The property industry has seen a dramatic decline in capital values over the last two years with peak to trough falls of approximately 44 per cent compared to a peak to trough decline of approximately 27 per cent during the recession of the early 1990s. This, together with the effect of the challenging economic climate, has led to a number of high profile insolvencies of property owners, developers and occupiers. Given the uncertain economic outlook, it is likely that these trends will continue. The law and practice surrounding insolvency in the real estate sector is complex and the aim of this article is to highlight some of the main issues in connection with two areas: acquiring property from an insolvent seller; and tenant insolvency.
Acquiring property from an insolvent seller
Although the market has not yet been inundated with property for sale by distressed or insolvent sellers it is likely that there will be a significant amount of distressed property on the market over the next few years. It is important, therefore, to understand the risks involved when buying property from an insolvent seller and to remember that a discounted price is not necessarily good value if the risks are not identified and reflected in the price.
In this regard, the underlying risks when buying a property from a distressed or insolvent seller are, in many ways, no different from those which exist when buying a property from any other seller. For example, there might be an issue with the seller’s title to the property, issues with the construction or condition of the property, or planning or environmental issues. The main ways in which the risks differ are that there will usually be significantly less information available in respect of the property and a much shorter timescale given to exchange contracts (which means there is less time to identify issues and find satisfactory solutions).
By way of example, an insolvency practitioner will often refuse to provide replies to enquiries and, if replies are provided, the insolvency practitioner will specifically exclude any personal liability for these. This means a buyer has very limited recourse if any information turns out to be incorrect. Similarly, there will be no title covenants given by the insolvency practitioner, such as the usual full title guarantee that the property is owned by the seller and is free from encumbrances, or a covenant for further assurance.
This places an even greater emphasis on the due diligence process to extract as much information as possible (both from the insolvency practitioner and from external sources) to ensure potential issues with the property are identified and the risks reflected in the price. In addition, it is important any documents required in connection with the change in ownership (for example, discharges of any charges, evidence of the insolvency practitioner’s appointment and any title deeds to be handed over) are available at completion.
In the current recession, tenant insolvency has often been in the headlines, particularly in the retail sector where household names such as Woolworths have ceased trading or have entered into a pre-pack administration before re-emerging as leaner and more competitive businesses, often at the expense of landlords owning unwanted stores. The law surrounding tenant insolvency is a very complex subject and this part of the article aims to highlight some practical actions for landlords to take if concerned about tenant default. These include:-
- Checking to ensure the rent and other sums due under the lease are paid on time and, if not, taking prompt action to recover these from the tenant so as to avoid significant arrears arising.
- Monitoring the tenant’s compliance with other important lease covenants, such as the tenant’s repairing obligations, and, if necessary, taking appropriate action under the lease in respect of these - for example, serving an interim schedule of dilapidations to ensure that any disrepair is remedied early, before it becomes a significant liability.
- Maintaining a regular dialogue with the tenant and, if appropriate, discussing temporary measures to help with cash-flow difficulties, such as payment of the rent monthly rather than quarterly. Any negotiations should be held without prejudice and subject to contract and any arrangements should be properly documented to ensure there is no long term waiver of the landlord’s rights under the lease.
- Checking whether any security exists for the tenant’s obligations (for example bank guarantees, rent deposits, parent company guarantees or previous tenants or guarantors with residual liability for the tenant’s covenants).
- Ensuring any procedural requirements in relation to any security held have been complied with. For example, in respect of any former tenant with residual liability to observe covenants under the lease, notice must be given to the former tenant within six months of any fixed amount becoming due under the lease, or else the former tenant ceases to be liable for these amounts.
Once a tenant is the subject of certain insolvency processes (such as administration or a creditor’s voluntary agreement) there is a moratorium which prevents a landlord from exercising a number of its rights under the lease without the consent of the insolvency practitioner or the leave of the court. Accordingly, specialist advice should be taken at this stage as to the options available and our real estate team would be happy to assist with any queries you may have.