Under paragraph 43 of Schedule B1 of the Insolvency Act, a moratorium comes into place to protect a company which has commenced the process of entering administration, or which is in administration. A very powerful feature of the moratorium is that it prevents a landlord from exercising its rights of forfeiture by peaceable re-entry except with the consent of the administrator or the permission of the court. The moratorium exists primarily to give the company in administration "breathing space", to enable the business to continue to be traded and ultimately to maximise value for creditors. Some landlords argue however that the moratorium unduly interferes with their proprietary rights, and that in pre-packs where the business is sold on day one of the administration, the moratorium is not protecting the insolvent estate, it is protecting the solvent buyer, who gains an unjustified benefit throughout negotiations with the landlord.
The questions that a court is to address in deciding whether or not to lift the moratorium were laid down some years ago in <em>Re Atlantic Computers  Ch 505</em>, and were recently applied in <em>Re SSRL Realisations</em>, which was a typical pre-pack structure, with the result that the landlord in that case was permitted to forfeit its lease. Given that pre-packs remain a favoured tool of the restructuring community for delivering value efficiently, we consider this case and its impact on pre-pack structures where leasehold interests form an integral part of the business that is being transferred.
What were the facts in this case?
SSRL Realisations Limited ("SSRL") was part of the Tragus Group, operating various restaurant chains including Strada, Café Rouge and Bella Italia.
In connection with the restructuring of the capital structure of Tragus, SSRL was placed into administration and its business and assets were sold to Strada Trading Limited ("STL"), a new company within the Tragus group, via a pre-packaged sale. In the usual way, from closing, STL went into occupation of SSRL’s leasehold properties, and traded the business it had bought from those properties. STL’s occupation was under licence from SSRL, pending the landlords giving their consent to assign the leases to STL.
Post-closing, in late September 2014, the landlords were approached for their consent to assign.
One of the landlords, of property located in the Brunswick Centre, Bloomsbury refused to consent. The lease had 16 years left to run. It was accepted that STL’s occupation was in breach of the covenants contained in SSRL’s lease. The reasons given by the landlord included that STL had no trading history and no independent financial strength (it was newly incorporated), SSRL was in breach of the lease (because it had let STL into occupation unlawfully), SSRL had not offered an authorised guarantee agreement ("AGA") to the landlord and the landlord had other, more financially viable parties interested in taking the lease. We note that none of these arguments are, in our experience, uncommon. Despite offers to enhance the covenant strength of STL by providing a parent company guarantee, a deposit equal to 6 months’ rent under the lease and even an offer from the administrators to revisit the provision of an AGA, the landlord continued to refuse to consent.
The property benefited from a licence granted by the landlord to use a seating area which was outside the Property. In early June 2015, the landlord terminated the seating licence. The licence, which was personal to SSRL, was not protected by the administration moratorium and could lawfully be terminated by the landlord in the circumstances.
Around that time, the administrators rescinded the sale agreement with STL to the extent it related to the property, and began marketing the lease to third parties. By the time the matter came to court, STL had vacated the property.
The landlord had itself identified a new tenant willing to take on the lease at an increased rent. So that it could re-let to that new tenant, the landlord requested that the administrators lift the moratorium so that it could forfeit the lease from SSRL. The administrators refused to do so, on the grounds that they had two other potential assignees interested in the lease, both of whom were willing to offer a premium.
Unfortunately for the administrators, by the time the case came before the court, it was clear that neither of their potential assignments would be successful. The first potential purchaser was another newly incorporated group company who could not offer a better financial covenant than STL. The second was Wagamama, an assignee for whom landlord’s consent could not reasonably be withheld, whose offer was conditional on the seating licence being provided.
How was the case decided?
The court accepted that the landlord’s withholding of consent to an assignment to STL was reasonable.
The court then rightly applied the test set out in Re Atlantic Computers, and asked itself:
- Would the purpose of the administration be impeded if the applicant were granted the right to exercise its rights? If not, leave will be granted.
- If yes, would more loss be suffered by the landlord if permission to forfeit were denied than would be suffered by the company in administration if permission were granted?
The court concluded that the purpose of the administration would not be impeded by the exercise of the landlord’s right to forfeiture because there were no grounds to believe that the administrators would be able to achieve a premium by assigning the lease. The only offer from an assignee to which the landlord could not unreasonably withhold its consent was from Wagamama, and Wagamama’s offer was conditional on the seating licence, which the administrators could not deliver to them. The court was also unconvinced by the administrators’ argument that there was a prospect of finding a suitable assignee who would pay a premium: the absence of a seating licence was, on the evidence, likely to prove a fatal obstacle to finding a suitable assignee. Even if the administrators were able to obtain a premium, on the evidence the likely level of that premium was significantly less than £250,000 and possibly in the range of £52,000 to £87,000 which, in the context of the estimated shortfall of £11m to the secured creditor (who stood to gain from the realisation of the value in the lease) was so small that its loss through forfeiture would not in any real sense impede the purpose of the administration.
The court said that even if its conclusions on the first limb were wrong, the balancing act demanded by the second limb of the test would also come down in favour of the landlord being granted permission to forfeit.
What are the practical implications of the case?
Comfort for landlords?
The case has been warmly received by landlords, and commentary has referred to it providing comfort for landlords who may feel that they now may take a more robust position opposite administrators and their newly-incorporated buyers.
Landlords’ confidence in challenging the suitability of a tenant installed via a pre-pack will be bolstered when the lease terms entitle the landlord to reasonably withhold consent. Administrators should never assume that a landlord will be prevented from forfeiting simply because of the administration moratorium. In many cases it will suit a landlord to have continuity of the income stream from the buyer, particularly if the property is over-rented or if the market is not strong. However where, as seems to be the case here, the property is desirable, the market is strong and/or the property is under-rented, a landlord has good reason to try to do better for itself.
Lease provisions on assignment
Administrators should always check the assignment provisions in a lease they intend to sell, to ensure that the proposed assignee can fulfil the pre-conditions to assignment contained in the lease, as without this an application for forfeiture may be hard to resist, with all the attendant costs, time and expense. A very large rent deposit or some other enhancement of the covenant strength of the newly-incorporated assignee may go some way to make it more difficult for the landlord to resist accepting the buyer as its new tenant but this will ultimately depend on the specific terms of the lease itself. It was not enough in this case.
The court accepted that it was reasonable in this case for the landlord to withhold its consent on, among other grounds, that no AGA had been offered, or appeared likely to be capable of being offered. Administrators are very reluctant to enter into AGAs because any liability arising under it will be an expense of the administration. To exit the administration the administrators will have to be satisfied that they have made suitable provision for the contingency of a demand being made under the AGA, giving rise to an expense liability. A back-to-back indemnity with the buyer’s group may de-risk the administrator but this can be tricky to put in place in practice. This is because there is a degree of circularity in the arrangement (if the buyer assignee fails to perform, resulting in a call on the AGA, will the buyer guarantor be able to perform?), and any enhancement of the covenant through, for example, a letter of credit is likely to be very expensive, because the contingent liability under the AGA subsists for the duration of the lease (in this case, 16 years). Insurance products may be available to administrators but at a cost. It is possible to contract out of administration expenses but query whether an AGA entered into by administrators which expressly excludes administration expenses is still an "AGA" for the purposes of a standard lease: the point is untested.
Conduct of the administrators
The administrators were criticised in submissions made by the landlord’s counsel for not acting more quickly when it should have been apparent to them in February 2015 that the landlord would not consent to an assignment to STL, by taking steps to terminate STL’s unlawful occupation and market the property. They did not do so until June 2015.
The court did not consider that the administrators had acted improperly or illegitimately. It does seem from the judgment however that the administrators were reliant on being kept up to date on the progress of negotiations by STL, and did not have a direct line of communication with the landlord. The court was quite understanding of the administrators’ approach. However the fact that there was a relatively long period from the time when the landlord had made its decision to withhold consent until the lease was marketed did count against the administrators in the eyes of the court, which took guidance from <em>Re Atlantic Computers</em> that administration is intended to be only a temporary and interim measure and that the landlord should not be prejudiced by the way the administration is conducted.
Inevitably a buyer will want to control correspondence and negotiations with the landlord on the terms and conditions of consent, and it may be sensible for administrators with limited cash on hand to fund the costs of running an assignment process to leave the buyer to it. However a lesson from this case is that it is prudent for administrators to maintain an open and direct line of communication with the landlord to ensure that they keep themselves apprised of progress and are sufficiently well informed to be able to form their own view on when negotiations have reached an impasse and obtaining consent from the landlord is a lost cause.
Could the administrators have taken steps to strengthen their arguments to resist a subsequent attempt to lift the moratorium when putting together the pre-pack? It did not feature prominently in the judgment but there was an element of deferred consideration payable by STL to SSRL; however if the payment was linked to achieving a successful assignment of the lease to STL it was lost in February 2015 when consent was withheld. While it will only be applicable where there are book debts in a business, we do know arguments can be successfully made to resist the lifting of the moratorium by a landlord where the buyer acts as agent for the administrators to collect in book debts for the benefit of the insolvent estate from the properties it is in occupation of (for example, in <em>Innovate Logistics Ltd (in administration) v Sunberry Properties Ltd</em>  EWCA 1261).
Windfall for landlord vs premium for creditors?
Landlord’s counsel argued that not lifting the moratorium would deliver a windfall to the secured creditor; SSRL’s counsel argued that lifting the moratorium would deliver a windfall to the landlord. The court did not accept either argument, and said that the potential gains or losses were no more than the product of the rights and obligations agreed between the landlord and the tenant.
What made value asymmetrical here was the revocation by the landlord of the seating licence. The landlord’s actions decreased the value of the lease to the administrators because the lease had more value with the seating licence that it did without it. This value was entirely in the gift of the landlord. Therefore it is hard to see how any lease assignment arranged by the administrators not having the support of the landlord (and its seating licence) would have achieved the same or greater value than the landlord would itself be able to achieve by marketing the property with the benefit of a seating licence.
In defence of the administrators, there is very little that could have been done to prevent the landlord from revoking the licence once it had decided to do so. The licence was personal to the company in administration, it was on its terms revocable in the circumstances and it was not protected by the moratorium. This perhaps underlines the importance of undertaking as much due diligence as possible on the vulnerabilities to achieving a successful assignment of a leasehold property, and in managing carefully the relationship with a landlord where they hold a strong hand.
This case does not make new law, or mark a novel approach to the application of the test laid down in <em>Re Atlantic Computers</em>x. Its significance derives from the fact that the administrators acted in a way which is not at all unusual or uncommon, in arranging a pre-pack transaction which resulted in a buyer going into occupation of leasehold properties to trade the business it had bought while it negotiated the terms on which it would take an assignment of the lease from the landlord, independent of the administrators. The administrators were victims of the chronology, and if there is a lesson to be learned it is that administrators would be well advised to monitor closely the progress of assignment negotiations between their buyer and landlords, and maintain an open and direct line of communication with the landlords, so that they can ascertain for themselves when negotiations have reached an impasse and act quickly to explore alternative options for realising value for creditors.
This article first appeared in the December 2015 edition of Corporate Rescue & Insolvency journal (2015 6 CRI 246). It was co-written by Ben Jones, Barry Gross and Emily Smith, a trainee in the Restructuring & Insolvency team.