The Court of Appeal recently considered the impact of the law of appropriation on the relationship between a landlord and tenant, where there is a debt outstanding from the tenant to the landlord.

In the case of Thomas v Ken Thomas Limited, the court concluded that when a tenant has accrued arrears of rent and subsequently offers the landlord payment of a sum, which the tenant specifies is to be allocated as rent for a specified period of those arrears, the landlord cannot then designate those funds as payment for a different period.

If the landlord is not satisfied, and does not wish to accept what the tenant is offering for payment of rent arrears, then to avoid waiving the right to forfeit the tenant's lease for breach of covenant, the landlord must either refuse the payment that the tenant is offering or return it within a reasonable period of time after having received it from the tenant.

The Facts of the Case

  • Ken Thomas Limited was a haulage contractor, which leased commercial premises under a ten-year lease from Mr Thomas. The rent was payable by monthly instalments on the first day of each calendar month. The lease also contained the usual covenant, which gave Mr Thomas a right to re-enter and take possession of his property on the grounds of non-payment of rent. This covenant would be deemed to have been breached if the tenant had failed to pay the monthly rent within twenty-one days of it having been due or if the tenant became insolvent (by reference to the Insolvency Act 1986).
  • Ken Thomas Limited fell into rent arrears and became insolvent. Under the Insolvency Act 1986, Ken Thomas Limited entered into a Company Voluntary Arrangement (CVA). It was proposed that the rent due for November 2004 would become subject to the terms of the CVA.
  • The company then offered to pay to Mr Thomas the full monthly rent for December in two instalments. Mr Thomas seems to have responded by indicating that he would regard the payments as applying to the November arrears. It was later agreed between the parties that further instalments should be paid, which the company specified would cover the liability to pay January's rent but Mr Thomas indicated he would accept these payments in satisfaction of the outstanding December rent.
  • In February 2005, Mr Thomas issued proceedings to forfeit the lease for non-payment of rent arrears and sought an order for possession of the premises. Ken Thomas Limited argued that Mr Thomas had waived his right to forfeit the lease by accepting the payments, after the right to forfeit had arisen.
  • The judge at first instance held that Mr Thomas had not waived his right to forfeit the lease for non-payment of rent, but that if Ken Thomas Limited was to pay the outstanding months rent plus all the VAT arrears, then the company would be granted relief.
  • Ken Thomas Limited appealed the judge's decision.

Decision

The court upheld the appeal, finding that:

  • Mr Thomas had waived his right to forfeit the lease for non-payment of rent, by accepting the payment of rent after the date upon which the right to forfeit had arisen. Once Mr Thomas had accepted the payment from Ken Thomas Limited, he became tied to the consequences of the appropriation of the funds for the rental periods that Ken Thomas Limited had specified.
  • As Ken Thomas Limited had made it clear to Mr Thomas that the payments were made with reference to rent due for December and January, Mr Thomas then had no right to treat those payments as clearing debt for some other period. If Mr Thomas was not willing to agree to the terms set out by Ken Thomas Limited then he should have rejected the payment from the outset or returned the payment within a reasonable time. By accepting the payments Mr Thomas was left as a creditor of the company for the rent due in November (and payment of the debt would be covered by the terms of the CVA) but could no longer purport to forfeit the lease for non-payment of that rent.
  • Under the law of appropriation, a tenant can appropriate the funds by specifically stating to which periods of time the payments they are issuing relate. It is only if the tenant does not appropriate the funds in this way that the landlord can appropriate the money to a period of the landlord's choosing.

The Message

The case demonstrates the importance of a landlord knowing the effects and consequences of accepting money to act as payment of rent from a tenant who is in arrears and so in breach of the lease. Before accepting any money from a defaulting tenant, a landlord needs to know the commercial aims that the tenant is trying to achieve and assess the advantages of accepting an available cash sum from a defaulting tenant against the consequences of the loss of the right to forfeit the lease for breach of covenant.

If a tenant is in breach of a covenant contained in the lease, and the landlord is fully aware of that fact, then by accepting money as payment of rent, with knowledge of the existing breach, the landlord waives the right to forfeit the lease in respect of that breach.

However, due to such case law emerging in both England and Scotland, with the potential of impeding a landlord's commercial aims, it has become common practice on both sides of the border for 'no waiver' of rent clauses to be included in leases between a landlord and tenant. This seeks to protect a landlord when demanding or accepting rent from a tenant, from losing its right to any remedies for the tenant's breach of the lease.

Such clauses were introduced in Scotland following a number of cases in which a tenant claimed that a landlord had surrendered its right to terminate a lease by continuing to accept rental payments following the tenant's breach or after a notice of termination had been served. The courts have held that the question of whether or not a subsequent acceptance of rent amounts to a waiver of the landlord's right to termination depends on the whole facts and circumstances of each case, so it is prudent to include such a clause in order to protect a landlord from the uncertainties of litigation as seen in Thomas v Ken Thomas Ltd.