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Eversheds Sutherland property column: September 2020

  • United Kingdom
  • Corporate Real estate
  • Real estate
  • Real estate planning
  • Real estate sector

10-09-2020

If not the tenant, then who?

As a result of the COVID-linked limits placed on forfeiture, the commercial rent arrears recovery regime and insolvency proceedings generally, it is more difficult than ever to recover rent from a defaulting tenant. Fortunately for landlords, the law in this area does provide some relief and, with a bit of careful analysis, landlords might be able to find a positive answer to the burning question: if the tenant won’t pay, who will?

A quick and easy response to this issue will, naturally, see many landlords immediately turning to their rent deposit accounts. Rent deposit deeds are invariably drafted in a landlord-friendly way so that, as soon as a tenant is in breach of its lease terms and any grace periods have elapsed, draw down can take place. While this may initially fill the financial void left by a tenant’s default, landlords should think carefully before proceeding. Although it is relatively rare to have both a rent deposit and another form of security for the same tenant, if there are other options available it will often be preferable to pursue those in the first instance. At the time, a particular guarantor may be the picture of financial health, and able (if perhaps not willing) to pay out under any guarantee it has given. However, with the unpredictability of the world economy, who knows what shape that guarantor will be in come the next quarter day? A well-advised landlord should consider recovery under the guarantee now while it is still possible, leaving the rent deposit intact for rainy days to come.

The benefits of pausing before drawing down were demonstrated in last year’s London Trocadero case where, on the tenant entering into administration, the landlord immediately drew down on the rent deposit. The High Court held that, while the payment of rent to a landlord could be an expense of the administration, the topping up of a rent deposit could not. On that basis, if the landlord’s cashflow could have sustained its business, the landlord would have been better off exhausting its claim in the administration process before touching the rent deposit.

For those landlords who do not have the benefit of a rent deposit or who want to explore other options first, an investigation of who, out of former tenants and guarantors, is still on the hook for the current tenant’s liabilities may prove a worthwhile exercise.

There is a clear distinction between "old" and "new" leases. Broadly speaking, an old lease is one which completed before 1 January 1996, although there are a number of exceptions. Given that for some time the market has been drifting away from long lease terms, with tenants often preferring shorter, more flexible, periods of occupation, old leases are becoming few and far between.

An old lease can be a gift for a landlord as not only will the original tenant and its guarantor remain liable for any tenant breaches, if there are any intervening tenants or guarantors, they are usually also responsible for any default by the current tenant. For a long lease that has passed through a number of hands, this gives the landlord a veritable smorgasbord of potential defendants to claim against.

Unfortunately, for landlords of new leases, the menu is less appetising. When a tenant assigns a new lease, it will be automatically released from future breaches by its successor. The tenant’s guarantor will be similarly released. An outgoing tenant can still be susceptible to a landlord’s claim if it has entered into an authorised guarantee agreement (AGA) or if the assignment was not permitted under the lease. Likewise, a guarantor may have been required to enter into a guarantee of that AGA (GAGA) which will preserve its legal responsibility. So perhaps not quite a smorgasbord, but a light sandwich buffet, if anyone can remember one of those!

For both old and new leases, once a landlord has worked out who might be liable, the next step is serving notices in accordance with the Landlord and Tenant (Covenants) Act 1995 (section 17 notices) to ensure that the right to bring a claim is protected. It is essential to remember that with both old and new leases, a landlord must serve a section 17 notice on the liable party within six months of the arrears becoming due. Failure to do so will bar recovery. As we approach the September quarter day this six-month deadline is critical, with time running out to serve section 17 notices for arrears arising from the first "lockdown" quarter day in March. Former tenants and guarantors should therefore brace themselves for a raft of section 17 notices in the run-up to the September quarter day. If receiving a section 17 notice, it is important to consider if the liability might have inadvertently been released and also whether the notice has been served correctly and in time.

In terms of inadvertent releases, the key thing to watch out for is variations to the lease which have not been consented to. If, for example, a guarantor was not party to a deed of variation, this could spell disaster for the landlord. Often, this aspect will turn on the nuanced wording of the lease and the variation, with the release taking effect unless the variation is "patently insubstantial or incapable of adversely affecting the guarantor", so it is worth spending some time considering this carefully before making a payment.

When it comes to serving the notices, the devil really is in the detail and the consequences of getting it wrong can be disastrous for landlords.

In a bid to restore its income quickly, a landlord might overlook the fact that a party who pays the arrears following receipt of a section 17 notice is entitled to claim an overriding lease from the landlord. This will put the landlord in a new direct relationship with the former tenant or guarantor and that will be the party who pays the rent and against whom the landlord enforces covenants going forward. They may have been a sensible tenant or guarantor with a good covenant strength in the past, but are they now? This is an important consideration before sending out an array of section 17 notices to all and sundry.

Landlords may feel like they have been lost in the melée as many areas of our economy rush for and receive welcome government aid. Even if there has not been a flood of new initiatives and funding to assist landlords, all is certainly not lost. It may not be perfect and always easy to navigate, but the law in this area does give options to landlords, who may need to look backwards as well as forwards during this tumultuous period.

The solution may not always be straightforward but, with a bit of due diligence, many landlords will be able to find a welcome response to the question: if the tenant won’t pay, who will?