In the second of this two-part series, Emma Humphreys looks at some of the choices available to landlords when it comes to recovering debt
There are various options available to landlords who wish to recover debt, including the use of Commercial Rent Arrears Recovery (CRAR) and pursuing subtenants, former tenants and former guarantors.
Using CRAR
CRAR replaced distress on 6 April 2014 and is governed by the Tribunal Courts and Enforcement Act 2007 (the 2007 Act) and the Taking Control of Goods Regulations 2013.
This new method of recovery retains the fundamental process of allowing a tenant’s goods to be seized and sold without any court order, but it imposes more restrictive preconditions.
CRAR is generally only available for leases of pure commercial premises, as it is unavailable if the property (or any part of it) is:
- let under the immediate lease as a dwelling;
- let as a dwelling under an inferior lease; and/or
- occupied as a dwelling.
Section 75(3) of the 2007 Act confirms that: “‘Let as a dwelling’ means let on terms permitting only occupation as a dwelling or other use combined with occupation as a dwelling.”
Accordingly, CRAR should be permitted where the premises are let (or sublet) for commercial use only and are being used for residential purposes in breach of the lease or underlease.
CRAR may only be used to recover “rent” as defined in section 76(1) of the 2007 Act, namely: “The amount payable under a lease… for possession and use of the demised premises, together with (a) any interest payable on that amount under the lease, and (b) any value added tax chargeable on that amount or interest.”
Section 76(2) states that liabilities such as payments of rates, council tax, services, repairs, maintenance or insurance are not recoverable via CRAR even if these amounts are reserved as rent by the lease.
Only a certified enforcement agent can take control of and sell goods using CRAR and they are required to serve “notice of enforcement” on the debtor before entry is permitted for the purpose of seizing goods. The minimum period of notice is seven clear days (excluding Sundays and bank holidays), although there is provision for the court to order a shorter period.
Following service of notice by the enforcement agent, tenants generally enter into a controlled goods agreement to allow goods to remain on the premises while they make payments to reduce the arrears.
Overall, CRAR offers a quick and cost-effective route to recovering arrears owed by tenants of commercial premises, particularly since it puts the tenant under immediate pressure.
However, landlords have been concerned that it will be less effective than distress because of the requirement to give advance notice to the tenant.
There are a number of rules restricting the availability of CRAR and landlords will need to check these carefully before seeking to use the remedy. For example, the level of rent arrears (excluding certain specified sums) when notice of enforcement is given and when control of goods is taken must be equivalent to at least seven days’ rent.
Pursuing subtenants
Moving away from action against tenants, landlords will have an additional route for recovering a tenant’s arrears where there is an underlease in place.
Until 6 April 2014, a superior landlord’s power to recover arrears from a subtenant arose under section 6 of the Law of Distress Amendment Act 1908. However, the 2007 Act repealed this procedure and replaced it with a new system to enable superior landlords to pursue subtenants for repayment of arrears owed by an intermediate tenant: see sections 81-84 of the 2007 Act.
Where a landlord is entitled to use CRAR to recover rent from its immediate tenant (see above), it can serve notice on the subtenant to entitle it to recover and receive rent direct from the subtenant – until such time as the arrears are settled or the notice is replaced or withdrawn. The notice must comply with the relevant regulations as to form and content, including specifying “the notified amount”, ie the amount of the arrears recoverable from the tenant by CRAR. The subtenant will become liable to pay the sums demanded by the notice 14 clear days after service; if it fails to pay, the landlord is entitled to exercise CRAR against it.
Serving notice to secure the payment of arrears by a subtenant can be a useful method of debt recovery, as it involves a relatively simple procedure and often results in an immediate cash flow. However, landlords should bear in mind that the notice will only cover the arrears due at the time when it is served; further notices will need to be served if additional arrears become due.
Pursuing former tenants and former guarantors
Where a current tenant is in arrears and took the lease by way of an assignment from a previous tenant, it is always worth considering whether there is a former tenant or guarantor who is liable and might be in a better financial position.
To assess liability, the rules brought in by the Landlord and Tenant Covenants Act 1995 (the 1995 Act) need to be observed. Generally, leases created before 1 January 1996 are known as “old tenancies” and leases created on or after 1 January 1996 are known as “new tenancies”.
With old tenancies, the principle of privity of contract ensures that the original tenant and guarantor to the lease remain automatically liable for the tenant covenants in the lease for the whole term, even after assignment.
This is also the case for any subsequent assignee and guarantor who covenanted with the landlord to observe the tenant covenants for the whole term, for example in the licence to assign.
With new tenancies, landlords need to check whether the most recent former tenant entered into an Authorised Guarantee Agreement (“AGA”) to guarantee the assignee’s obligations and liabilities under the lease. An AGA lasts only until the assignee whose liabilities are guaranteed remains as the tenant and it will fall away if that tenant subsequently assigns its lease.
The position regarding guarantors entering into AGAs was examined in Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330 (Ch); [2010] 1 EGLR 29, where the court held that an AGA was invalid to the extent that it sought to impose liability on a former guarantor.
This was approved by the Court of Appeal in K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904;[2011] PLSCS 798 although the court indicated that a former guarantor may be required by a landlord to guarantee the liability of the tenant under an AGA, ie by way of a “sub-guarantee” (see Tindall Cobham 1 Ltd v Adda Hotels [2014] EWCA Civ 1215; [2014] PLSCS 249 for a recent illustration of the operation of the restrictions in the 1995 Act).
Once liability is confirmed, landlords need to observe section 17 of the 1995 Act. This requires a landlord to give notice – before any action is taken – of its intention to recover a tenant’s arrears of fixed charges from a former tenant or its guarantor (fixed charges include rent, service charge, insurance rent and other liquidated sums due under the lease).
If the landlord fails to serve the section 17 notice within six months after the date on which the fixed charge became due, it will lose the right to pursue the former tenant or guarantor for those particular arrears.
Once a former tenant or guarantor pays the sums (including interest) demanded by a section 17 notice, it can require the landlord to grant it an overriding lease. This will operate to place the former tenant or guarantor into the position of being the current tenant’s direct landlord. The former tenant or guarantor may then decide to terminate the tenant’s lease and seek to assign the overriding lease or sublet the premises.
This method of debt recovery uses a relatively simple procedure which can have swift results. However, a section 17 notice can only cover the arrears due at the date of service, so new notices will need to be served if further arrears accrue.
The service of a section 17 notice may also result in the landlord obtaining a new tenant with a stronger covenant if the recipient of the notice requests an overriding lease. However, the right to an overriding lease can obviously present problems where the landlord would prefer to have vacant possession of the premises.
Why this matters
These methods of debt recovery can give fairly swift results, but it is important to follow the particular procedures to ensure that each method is exercised correctly.
With notices to former tenants and guarantors under section 17 of the 1995 Act, it is vital that deadlines for their service are diarised. For example, a notice in respect of rent due on 24 June 2014 must be served by 24 December 2014. A section 17 notice should also make it clear if any sum demanded may later be determined for a higher amount, eg service charge.
If the recipient of a section 17 notice fails to pay the sums owed, the landlord can take action to recover these sums, namely issuing court proceedings or serving a statutory demand (these processes were detailed in the first article in this series “Recovery strategies”, p106 EG 25 October). However, before pursuing any proceedings, landlords should investigate the financial position of the relevant party to ensure that it is worth incurring costs on taking action.
With notices under section 81 of the 2007 Act, the landlord should adhere to the provisions of the statute as to form, content and service. A recipient is only obliged to pay the rent due under its sublease, rather than any higher sum of rent due under the intermediate lease. However, the subtenant must continue to pay its rent to the superior landlord until such time as the tenant’s arrears have been settled. If the subtenant’s rent is insufficient to discharge the tenant’s arrears, then the superior landlord will need to consider the other methods of debt recovery available to it in order to pursue the tenant (or any other parties) for the shortfall.
With CRAR, a landlord should consider in advance whether the circumstances of the tenancy and arrears satisfy all of the relevant preconditions. If the lease covers mixed-use premises, then an alternative method of debt recovery will need to be used. This may also be sensible where the arrears include sums such as service charges and/or insurance. If CRAR is available and appropriate, an enforcement agent may take control of goods only if they are goods of the debtor. Fortunately for landlords, the 2007 Act contains a fairly wide definition of “goods” as “property of any description, other than land”. However, certain “exempt” goods may not be seized, such as items necessary for the debtor’s personal/business/study use up to an aggregate value of £1,350.
Emma Humphreys is a partner at Charles Russell LLP
