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01 Nov 2018

Real property leases and insolvency ipso facto clauses


4 min

Landlord rights in insolvency under the spotlight.

Finding and securing appropriate premises for your business is a serious and stressful experience. Akin to most big decisions made in life, like buying property or choosing a partner, negotiating a lease with your ‘chosen’ landlord can affect a range of other decisions, which in the case of a lease over real property is inextricably linked to several aspects of the business’s operations. The terms you negotiate and settle on can include committing to a long-term lease with the option to renew for a shorter term, fit-out and make-good conditions, escalation clauses e.g. CPI increases, and upfront costs. But what about the insolvency terms in the lease, and how do the fare against the current insolvency laws including the little known ‘ipso facto’ clauses?

Landlords and insolvency practitioners have different rights when a tenant becomes insolvent. The type of insolvency administration determines the immediate rights between the parties, and the tenancy terms determines what claims the landlord has against the insolvent tenant.

The result of most administrations will either be that:

  1. The tenant will vacate the premises and the landlord will lodge a claim in insolvency appointment.

  2. The tenant’s financial affairs will be rectified through some formal arrangement and the tenancy will continue.

In both instances, some outstanding rent is likely to remain unpaid.OTP_landlords

Commonly the first question asked is who becomes liable for rent during the administration and what amounts can be claimed as a creditor? The second question is usually will the insolvency practitioner disclaim the lease or vacate the premises, which then triggers any ability for a landlord to re-enter or re-tenant the premises.

A lease, being a contract, generally survives the initial appointment of an insolvency practitioner. Regardless of whether the tenant is a company or an individual, the tenant is liable under that contract and the estate of the tenant (i.e. the insolvency administration) will deal with the liability for unpaid rent as a provable debt.

The lease’s contract terms may also include some provision for dealing with insolvency, usually an automatic breach upon liquidation, bankruptcy etc, which are inherently agreed to by signing the lease. But, a new operation of law can override such insolvency clauses with the ‘ipso facto’ laws for any contracts (i.e. leases) entered into 1 July 2018 by restricting the enforceability of termination clauses where a voluntary administrator or a managing controller is appointed to a company. The ipso facto legislation applies to stay the enforcement of such clauses in relation to voluntary administrations—and any liquidation that follows a VA—and managing controller appointments for the duration of the appointment.

So, the ipso facto laws now mean that landlords cannot terminate a lease simply due to the tenant’s insolvency status, which supports the purpose of a VA—allowing creditors to consider the possibility of a Deed of Company Arrangement (DOCA) to enable the business to trade on and usually, requires the tenant to remain in the business premises.

Importantly however, a landlord’s contractual rights to terminate the lease contract for a breach of non-payment or other breach of the lease terms remain.

Regardless of which kind of insolvency practitioner is appointed and the outcome of any type of insolvency appointment, the insolvency practitioner is never liable for any breach of the lease, including any costs for removal of rubbish or to ‘make good’ on a fit-out etc. The contractual arrangement is between the landlord and the tenant, not the insolvency practitioner.

While the lease’s liabilities are clearly demarcated to the tenant, in a VA or receivership appointment those insolvency practitioners are personally liable for rent after the initial rent-free, seven-day period, which forces the insolvency practitioner to decide to continue to occupy the premises or vacate.

Landlords can lodge a proof of debt in any insolvency appointment for all rent payable under the lease, less the amount received to date, and any amount expected to be received from a new tenant for the remainder for the lease term through the landlord’s requirement to ‘mitigate their loss’. They can also add to this proof of debt claim their legal costs associated with this process (if the lease terms provide for this).

For more information on what happens to your clients’ lease over real property in an insolvency situation, please refer to our landlord rights factsheet, click here or contact your local Worrells Partner.

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