For landlords, tenants and creditors alike, the recent judgement handed down by the Court of Appeal in the case of Jervis v Pillar Denton Limited; re Game Station, has major financial consequences.
Corporate restructuring specialist at Colliers International, Nick Hammond addresses the decision made and what it means for all parties concerned on the treatment of rent during an insolvency process; specifically, administration.
Against the backdrop of financial difficulties within the retailer, Game Station appointed administrators on 26 March 2012.
This was naturally of concern to the affected landlords, not least because the process commenced the day after the March quarter day, whereupon circa £10m in rent fell due under Game’s various leases over hundreds of high street stores nationwide.
Given the economic turmoil which has been prevailing during recent years, this situation has not been uncommon. Two particularly important examples and which have hitherto set precedents on the matter are those commonly known as Goldacre and Luminar.
• In the 2009 Goldacre case, the landlord applicant appealed that rent should rank as an expense of administrations as it does during liquidations (known as the Lundy Granite principle); the High Court decided in their favour, ruling that the full amount of rent that falls due following the date of the tenant’s administration was payable as an “expense” of the process (re Insolvency Rules 1986) if the premise are being used by the administrators. However, what was lacking from this ruling was any direction regarding pre-appointment arrears…
• In 2012, the Luminar case enlightened on this point. Here, it was alleged, again by the landlord, that occupation of the affected premises by administrators while avoiding rental liabilities was unfairly prejudicial, although the Court held that expenses of the insolvency process were obligations incurred only after commencement of the process, leaving landlords to have to prove for any unpaid pre-appointment rents as unsecured creditors.
These decisions have been beneficial for landlords and tenants (well, creditors) respectively. They have enabled landlords to collect rents in full as they fall due during the insolvency process where the premises are used for the benefit of the tenant’s creditors; given that typical rent payment structures are on a quarterly in advance basis, this is clearly advantageous for a landlord’s cash flow. Whereas, this structure also means that administrators can enjoy the remainder of a payment period “FOC” provided that the appointment is post and not pre the due date.
For those tenancies where rent is due in arrears, however, the story is a little different and the merits for landlords and administrators effectively vice versa. Also, what if only a portion of the premises are being used by the administrator and it is capable of sub-division…? Good question.
The game continued
In reliance on the Goldacre and Luminar principles, the administrators in the Game Station case avoided discharging rents that fell due pre-appointment on the premises which they continued to trade, thereby providing an effective rent free period for the remainder of the March quarter worth app. £3m. Despite being challenged, these actions were upheld by the High Court.
For the landlords affected, this was bad news – an entire quarter’s worth of rent in arrears and in relation to which they would need to prove as a mere unsecured creditor, likely among many others eagerly awaiting a resolution. For the administrators, the reassurance of Goldacre and Luminar was favourable as almost three months of free trade has to be beneficial to the realisation and hence the creditors, right?
So what are the landlords worrying about? One thing…ranking.
Notwithstanding the established precedents and the support of the same by the High Court, in consideration of the issues involved being of general concern to administrators, landlords and other professions alike, permission was granted to submit to the Court of Appeal.
Play on, but…
The Court of Appeal has now considered the matter and the arguments of the opposing parties – in brief, these are that the Lundy Granite principle should be applied to rents in advance, in the interests of policy relating to the conduct of administrators once in office but similarly company directors during prior trading (landlord); but that only rent in arrears can be apportioned to a period of use, as per the Apportionment Act 1870, and that directors and administrators should not be expected to cavalierly stray from their duties, surmising that said policy concerns are effectively a misnomer (tenant).
Harking back to a series of nineteenth century cases, the COA have ruled in favour of the landlord, with reference to what is known as the “salvage principle” – this is an equitable paradigm which has been neatly articulated as those taking the benefit of the administration should not escape bearing the burden of the proper cost of it (Shirlaw v Taylor ). The Court’s decision reflects that this is not mutually exclusive with being able to prove for a debt even if said debt does not fall within the bounds of the Apportionment Act (i.e. a payment in advance).
In other words, where premises are used by an administrator for the benefit of the administration, rent is payable as an expense for the period during which the property is used. Moreover, rent is to be treated as accruing day to day during the period of use and which is a matter of fact, irrespective of payment dates prescribed by a tenancy.
Now overruled, Goldacre and Luminar are history.
So what do we think of all this?
The ruling was not totally unexpected, as many stakeholders have for some time made a lot of noise about the issue – hardly surprising given its market relevance, absolute nature, and, of course, financial implications.
Goldacre and Luminar have hitherto meant that, on the one hand, landlords can expect a full period’s rent that falls due on premises in use by an administrator; but on the other, administrators have been able to avoid paying any rent that fell due prior to their appointment.
However, the landscape of corporate occupier administrations is no longer an all or nothing affair, but now one of quantum merit. This is likely to herald the end of what have been referred to as ‘strategically timed’ administrations and will have repercussions on all parties concerned, particularly IP’s and whose estimated realisations now need to be revisited to account for “pay as you go” rent.
There is an argument that landlords now get the best of both worlds: QIA rents during ‘normal’ trading and pro rata ones during an insolvency process; albeit, whilst the decision is in favour of the landlords’ submissions in terms of apportioning rents, it also means (for the very same token) that they have forgone the ability to collect a full period’s rent in advance even where the use of premises is not commensurate with this timeframe.
For creditors, there is no longer an implication one way or the other subject to the frequency of prescribed rent payment dates. For administrators, their duties to creditors continue as before, but with rental liabilities now an expense occurring in real time instead of fixed predefined periods. One can see the balance in the Court’s rationale.
There will, nevertheless, continue to be questions raised about the ruling. A period of free trading is surely of benefit to an administration and therefore creditors, so why not allow this practice to continue? Has it made administrations more expensive and are they now less viable? And with reference to our earlier query, what if only a portion of the premises is being used – does the pro rata approach apply here too?
More generally, is the institutional QIA rent structure antiquated and should it be modernised as lease lengths and other terms have been? Similarly, if landlords are so concerned about protecting their cash flow, why not move to monthly rents as a number of high profile retail occupiers have suggested – would this in itself mitigate the burden on tenants and reduce the likelihood of default? We could go on…
For the time being, the whistle has been blown.
To quote Lord Justice Lewison, Insolvency Practitioners must treat rent on relevant premises as an expense of the insolvency process on a "wait-and-see" approach during the “period of beneficial retention”. It seems that PAYG is the new contract. But don’t hold your breath…
Whilst the COA has refused permission to appeal, Game is understood to be mulling the possibility of contending directly to the Supreme Court – we are then, for the time being, on tenterhooks to see whether the saga has yet another chapter.