Game: Potential outcomes for landlords and administrators in 2014

Stewart Perry, a partner at Clyde & Co, Richard Heis, a partner at KMPG, and Samantha Bewick, a director at KMPG, examine current issues for landlords and what the Court of Appeal might say in the Game appeal

The case of Goldacre (Offices) Ltd v Nortel Networks UK Ltd (in administration) [2009] EWHC 3389 (Ch), [2010] All ER (D) 54 (Jan) has caused many difficulties for administrators.

The case of Leisure (Norwich) II Ltd v Luminar Lava Ignite Ltd (in administration) and others [2012] EWHC 951 (Ch), [2012] 4 All ER 894 (Luminar) took the Goldacre reasoning to its logical extreme, and has now also become difficult for landlords. Fortunately, in February 2014, the appeal in the case of Jervis v Pillar Denton Ltd (Game Station) & Others [2013] EWHC 2171 (Ch) (Game) will give the Court of Appeal the opportunity to bring clarity, and some would argue justice, to this area of the law.

What are the current issues?

The obligation to pay rent and other sums pursuant to a lease entered into before entry into administration is a provable debt. As such it does not fall within the definition of expenses as set out in the Insolvency Act 1986 or Insolvency Rules 1986, SI 1986/1925. However, where there are ‘special facts’ (as referred to in Re Nortel GMBH (in admin); Re Lehman Brothers International (Europe) (in admin) [2013] UKSC 52, [2013] 4 All ER 887, para [57]), the court can oblige the administrator to treat those provable debts as if they were expenses. In the Lundy Granite case (Re Lundy Granite Co (1871) 6 Ch App 462), the principle was set out as follows:

‘If the company for its own purposes, and with a view to the realisation of the property for a better advantage, remains in possession of the estate, which the lessor is therefore not able to obtain possession of, common sense and ordinary justice require the court to see that the landlord receives the full value of the property.’

In other words, to the extent that the liquidator uses the property for the benefit of the liquidation estate, he should pay for it.

Although this is a strict rule applied in liquidation cases, prior to the Enterprise Act 2002 (EA 2002), Re Atlantic Computer Systems plc [1992] Ch 505, [1992] 1 All ER 476 said the court had a discretion as to whether the provable debt should be treated as an expense in administrations. In that case, the court exercised its discretion and undertook a balancing exercise to determine whether or not the administrators should retain the benefit of the leased asset and if so what payment should be made to the lessor. This view was accepted as law, even after the EA 2002 amendments, in the Court of Appeal case of Sunberry Properties Ltd v Innovate Logistics Ltd (in administration) [2008] EWCA Civ 1321, [2008] All ER (D) 163 (Nov).

In Goldacre, however, Purle J stated the new formulation of administration expenses brought in by the EA 2002 (and in particular the new r 2.67 of the Insolvency Rules 1986) made the administration expense regime directly equivalent to that in the liquidation process, and therefore the liquidation rules had to apply and the discretion formerly set out in Atlantic Computers was destroyed. Goldacre decided that any sums that become due during a period of occupation of the property automatically fall to be an expense of the administration. Purle J went on to say that expense obligation would include not only rent, but insurance, service charge, and even dilapidations, in fact any contractual obligation that fell due during the administrators’ occupation. He also stated that apportionment would not apply, so the whole amount of such sums was payable, even if the property was only used for a short time.

On the assumption rent is payable quarterly in advance, the net effect of Goldacre and Luminar is:

  • an administrator appointed the day after a quarter day can use the property until the next quarter day without incurring rent as an administration expense, and
  • an administrator appointed the day before a quarter day, and who only uses the property for two days, has to pay the entire quarter’s rent as an expense

While there are a number of possible outcomes from the Game appeal, there are a number of potential impacts the appeal may have.

Will Goldacre remain unchanged as good law?

Stewart Perry (SP): I think it is unlikely that the law as expressed in Goldacre will remain unchanged. However, there have been a number of cases since Goldacre which have referred to it and applied its reasoning. The legal consequences of the decision are set out above.

Richard Heis (RH): Appointments will be timed for the day after the quarter day, to the potential detriment of landlords, but to the advantage of the general body of creditors, who will benefit from up to a full quarter’s occupation at no cost. It is not helpful to the rescue culture to have this arbitrary deadline of the quarter days. It is also unhelpful, and potentially makes administrations of certain companies unworkable, that the dilapidations liability which may have built up over many years may become payable as an expense through an accident of timing. This may unnecessarily drive certain companies into liquidation, probably with a worse outcome for creditors.

Will we return to the Atlantic Computers approach?

SP: Another possibility is that the Court of Appeal overturns Goldacre and states that the court retains a discretion in administration expense ‘special facts’ cases such as these.

Samantha Bewick (SB): This is a return to the previous principle, colloquially expressed as ‘pay for what you use’. This, in my view, preserves a fair balance between different creditor and expense groups, and fully reflects the decisions the administrator makes in the best interest of the parties as a whole, rather than an accident of timing benefiting one group over another. However, it would be unworkable for administrators to have to go to court to establish the principle in each case. I would hope that the Court of Appeal would lay down general guidance.

What about legislative change?

SP: It is unlikely any legislative change could take place before the Court of Appeal hearing in February, but that does not rule out an amendment later in the year. In Australia, for instance, a similar rule as to the adoption of employment contracts is used in respect of leases. This gives the administrator use of the company’s properties for five business days after which he must pay rent (and other sums payable under the lease) attributable to the period of the administrators’ occupation.

RH: There is a lot to be said for the Australian approach mentioned above—some landlords may feel that it gives an opportunity for them to be exploited especially if the period is longer—and it is a departure from the principle of ‘pay as you use’—but it would certainly be better than the current position which is based on the arbitrary timing of quarter days.

What about apportionment of rents?

SP: Goldacre states the rental obligation for payments in advance cannot be apportioned and therefore nor can the expense liability. However, the issue in these cases is what part of the ordinarily contractual liability (which cannot be apportioned) should be elevated to an expense due to ‘common sense and ordinary justice’. In my view it would have more common sense and ordinary justice for the administrator to only pay for the period for which he is in occupation. This argument has a number of supporting factors including many Lundy Granite principle cases which themselves refer to apportionment.

SB: In practice, while the contract itself may not be apportionable, it is not difficult to apportion the rents on a daily basis. I agree it is a matter of which portion of the contractual liability should be treated as an expense. Fairness would imply that you should pay for what you use—or to put it differently, the expense element should only arise from the decision of the administrator to use the premises for the benefit of the administration.

What about compensation for the use of the lease or the property?

SP: Another potential clarification of Goldacre could be a greater emphasis on whether the administrator is using the lease or the property. The Lundy Granite principle is concerned with the landlord receiving the ‘full value of the property’. If, for instance, the administrator is seeking to sell the lease, then the administrator should pay all sums at the contractual rate under the lease. If, however, the administrator has no intention of assigning the lease, and is simply using the property for a time, then perhaps the administrator should only pay the landlord the market rent for the property for that period.

There are a number of insolvent companies whose rental liabilities were significantly more than the market rent. If the Lundy Granite principle is to compensate the landlord, it is certainly arguable he should only be compensated for the lower of the contractual or market rent. It is also arguable that ‘common sense and ordinary justice’ would say that landlord should not receive that part of the rent which is greater than the market rent as an expense ahead of the equally legitimate claims of the other unsecured creditors.

RH: This is an interesting idea but may be difficult in practice. At the outset, it may well be unclear whether the administrator will wish, or indeed be able, to assign a particular lease, so the cost to the administration will be uncertain. It may also be difficult to establish a market rent, given the variations in the provision of rent-free periods, tenant incentives, market movement and so on. There is a great benefit to all parties of predictability—in my view this would outweigh potential unfairness caused by this point and in any case if the lease has value then the landlord should receive all the money he is owed after it has been transferred.

What would you like to see happen?

SP: For the sake of ‘common sense and ordinary justice’ I hope that the Court of Appeal overturns Goldacre. For the sake of the rescue culture, I hope the court takes us back to Atlantic Computers or allows administrators to pay the market rent for the property.

RH and SB: We agree entirely that we should return to Atlantic Computers. Administration is there to balance the interests of all parties, and a situation where, through planned or accidental timing, one party is significantly advantaged at the expense of another, seems to contradict this. There is a wider principle which can be seen in the recent Nortel/Lehman pensions case of pay as you use. Recent years have seen various departures from the principle of an administration expense being the costs of trading the business while the administrator attempts to find a buyer. It would be very helpful for the rescue culture if the court follows the Supreme Court in Nortel/Lehman and takes us further back towards Atlantic Computers.

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