In this month’s potted guide, Jonathan Seitler QC guides practitioners through the basics of an area of the law in which landlord and guarantor clients dread having to become involved: disclaimer of leases on the liquidation or bankruptcy of the tenant
Disclaimer checklist
- What is a disclaimer?
- How does a lease become disclaimed?
- Who must be served with the disclaimer notice?
- What is the effect of a disclaimer?
- What is the position of third parties? (1) Guarantors and previous tenants?
- What is the position of third parties? (2) Sub-tenants and mortgagees
- How do vesting orders work? (1) Applications by persons interested
- How do vesting orders work? (2) Applications by the landlord
- For what money claim can the landlord prove in the tenant’s insolvency?
- Who can apply for an overriding lease?
What is a disclaimer?
A disclaimer is where the liquidator of an insolvent tenant or the trustee in bankruptcy of a bankrupt tenant (“the trustee”) is permitted to divest onerous property of that tenant. “Onerous property” is defined in terms of (a) any unprofitable contract and (b) any other property which is unsaleable or not readily saleable or is such that it may give rise to a liability to pay money or perform any other onerous act: see Insolvency Act 1986 (“IA 1986”) sections 178(3), 315(2).
It will therefore include leases and agreements for lease. The whole of a lease must be disclaimed or none at all.
On the appointment of a liquidator or trustee, any person interested in the property may apply to them in writing to force an election within 28 days of whether to disclaim or not: IA 1986 sections 178(5), 316(1). If the liquidator or trustee does not disclaim within that period, the right to disclaim is lost.
How does a lease become disclaimed?
This is simple, in theory. The liquidator or trustee first files a notice of disclaimer in court. This is an “administrative act” in the sense that the court will not take active steps to approve or disapprove it. However the notice must comply with the statutory requirements for it to be valid and effective: Insolvency Rules 1986 (“IR”) 4.187 and 6.178. The notice must also be served at the Land Registry, though failure to do so does not appear necessarily to invalidate it: Hunt v Conwy County Borough Council [2013] EWHC 1154 (Ch); [2013] PLSCS 119.
Who must be served with the disclaimer notice?
Within seven days of its filing, the liquidator or trustee must serve it on any underlessee, mortgagee, person occupying or claiming a right to occupy (if the property is a dwelling house), any person claiming any interest in the disclaimed property or any person under a liability in respect of the disclaimed property not discharged by the disclaimer, of which the liquidator or trustee is aware: IR 4.188 and 6.179.
In relation to (all) underlessees, mortgagees and persons in occupation or claiming a right to occupy a dwelling house, the notice takes effect when the last of that class have been served and 14 days passes without an application for a vesting order having been made.
While it is clear that a failure to serve the notice on a person entitled to it of whom the liquidator/trustee is aware will invalidate the disclaimer, there is uncertainty about what happens after failure to serve a person entitled to the notice of which it is unaware.
There is a procedure for a notice to be given late but a significant gap in the law as to whether that late service pushes the effective date of disclaimer forward to its date of service.
What is the effect of a disclaimer?
A disclaimer “operates so as to determine, as from the date of the disclaimer, the rights, interest and liabilities of the [insolvent company or bankrupt] in or in respect of the property disclaimed”: IA 1986 ss 178(4), 315(3). This means that, as between the landlord and the tenant, the lease is over and the landlord is entitled to possession. The tenant remaining in possession does so only as trespasser and, on disclaimer, the landlord thereupon becomes liable for business rates.
What is the position of third parties?
(1) Guarantors and previous tenants
The disclaimer only releases the tenant from its obligations under the lease so far as it is necessary for that purpose. The rights and (more pertinently) liabilities of guarantors, original tenants, previous tenants subject to authorised guarantee agreements (“AGAs”) and sub-guarantors (guarantors of those former tenants) therefore remain on foot: see Hindcastle Ltd v Barbara Attenborough Associates Ltd and others [1996] 1 EGLR 94 and Doleman v Shaw [2009] EWCA Civ 279; [2009] 2 EGLR 35.
While, following disclaimer, the tenancy no longer exists as between landlord and tenant, that relationship is preserved notionally for the purpose of maintaining alive the obligation on the surety and those other third parties. The practical consequences of this unusual situation mean that many modern leases now require the landlord to call for the guarantor to itself take an overriding lease within a certain period of the disclaimer.
What is the position of third parties?
(2) Sub-tenants and mortgagees
The disclaimer of a headlease provides the sub-tenant with an opportunity to escape its sub-lease on the basis that “the branch falls with the tree”. The landlord cannot enforce covenants in the disclaimed lease against the sub-tenant who never signed up to those covenants with the landlord in the first place, though if a sub-tenant chooses to remain in possession it is entitled to do so as long as it chooses to abide by those covenants under the disclaimed lease. The sub-tenant can ask itself, “should I stay, or should I go?”
The position of the mortgagee of the disclaimed lease is similar: SCMLLA Ltd v Gesso Properties (BVI) Ltd [1995] EGCS52. Its rights as mortgagee of the disclaimed interest continue notwithstanding the disclaimer, though to protect its interest the mortgagee will have to pay the rent and comply with the covenants under the now “notional” disclaimed lease.
If the sub-tenant or mortgagee do not consider it in their interests, however, they cannot be forced by the landlord to assume those liabilities under the disclaimed lease.
As long as the landlord does not retake possession and end the lease (by forfeiture) the rights and obligations of those persons continue under that “notional lease”.
How do vesting orders work?
(1) Applications by persons interested
Following disclaimer, any person claiming an interest in the property disclaimed or under a liability in respect of it (not discharged by the disclaimer) may apply to court to vest the property or a part of it, in themselves or in a trustee for them: IA 1986 sections 181, 320. Previous tenants still liable to the landlord, guarantors, sub-tenants, mortgagees – and even the landlord itself – are able to seek a vesting order. In addition, a person in occupation or entitled to occupy a dwelling house of which a bankrupt’s lease has been disclaimed by the trustee, can seek such an order: IA 1986 ss 320(2)(c). In all cases the application must be made within three months from the date on which the applicant first became aware of the disclaimer.
Whether the court will make a vesting order will depend on the applicant’s ability and willingness to assume the liabilities and obligations under the disclaimed lease. Whether this will include assuming a liability for accrued breaches will be a matter for the court’s discretion.
The order of preference among competing parties for a vesting order gives priority to a sub-tenant and mortgagee over guarantors or former tenants, while all the aforementioned have priority over the landlord (see Re A E Realisations (1985) Ltd [1987] 3 All ER 83) though the court will also seek to balance the rights of competing parties.
How do vesting orders work?
(2) Applications by the landlord
A landlord can make an application to the court for the disclaimed lease to be vested in a sub-tenant or mortgagee under IA 1986 sections 182, 321. If the sub-tenant or mortgagee does not take it up, it will be excluded from all further interest in, and the right to possession of, the property. The vesting order will subject the sub-tenant or mortgagee to the liabilities under the disclaimed lease.
For what money claim can the landlord prove in the tenant’s insolvency?
The landlord, like anyone else, can prove in the winding up or bankruptcy for its loss: IA 1986 sections 178(6), 315(5). The landlord’s loss is its future rent (subject to any tenant’s break clause in the disclaimed lease) discounted for early payment at the date of the disclaimer, minus any income received or reasonably receivable from any re-letting or vesting of the lease in another party, subject to voids for the period of marketing, plus any costs such as rates and necessary repairs, incurred for the purposes of that re-letting: see Christopher Moran Holdings Ltd v Bairstow and another [1999] 1 EGLR 1.
Who can apply for an overriding lease?
Former tenants still liable to the landlord (under old tenancies or an AGA) and sub-guarantors (guarantors of those former tenants) who have paid in full amounts required to be paid by the landlord under section 17 of the Landlord and Tenant Covenants Act 1995, have rights to an overriding lease under section 19 of that Act. The right is exercised by a written request to the landlord at the time of, or within 12 months of, making that payment. Only one overriding lease can be granted and where competing requests are made, the first in time prevails. If more than one are made on the same day, former tenants take precedence over guarantors and, as between the same category, the one whose liability arose earliest prevails.
A vesting order is more attractive to a tenant from an SDLT perspective than an overriding lease but is more uncertain, involving as it does the court’s discretion.
The rules as to overriding leases do not, however, apply to guarantors of the insolvent tenant absent any express provision in the disclaimed lease.
Leading authorities
- Re A E Realisations (1985) Ltd [1987] 3 All ER 83
- SCMLLA Ltd v Gesso Properties (BVI) Ltd [1995] EGCS 52
- Hindcastle Ltd v Barbara Attenborough Associates Ltd and others [1996] 1 EGLR 94
- Christopher Moran Holdings Ltd v Bairstow and another [1999] 1 EGLR 1
- Doleman v Shaw [2009] EWCA Civ 279; [2009] 2 EGLR 35
Useful resources
- Insolvency Act 1986 sections 178 to 182 and 315 to 321
- Insolvency Rules 1986 4.187 to 4.194
- Landlord and Tenant (Covenants) Act 1995 sections 19 and 20
- Peter Levaggi and Roger Elford Jordans Property Insolvency (2nd edition, Jordan Publishing, 2015)
- Patrick McLoughlin Commercial Leases and Insolvency (Tottel Publishing, 2008)
- Woodfall: Landlord and Tenant 16.202 – 16.225 (Sweet & Maxwell)
- Hill and Redman’s Law of Landlord and Tenant Chapter 12 (Butterworths)
Seitler’s leading practitioners
- Lucy Housego, Linklaters
- Peter Levaggi, Charles Russell Speechlys
- Gary Scott, Philip Ross Solicitors
- Harriet Swainson, Walker Morris
- Joe Walker, Howard Kennedy
- Sue Wilson, Irwin Mitchell
