Real Estate Legal Update : UK Real Estate Lawyer & Attorney : Reed Smith Law Firm : Corporate Property, Planning Law

This post was written by Katherine Campbell and Siobhan Hayes

In Agricullo Limited v Yorkshire Housing Limited [2010] EWCA Civ 229, the Court of Appeal considered a costs recovery clause in a lease when the landlord was seeking compliance with the tenant's repairing obligation. The costs recovery clause in this particular lease provided for the landlord to recover the costs it incurred in "connection with any steps taken in or in contemplation of, or in relation to any proceedings under section 146 of the LPA 1925". In this the landlord served a section 146 notice but, as is often the case, subsequently negotiated a deal with the tenant regarding repairs.

The Court of Appeal held that:

• Although agreement was reached with the tenant whilst the tenant was under the threat of proceedings, the work carried out by the landlord and its advisors in reaching that agreement, was not undertaken in connection with, or in contemplation of, proceedings. The landlord was, therefore, unable to recover its costs.
• If the costs recovery clause had been drafted so as to entitle the landlord to recover any costs incurred in enforcing the tenant's covenants, the landlord would have been able to recover its costs.

For landlords, therefore, the best costs clauses are the widest. Restricting costs recovery to circumstances where a section 146 notice is served is bad enough, but restricting it even further to steps taken in contemplation of proceedings is even narrower.

Many leases often have additional wording in costs clauses allowing a landlord to recover the cost of preparing and serving a schedule of dilapidations. A clause like this might have helped the landlord in this case and so might a well drafted indemnity clause where the tenant indemnified the landlord for any costs incurred as a result of any breach of the lease.

Of course, if you litigate because of a breach of covenant and are successful, you are entitled to recover the costs of the litigation under the rules of court, but even then, the costs incurred pre-litigation will be in the discretion of the court and you are very unlikely to recover a substantial amount of those pre-litigation costs.

So our message to landlords is not to assume full costs recovery even though the tenant is in breach and you are successful or negotiate a satisfactory settlement. Before embarking on an expensive course of action check the costs and indemnity clause as well as the financial strength of the tenant.

For further advice please get in touch with the authors or your usual contact at Reed Smith.
 

The case involved a lease granted to Tenant A whose obligations were guaranteed. When Tenant A assigned its lease to Tenant B, the landlord granted consent and relied on the lease clause requiring that both Tenant A and its guarantor enter into an authorised guarantee agreement. The Court decided that, when Tenant B defaulted and the landlord tried to enforce against the guarantor, the landlord was unable to do so as the guarantee was void because of the anti-avoidance provisions of the Landlord and Tenant (Covenants) Act 1995.

What are the implications for tenants? Here are some initial thoughts pending the appeal of the case:

Taking a new lease - as landlords’ unease increases over the enforceability of guarantees following assignment, you can expect landlords to examine covenant strengths of tenants and their guarantors separately. It is likely that parent companies, which, in the past, would have stood as guarantors, may find themselves having to enter into leases as sole or joint tenant either instead of or alongside their subsidiaries. This may upset the structure many groups adopt for holding property in one entity or the desire to keep businesses in separate divisions.

Ease of assignments - a landlord is likely to be particularly wary of consenting to an assignment where the existing tenant is of a relatively weak covenant strength and the landlord is relying heavily on the covenant strength of the existing tenant’s guarantor. Existing lease assignment clauses are often heavily weighted in the landlord’s favour. We expect that landlords will refuse consent to assign rather than lose a valuable guarantee. If it is proving difficult to obtain consent to an assignment, it may be worthwhile for tenants to consider subletting as an alternative.

Assigning to a group company - we think it will get harder to do authorised group assignments where a parent company guarantees the performance of one of its subsidiaries as tenant. In order to obtain the landlord’s consent to an intra-group assignment, tenants may have to offer a different company to act as a guarantor for the assignee or be prepared to provide alternative security.

Alternatives to guarantors - you may find more and more landlords seeking rent deposits, letters of credit and other alternative security arrangements in lieu of guarantors. Rent deposits do, of course, bring their own complications, not least the question of how to protect each party from the consequences of the other becoming insolvent. They also tie up a large amount of cash for a long period, but the principle behind them is relatively simple and their certainty has a definite appeal for landlords. Where the tenants can offer them, rent deposits may be the key to unlocking deals.

Existing guarantors - bad news for landlords is potentially good news for guarantors who believe themselves to be guaranteeing obligations under authorised guarantee agreements. If the tenant whose performance a guarantor originally guaranteed has assigned the lease, any authorised guarantee agreement that the guarantor entered into as part of the assignment process may now be unenforceable and the guarantor may be released from its liability.

Conclusion and Warning

This case is being appealed and the outcome will affect many leases and guarantees. For the time being, however, the High Court decision stands, causing concern for landlords granting new leases to tenants with guarantors, for existing investors for whom covenant strength and value depend on such a guarantee, and for potential buyers of investments. Tenants should be prepared for landlords taking an increasingly cautious approach to covenant strength, making their plans for their leases harder to implement.

Please contact your usual Reed Smith attorney for specific advice.

The case involved a lease granted to Tenant A whose obligations were guaranteed. When Tenant A assigned its lease to Tenant B the landlord granted consent and relied on the lease clause requiring that both Tenant A and its guarantor enter into an authorised guarantee agreement. The Court decided that when Tenant B defaulted and the landlord tried to enforce against the guarantor that it could not do so. The guarantee was held to be void because of the anti-avoidance provisions of the Landlord and Tenant (Covenants) Act 1995. Leave to appeal has been granted and we expect the appeal to be lodged.

This case has serious implications for landlords granting new leases with guarantors, to investors where covenant strength and value depend on such a guarantee and to potential buyers of those investments. Here are some initial thoughts -

Granting a new lease involving a guarantor - consider now making the guarantor a joint tenant rather than a guarantor. This will avoid the dilution of covenant strength that all too easily happens on assignment. If your tenant is taking separate leases of a number of floors think again about whether this should be a single lease deal. We have a number of options for changing the lease assignments clause and suitability depends on the market place so needs individual advice.

Assignment of a lease involving a guarantor - review any applications for consent being processed to require other security for the assignee to compensate for not being able to call on the original guarantor to guarantee the liabilities of the assignee. These cases often turn on the wording of the lease and we are working with our clients to adopt appropriate solutions to manage individual risk in a situation where tenants have number of statutory rights.

Buying an investment - check that the potential impact of this case is factored into the valuation where an AGA has been given by a guarantor.

Investors suing AGA guarantors - expect some robust defences from guarantors like the one in this case. Consider all your enforcement options.

Please contact your usual Reed Smith attorney for advice.

Certain categories of expense which may be incurred by the company after it has gone into administration, and which an administrator has to pay are known as "expenses of the administration" and the assets of the company in administration must be applied towards payment of these expenses ahead of any payment to creditors under floating charges or to unsecured creditors.

The categories of expense include "expenses properly incurred by the administrator in performing the functions in the administration" and "any necessary disbursements by the administrator in the course of the administration". These two categories of expense in fact rank ahead of the administrator's own remuneration.

In December, the Court decided that, if a leasehold property is occupied by a company in administration for the benefit of creditors, the administrator must pay the rent under the lease as an administration expense because it falls into one of the two categories mentioned above. The rent is payable whether or not the landlord demands it.

Before this case, there had been no decision about whether rent could be claimed by a landlord as an administration expense for the period following the administrator's appointment. The moratorium which arises on administration prevents landlords (and other creditors) taking action against a company in administration. This means that landlords are unable to take forfeiture proceedings to recover rent without the consent of the administrators or the permission of the Court.

In practice, many administrators were paying rent on the premises the company occupied but had a discretion about what and when to pay and since landlords were considered to rank as unsecured creditors, prospects of recovering arrears were poor even for the rent that accrued during the administration only.

In the case under discussion, the company in administration was only in occupation of a small part of the premises and argued that the liability for rent should be assessed by reference to the floor space which they were actually occupying. On the particular facts, the Court felt that the administrator should pay the full rent following evidence from the landlord's surveyor that, as long as the company remained in occupation, there was no realistic prospect of maximising the return from the premises. Clearly, this might not always be the case.

A factor which is not in the landlord’s favour is whether the assets of the company are sufficient to enable the administrator to pay the rent as it arises. If the sufficiency of the assets to meet the rent, together with other priority claims, is in doubt, the administrator will be justified in deferring payment until he leaves office. As such, landlords do not have a right to immediate payment, but they are entitled to know that the accruing rent is being treated as an administration expense with appropriate priority for as long as the company is making use of the premises and that, subject to the assets being enough, it will be paid at the end of the administration. This is not ideal but there is nothing else that can be done.

Where, as in the case decided in December, the assets are acknowledged to be sufficient to meet the rent as it arises, the administrator had no justification for not paying the rent quarterly in advance in accordance with the lease for as long as the company continued to occupy any part of the premises for the purposes of the administration.

Sadly landlords facing pre-packs will not gain from this as the process involves the new company taking occupation immediately the administration and sale have been set up. The landlord is often simply left trying to negotiate the terms of the new company’s occupation. In that situation it can be helpful to agree a surrender with the administrator and to have a direct relationship with the new company and the ability to recover something for the occupation of the property direct without involving the administrator. If that is not the case then under some pre-pack sale agreements the new company is required to pay the administrator rent and landlords so sometimes claim that successfully from the administrators.

Action Points for Landlords:

1. When you know the tenant is in administration but the premises are being traded from contact the administrator to persuade him to pay rent as an expense.

2. Where there is an asset sale of the business by the administrator to a new company who is trading from the premises put the administrator under pressure to cover the rent until a formal assignment is completed. Our experience is that sometimes this can be successful.

When formal notices have to be served, there is often a significant event that will happen as a result. It can be vital that the formalities of the clause specifying how notices are to be served are observed because as one case famously said if the clause had said that the notice had to be on blue paper it would have been no good on pink paper!

Three different statutes affect the service of notices in the property world and all of them will be overridden by any specific provisions written into the document under which the notice is to be served. The technicalities of this would not make interesting blog reading although they exercise real estate lawyers' minds when notices have to be served.

Taking the example of the break notice the well advised tenant will be asking:

• What does the lease say about how a notice is to be served? Is the specified method for service mandatory or is it just a permission to serve as specified? Old leases often specified that documents could or should be served by registered post which no longer exists. What is the appropriate method today?
•  Am I likely to have a dispute about whether notice has been validly served and if so how can I go about proving I served properly?
•  What is the up-to-date address for the landlord? If you now have an overseas landlord how can notice be served on it validly and how long will it take?
• Does the notice have to be received to be effective?
•  Will the notice be deemed to have been received even if it does not come to the attention of a specific individual by the deadline and if so how soon is it deemed to be received?
•  What deadline am I working to?

For Landlords the alarming message is that non receipt by the deadline is not necessarily the end of the story. Notices may still have been served validly even if never received, depending on how the notice is or has to be served. There is no easy solution to this for Landlords.

The current postal strikes add further complications. The News is all about the backlog of mail and fears that some of it may never be delivered. We have recent experience of a break notice sent by recorded delivery taking over a week to arrive.

Here are a few practical tips which might help when serving break or other kinds of notice:

•  Check carefully what the document says about service and if the required method is mandatory, stick to it by the letter and serve it in plenty of time - so much time that you could do it again before the deadline if something goes wrong!
• If you suspect that strict compliance with the service requirements will result in the notice not reaching the recipient by the deadline (whether because of the post strike or for other reasons) then consider ways of minimising the risk of future disputes. One approach will be to make contact by more practical means to make sure the right person knows what is happening within the deadline  e.g. serve by post if that is the required method but also deliver a copy/duplicate by hand.
• Make sure you can prove service of your notice.
•  Ask for an acknowledgement of receipt and chase for it if not given promptly.

Extra service might entail a bit of expense, time and effort but the costs are likely to be far cheaper than paying rent and other outgoings for unwanted space until the end of the term or until the next break date!

We know, of course, that this is a time where legal spend is being watched by many but not instructing your solicitor to serve notice could be a false economy.