier will usually require the landlord to notify it when it becomes aware of a default by the tenant. Further, the financier will want the ability to step in and cure such default. Insolvency of the tenant is discussed in more detail below, but in respect of other defaults, the financier will usually agree a period of time with the landlord within which it must exercise such cure rights.
The landlord may terminate if the financier has not cured the breach within the agreed period.
Protection against insolvency of the tenant
A tenant’s insolvency and the appointment of an administrator or receiver will usually trigger a default under the lease and allow the landlord to terminate the lease. At the same time, insolvency of the tenant will usually also enable the financier to enter into possession of the lease under the terms of the financier’s security.
The compromise position for both landlord and financier in these circumstances is to include a provision in the tripartite agreement allowing the financier to cure the insolvency default by appointing a receiver and otherwise continuing to perform the tenant’s obligations, including payment of rent and other outgoings.
Beyond performance, the financier will want to assign the lease to any purchaser of the business and so will also require an express right to do so in the tripartite agreement.
Breach of tripartite agreement
In the event that the landlord exercises its rights under the lease in breach of the rights afforded to the financier under the tripartite agreement (for example, by retaking possession of the premises in breach of the financier’s step-in rights) a financier may look to the courts for an order that the financier be entitled to specific performance.
While a financier would ordinarily avoid court proceedings, in circumstances where it would be difficult to determine the loss suffered by a financier, an order for specific performance is a favourable outcome in preserving the financier’s security.
A way forward
Negotiating a tripartite agreement doesn’t necessarily need to become protracted. Financiers need to consider the items that are important in protecting the secured assets and limit their requests accordingly. While the parties may have different objectives, a focused consideration of the key commercial issues identified above can help steer the parties to reach a position that is most effective in securing the continuity of operations.
Maybe three’s company after all.