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Landscape changes for landlords in corporate collapses

THE WAY LANDLORDS are paid in a corporate collapse is set for upheaval, in which they are likely to benefit. For other businesses that sit within the ecosystem of such an insolvency, the situation becomes more complex.

A consortium of landlords appealed and won a case that will see them repaid £3m in back rent due prior to the collapse of digital game retailer GAME from the new owners of the business.

The court ruling, which many in the insolvency profession see as sensible, confirmed that where an administrator makes use of leasehold property for the purposes of an administration, the rent is paid as an expense for the period during which the property is used. This is true whether the rent is payable in arrears or in advance, and the date upon which the rent becomes due and payable is irrelevant. This is good news for landlords, but for finance directors representing unsecured creditors, the ruling may affect the amount recovered by them in an administration.

Life before the Appeal

Until this decision, whether rent for a property that was being used by a company in administration was payable in priority to other creditors depended on the date on which the rent fell due during the period of occupation. This was because rent was generally payable in advance, rather than in arrears, and the courts had taken the view that it was not possible for the rent to be apportioned under the Apportionment Act 1870. Consequently, if a quarter’s rent became due before the appointment of administrators, no part of that rent was payable as an expense of the administration.

The question in the current case arose in the context of the administration of the Game group of companies. One of the companies in the group was the tenant of hundreds of leasehold retail properties from which the group traded. In relation to most of those properties, rent was paid quarterly in advance on the usual quarter days. On 25 March 2012, approximately £10m in rent became due under the various leases. It was not paid and the group entered administration the following day.

Some stores were closed down immediately; but trading continued in other stores included in a sale of the business and assets of the group to Game Retail Ltd (“GRL”), a new company which was not part of the Game group. Approximately £3m of the March rent remained outstanding for those stores. Relying on the law as it stood, the administrators declined to pay the rent which had fallen due before their appointment and a consortium of landlords challenged this.

The Decision

The Court of Appeal decided that rent for what Lord Justice Lewison called the “period of beneficial retention” should be payable as an administration expense and apportioned on a “pay-as-you-go” basis, with payments that become due during that period being subject to a “wait-and-see” approach. The Court held that the “salvage principle” (developed in equity during the nineteenth century mainly in relation to distress cases) provided that a landlord should receive the full value of the property where the company in administration uses it for its own purposes, applied equally to non-distress cases.

Lord Justice Lewison noted that rent payments differ from other debts in an administration, as a landlord has the right to prove for rent that falls due both before and after the date of administration under r. 2.87 of the Insolvency Rules 1986. Whether or not that debt should be payable as if it were an expense of the administration under the salvage principle depends on whether the tenant company is using the property for the benefit of the administration, with no corresponding benefit to the landlord.

The Court held that just because rent is not apportioned under the Apportionment Act 1870 that does not mean that the salvage principle is inapplicable, and that the salvage principle is not mutually exclusive from the right to prove for a debt in an administration. The Court of Appeal confirmed that the salvage principle can take effect at any time and it is a question of fact what period the principle should cover, not to be determined merely by reference to the date on which payment falls due.

This decision was widely expected by the insolvency industry as it removes what many felt was an unsatisfactory position in the state of the law previously: rent will now be charged on a ‘pay-as-you-go’ principle, which, pending any appeal, will see the end of the recent practice of administration appointments being timed after quarterly rental was due, so as to benefit from a rent free period. The decision has the effect of putting landlords on a similar footing to suppliers of other goods and services used by a company while it trades in administration so that they will be paid the full rent for the property for the period it is used for the benefit of the insolvency.

The Court of Appeal refused permission to Game Retail Ltd (GRL) to appeal, but it is understood it is considering the possibility of taking the case to the Supreme Court and it will be interesting to see if the Supreme Court will be prepared to hear any further argument on the point.

Devi Shah is co-head and Jessica Walker is a senior associate in the Restructuring, Bankruptcy & Insolvency group at Mayer Brown

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