Property insolvency issues and the next recession

In light of the predicted downturn in the property market

Pranai Karia outlines likely property insolvency issues

Introduction

Most professionals involved with insolvency work are gearing up for the predicted downturn. So perhaps this is the time to look at changes in the law and their impact on insolvency property issues.

Types of insolvency

Lending practices have been more cautious. There is less development lending, especially speculative lending.

With limited speculative funding, the risk of not being able to service a loan on an investment property shifts to a tenant's ability to pay. Given higher rents and the prospect of significantly higher rates following the 1998 rating revaluation, the possibility of tenant insolvency will become a major consideration, especially in the light of changes in the law relating to the liability of previous tenants.

Such speculative funding as exists will probably have been provided by institutions or through joint ventures. It is likely that insolvencies on development transactions will result from developers funded by such means. Joint ventures give rise to a host of additional issues which are not discussed in this article.

Changes in the Law

Past legislative changes and cases will impact on the issues surrounding an insolvency and its likely outcome. Moreover, the law is under constant review; the House of Lords for instance is currently reviewing a significant case relating to disclaimers which may have further consequences.

We consider below a number of important areas where changes or proposed changes in the law since the last recession will have particular significance in property insolvencies.

Disclaimers on liquidation

Disclaimers sit awkwardly with property law and can have unpredictable consequences.

A liquidator must be extremely careful in specifying exactly what property is being disclaimed. A disclaimer of a licence permitting assignment of a lease has the same effect as a disclaimer of the lease itself. It is not possible to disclaim one obligation in respect of a property and retain the benefit of others. A disclaimer ends the company's rights, interest and liabilities in the property. However, the court can make provision for any surplus on any disposal of the property to be paid to the liquidator even after a disclaimer, thus enabling the creditors to participate in the profits of the disclaimed property.

On the other hand, where a tenant is in voluntary liquidation, a landlord can (subject to mitigating to the extent that the property can be re-let) claim the full loss of rent it suffers, enabling recovery of any over-renting. Disclaimers may not therefore be effective mechanisms to avoid lease liabilities.

Not all liabilities can be disclaimed; for example a liquidator cannot disclaim a waste management licence granted by the Environment Agency.

A disclaimer does not affect a mortgagee's rights to exercise its power to sell or let. However, following a disclaimer, the property (unless held on trust) will vest in the Crown bona vacantia. It is doubtful that a receiver can continue to act in the name of the company; either the Crown can be asked to transfer the legal title or the mortgagee can transfer pursuant to its powers.

Sureties are now not released on any disclaimer by the liquidator of the principal so that a surety's liability will continue for the full period that the principal would have been liable but for the disclaimer.

The position of sub-tenants is strengthened considerably. Where a head tenant is in liquidition, sub-tenants are not obliged to accept a vesting order of a disclaimed headlease. If they decline to do so, their interest in the property is terminated. The consequences of this are draconian for a landlord. Under threat of a disclaimer a landlord may pay a premium to the liquidator for a surrender to preserve the income from the sub-tenants.

Privity of Contract

The Landlord and Tenant (Covenants) Act 1995 removed the liability of previous tenants for breaches of covenants by subsequent tenants in relation to all new tenancies (i.e. post 1995). The Act does allow a landlord the ability to require the outgoing tenant to guarantee the incoming tenant, but not a subsequent tenant.

In future, it will be vital to check whether the tenancy is an old tenancy or a new tenancy. If the landlord has no previous tenants who remain liable, the landlord is likely to be more flexible in agreeing revised terms or a surrender.

Non-domestic rates

It appears that government proposals for changes to the law on rates will make receivers personally liable for rates due after their appointment, but limit liability to the assets in the receivership. Payment may be deferred until sufficient assets have been realised. There may be a three month waiver during which no liability would accrue.

These proposals are not attractive to lenders. The receivers would be liable for rates on low value unoccupied leasehold property. It may be advantageous for the company to be wound up, with the liquidator disclaiming the lease which could shift the burden of rates to the landlord.

If a three month waiver is given to receivers then that will give some time for the receivers to decide what action to take.

Practical matters

On insolvency the options will need to be considered quickly and decisive action taken to reduce financial risk and provide the best return to the banks/creditors. Some further suggestions are:

• it should be remembered that a sale of a property by a mortgagee is treated as a VATable supply by the borrower. Customs should be asked to check their records relating to elections to charge VAT made by the borrower;
• serious consideration should be given to conducting a review of the title to flush out problems. This will avoid surprises at the time of sale;
• local authority searches can assist in throwing up likely problems in connection with a sale, as well as in bringing planning matters up to date. Some consideration should be given to environmental and contaminated sites which could affect a sale;
• the property should be inspected for details of occupiers to be checked against title deeds; if necessary immediate steps can be taken to evict unlawful occupiers;
• where occupational leases are involved a strategy for approaching landlords for necessary consents should be put together and thought given to the structure of the sale to reflect the likely period for obtaining landlords' consents. Should the buyer, for example, be allowed into occupation before the landlords consent? If so, on what terms? What risks would the insolvency practitioner or receiver be taking in these circumstances? Conclusion Whilst perfection is an ideal, looking out for the above issues promptly on the insolvency occurring and careful planning and administration can help in making sure that a property can be "ready for sale". This must produce a better realisation for lenders and creditors and any initial cost incurred should be more than recouped.