We are (or were!) emerging from nearly two years of restrictions caused by the Covid-19 pandemic which forced people to stay at home and businesses to close causing shock waves throughout the economy. The government put in place the package of emergency measures and support which we are now all too familiar with. However, the question always lingered, what next? What about when the money runs out? The answer for tenants has come in the form of the Commercial Rent (Coronavirus) Bill (‘the Bill’) which attempts to ease commercial occupiers out of the moratorium on action against them by landlords for non-payment of rent.
The Bill is accompanied by a ministerial foreword and code of practice. The former says that the latter ensures “… where it is affordable, a tenant should aim to meet their obligations under their lease in full” and that “… the preservation of the tenant business’ viability should not come at the expense of the landlord’s solvency”. The problem is, that is much easier said in a ministerial foreword than done in practice.
This article is the first in a two part series co-authored by members of the Property and Insolvency team at Gatehouse Chambers. This first part will consider the practical difficulties with the Bill if it were to come into force as it is currently drafted following on from Katrina Mather having had (apparently) the first case attempting to interpret the Bill’s provisions*.
Taking a brief recap of what the Bill says:-
- it applies to business tenancies under the 1954 Act definition;
- it applies to rent which accrued during the period that a business was required to close by government restrictions (‘the protected rent period’);
- where there is unpaid rent for the protected rent period, the landlord or tenant can refer the dispute to an arbitrator who will make a decision on what should happen to the arrears;
- the reference is (currently) to be made within six months of the Bill coming into effect;
- the arbitrator’s award can write-off all or part of the arrears, spread payments or delay repayment of arrears for up to 24 months from the date of their decision;
- when deciding what to do about the arrears, the arbitrator is meant to assess the viability of the tenant, the solvency of the landlord and balance those two competing interests in reaching their decision;
- the identity of the professional bodies from which arbitrators can be appointed are yet to be identified;
- the Bill allows an application to be made to stay “debt claim” proceedings which the court must accede to if the proceedings were commenced between 10th November 2021 and the Bill becoming an Act.
Key problem: difficulty with definition of viability and solvency
What is the arbitrator to do when deciding what award to make? The principles to be applied are set out in the Bill. Current section 15 reads:
The principles in this section are—
(a) that any award should be aimed at—
(i) preserving (in a case falling within section 13(4)(a)), or
(ii) restoring and preserving (in a case falling within section 13(4)(b)), the viability of the business of the tenant, so far as that is consistent with preserving the landlord’s solvency, and
(b) that the tenant should, so far as it is consistent with the principle in paragraph (a) to do so, be required to meet its obligations as regards the payment of protected rent in full and without delay.
They are probably the most important few words in this Bill defining what the balance will be for the arbitration between landlords and tenants. The most important questions must therefore be:-
a) what do those words mean; and
b) what is the process by which the arbitrator will go about deciding those issues?
The current guidance notes say an awful lot about how landlord and tenant should co-operate and reach negotiated settlements but specifically avoid the issue of what these few words mean, in terms refusing to define the completely novel legal term, ‘viability’.
Let’s start with what might be seen as the familiar territory of the solvency or insolvency of the landlord. Presumably the test is intended to be the same as the general law but there is no suggestion of whether it is to be a cash flow test or a balance sheet test (or perhaps both in the Re Casa Estates sense). There are clearly going to be very obvious cases of landlord’s insolvency on a cash flow basis – where the SPV as landlord of a single unit is unable to meet its borrowing covenants because the rent isn’t being paid for instance. But there are going to be situations that are far less clear, perhaps the most obvious under the current circumstances would be the landlord is balance sheet solvent but cash flow insolvent because rents are not being paid. It remains to be seen whether any of these issues are clarified as the Bill passes through Parliament.
Given how involved / difficult those issues are with those of us familiar with insolvency and restructuring that only canvasses the landlord element and the relatively familiar concepts of solvency. As to the tenant, the arbitrator must consider the ‘viability’ of the tenant. Helpfully (!) there is no definition of ‘viability’ in either the Bill or the guidance notes in circumstances where it is a concept unknown to the law. What makes it more difficult is that it seems likely to be presumed that because the word ‘viability’ has been used as regards the tenant business and insolvency has been used as regards the landlord’s business, the former is intended to connote something different to solvency (or otherwise). Whilst presumably solvency will be an element of the test, the use of a different term suggests something more, but the rather obvious question is ‘what?’. Is there to be a timing element? One could see the relevance but that is already included to an extent within the cash flow solvency test.
To take some real world difficulties:
- The tenant has taken on 3 extra sales staff post-pandemic. The figures are dreadful, but the tenant says that it anticipates that the extra staff will generate sales revenue to put the company back into profit in two to three years. How does the arbitrator begin to weigh that?
- The tenant company produces evidence of the sharp drops in high street footfall that leaves the accounts in tatters. The business is plainly not viable (on any definition) on current daily sales figures but the tenant predicts that footfall will improve in the next 24 months. If the prediction is correct then there may be profit to be made.
- The tenant was a new company pre-pandemic and was in the initial investment and development phase with growth forecast over a five year period with predicted profits in year 5. The pandemic has intervened and the accounts are disastrous (but significantly as to be expected). Is the Tenant going to be able to show a ‘viable’ business when even on its own business plans it wasn’t moving to profit for 5 years and that has been delayed?
There are two other issues that we foresee as posing significant difficulties in the course of arbitrations under the scheme as it is currently envisaged:-
- disclosure; and
- multi-site disputes possibly with a range of tenants and landlords.
As many insolvency cases show, the exploration of solvency can be expensive, time consuming and difficult. If landlords intend to rely heavily on their solvency to defeat tenants’ requests for a reduction in rent or time to pay, that is going to require extensive disclosure and analysis. It may well be that expert evidence will be required and the identity of the arbitrators is going to be crucial.
Equally tenants arguing viability could be subjected to huge disclosure exercises particularly as the scope of the exploration of ‘viability’ is without definition. Management accounts pre- and post- pandemic, bank accounts, employment records, pay records, lending obligations and terms etc. could all be relevant to the issue of viability and there will no doubt be many occasions where landlords will seek to exploit holes in disclosure to attack the viability issue.
The arbitrators will also have to grapple with issues of commercially sensitive information – the guidance makes reference to profit margins, something that it seems highly unlikely that many businesses will be willing to freely disclose.
As to the second point, it remains to be seen what will happen where disputes that involve multiple sites are referred to arbitration. Where the same landlord and same tenant are involved, a process of joinder would work. However, it is far from beyond the bounds of possibility that a multi-site tenant would plead viability depending on the outcome of negotiations with other landlords and / or arbitrations and the landlord would plead as to solvency on the basis of the outcome of similar discussions or arbitrations relating to other tenants. It is difficult to see how joinder of proceedings could resolve that dispute and that leaves open the possibility of arbitrations being decided on numerous hypotheticals.
We would stress that we don’t want these points to be seen as unnecessarily negative. There is no doubt that the underlying intentions of the Bill are well meaning and are designed to play an important role in the UK’s post-pandemic economic recovery by significantly reducing the likely ‘cliff edge’ effect of the removal of the restrictions relating to the forfeiture / enforcement of commercial rent arrears. However, it seems to us that it is important that if this legislation is to be useable and used, the paucity of the current drafting must be rectified as it passes through Parliament. As it stands there is a huge risk that the ultimate Act will be significantly under-utilised.
Immediate impact – stay of proceedings
*For anyone wondering, how there has already been a decision on the interpretation of the Bill (yet to be reported), there were decisions in the Insolvency and Companies Court last summer pre the introduction of the Corporate Governance and Insolvency Act 2020 (‘CIGA’) affirming that the court can within its inherent discretion take into account pending changes to the law. Obviously the rights and wrongs of that principle is a huge debate in itself, but it is the best authority we have. For anyone interested, here’s a link to Re a Company which applies Travelodge Ltd v Prime Aesthetics Ltd  EWHC 1217.
Obviously the compulsory (upon an application) stay of proceedings will not be effective until the Bill comes into force. However, in the meantime, tenants who are defending rent arrears claims from their landlords in court can make applications to stay proceedings under the court’s inherent case management powers pending the new law, inviting the judge to have regard to the Bill under the above cited authorities.
Such a stay would be entirely discretionary and the tenant would need to persuade the court that the arbitration scheme is likely to be available to them and (in the authors’ view) that the arbitration is likely to result in a successful outcome for the tenant. Without the court being satisfied of the latter, staying proceedings would be redundant and contrary to the overriding objective as well as offending the landlord’s legitimate expectations.
Is the Bill (when it becomes an Act) going to create an enormous ripple throughout the landlord and tenant landscape? In our view, quite possibly not for the reasons set out below– but the impact is likely to be greater if we are back under new or resurrected restrictions which impact upon businesses trading (or have a negative impact on their trade) so watch this space!
First, the scope of protected rent is relatively narrow in terms of the economic fallout of the Covid restrictions and difficulties that tenants may be facing that (a) makes it more likely that agreements will have been reached already but (b) means that the arbitration scheme may be of limited utility to tenants who have faced cash flow difficulties since their businesses have been able to reopen.
Secondly, the Bill is not expected to come into force until the end of March at the earliest. Therefore, there is still a considerable period of time until the arbitration mechanisms will be available to landlords and tenants. The Code itself provides guidance intended to aid parties in reaching agreements before the Bill comes into force. Add to that the lack of ability for landlords to have done anything when faced with a tenant not paying other than negotiate and reach an agreement and it’s likely that a lot of the parties who would have availed themselves of (or would have been forced into) the arbitration scheme will have already have reached agreements.
Thirdly, the procedure is new and unknown. The problems we foresee with interpreting and applying the ‘viability v solvency’ provisions is set out above and Katrina’s recent case did not have the outcome on interpretation which might have been expected. Tenants and landlords alike might prefer to enter into agreements between themselves rather than embark upon the unknown and have a decision imposed on them by a third party.
Fourthly, the procedure may be slow and has the potential to impact on the contractual rights of the landlord for several years to come. The Bill envisages a six month period from its enactment for cases to be referred to arbitration. The arbitration process then needs to be seen through and the arbitrator’s decision may impact upon the parties for up to two years after the event. Therefore one can certainly see the decision impacting the parties for the next three years – and during that period it is very possible that the economic landscape will have changed enormously. This is potentially very unattractive.
Taking all the above into account, it may, for possibly the first time, be a more attractive option for landlords to open the Pandora’s box of insolvency rather than be forced into an unknown and potentially drawn out arbitration procedure. The moratorium provisions in Schedule 2 do not apply to winding up proceedings – they only apply to “debt claims”. There are still restrictions on landlords presenting winding up petitions but if the landlord can jump through the requisite hoops (of which there are many) they may go for insolvency instead of arbitration.
What to do now?
If you’re a landlord with extant money judgment proceedings, cross your fingers that the tenant doesn’t apply to stay the proceedings pending the introduction of the Bill. If you have reached an agreement with the tenant, make sure it is recorded and is enforceable so that the tenant cannot try to look behind that agreement and pursue the arbitration scheme. Otherwise, watch this space for pending amendments – we are expecting the Bill to be amended to give some protections to guarantors and we will write further on that topic in the New Year.
Katrina Mather, Lina Mattsson and Jonathan Titmuss