In the first of two articles covering methods of debt recovery for landlords, Emma Humphreys discusses the important issues to consider before taking any action
Before taking any steps to recover arrears owed, landlords should bear in mind some important issues.
First, they should always check whether the debtor is insolvent because – depending on the type of insolvency – this may prevent the landlord from pursuing certain courses of action. Subject to this, a landlord should also consider whether there would be any advantage in recovering possession of the premises by forfeiting the lease.
This option needs to be considered early on because it is easy to waive the right to forfeit, including through the use of some methods of debt recovery. An alternative option for a landlord to explore is whether it is possible to agree some accommodation of the tenant’s financial difficulties, for example through payment of rent on a monthly basis.
After these points have been considered, if the landlord still wants to pursue the tenant for the arrears, the next consideration is how best to do this.
Court proceedings
Issuing court proceedings is often the primary route considered by a landlord when faced with a tenant owing arrears. Indeed, such action is now more likely to be necessary for landlords of commercial and mixed-use premises because of the changes introduced by the Tribunals, Courts and Enforcement Act 2007.
Ideally, the issue of a court claim should be a last resort in many cases because the process is generally slower and more costly than some of the alternative methods of debt recovery. Since the introduction of the Jackson reforms, significant costs can now be incurred simply by complying with the rules for providing information to the court about the appropriate case management route. It is also worth remembering that, once proceedings are issued, a claimant landlord will lose some degree of control over the process of pursuing the debt. Even more importantly, if a landlord later decides to discontinue its claim, the claim is dismissed, and the landlord may have to pay the defendant debtor’s costs of the proceedings.
Procedurally, the landlord needs to serve a claim form and particulars of claim on the defendant debtor. The debtor then has either 14 or 28 days to serve a defence, depending on whether an acknowledgment of service is filed. (If the proceedings include a claim for forfeiture, there will be a slightly different process.) If no defence is filed, the landlord will be able to seek judgment in default and this should be granted fairly swiftly in straightforward arrears cases. Alternatively, if it is a relatively simple matter where the defendant has no real prospect of successfully defending the claim, the landlord may be able to obtain a summary judgment. The hearing of such an application should take place within a number of months.
In the event that neither judgment in default nor a summary judgment is granted, the court will give directions to govern the exchange of evidence in preparation for a trial and set a budget for costs (in most cases). Such circumstances usually occur where a counterclaim is made by the tenant which needs to be considered by the court. Landlords should therefore consider, before issuing proceedings, whether the defendant has any potential counterclaim that could be raised to complicate matters, since complying with directions can take some time and be fairly costly.
Of course, obtaining judgment is not the end of the story; landlords often need to take steps to enforce a judgment, and this increases costs. This means that landlords should always investigate, before issuing proceedings, whether the debtor has sufficient assets to pursue. If the debtor has no income or assets to enforce against, there is little point in obtaining a judgment.
In light of the delay and costs that often result from pursuing court proceedings, it is sensible for landlords to consider whether there are any alternative methods of debt recovery available to them.
Rent deposits
One direct method of recovery is withdrawing money from a rent deposit to settle arrears, although landlords need to check certain points and procedures before this step is taken. As a basic starting point, the rent deposit deed must be checked to ensure it permits the landlord to use the deposit to settle the tenant’s particular liability.
With assured shorthold tenancies, landlords are required by section 213 of the Housing Act 2004 to register their tenants’ deposits with one of the appropriately authorised protection schemes. Those schemes set out procedures for seeking to withdraw from the rent deposit at the end of the tenancy and offer a system for dispute resolution if the parties cannot agree the appropriate withdrawals.
With other types of tenancy, landlords are usually required simply to give notice to the tenant of any withdrawal from a rent deposit and the relevant rules concerning the service of notices must be complied with. The deed may also allow the landlord to require the tenant to replenish the rent deposit after a withdrawal and provide that any failure to do so will give the landlord a fresh right to forfeit the lease. This provision is often used by landlords to their advantage since they can ensure immediate cashflow by using the rent deposit to settle the arrears, but then forfeit the lease if the tenant fails to replenish the rent deposit.
Before using a rent deposit, a landlord should assess whether it is preferable to keep it to use towards the tenant’s future liabilities, particularly those that may be more difficult to pursue than rent arrears such as damages for dilapidations (if the rent deposit deed allows this). However, the prospect of the swift cashflow that a rent deposit can yield may encourage a landlord to decide to use the funds despite the risk of future shortfall.
Serving a statutory demand
The service of a statutory demand does not, by itself, constitute a method of debt recovery; it is a preliminary step to pursuing bankruptcy or winding-up proceedings. However, it can be a very effective indirect method of debt recovery because it puts pressure on tenants or other debtors by raising the real possibility that they will be declared bankrupt (in the case of an individual) or put into liquidation (in the case of a company).
A statutory demand can be served only where a debtor owes at least £750 and the debt must be liquidated and undisputed. This means that a statutory demand is inappropriate for claims such as damages for dilapidations. If a landlord serves a statutory demand in respect of an unliquidated or disputed debt or a debt of less than £750, the recipient debtor can apply for the statutory demand to be set aside and may well recover the costs of doing so. Before serving any demand, it is also important for a landlord to consider whether the debtor has any potential counterclaim against him in relation to the tenancy, which could lead to the demand being set aside.
Once a statutory demand is served, the debtor has 21 days in which to settle the sum demanded. After this period has passed, the landlord can present a bankruptcy or winding-up petition to the court. However, depending on the debtor’s financial position, this option may not always be worth pursuing because the landlord will only rank as an unsecured creditor in any bankruptcy or liquidation. In practice, this often means that the landlord will recover a small percentage, if anything at all, of the original debt.
Despite this, the service of statutory demands remains a popular option with many landlords. This is because a statutory demand can be served relatively quickly and can put the debtor under significant pressure to settle the debt. However, if payment does not result, a landlord will need to consider seriously whether it is worthwhile pursuing matters to the next stage, given that the costs of pursuing a petition may be substantial and may never be recovered.
Furthermore, landlords need to bear in mind that trustees in bankruptcy and liquidators are entitled to disclaim onerous property, including leases. In that event, the tenant’s obligations under the lease will end and there may be insufficient assets to satisfy any claim by the landlord for the loss suffered as a result.
Why this matters
Knowing the options for recovering arrears was particularly important during the recent recession, but landlords still need to be prepared to deal with arrears even in an improving market. The difference in a better market is that landlords often feel more confident about re-letting the premises and may therefore prefer to seek to use forfeiture at an earlier stage.
Landlords faced with a tenant in arrears will usually be keen to recover the debt as soon as possible and without incurring too many extra costs. Although costs can often be recovered if court proceedings are issued, the court has discretion here. Full costs recovery is very rare in court proceedings: a landlord will usually recover only around 60-70% of costs. However, the position will be made easier where there is a lease provision obliging repayment to the landlord of costs incurred in dealing with the recovery of arrears.
The difficulty with court proceedings is that they usually increase costs significantly and this can put an additional burden on the tenant. Court proceedings usually also take some time to reach a conclusion and there is no guarantee that the debtor will be able to satisfy the judgment. Landlords should therefore always consider whether any alternative methods of debt recovery are suitable in their particular case.
Two such methods are using any rent deposit held and serving a statutory demand. Both of these options are relatively straightforward, but they need careful consideration by a landlord before either route is pursued.
Depending on the terms of the lease and rent deposit deed, a landlord may be able to use a rent deposit to settle his costs. However, this may leave less money for future liabilities if the tenant fails to replenish the deposit.
Where a debtor pays sums covered by a statutory demand, the landlord will not be entitled to his costs of serving the demand unless the lease provides for such recovery, as mentioned above. However, even if there is such an entitlement, it may not be worth incurring further costs on pursuing this, particularly since the costs claimed are likely to be disputed and a statutory demand will therefore be inappropriate.
If the landlord presents a bankruptcy or winding-up petition based on the statutory demand, substantial costs are likely to be incurred and these costs may not be recovered if there are insufficient assets available.
Emma Humphreys is a partner at Charles Russell LLP. The second part of this article will be published on 8 November