Recovering Rent as an Expense of Administration

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Recovering Rent as an Expense of

Administration Philip Rainey QC

Barrister, Tanfield Chambers, London

Jonathan Upton

Barrister, Tanfield Chambers, London

It has been two years since the decision in Goldacre (Offices) Ltd v Nortel Networks UK Ltd (In Administration) [2009] EWHC 3389 (Ch); [2010] Ch. 455. Since then, the Chancery Division has handed down two further judgments on the applicability of the “Lundy Granite” principle to rent, namely, MK Airlines Ltd (In Liquidation), Re, (Unreported), Chancery Division (Companies Court), May 16, 2012 and Leisure (Norwich) II Ltd v Luminar Lava Ignite Ltd (In Administration) [2012] EWHC 951 (Ch). The principle enables creditors in respect of leases or other contracts entered into before the liquidation to recover debts in full, as expenses of the liquidation, where contracts have been continued by the liquidators for the benefit of the liquidation.

The Lundy Granite principle

The principle is named after the influential case of Re Lundy Granite Co, ex p Heavan (1871) L.R. 6 Ch. App. 462. The landlord of Lundy Island, which was let to a third party, distrained upon goods of the company in liquidation which had been left upon the tenant’s property. The tenant had agreed to assign the lease to the company but had not actually done so. He had, however, allowed the company into possession and the company had brought its goods upon the land and,, after the winding up order, the liquidator had retained possession with a view to a sale of the company’s assets on the land. The distraint was for rent which had fallen due more than a year after the winding up order. The distress was allowed to proceed for two reasons. First, the distress was not in respect of a claim for rent against the company, for which the landlord could have proved in the liquidation. The company was not his tenant. The landlord was exercising his ancient right to distrain upon any goods on the land, whether they belonged to his tenant or not. It should not make a difference that the third party to whom the goods belonged happened to be a company in liquidation. Second, even if the rent had been owing by the company, the liquidator had retained possession of the land for the purposes of the liquidation. James L.J. said, (at 466)

“ … if the company for its own purposes, and with a view to the realisation of the property to 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.”

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This second reason became known as “the Lundy Granite principle”. In Toshoku Finance UK plc (In Liquidation), Re [2002] UKHL 6; [2002] 1 W.L.R. 671, Lord Hoffmann discussed the Lundy Granite case and explained the basis of the principle at [24]–[29]:

“24. Although these principles were evolved in relation to a statutory discretion to allow a process of execution to proceed, it was obvious to everyone that there could be no practical difference between allowing a landlord to levy a distress for rent falling due after the winding up and directing the liquidator that he should be paid in full. It is important to bear in mind that the rent was a future debt for which the landlord could have proved in the liquidation: see, Hardy v Fothergill (1888) 13 L.R. App. Cas. 351. Under rule 12.3(1) of the 1986 Rules, all claims by creditors are provable as debts against the company ‘whether they are present or future, certain or contingent, ascertained or sounding only in damages’. But a ‘debt’ is defined by rule 13.12(1) as:

‘(a) any debt or liability to which the company is subject at the date on which it goes into liquidation; [and]

(b) any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date …’

  1. Thus debts arising out of pre-liquidation contracts such as leases, whether they accrue before or after the liquidation, can and prima facie should be proved in the liquidation. In this respect they are crucially different from normal liquidation expenses, which are incurred after the liquidation date and cannot be proved for. In the Lundy Granite Co case (1870-1871) L.R. 6 Ch. App. 462 the court was therefore exercising the discretion conferred by s.87 of the 1862 Act to decide that, contrary to the normal pari passu rule, a creditor who had a debt which was capable of proof at the date of liquidation should be paid in priority to other creditors. What was the justification for the exercise of such a discretion?
  2. A reason, or at any rate a rationalisation, was put forward by Lindley LJ, giving the judgment of the Court of Appeal in In re Oak Pits Colliery Co (1882) 21 Ch D 322 , 330:

‘When the liquidator retains property for the purpose of advantageously disposing of it, or when he continues to use it, the rent of it ought to be regarded as a debt contracted for the purposes of winding up the company, and ought to be paid in full like any other debt or expense properly incurred by the liquidator for the same purpose …‘

27 My Lords, it is important to notice Lindley LJ was not saying that the liability to pay rent had been incurred as an expense of the winding up. It plainly had not. The liability had been incurred by the company before the winding up for the whole term of the lease. Lindley LJ was saying that it would be just and equitable, in the circumstances to which he refers, to treat the rent liability as if it were an expense of the winding up and to accord it the same priority. The conditions under which a pre-liquidation creditor would be allowed to be paid in full were cautiously stated. Lindley LJ said, at p 329, that the landlord ‘must show why he should have such an advantage over the other creditors’. It was not sufficient that the liquidator retained possession for the benefit of the estate if it was also for the benefit of the landlord.

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Not offering to surrender or simply doing nothing was not regarded as retaining possession for the benefit of the estate.

29. The principle evolved from Lundy Granite is thus one which permits, on equitable grounds, the concept of a liability incurred as an expense of the liquidation to be expanded to include liabilities incurred before the liquidation in respect of property afterwards retained by the liquidator for the benefit of the insolvent estate. Although it was originally based upon a statutory discretion to allow a distress or execution against the company’s assets, the courts quickly recognised that its effect could be to promote a creditor from merely having a claim in the liquidation to having a prior right to payment in full. As in the case of other equitable doctrines, the discretion hardened into principle. By the end of the 19th century, the scope of the Lundy Granite Co principle was well settled.”

MK Airlines Ltd (In Liquidation)

In this case, the deputy judge, Mr Nicholas Strauss QC, had to consider whether two quarters’ rent due during the provisional liquidation period was to be treated as an expense of the liquidation on the Lundy Granite principle. If it were to be so treated, the rent would be payable in priority to most other liquidation expenses pursuant to IR 1986 r 4.218(3)(a)(ii).

In ABC Coupler and Engineering Co Ltd (No 3), Re [1970] 1 W.L.R. 702, the provisional liquidator on appointment closed down the business which had been conducted on the premises, had the company’s plant and machinery valued and thought about what he should do. Judge Plowman had to consider whether rent incurred while a provisional liquidator was in place was payable as a liquidation expense. He held that the test was whether the liquidator had retained possession “for the convenience of the winding-up” and that this depended on his motivation. It was only from the time he decided to put the lease on the market that he was retaining the premises for the benefit of the winding up and was liable to pay the rent in full.

In MK Airlines Ltd, counsel for the joint liquidators argued that the Lundy Granite principle could not apply to a provisional liquidation. ABC Coupler was a case in which a winding-up order had already been made and the liquidator—not the liquidation—was provisional. It was the provisional liquidators’ job to look after the assets for the time being, and no more, and they could not have the requisite motivation to retain possession for the convenience of the winding up.

The deputy judge disagreed. The decisions in Exeter City Council v Bairstow [2007] EWHC 400 (Ch); [2007] 4 All. E.R. 437 and Goldacre (Offices) Ltd v Nortel Networks UK Ltd (In Administration) [2009] EWHC 3389 (Ch); [2010] Ch. 455 that the Lundy Granite principle applied to administrations and was mandatory were substantially based on the similarity between the wording of IR 2.67 (applicable to administrations) and what is now IR 4.218(3)(a)(ii) (applicable to liquidation). The same principle must have been intended. The deputy judge held this applies, a fortiori, as between IR 4.218(3)(a)(i) (applicable to provisional liquidation) and IR 4.218(3)(a)(ii) (applicable to full liquidation) so that the Lundy Granite principle does apply to a provisional liquidation.

On the facts, the deputy judge held that, as the joint liquidators were appointed only two days after the first of the two quarters’ rent was due, they could not have decided whether to retain the lease and thus did not have the requisite motive to retain possession “for the convenience of the winding-up” when the first quarter’s rent was due. He further held that merely retaining and securing property situated on the leased premises did not constitute a use to engage the principle. The deputy judge was, however, satisfied that the liquidators had decided to retain the 181

lease for the benefit of the provisional liquidation by the date the second quarter’s rent fell due so that it was an expense of the liquidation.

Leisure (Norwich) II Ltd

In this case, the court (HH.J. Pelling QC) considered whether rent due prior to the appointment of administrators constituted an expense of the administration.

The tenants, as part of a company group which had been one of the largest nightclub operators in the United Kingdom, had leased four properties for that purpose. Rent was payable quarterly in advance on each quarter day. At the time of the administrators’ appointment, the tenant had fallen into arrears. The landlord sought the administrators’ permission to forfeit the lease (in accordance with para.43(4) of Sch.B1 to the Insolvency Act 1986) but the administrators refused. The landlord demanded payment from the administrators of sums due before their appointment.

His Honour Judge Pelling QC referred to Progress Assurance Co, ex p. Liverpool Exchange Co, Re [1870] L.R. 9 Eq. 370, Lundy Granite Co, ex p. Heavan, Re [1871] L.R. 6 Ch. App. 462 and Oak Pits Colliery Co, Re [1882] 21 Ch.D. 322. The learned judge noted that all of these cases concerned rent that had accrued since the commencement of the winding-up. In Oak Pits, Lindley L.J. drew a clear distinction between cases concerning rent in arrears at the commencement of a winding-up and those cases where rent accrued due subsequently. In relation to the first of these categories, Lindley L.J. said that the landlords must prove the debt like any other creditor. This was so even where the liquidator had retained possession. It was only in relation to rent that had accrued after the commencement of the winding-up and where the liquidator had retained possession for the purposes of the winding-up that the landlord would be permitted to distrain for his rent.

Counsel for the landlord relied on the decision in Silkstone and Dodworth Coal and Iron Company, Re (1881) L.R. 17 Ch. D. 158. In that case, the rent under a lease of a coalmine was payable half-yearly in arrears. The landlord gave notice to the liquidator requiring payment of a half-year’s rent which became due after the winding-up of the company, or that the working should be stopped. The liquidator neither paid the rent nor stopped the working. It was held that the liquidator, having elected to continue the working for the advantage of the company, must pay the full rent. The learned judge, however, held that Silkstone did not support the landlord’s argument. In Silkstone, the obligation under the lease was to pay rent in arrears on the due date and the point being made was that the liquidator was required to comply strictly with all obligations that arose for performance after the liquidator had elected to continue in possession of the property as the price of being permitted to do so. The fact that some of the rent that became payable related to a period before the liquidator had so elected was immaterial because the obligation to pay did not arise until after the liquidator’s election and was an obligation to pay in full. The learned judge questioned whether Silkstone would be decided in the same way today, but did not reach a conclusion. He, therefore, held that the landlord was not entitled to payment of the rent that accrued due prior to the commencement of the administration.

Conclusion

In summary, the position is as follows:

1. Where rent is payable in advance and falls due for payment prior to the commencement of the liquidation or administration, then it is a provable debt but is not payable as a liquidation or administration expense (even though the liquidator or administrator retains the property for the purposes of the liquidation or

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administration for the whole or part of the period for which the payment in advance was payable);

  1. Where rent payable in advance becomes due during a period when the liquidator or administrator is retaining the property, or when the liquidator or administrator continues to use it (the “convenience or benefit” test), for the purposes of the liquidation or administration, then the whole sum is payable as a liquidation or administration expense even though the liquidator or administrator gives permission to forfeit or vacates before expiry of the period for which the payment in advance is due; and
  2. Where rent is payable in arrears and accrues due during a period when the administrator or liquidator is retaining property, or when the liquidator or administrator continues to use it, for the purposes of the liquidation or administration, the liquidator or administrator will be liable to pay as an administration or liquidation expense at least the rent that accrues from day to day for so long as he or she retains possession of the premises, or continues to use it, for the purposes of the liquidation or administration. Whether the office holder will be liable to pay that part of the rent that has accrued in arrears that is able to be referred to a period prior to the commencement of the administration or liquidation depends upon whether Silkstone is to be followed.

Following Goldacre and Luminar, a tenant’s liability to pay rent as an expense depends on when administrators are appointed and when they elect to retain the relevant property for the purpose of the administration. A landlord is unable to forfeit or distrain without permission after a company serves a notice of intention to appoint administrators and a tenant may avoid paying a quarter’s rent as an expense by appointing administrators shortly after a quarter day. This may be a lifeline to struggling businesses and reduce the number going to the wall. On the other hand, if administrators are appointed and retain the property shortly before a quarter day but stop using the property in the middle of a quarter, the landlord will receive a windfall. Whether these decisions lead to greater cooperation between landlords and administrators for the benefit of the rescue culture as a whole remains to be seen.

The law is stated as at August 28, 2012.