Landlord and tenant update
Article Type: Law Briefing From: Journal of Property Investment & Finance, Volume 27, Issue 3
Hard times – tough choices
Since September 2007 economic news has been unremittingly negative. The British Property Federation recently hosted discussions between landlords and tenants in the UK retail sector following tenant demands for a shift in the pattern of rent payments from quarterly in advance to monthly – preferably in arrears. This tenants’ campaign, spearheaded by Arcadia’s Sir Philip Green, reflects increasingly difficult trading conditions and cash flow issues on the High Street. In essence, landlords are being called on to agree to a decisive move away from the traditional structure of the “institutionally acceptable” lease, and towards a more flexible and tenant-friendly contract to occupy. It comes at a time when the prospect of new statutory procedures for recovering commercial rent arrears add to an already fraught decision-making process required of landlords faced with tenant default.
Forfeiture?
In a difficult market, the landlord may not feel sufficiently confident about reletting the property to forfeit a defaulting tenant’s lease. However, it must consider this option first because it is alarmingly easy to waive the right to forfeit through the use of some methods of debt recovery or by entering into discussions about concessions or variations to alleviate the tenant’s problems. In essence, once a landlord becomes aware of a breach the right to forfeit for that breach will be waived by any act or negotiation that recognises the continuation of the tenancy.
Forfeiture may be by court action or (where used solely for business purposes) by “peaceable re-entry”, typically by changing the locks. The tenant and any subtenant or mortgagee may apply for relief from forfeiture. Any potential new tenant will be concerned to ensure that the premises are genuinely vacant and available for re-letting, and that they will not be stepping into the middle of an ongoing dispute. Pre-contract enquiries usually ask whether there has been any forfeiture within the preceding six months:
Where a lease is forfeited by “peaceable re-entry” there is no court order and the landlord is deemed to be “proceeding to enforce”. There is no mandatory time limit within which the tenant, subtenant or mortgagee can apply for relief, but in practice the court adopts six months as a guideline. A reply confirming that at least six months has passed since forfeiture is usually accepted as confirmation that the tenancy has ended.
Where forfeiture is for non-payment of rent and no payment into court has been made before trial, the court must order possession on a specified date not less than four weeks after the order unless within that period the tenant pays into court all arrears and costs. The court may extend this period at any time before possession. The tenant has six months after the landlord secures possession to apply for relief against forfeiture.
Under s 210 of the Common Law Procedure Act 1852 where more than six months’rent is outstanding a landlord may obtain judgment for possession without formally demanding the rent. If the tenant fails to apply for relief within six months after execution of that order he is “barred and foreclosed from all relief or remedy in law or equity”.
An order for relief might require the tenant to comply with conditions by a specified date. The court retains discretion to extend that time limit. On due diligence, incoming tenants must specifically confirm that no time limit is running and (if there is) that no application has been made to extend it.
Mixed use property
Where property is used both for business and residential purposes, the landlord must check compliance with all applicable statutory protection. Key issues include:
Where a single lease is used for business and residential parts (e.g. a shop with flat above) forfeiture cannot be by “peaceable re-entry”. Court proceedings are required.
Two months’ notice given before the end of any initial fixed term will end an assured shorthold tenancy (AST), even if the notice period expires after the end of the fixed term. Notice given after the end of the initial fixed term(or at any time where the tenancy is “periodic”) must be at least two months and must expire at the end of a “period” of the tenancy (e.g. the end of a month where the tenancy period is monthly).
Residential tenancies created before 15 January 1989 are likely to be“protected tenancies” under Rent Act 1977. Rent Act protected tenants enjoy extensive statutory protection, and their presence can significantly diminish the value of the landlord’s interest and the flexibility that might be required by an incoming business tenant.
If a tenancy is “assured” rather than an AST then termination depends on the landlord’s ability to prove one of the statutory grounds set out at s 8 Housing Act 1988.
Debt recovery
Landlords may be reluctant to forfeit if there is little realistic prospect of a swift reletting. While the tenant remains on the hook, there remains some hope of recovering arrears or of breaches of covenant being remedied. Unless and until the tenant is insolvent, and the statutory moratorium on legal proceedings applies, debt recovery might be a pragmatic option. However, the existing methods can be slow and costly.
Court proceedings are generally slower and more costly than some of the alternative methods of debt recovery. There is also a costs risk. If a landlord subsequently decides to discontinue its claim or if its claim is dismissed, it may have to pay the defendant debtor’s costs.
The landlord must serve a claim form and particulars of claim on the tenant who then has either 14 or 28 days to serve a defence, depending on whether an acknowledgment of service is filed. If no defence is filed, the landlord may seek judgment in default, the hearing for which will normally be held within a few months. Alternatively, if it is a relatively simple matter and the defendant has no real prospect of successfully defending the claim, the landlord may be able to obtain summary judgment. Again, the hearing of an application should take place within a few months.
If neither judgment in default nor summary judgment is granted, the court will give directions governing the exchange of evidence in preparation for trial. This can arise where the debtor raises a counterclaim against the landlord that the court considers should be tried. Complying with directions takes time and can be costly, so before issuing proceedings landlords should consider whether the debtor has a potential counterclaim that could complicate the issue.
Obtaining judgment is not the end of the story. Landlords will have to take steps and incur further costs to enforce a judgment. If the tenant has no income or assets to enforce against, there is little point in obtaining a judgment.
Statutory demands
Serving a statutory demand is not in itself a method of debt recovery. It is a preliminary to pursuing bankruptcy or winding-up proceedings. It can, however,be an effective indirect method because it puts pressure on a tenant by raising the real possibility of bankruptcy (in the case of an individual) or liquidation(in the case of a company).
A statutory demand can be served only where the debtor owes at least £750 and the debt is liquidated and undisputed. If a landlord serves a statutory demand in respect of an unliquidated or disputed debt or a debt of less than£750, the debtor can apply for the statutory demand to be set aside and may recover its costs of doing so.
Before serving a demand, the landlord must consider any potential counterclaim, since this could also lead to the demand being set aside. Once a statutory demand has been served, the debtor has 21 days in which to settle the sum. After this period has passed, the landlord can present a bankruptcy or winding-up petition to the court. Depending on the tenant’s financial position, this option may not be worth pursuing because the landlord will rank only as an unsecured creditor in any bankruptcy or liquidation. In practice, the landlord will recover only a small percentage, if anything at all, of the original debt. 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 pay any claim by the landlord for the loss suffered as a result.
Commercial rent arrears recovery – a new procedure
The Tribunals, Courts and Enforcement Act 2007 will abolish the law of distress for rent and replace it with a modified statutory procedure known as commercial rent arrears recovery (CRAR).
Much like the old law of distress, CRAR is a “self help” remedy and does not generally require the involvement of the courts. It is initiated by a landlord’s instruction to “enforcement agents” (the new name for bailiffs) to collect the rent or take control of goods. The court retains power to intervene if the tenant applies for an order to prevent any abuse of the process or a potential breach of the European Convention on Human Rights.
CRAR is available only to landlords of leases of commercial premises, and will not apply to residential or mixed-use premises.
What can be recovered?
“Rent” is narrowly defined. It includes only payments for “possession and use of the demised premises” (including any interest and VAT on that amount). It does not include other sums such as rates, council tax and service charges even if they are defined or reserved as rent in the lease.
A landlord of commercial premises will be permitted to recover rent only if the net amount outstanding (excluding any interest, VAT and permitted deductions) exceeds a specified minimum. The Ministry of Justice has not yet fixed the minimum figure. The rent must have become due and payable before notice of enforcement is given. The amount must be certain, or capable of being calculated with certainty. The net amount must still exceed the statutory minimum at the time the enforcement agent takes control of the goods, so it is necessary for a landlord to recalculate the net unpaid amount immediately before seizing any goods.
The procedure
CRAR provides three methods for “taking control of goods”:
- 1.
by a controlled goods agreement (formerly “walking possession”);
- 2.
by securing goods on the premises or on a public highway; and
- 3.
by removal from the premises.
The landlord must first serve 14 days’ written notice giving the tenant an opportunity to seek legal advice. The notice contain information prescribed by the 2007 Act. The landlord may dispense with notice only if there is a reasonable chance that the tenant may try and dispose of or relocate any goods. Before relying on this provision the landlord must be sure that he can produce objective evidence to satisfy the court. Seizure of goods must then take place within three months of service of the notice, but an application may be made to the court to extend this, up to a maximum limit of 12 months, if a good reason can be given.
Entry by the enforcement agent should be through normal methods of entry. Reasonable force is permitted, but only if ordered by the court and only as a last resort.
The 2007 Act also includes detailed provisions dealing with the storage,valuation and sale of goods, the distribution of sale proceeds, and the remedies available to landlords and tenants.
Although the Act is abolishing the law of distress, it preserves the landlord’s ability to serve notice requiring a subtenant to pay the rent owed under the sublease directly to the landlord, rather than to the defaulting tenant, until the amount of arrears is settled.
Rent deposits
If a rent deposit was taken from the tenant at the outset, it can provide a simple method of dealing with tenant default and results in an immediate release of cash. However, less money will be available to cover any future liabilities under the lease should the tenant fail to “top up” the deposit. Unless that failure itself gives the landlord a right to forfeit, this route may not put the tenant under any real pressure to comply with its lease obligations.
Rent deposit agreements usually cover any default or breach by the tenant,and not just rent arrears. A landlord must ensure that it serves notice in accordance with the provisions of the deed and check:
Whether the rent deposit should be kept to cover the tenant’s future liabilities, particularly those that may be more difficult to pursue than rent arrears, such as damages for dilapidations.
Whether the deed allows the deposit to be used to settle the particular claim that it has against the tenant.
The rent deposit will generally be held either:
by the landlord as trustee, and on terms allowing the landlord to withdraw sums in the event of tenant default; or
it remains the tenant’s money but is protected by a legal charge in the landlord’s favour.
The validity of a charge created by a corporate tenant may depend on registration at Companies House within 21 days after creation. For rent deposits created before 26 December 2003 the need for registration was clear. For rent deposits created on or after that date it depends on the Financial Collateral Arrangements (No. 2) Regulations 2003.
Under those Regulations charges over cash no longer need to be registered where:
the purpose is to secure the relevant financial obligations owed to the collateral-taker (the landlord);
the collateral-provider (the tenant) creates a security interest in financial collateral to secure those obligations;
the financial collateral is delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control of the collateral-taker or a person acting on its behalf; and
the collateral-provider and the collateral-taker are both non-natural persons.
A rent deposit provided by a corporate tenant to a corporate landlord falls within this definition. Nonetheless, it remains widespread practice to register the charge. Presumably this will continue unless and until there is judicial confirmation that registration is not required.
Registration is still required where the landlord is an individual or partnership (as both parties must be “non-natural persons”).
If a charge should be registered, but is not, then it is void against a liquidator, administrator or administrative receiver. However, in Obarayv. Gateway (London) Ltd (2000) EGCS 149 the court held that, while the charge was void, contractual provisions entitled the landlord to withdraw sums where (but only to the extent that) the tenant was in breach before the liquidation.
S 395 will be superseded by s 860 Companies Act 2006, which is expected to come into force on 1 October 2009.
VAT
Where the deposit is held on trust there will a separate charge to VAT when the money is paid to the landlord. For that purpose any sum taken “on account” of VAT will count as part of the VATable deposit. So, if a landlord took a deposit of £100 plus a sum “on account” of VAT,the deposit would amount to £117.50. The VAT payable when the deposit is handed over would be 17.5 per cent of £117.50.
Where the landlord has “opted to tax” the deposit will be equal to 117.5 per cent of the rent for the relevant period. The element taken on account of VAT does not become VAT until it is withdrawn in connection with a taxable supply. If the tenant’s breach is non-payment of rent the landlord must issue a VAT invoice within 30 days of making the withdrawal.
If the landlord withdraws sums to cover a breach of covenant other than non-payment of rent – such as disrepair – then as damages they are outside the scope of VAT. The landlord cannot issue a VAT invoice, even if the sum withdrawn includes VAT payable to third parties, such as contractors called into carry out repair works.
SDLT
For SDLT purposes a rent deposit may be treated as a premium for the grant of a lease if it is greater than two years’ rent.
Repayment
Any part of the deposit not validly withdrawn by the landlord must be repaid to the tenant at the end of the tenancy or earlier if required by the rent deposit deed. Rent deposit agreements often direct repayment when the tenant can show three consecutive years’ pre-tax profits of at least three times the annual rent. That is no more than a “rule of thumb”. As lease terms reduce (and economic conditions deteriorate) it is likely that landlords will seek to retain deposits until the end of the term.
For “new” tenancies, the obligation to repay a deposit (along with the right to make withdrawals) automatically passes to the new landlord when the landlord’s interest is sold. The former landlord is not automatically released from the obligation to repay, but may either:
provide that the obligation will end when the landlord sells its interest;and
apply for release under ss 6-8 Landlord and Tenant (Covenants) Act 1995.
For “old” tenancies there is no automatic transmission of the obligation to repay. The original landlord remains liable and must protect itself against the possibility that its successor will default. This was often achieved by providing for a new rent deposit agreement when the landlord’s interest was sold, and obliging the tenant to join in that agreement. Where that was not done, liability to repay might well have remained with the former landlord.
Interest on the account forms part of the deposit and must usually be returned to the tenant when the deposit is released.
Guarantees
Landlords frequently seek a covenant from the guarantor as “principal debtor” or “primary obligor” so that its liability is not merely secondary to that of the tenant. Even with this wording, the guarantor’s liability can never exceed the tenant’s. Its value is that the guarantor may remain liable even if the landlord’s claim against the tenant is unenforceable.
Release
A guarantee can be lost where changes are made (expressly or by conduct) to the underlying contract. Guarantee clauses must contain protective wording to avoid release in case of:
Giving time. The guarantee should expressly prevent release despite“any time or indulgence granted by the landlord to the tenant, or neglect or forbearance on the part of the landlord in enforcing the payment of rent and the other covenants in the lease”.
Variations. Variation of the contract between landlord and tenant releases the guarantor unless the guarantor consents, or the variation is“self-evidently insubstantial or non-prejudicial to the guarantor” (Holmev. Brunskill (1878) 3 QBD 495).
Protective wording can preserve but not increase a guarantor’s obligations. The guarantor will assume enhanced obligations only if it expressly agrees to do so. When reporting on a lease that has been assigned, highlight differing levels of liability between the current tenant, its predecessors and their guarantors.
Disclaimer
Disclaimer by the tenant’s liquidator or trustee in bankruptcy does not release the guarantor, or the guarantor of any former tenant who remains liable. The guarantor’s liability continues as though the lease still exists. However, future liability and any obligation to accept a new lease end if the landlord retakes possession of the property after disclaimer.
Eviction and repossession
Mixed use premises present particular difficulties. Residential occupiers enjoy significant statutory protection from eviction or harassment. Harassment and illegal eviction are criminal offences, and a person who is harassed or illegally evicted can also claim damages through the civil court.
Section 2 of the Protection from Eviction Act 1977 provides that a right of re-entry or forfeiture may only be enforced by court proceedings where premises are “let as a dwelling”. In Pirabakaran v. Patel[2006] 4 All ER 506 the Court of Appeal held that the phrase “let as a dwelling” means “let wholly or partly as a dwelling”. Statutory protection therefore applies to premises let for mixed residential and business purposes. Where mixed use premises are let under a single lease, a court order is required before the landlord can forfeit that lease.
The Protection from Eviction Act 1977 makes it an offence to:
do acts likely to interfere with the peace or comfort of a tenant or anyone living with him or her; and
persistently withdraw or withhold services for which the tenant has a reasonable need to live in the premises as a home.
It is an offence to do any of these things intending, knowing, or having reasonable cause to believe, that they would cause the tenant to leave their home, or stop using part of it, or stop doing the things a tenant should normally expect to be able to do. It is also an offence to take someone’s home away from him or her unlawfully.
A person who is convicted by magistrates of an offence under the Act may have to pay a maximum fine of £5,000, or be sent to prison for six months, or both. If the case goes to the Crown Court, the punishment can be prison for up to two years, or a fine, or both.
Section 6 of the Criminal Law Act 1977 prohibits violent re-entry. An offence under this section is committed only if the tenant or some other person is present at the time of re-entry.
Tenants
A landlord’s right to get property back from a residential tenant can normally be enforced only through the court.
A landlord seeking possession from an assured or assured shorthold tenant must first serve notice on the tenant. Depending on the grounds on which the landlord is seeking possession, the period of notice will be either two weeks or two months. A landlord seeking possession from most other kinds of residential tenants or licensees must serve a notice to quit giving at least four weeks’notice. In either case, the tenant is not required to leave the property until the notice expires, and even then may not be evicted without an order of the court.
Licensees
The Housing Act 1988 requires a licensor to obtain a court order before evicting a licensee. Licences granted on or after 15 January 1989 are exempt from this requirement only if granted:
by resident landlords to people with whom they or a member of the landlord’s family share accommodation, provided it is in their only or principal home;
to trespassers (when granted as a temporary expedient);
to those occupying a property for a holiday, or occupying it rent-free;
to people living in certain publicly funded hostels; and
to people living in certain publicly funded hostels.
Where the business and residential parts of the premises can be let separately, the landlord may choose to avoid this problem by granting the tenant separate leases for the business and residential elements. If the premises cannot be severed, the landlord may consider letting them as business premises only and prohibiting residential use. However, this could well reduce the market rent and is likely to make the premises less marketable at a time when difficult economic conditions must amplify the need for flexibility.
Malcolm DowdenLexisNexis, UK
