The English rent quarter days – March 25, June 24, September 29 and December 25 – are circled in administrators’ calendars. The need to pay a quarter’s annual rent in advance has proven to be the trigger for many retail administrations; and frequently administrators are appointed the day after, or very soon after, one of these four dates.
Following Goldacre (Offices) Ltd v Nortel Networks UK Ltd (in administration) [2009] EWHC 3389 (Ch); [2010] 09 EG 168 and Leisure (Norwich) II Ltd v Luminar Lava Ignite Ltd (in administration) [2012] EWHC 951 (Ch), it is now established that rent due before the date of an administrators’ appointment is not treated as an expense of the administration. As a result, administrators may think that they have a period of three months before the next quarter’s rent becomes due, to sell any existing stock and close down unprofitable stores. In practice, administrators will use this time to avoid paying rent and maximise recovery for the creditors as a whole, which is their primary objective.
Administrators of UK-wide portfolios need to be aware of a Scottish legal right known as hypothec that gives landlords a right to sell stock and other goods to recover rent due to them. If administrators treat all properties in the UK in the same manner, they may find themselves personally liable to Scottish landlords if they sell stock and close doors without considering hypothec.
What is hypothec?
Hypothec is a legal right that all commercial landlords in Scotland have automatically. It is a security created by statute over moveable property such as stock and other goods in the property. It is available only for unpaid rent and lasts as long as the rent remains unpaid. As a security it gives the landlord priority in the event that there are competing creditors and, most importantly, for insolvency situations, it is not subject to the same rules as other creditors in the event of the tenant’s administration.
When an administrator is appointed, the hypothec exists automatically without the landlord having to notify the administrator. The hypothec gives the landlord a security over any moveable property within the premises leased by the tenant for the purpose of paying unpaid rent. This security means that the landlord has first right over any stock, ahead of the administrator.
Hypothec only covers:
• unpaid rent and would not apply to service charges or other costs due to the landlord that are not rental costs for the property; and
• property owned by the tenant.
If a moveable item is owned in common by the tenant and a third party, then the hypothec arises only to the extent of the tenant’s interest in that property. The hypothec would not cover any items under hire purchase or potentially any stock under sale or return-type arrangements.
Actions for landlords and administrators
If a landlord is owed rent for a property in Scotland the landlord should, as best practice, write to the administrator as soon as possible following appointment and inform it that the landlord will be seeking payment of arrears by way of hypothec.
It will be difficult for the landlord to identify the value of the potential hypothec security as the landlord will not know what stock or other goods in the property may be subject to the security. The landlord can, however, put the insolvency practitioner on notice so that as early as possible in the administration the administrator knows that they must account to the landlord for the value of any potential hypothec security.
Even if a landlord does not claim its right as a creditor, the administrator should assume that the landlord would wish to as the hypothec security exists automatically by statute and is required to be accounted for in any distribution.
Administrators on appointment should ensure that they have accurate records of any moveable items within any Scottish commercial property. This will allow administrators to accurately account to landlords for the value of goods (less the cost of sales) representing their secured recovery under the hypothec for unpaid rent.
Although the Insolvency Act 1986 provides that administrators can sell property subject to a floating charge as if it were not subject to that charge, this does not give free rein to sell disregarding hypothec: a hypothec security is not a floating charge. An administrator requires a court order to sell property subject to the hypothec, but in practice this is seldom obtained. Caution should, however, by used.
Customers are protected when buying any items subject to the hypothec as they are considered to have bought the items in good faith, and any purchase in good faith will no longer be subject to the hypothec security as far as the purchaser is concerned.
This can create a big problem for administrators as landlords could challenge administrators and claim that the administrators do not have the authority to sell such items.
So, if administrators don’t account to landlords for their hypothec, then landlords (as creditors) could claim breach of administrators’ duty. There is no opportunity for administrators to exclude personal liability if they have sold items without taking into account the hypothec.
Factor it in
It is important that all administrators (especially those appointed in London for a UK-wide insolvency) are fully aware of when and what hypothec covers.
Hypothec provides landlords of Scottish property with an avenue for recovering unpaid rent that is not available to landlords in England. The consequences for administrators who ignore this claim could, in serious cases, result in a personal liability claim.
Well-informed administrators and landlords are those who not only believe the hypothec, but who ensure its existence is factored into their dealings with Scottish retail properties.
Alan Hughes is a senior associate at Dundas & Wilson
