Dubbed "the year of the CVA", 2018 has so far seen a spate of high profile retail insolvencies. Landlords are seeking to protect their position in this volatile climate.
The rules governing the actions landlords can take in insolvency situations are complex. They depend on whether the tenant is a company or individual, the specific insolvency process involved and whether the Financial Collateral Arrangements (No. 2) Regulations 2003 (FCAR) apply.
Specialist legal advice tailored to the specific matter in question will always be necessary, but this legal insight gives an overview of when and how a rent deposit can be enforced in the different corporate insolvency processes. It also explains how a landlord may have more options available to it if a rent deposit, or a charge over a rent deposit, is within the scope of the FCAR. We are focused here on corporate insolvency and this insight does not consider the effects of individual tenant insolvency.
What is a rent deposit?
A rent deposit is a sum of money given by a tenant to a landlord to secure the payment of rent and other obligations under a lease. There is usually a deed that sets out the circumstances in which a landlord can draw down on the deposit.
A rent deposit can be held in a number of different ways including, but not limited to:
- By the landlord absolutely for itself or on trust for the tenant; or
- By the tenant and charged to the landlord; or
- By a third party as stakeholder.
The formalities for the creation of a valid and enforceable rent deposit deed have changed over the years. This insight does not address such questions and assumes that the rent deposit was validly entered into and any registration or other formalities were complied with.
Whether or not the deposit falls within the ambit of the FCAR depends upon the drafting of the rent deposit deed in each case. Given the potential benefits on a corporate tenant's insolvency, landlords should consider drafting future rent deposit deeds so as to come within the scope of FCAR.
What are the FCAR and do they apply to rent deposits?
The FCAR apply to financial collateral arrangements entered into between two parties on or after 26 December 2003, where neither party is an individual. A financial collateral arrangement secures or otherwise covers financial obligations owed by one party to the other. It must be evidenced in writing. Financial collateral includes cash or other financial instruments.
In summary, the two types of financial collateral arrangement are:
- A title transfer collateral arrangement, which involves the transfer of ownership in financial collateral to secure financial obligations; and
- A security collateral arrangement, where one party creates a security interest in financial collateral to secure its financial obligations.
A rent deposit will not automatically fall under the FCAR. However, there are some circumstances when a rent deposit may constitute either a title transfer or a security financial collateral arrangement. This should be assessed on a case by case basis.
What can a landlord do with a rent deposit if its corporate tenant enters an insolvency process?
The landlord's options will vary according to the insolvency process involved and whether or not the rent deposit is governed by the FCAR.
Company voluntary arrangement (CVA)
- The specific terms of the arrangement and the structure of the rent deposit should be considered in each case.
- Where the rent deposit is not charged, the landlord's rights may be compromised under the terms of the CVA.
- Where the rent deposit is charged, and the landlord has not agreed to anything different in the arrangement, then its rights to enforce the charge should not be affected i.e. the deposit can be used.
- Even if the rent deposit is secured, there is still a risk that the level of secured debt may be affected by the compromise in the CVA.
- In certain circumstances there may be a moratorium against creditor action while the terms of the CVA are negotiated.This moratorium will not apply to a landlord whose rent deposit falls within the ambit of the FCAR.The landlord is likely to be able to continue to rely on the rent deposit and enforce any security connected with it in spite of the moratorium.
- The administration moratorium prohibits enforcement of security or bringing (or continuing) legal proceedings against a company in administration without the court's or administrator's consent.
- In practice, administrators may often consent to the drawdown of sums from a rent deposit.
- Where the FCAR applies to the rent deposit, the moratorium is disapplied.This means that no consent will be needed for the landlord to make deductions or institute proceedings.
- There is no automatic moratorium against creditor action in a voluntary liquidation.The landlord would not be prevented from enforcing the rent deposit in these circumstances.
- Where the tenant is in compulsory liquidation (being wound up by the court) the landlord may drawdown on the deposit money without consent.The liquidator's consent will be needed if the landlord wishes to commence or continue any legal proceedings.
- Liquidators have the power to disclaim onerous property in some circumstances.If a rent deposit satisfies all the statutory requirements it is possible that a liquidator could disclaim it unless the FCAR applies to the rent deposit.The power of disclaimer is disapplied in connection with any arrangements falling within the FCAR.
IPs may be aware that there are a number of provisions in the FCAR that relate to floating charge security. In order to be effective, any security created by a rent deposit deed is highly likely to be fixed rather than floating, and so these provisions have not been addressed in this note.
What other options does a landlord have when its corporate tenant becomes insolvent?
Landlords may have other options available to them where a tenant stops paying rent. Some of these may be constrained once a tenant has entered into a formal insolvency process. This insight does not intend to address all of the potential implications for a landlord where its tenant gets into financial difficulty.