The recent downturn in the economy is undoubtedly having an adverse effect on the cash flows of a large number of businesses in the UK. Businesses are keeping a much closer eye on outgoings and expenses, and may be looking to ease financial pressure by making payments due to creditors as late as possible.

For a business operating from leased premises, quarterly rental payments are likely to be one of the biggest outgoings. The longer the rental payment remains in the tenant's bank account, the more interest they will accrue and the more likely that cash flow issues will be eased.

However, late payment of rent could prove to be an early warning sign of real financial difficulty – that the tenant is unable to pay its debts as they fall due. Should the tenant enter into a formal insolvency procedure, the landlord will be dealing with the insolvency practitioner (IP) appointed to the company in order to secure return of the premises. Subject to rights of hypothec in Scotland, the landlord will have only an unsecured claim for any rent that remains unpaid.

Early action is key

The key advice for landlords is to remain vigilant. Ensure that systems are in place in order that late or non payment of rent or other non-compliance with lease covenants is identified as early as possible. Take steps to remedy the position at the earliest opportunity. Companies in financial difficulty will often give priority to those creditors that are pressing most for payment. However, payment should only be made of those amounts that have fallen due; accepting payment of future rentals runs the risk of reversal of the payment if the tenant subsequently enters into a formal insolvency procedure.

Right of hypothec

Changes have been made to the landlords' right of hypothec which applies in Scotland. (View our recent E-Bulletin article on the revised rights of hypothec available to landlords.)

Formal insolvency

Again, the key advice here is to take early steps to contact the IP. The IP appointed to the tenant will in the majority of cases have little or no prior knowledge of the tenant's contractual position. Often, the tenant's books and records will be less than adequate and directors/employees may not be on hand to assist the IP. We would therefore suggest that the IP is provided with a copy of the lease and details of the rental payments outstanding or due.

Landlords should also establish in the early course their proposed approach to their tenant's insolvency. In some cases, if the IP intends to trade the business on, in the hope of achieving a going concern sale, he may agree to meet the ongoing rent. In some cases, the IP may seek to vary the terms, and possibly the amount of payment, possibly by agreeing a slightly reduced rent and/or that payment will be made on a monthly, rather than quarterly, basis. It is of course a commercial decision for the landlord whether the terms offered are acceptable. The hope is of course that a business sale will lead to the assignment of the lease to a new, solvent tenant.

If variations to the terms of payment are agreed however, steps should be taken to ensure that the IP agrees to pay the ongoing rent as an expense of the insolvency procedure. This will ensure that the rent is payable in priority to the unsecured creditors, preferential creditors and any floating charge holder, rather than as another unsecured liability of the tenant.

Establish value

It is worth bearing in mind that the lease may be a key asset of the tenant and a primary concern of the IP. If this is the case, the landlord will be in a stronger bargaining position than otherwise. Retention of the lease, and possibly agreement to an assignation or assignment of the lease when a sale is secured, may be key from the IP's perspective. The landlord should give early consideration to the terms on which consent to any assignation or assignment will be given, subject to the terms of the lease.

What type of insolvency is it?

It is also important to establish the type of insolvency proceedings that the tenant has entered into. This will determine whether the landlord's right of irritancy is immediately available (assuming there has been a breach of the terms of the lease giving rise to the right). If the tenant has entered into liquidation or receivership, there should be no bar to the exercise of rights of irritancy, subject to any requirements to act reasonably. In liquidation in particular, the IP will have limited rights to continue the business of the tenant and he may be happy for the landlord to exercise his rights of irritancy forthwith. 

However, if the tenant has entered into administration, an automatic stay on any proceedings against the tenant will arise. This will prevent the landlord from exercising his rights of irritancy without the leave of the administrator or consent of the court. Generally, the administrator/court will not grant leave in the very early days of the administration, the rationale being that the administrator requires a period of time to establish what steps should be taken in the interests of the creditors of the tenant as a whole.

However, case law has established guidelines that an administrator should follow when considering whether to grant the leave requested. In particular, leave should normally be given to a landlord to exercise his proprietary rights where that exercise is unlikely to impede achievement of the purpose of the administration. A balancing exercise requires to be carried out, weighing the interests of the landlord against those of the tenant's other creditors. Great importance should however be placed on the landlord's proprietary interests.

Generally, the court will take a dim view of the actions of an administrator who refuses leave where there are no good grounds to do so, resulting in the landlord being required to make an application to court for leave instead. The recent English case of Metro Nominees (Wandsworth) (No.1) & Ors v K Rayment & Ors is a case in point. For commentary on this aspect click here and here for previous e-bulletin articles.

Conclusion

The key message for landlords is to remain diligent, watch for the early warning signs outlined above and to take immediate action when the landlord suspects that the tenant may be in financial difficulty.