No landlord wants to find themselves in a position where a tenant who has recently entered into a ten-year lease with an option to renew for five years, becomes insolvent. However, there is always a risk a tenant will become insolvent during the term of a lease. As a landlord, you need to be aware of your rights if this occurs. What should you do if you discover that one of your tenants is insolvent?
How can you gain access?
Often the first question a landlord has when a tenant goes insolvent is: ‘How can I gain access to the premises?’ The answer depends upon whether the tenant is in administration or liquidation.
Liquidation occurs where a company is unable to pay its debts as and when they fall and an external liquidator is appointed to wind it up. Once appointed, the liquidator can disclaim the lease, relinquishing the rights and obligations arising under the lease. The effect of a disclaimer is that the lease is brought to an end and the landlord can resume possession of the premises.
Issues arise, however, if the liquidator does not disclaim the premises or fails to do so in accordance with the Corporations Act 2001. This leaves the landlord in a situation where it may need to serve formal notice to terminate the lease. A landlord’s ability to terminate will depend upon the terms of the lease and the application of the relevant Leases Act. However, most leases will give the landlord an immediate right of termination if the tenant becomes insolvent.
Terminating a lease is more difficult if the tenant is in administration. Administration occurs where an external party is appointed to investigate, manage and report on the financial affairs of the company. While the landlord will often have a right to terminate the lease due to the company’s insolvency, this right is constrained by provisions of the Corporations Act requiring the consent of the administrator or the Court. The administrator is also automatically granted a period of five business days under which they do not incur personal liability for rent under a pre-appointment lease. During this period, the administrator ordinarily will give the landlord notice if they do not intend to exercise their rights in relation to the property.
How to recover rent and other losses
An administrator will be liable for rent if the tenant continues to trade from the premises after 5 business days from the appointment of the administrator. A landlord cannot recover rent directly from a liquidator; instead, the landlord will become a creditor in the liquidation in the amount of the arrears.
Where a liquidator is appointed or the tenant ceases to trade from the premises, the best option available to a landlord is to apply any security bond or bank guarantee held to cover actual losses. It is important to act quickly and seek advice prior to calling upon this security to ensure this does not give rise to a claim in favour of the administrator or liquidator. Further, any security held can only be applied to actual losses incurred by the landlord; for example, unpaid rent and costs associated with make-good.
Landlords should also be aware of the requirement to mitigate losses. Where a tenant is insolvent and disclaims the premises, the landlord has an obligation to take reasonable steps to find a new tenant, reducing the losses that would otherwise have been suffered.
What happens if losses are greater than the security held?
If actual losses are greater than the security held, there are options to recover this from the remaining assets of the tenant. A landlord is generally an unsecured creditor and will need to lodge a proof of debt to recover any additional loss. Whether the landlord is successful in any such claim will depend upon the particular circumstances of the tenant, including its other creditors and assets available for distribution. However, it is often of little utility to pursue a claim for further losses from the tenant directly once the tenant becomes insolvent, as distribution to creditors are often cents in the dollar, if made at all.
While having a tenant go insolvent may place a landlord in a difficult situation, understanding your rights and managing the process well can mitigate any losses suffered. Should you find yourself in a position with a tenant who has become insolvent, please do not hesitate to contact a member of our experienced leasing team.
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