BPF's "Taking the Profit" - extracting maximum value

The British Property Federation (BPF) is an organisation which represents Landlords.  Therefore it is an organisation which is important to me because it is important to my clients.  It recently launched its "Taking the Profit" campaign.  The target of that campaign is the use of administration particularly in the retail sector as a route to turning a distressed business into a more profitable one with the result that landlords either face shop closures or reduced rental income.  I made one prediction in my blog on New Year's Day and this fight was it.  Thank you to the BPF.
As frequent readers of my blog will know, I have much to say on the insolvency regimes and have blogged many times on the issues facing landlords arising out of administrations and other insolvency regimes as well as the impact of recent case law.  It is good to see the BPF seeking to tackle the issues head on and I cannot argue with the first points the BPF makes that the government has failed to act on tightening up pre-packs and making it easier to complain against Insolvency Practitioners.
However, whilst the BPF is to be praised for raising potential abuse of the insolvency regimes for the benefit of shareholders at the cost of creditors (and particularly landlord creditors) I think that in highlighting certain areas which are, perhaps, most headline grabbing some important areas for review have not received similar attention.  Some of the publicity around this campaign suggests that landlords are the unwitting, weak and undefended party in a war which is being waged against them by a united force of IPs and private investors.  Quite simply, in my experience, this is not the case.  Now it may be that my experience (which I admit is largely at the 'better' end of the retail property market (by better I mean primary and secondary) and involves dealing with the likes of KPMG, PWC, E&Y, BDO, Grant Thornton and others) largely misses out the activities at the tertiary end of the market and perhaps practices at that end are a little more shady.  However, my suspicion is that some landlord practices at that end of the market are not quite 'code compliant'.  Further by failing to identify the real reasons why the current regime unfairly prejudices landlords over and above other creditors risks losing the war.
The bad arguments
1.  It is largely pre-pack administrations where landlords are leant on to agree concessions
This is not the case. A pre-pack is when a deal is agreed and documented (but not signed) before the appointment of administrators.  Some of the administrations where landlords have been pressured to give rent concessions have been pre-packs.  However, most high profile administrations have not been pre-packs yet rent concessions have been sought by the new buyer.  Therefore, the BPF is, in fact and rightly, targeting administrations and not just pre-packs with this campaign.
2.  Administrations are effectively being used to transfer funds from pensioners who have invested in property funds and property companies to private investors buying businesses from administrators and then seeking rent concessions or threatening to close down
Using pensioners in any argument seems to be 'de rigueur' at present.  I think care needs to be exercised in utilising this argument.  Apart from anything else when it comes to unprofitable sites there are arguments that the landlord community carries some of the blame:

• in good times landlords happily agree high rents fully in the knowledge that if trading conditions deteriorate that rent may break the business
• the UK leasing model with relatively long lease lengths, upwards only reviews and full repairing and insuring provisions, whilst providing secure income in the sense of no costs, means that rising service charges add to the burden on tenants increasing the risk of insolvency
• the use of quarterly rents creates cash flow issues for tenants and also creates greater risk for landlords in the light of recent case law
• whilst some landlords have been sympathetic to struggling tenants many others have taken an aggressive route refusing to consider any concessions accusing the tenants of trying to make them pay for a bad business

3.  Landlords are being forced to agree rent reductions
No one is being forced to do anything.  Landlords may not like the threatening manner in which some agents and/or buyers act; saying that unless the rent is reduced a unit will be closed down.  But, at the end of the day, the landlord can call their bluff and refuse to agree the concession.  Landlords are not above being threatening either.  I had one case where a landlord (not institutional) unlawfully re-entered a property through the use of, what can only be described as, thugs because he did not like the possibility of a CVA.  That is far more serious than aggressive posturing in a negotiation.
Landlords are big boys and just as able to use an aggressive negotiating stance.  As advised in a recent blog landlords have quite a good negotiating position albeit limited by the commercial realities affecting each individual property.  In reality landlords are often paying for the fact that they own a property which is not in a prime location and which can no longer command rents at the level originally agreed.  If they could get a better rent then they should refuse the rent concession and get possession.  That is called risk and, without wishing to teach grandmothers how to suck eggs, that risk should have been reflected in the yield when the property was acquired.

The other side of the coin

The BPF is absolutely right to put the issue of administrations on the public agenda.  I think it is important to recognise that there are issues with the system which impact (possibly unfairly) on landlords which should be at the forefront of the campaign:

• the current legal position on payment of rents (especially in the light of the decision in the recent case of the Leisure (Norwich) II Ltd & Others -v- Luminar Lava Ignite Ltd (in administration) & others [2012] EWHC 951 (Ch) gives freedom to tenants not to pay rent and for administrators to trade rent free until the next quarter day.  The Game administration is the biggest example of this.  This flies in the face of the "pay for what you use" approach to insolvency situations and is unique to leases due to a clash between real estate law and insolvency law.
• the moratorium preventing forfeiture without consent - with all other contracts the provider can effectively terminate the contract on insolvency and there is nothing to stop them from doing it.  However termination of the lease can only occur by use of forfeiture which is a form of proceedings.  Due to the moratorium such action requires court approval (or administrator consent).  This exposes the landlord to greater potential future loss than other creditors who, whilst they might lose out on arrears, are not exposed to further losses unless they choose to contract with the administrators or the new business

In my view these are the mischiefs which the BPF should be seeking to undo.  Whilst anti-private equity and pro-pensioner arguments attract good press the reality is that they do not properly encapsulate the issues with a system which, whilst not completely broken, is not working in perfect harmony either.

All that glitters is not Goldacre

In January 2010 I blogged on a very recent decision called Goldacre (Offices) Limited -v- Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch.).  In November of the same year I picked up on a Scottish case (Cheshire West and Chester Borough Council -v- Springfield Retail Limited (in administration)) in which the decision in Goldacre was applied and certain parts clarified.
Landlords were very happy with Goldacre.  The principle meant that administrators could no longer calculate rent on a daily basis but rather had to pay for the full quarter.  However, as I highlighted the decision in Goldacre did create a level of uncertainty.  Most importantly it left open the possibility that where an administrator is appointed after a rent payment date and then rent has not been paid that the outstanding rent will be an unsecured claim.
A question answered
That question is unclear no longer.  In the High Court decision handed down by His Honour Judge Pelling QC (oral judgment only) it was decided that where a company goes into administration any unpaid rent which fell due before the appointment of the administrators will be an unsecured claim against the company and not an administration expense.
Whereas after Goldacre landlords were jumping for joy many are now holding their head in their hands and here is why.  On 26 March 2012 that behemoth of retailers, Game, entered into administration.  Whilst I do not know for certain I would countenance that any lease where the rent fell due on 25 March (the March Quarter Day) did not get the rent paid prior to the administration.  Those landlords now have no chance of receiving any payment for the quarter from 25 March to 23 June whilst at the same time they cannot recover possession of the property due to the moratorium.  Going to court is not attractive as it will now require the Court of Appeal to rule on the matter which means losing at first instance just for the pleasure of some time in front of our learned Law Lords.
A bit of history
In truth the whole episode is a rather sorry tale of a silly issue resulting in unhelpful law.  Goldacre was not really about when the liability to pay rent arose.  Rather it was about whether administrators should have to pay the full rent when they were only utilising a part of the let property.  Up until Goldacre both administrators and landlords operated on the principle that you pay for what you use (i.e. for each day you use the premises the administrators must pay).  This is a recognised principle in insolvency law.
The problem is that this principle crashes head-on with the law in relation to rent that rent payable in advance cannot be apportioned (rent in arrears can thanks to the Apportionment Act 1870 - interestingly a piece of legislation enacted for the benefit of landlords who previously could not recover rent arrears having forfeited a lease where rent was payable in arrears).
In effect the court has decided that the non-apportionment principle cannot be overriden by the pay-what-you-use principle and so we land up with a position which neither landlord nor administrator actually want.
Landlords lose out on rent for the quarter in which the administrators are appointed.  Administrators risk having to pay for a full quarter whilst only utilising the property for a small part of it.
So who has the upper hand now?
Almost certainly administrators acting for tenants do.  There is little doubt that where a company is on quarterly rents payable in advance on the usual quarter days that it can provide the administrators with significant breathing space if any appointment is done immediately after a quarter day having not paid that quarter's rent.  The administrators can trade rent free for a quarter.  There is little doubt that the two decisions effectively invite companies to do this and, frankly, they would be silly not to avail of the opportunity.
However, in a lot of cases struggling companies approach their landlords much earlier when in difficulty to seek either rent concessions or changes to rent payment dates.  Many landlords will simply reject such requests or agree to move to, say, monthly rents or staggered payment arrangements to assist with cash flow.  However, landlords would be well advised to use any such approaches as an opportunity to change the balance in their favour.  The law is all about when liability to pay arises and if you can change when the liability arises you can avoid suffering unnecessarily when the tenant ultimately goes into administration.

Game-over for UK commercial real estate investment?

It's MIPIM week and whilst colleagues and contacts are wining, dining and networking on the shores of the Meditteranean, I sit here pondering whether we may be witnessing the end of the UK as an attractive place to invest in commercial real estate.  With headlines such as:

"James Dyson calls for looser employment laws and shorter leases"

it is easy to see that the established UK form of investment lease is under threat.  It is a threat from within and without.  The question is whether this threat is such that it could ultimately destroy the attractive nature of the UK as a place to invest in real property?
In order to understand the threat one must first understand some of things that make the UK such an attractive place to invest in commercial real estate assets.  A non-exhaustive list of the attractions are:

• Long lease terms - historically leases have been for long terms certainly in excess of 10 years and often as long as 25 years or more. This creates long term secure income.
• Landlord friendly law - the concepts of privity of contract and very limited tenant protection mean that once a deal has been agreed between the parties it will bind them for the term.  Again security of income.
• Full repairing and insuring terms (FRI) - in the UK the full costs of managing a property can be recovered from the tenants so the annual rent is effectively a net income save for tax.
• Upwards only rent reviews - apart from at the end of a lease term the landlord is always guaranteed its minimum rent level. It may not go up but it can't go down.
• Quarterly rent payable in advance - a beneficial cash flow from the landlord's perspective.

Looking at the list above you might wonder what the challenges now arising are.  Certainly there is no threat of legislation.  In fact, UK landlords probably took a lot of heart from the change of mind by the Irish government not to introduce legislation imposing upwards-downwards rent reviews.  If a country in as dire property straits as Ireland cannot justify such legislation how much more so would a country such as the UK which has probably seen the worst effects pass struggle to justify such a move.  The 2003 report by De Montfort University and the BPF further cautions against such legislation.
However, there have been changes. These have been subtle and occurred over time.  The cumulative effect of the changes is potentially game-changing.  Let's consider some of those changes:

• Loss of privity of contract - this is the only legislative change aimed squarely at landlords.  The removal, in  January 1996,  of the doctrine that once a tenant signed a lease it would be bound by its terms even after an assignment was a major blow to the investment fraternity.  The risk was that the tenant would assign the lease to a lesser covenant and dilute the investment value of the asset.  Various attempts have been made to try and strengthen the landlord's hand but invariably they either have a negative effect at rent review or fall foul of the anti-avoidance measures as most famously occurred in the Good Harvest decision as approved by the Court of Appeal in the House of Fraser case.
• Shorter lease terms - over the past decade lease terms have become shorter. Tenants are less prepared to sign up to long leases form which they cannot easily extricate themselves.  Some of this is as a result of the "tenant's market" with higher levels of voids.  However SDLT has also had an impact with every additional year on the lease costing the tenant tax up-front.  If lease accounting rules do change this may add further weight to the shorter lease term argument.
• Lower recoverability and greater flexibility- landlords have become much more attuned to the needs and expectations of their tenants.  Further, under the threat of legislation a voluntary commercial lease code has been introduced.  This requires landlords to give optionality to tenants.  It requires landlords to comply with the RICS Service Charge Code.  Invariably this increases the likelihood of irrecoverable costs being incurred in respect of a property which fall to be paid by the landlord denting its income.  Gone are the days when tenants could be charged for everything under the sun including rebuilding the property.

The above are the more tangible changes that have occurred.  There are also less tangible, or at least more spontaneous or reactionary events which take place from time to time which change the playing field:

• Monthly rents - during the recent downturn there have been numerous requests and demands that landlords accept monthly rather than quarterly rent payments.  The argument from the tenant's point of view (especially in the retail sector) is that quarterly rents do not reflect the reality of business where cashflow is not quarterly.  Concessions have been given but the pressure remains for a complete change in standard to monthly.  Whether this will happen remains uncertain.
• Use of CVAs and Administration - the number of retailers failing since 2007 has continued to rise and barely a week goes by without another retailer or leisure operator announcing it is in difficulty and needs to restructure.  To date CVAs have not really been used successfully to reduce rental liabilities but it is only a matter of time before this is tried again.  Administrations are very much in vogue and, as I consider in my piece on La Senza and Blacks, the administration is used to renegotiate lease terms (and in particular rent) with landlords.

Therefore, whilst leases may contain upwards only rent reviews the certainty of maintaining that level of income remains threatened.
So, returning to my original question, is the attractiveness of the UK as a top spot for investment in real estate at serious risk?  In my view the answer remains a no despite all the issues highlighted.  There are some very good reasons why not:

• whilst there is an increase in the irrecoverable nature of some costs the fact remains that FRI leases are the norm and the vast majority of costs are recoverable resulting in the rent being a net figure
• many of the threats and issues are more as a result of the current economic climate and my expectation is that once the dark clouds disappear then "normal" market practice and attitudes will return
• part of the attractiveness of the UK is that it provides a stable political and legal framework.  For foreign investors this is a key attraction and the return generated may fluctuate but the risks do not alter much over a long period of time.

No, I think that the UK real estate market is not truly threatened by these small changes and challenges that arise from time to time.  In reality the biggest threat to the UK real estate market continues to be the ever decreasing amount of credit that is available in the market.  When the credit markets return the above will seem like a bad dream!

Blacks and La Senza: Aggression vs Seduction?

Yesterday saw the first of what will most likely be a wave of pre-pack administrations of high street names when both Blacks Leisure and La Senza went into administration and immediately thereafter their businesses (or at least the profitable parts of it) were sold to willing buyers.  Pre-pack administrations have come in for a lot of criticism on the basis that they often, if not always, return no value to unsecured creditors or shareholders.  However, they have their merits and, in a lot of cases, genuinely achieve the best result possible overall for stakeholders.  Therefore, much to the dismay of some readers, I am not about to launch into vitriolic criticism of the use of pre-packs to save jobs and businesses with unsecureds being left high and dry.
There is, however, one common thread of both the La Senza and Blacks pre-packs which are worth highlighting and, as a landlord, preparing for: lease renegotiations.  In the case of Blacks, the official press release from JD Sports Fashions stated:

"Following the elimination of any underperforming stores and other cost reduction initiatives we believe the business can be run successfully as independent fascias within the Group."

With La Senza, less than half the retail sites leased by the group were bought out of administration with the majority of sites closing down so, it is likely, only the performing stores were part of the original deal.  However bearing in mind the official press release which stated:

"Today’s announcement represents a first step in a long-term commitment to developing the La Senza UK business, which we believe has great potential."

it seems likely that 'new' sites are on the cards.
My prediction is that in both cases landlords will be approached by the new owners to renegotiate lease terms.  What we have is a difference in approach from the new owners; one is seeking to pressure landlords whilst the other is seeking to seduce them.
In the case of Blacks the new owners have probably taken a licence to occupy all the sites and will now meet with the landlords of "underperforming sites" to seek to renegotiate the leases.  This will be the stick or 'Aggression' based approach; if the landlord does not agree the terms the site will be closed and the landlord left with the void costs, which would include empty rates liability, service charge irrecoverability and an unoccupied site which quickly becomes unattractive.
In the case of La Senza whilst landlords of transferring sites might be approached, bearing in mind the number of up front closures, I anticipate that the new owners will approach landlords of some of the closed sites and propose new terms under which they would be willing to re-open.  This is more of a 'carrot' or 'Seduction' based approach offering to relieve landlords of the void exposure.
As a landlord it is important that you are aware of what your negotiating position is in respect of any approaches.  It is worth keeping the following in mind (and get detailed legal advice in respect of them where relevant):

• an administrator has no right to disclaim or unilaterally surrender a lease or otherwise bring a lease to an end earlier than a solvent tenant (only a liquidator has that power).  Therefore rates liability in particular should not fall on a landlord simply because of the tenant going into administration although ultimately liquidation is likely).
• if the property is still being used (and this is particularly important in the case of Blacks) then the lease liabilities arising are likely to be an expense of the administration.
• due to the decision in Goldacre expect there to be significant pressure to get deals done before rent payment dates as administrators in particular will wish to ensure that they can avoid any risk of the next period's rent being payable as an expense in whole.  My view is that a challenge to Goldacre or an attempt to extend it is very likely this year.
• pre-conditions or requirements set out in the lease as things which the landlord can rely on in terms of refusing consent to an assignment apply to an assignment by a company in administration just as much as they do in non-insolvency positions.  Obviously a balance is to be achieved but if you really do not want to consent to an assignment or the proposed terms don't think you will have no choice in the matter.
• the courts will not be quick to grant consent to forfeiture.  In our experience to date courts have given administrators quite a long time to try and assign a lease so even where the proposed assignee cannot meet lease pre-conditions do not assume the courts will be on your side.

La Senza and Blacks might be the first major retailers of 2012 to go to the wall but, if the reports are to be believed, they certainly will not be the last.  Whether buyers of such portfolios use might or seduction methods to seek new lease terms we can only speculate but what La Senza and Blacks show is both approaches are being considered and pursued.  Either way, make sure you use protection!

Retail 2012 – a showdown between administrators and landlords?

A very experienced insolvency practitioner who has acted as administrator on some of the most high profile insolvencies of well known British retailers recently mentioned to a colleague that:

“The main problem facing retailers today is that rents are too high.  Landlords will need to accept that if they want their businesses to survive they will need to reduce significantly the rents payable.”

There is undoubtedly truth in what this IP says; if landlords reduced rents then margins would increase and/or retailers could reduce prices to make their goods more attractive to you and me.  There we go then; in one foul swoop we can fix the problems of the high street, make British retailers more profitable thus increasing tax revenues for Her Majesty and, as Gordon Brown once said “save the world” .
There is just one small problem with this hypothesis; in reality it is nothing more than window dressing.  Put another way, what is being suggested is in effect seeking to simply alter a different variable in a rather complicated equation where ultimately the same final answer always applies:

TRS = RP + BI + LP + BI;

where

TRS = Total Retail Spending;
RP = Retailer's Profit;
BI = Bank Interest; and
LP = Landlord’s Profit.

This is obviously an oversimplification of where the money spent on the high street actually goes but it is sufficient to highlight that by reducing rent what in effect happens is that LP decreases so that RP increases.
This equation also highlights another important factor; that of Bank Interest.  This affects both retailers and landlords alike and once again highlights that in reality the real issue which is damaging the High Street is debt.
In fact the one common factor affecting all three contributors to the equation (retailers, landlords and, just as importantly, the consumer) is debt.  Therefore the IP quoted above could have been more accurate if he had stated that the main problem facing retailers today is that there is too much debt in the economy.  So why not say this?
A number of answers spring to mind (in increasing accuracy):

1. IPs are generally appointed at the behest of the banks.  It would hardly be sensible for IPs to bite the hand that feeds them.
2. Banks have already taken significant hits so is it realistic to expect them to take further hits?
3. Landlords rely on tenants.  If tenants cannot pay the rent then landlords will ultimately lose out.  High rents can only be justified if there is a willing tenant.

I believe that the IP quoted was expressing the view that the average level of rents on the high street is so high that it is not reflective of the economic realities in which we live and were we to test the market then the average rent would fall significantly.
He is right but averages are misleading.  In reality there are a lot (easily the majority if not the vast majority) of retail sites where the rent is too high and should be cut.  However, there are a lot of sites where the rents could go higher as the landlord could easily re-let the property to another retailer if it became available.  Bond Street is an example but so are certain locations on Oxford Street or in major shopping centres such as Westfield London or Bluewater in Kent.
A recent review of the high street predicted a significant increase in the number of retail insolvencies in 2012.  The prediction is that those retailers with 50-500 stores will be worst hit.  What this is likely to mean is that CVAs which had been utilised a lot in 2007 and 2008 to save a number of retailers (or at least delay their demise by a year or two) is less likely to be successful.  If the IP is right in order to survive these retailers will need to do more than simply close sites; they will need to reduce the rents on a significant number of sites that are to remain open.  This is yet to be achieved through a CVA and the most well-known attempt at such a large scale CVA routed rent reduction (Stylo in 2008) was a total failure.
Therefore we are more likely to see a significant increase in administrations (as we have already in the last few weeks).  The courts to date have provided a significant amount of leeway to administrators by protecting them against claims for forfeiture by landlords even where landlords have been able to show they have alternative tenants to the administrators’ preferred assignee.  However landlords have seen some successes; most notably in the case of Goldacre (Offices) Limited v Nortel Networks (UK) Limited.  Yet even this decision is now being turned by administrators to their advantage with a refusal to pay any rent for the quarter during which they are appointed on the basis that they are appointed after the quarter day.
My prediction for 2012 is that we will see this issue and many other similar issues relating to the rights and obligations of administrators to make use of premises litigated through the courts.  So 2012 may prove bad for the high street but it is likely to provide ripe pickings for the IPs, real estate insolvency lawyers (like me I must admit) and real estate litigators.  Every cloud must have a silver lining; at least for some of us.

On-line precedents: Help or hindrance?

The  internet has brought many benefits to lawyers and particularly to firms who wish to avoid (or cannot justify) the employment of a Knowledge Development Lawyer (aka a Professional Support Lawyer). Whereas previously in order to keep up with the latest legal developments one had to subscribe to countless hard copy journals; constantly receive updates from publishers; then spend time updating the loose leaf guides (often a job for the unsuspecting summer student) now this all happens on-line saving significant time (and paper for the more environmentally conscious of us). None of this is a bad thing and is of great benefit to large and small firm alike. This is further enhanced by the availability of automatic updates notifying you of changes to law, recent case updates and similar.  Keeping up to date has never been easier and, frankly, I wonder how we ever managed without - perhaps we were blissful in our ignorance?!?

Courtesy of Rev Dan Catt via Flickr

However there is another development which is in my experience is less than helpful - the emergence of the on-line precedent. On the surface what could possibly be wrong with on-line precedents? Apart from anything else, I hear you say, they result in much more standardisation; who needs 10 different forms for the same transaction. Surely this is a good thing and will help save time and reduce costs?  I even suggested something similar myself in respect of standardising leases, did I not?
Well having recently run a transaction involving a significant number of properties across a portfolio with multiple other small firms involved I can say that this is not the case. Part of the transaction involved obtaining licences from landlords and due to the nature of the properties most often the landlords were represented by small firms. What we noticed was that the same clauses were appearing on almost all the licences we were receiving and the same problem clauses at that.

Why were these clauses a problem?  Let me outline the two most major issues the "standard" precedents caused:

1. In some cases the clauses were not commercially acceptable. Whilst in the context of a simple transaction involving two individuals or a company owned by its directors they were probably okay, on anything more complicated they became onerous and unworkable. The clauses were not something we as a firm or the other large firms involved have in our standard institutionally accepted forms of documentation. However by including it in their on-line resource the resource provider has created the impression that it is standard in the market. I lost count of the number of times we were greeted with a, "This is a standard requirement of our client and is standard in the market" response. If your client's precedent is an on-line resource I suspect your client is pretty oblivious to most of its terms and just because it is in a precedent does not make it market standard!
2. The guidance provided by the on-line resource can be unhelpful and, at worst, obstructive. Suggesting a clause is necessary because without it your client's insurance is at risk when in reality the clause is asking a tenant to take on a risk it cannot mitigate with no obligation on the landlord to assist when it could easily do so is hardly a recipe for productive negotiation. Whilst some firms adopt an aggressive first draft and look then to compromise that only works when the draftsman understands what is necessary and what is unnecessary. We spend a significant amount of time going through our precedents with new joiners explaining the purpose of each and every clause.  The purpose of this training is to ensure that they understand why the clause is there and, by extension, if and how it can be amended or, in certain circumstances deleted.  On-line precedents do not come with this level of training.  Therefore, when an amendment is sought, fear sets in because the lawyer does not have the confidence that they fully understand why a clause has been put into a document.  Whilst the argument we put forward may sound convincing what if we are ignoring another reason for the clause's existence?  Conceding the point might result in their client being exposed and the lawyer being negligent.  Therefore, better to resist and rely on the "it is a standard clause" defence.

There is no point complaining unless you propose a solution.  The first solution would be to get rid of on-line precedents but I accept this would be a step backwards and not particularly helpful to the legal fraternity.  If I am honest I think the issue really lies with the draftsmen of these precedents.  In some cases it is my suspicion that the draftsmen are not transactional lawyers but rather professional KDLs.  Whilst this works within a transactional firm this is because the KDLs have the benefit of engaging daily with the transactional lawyers.  This creates a necessary and mutually beneficial exchange of thoughts and ideas.  Draft clauses which show themselves to be commercially unviable fall on the lawyers' equivalent of the cutting room floor.
However, some of the on-line precedent providers loudly and proudly claim that there precedents have been drafted for them by lawyers and law firms so lack of transactional experience cannot along explain the issue.  The problem with this source of precedent is that, whereas within the law firm there exists a peer group within which a proposed amendment can be discussed, evaluated and agreed/amended/rejected with the benefit of the collective hive mind, for the smaller practitioner such support simply does not exist.  Therefore firms providing these drafts must ensure that their drafts are commercially and legally unbiased.  If the starting point is a reasonable one then the fact that a lawyer is less willing/confident to concede a point is not likely to be such an impediment.

Don't get me wrong.  This blog is not intended to be a criticism of my peers who work in smaller firms.  Frankly I think that they do an incredible job.  It is easy to forget how much I rely on the support I have from KDLs, peers and, indeed, as much on-line resource as I could possibly ask for.  Lawyers in smaller firms simply do not have that level of support and yet provide as excellent advice and client service as many a large firm.

No, my criticism is of the providers of supposed tools aimed at reducing the burden of the small firm lawyer.  As I have mentioned previously the role of the transactional lawyer (and by extension his drafting as his tool) is not to seek to screw the opposition.  Those who provide resources to enable the lawyer to do this need to ensure that those resources truly assist the lawyer in furthering his goals and do not, instead, become an unnecessary and unwelcome hurdle to be overcome.

In defence of sale and leasebacks post Southern Cross

The Southern Cross collapse has cast a very strong spotlight on the use of sale and leasebacks in the care home industry and in property heavy businesses in general. Southern Cross is not the first well known name to collapse with a sale and leaseback business model; remember Woolworths? Or going back further the Forte group? But, whilst all these collapsed entities share a common theme in having utilised sale and leasebacks it is flawed to conclude that any entity which undertakes a sale and leaseback is primed for collapse and, as a response, call for such arrangements to be heavily regulated or outlawed.
How do you justify a sale and leaseback?
First of all it is important to understand the rationale for undertaking a sale and leaseback. In simple terms it is about efficient and productive use of equity. Simply put owning a property outright means your capital is tied up in an illiquid asset. It also means that not only are you running an operational business but you are also exposed to the property investment market with the value of your property fluctuating with property values generally. When the building comes to the end of its useful life (which modern buildings appear to do in a very short space of time) you then have to go to the expense of redeveloping it or selling the land for development.
Extratracting value by borrowing and securing the loan against the property might deal with the immediate issue of cash being trapped in an illiquid asset but it does not deal with the other issues highlighted above. Further owning the property outright and mortgaging has a very negative effect on a company's balance sheet something which, under current accounting principles, a lease does not.
In fact, failing to use sale and leasebacks to some extent might have hampered Southern Cross' expansion.  Whilst one might argue this would have been a good thing one has to consider how, with an increasingly ageing population, having less care beds available is necessarily in the public interest.
I have been involved in a number of sale and leaseback transactions and also acquired and sold properties which have been investments created by them including some Southern Cross properties.  Sale and leasebacks come in all shapes and sizes but I can confidently say that it is not the sale and leaseback model that is the problem but rather the way it is structured and its misuse.
A lease is a very flexible instrument and property valuation more of an art than a science.  Accordingly, by varying the lease inputs in relatively small ways the capital value of a property can be increased or decreased significantly.  But sometimes you can change the same variable without getting the same results.  For example, altering the initial rent on a sale and leaseback transaction will have a greater appreciable effect on capital receipts where rent reviews are index-linked than if they are open market.
Let's consider the Southern Cross approach.  Anecdotal evidence suggests that most of their leases were relatively long term (30+ years) on a full repairing basis with index-linked rents subject to a cap and collar.  Analysing these inputs and whether they were sensible choices for Southern Cross to make I would conclude:

• Term - on the basis that you are not going to move residents around homes you need a long term.  Further the large scale capital expenditure needs a long enough period to be amortised over the life of the lease
• Full repairing - SX would need to maintain the homes in order to comply with CQC and Care Standards so this covenant is not imposing a more onerous obligation on them.  Leasing a commercial property is not about being relieved of the financial implications of repairing it it is about best use of available cash
• Index-linked rents - SX's business model was based on local authority spending.  Historically this has always risen in line with a pricing index.  Therefore linking rents to such an index is more logical than relying on either fixed uplifts or open market reviews where true comparables are very difficult to find
• Cap and Collar - These are important for certainty.  From SX's point of view a cap limited its exposure to higher levels of inflation (and bearing in mind the concerns on inflation in 2007-2009 this was a good call).  The quid pro quo to a cap is a collar to provide the landlord with some comfort that there will always be a rise.  Frankly bearing in mind actual inflation you cannot blame the collar for the failure.

So why did SX fail and is the sale and leaseback structure blameless?
The sale and leaseback structure is not blameless but the issue is more likely that SX agreed rents that were too high in the first place.  The incentive for this is clear.  Within reason the higher the initial rent the higher a price a buyer will pay.  SX extracted maximum value for each property by agreeing to pay the maximum rent which it was felt the business operated at that care home could bear; it left no room for drops in income.  Had their assumptions borne out no one would have questioned their actions and everyone would be marvelling at what a fantastic job the board had done.
However, before singling out the board of SX for criticism regarding their assumptions let's not forget the following:

• landlords had their own advisors who were as well placed as SX to study the demographics, macro- and micro-economics behind the business and lease structure and highlight concerns - did they?
• we had a Labour government which had continued to increase year-on-year its public sector spending in key areas including elderly care and shown no interest in reducing it (even after the credit crunch hit)
• we had Gordon Brown as chancellor telling us he had "abolished boom and bust" and many were happy to believe him
• we had banks with apparantly endless resources able to lend at high leverage

In reality SX was as much a victim of the lax lending practices and flawed belief in our own perpetual success than a totally flawed and unjustifiable business model.  That others have survived where it failed may be more a matter of luck than judgement.
Jamie Buchan, SX's soon to be ex-Chief Executive, said in an interview with Adam Shaw on BBC Radio 4 Today this morning, that he expects changes in the sale and leaseback model in the future after their troubled experience.  Paul Pressland who responded to @AdamShawBiz's tweet said "it is simple, agree a rent you can sustain not one that gives you the greatest capital sum!".  Whilst it may not be that simple it certainly would be a good start.

“Good Harvest” now been tithed?

The Court of Appeal today issued its judgment in K/S Victoria Street v House of Fraser (Stores Management) Ltd & Ors [2011] EWCA Civ 904 (27 July 2011).  Some might call this case “son of Good Harvest” and it was the Court of Appeal’s first chance to consider the decision made by Mr J Newey in Good Harvest Partnership LLP v Centaur Services Ltd.  Those of you who have been reading my blog for a while may remember that I got excited about the first instance decision in House of Fraser as Mr Randall QC opted to follow Good Harvest even though he felt that the reasoning in it was flawed!

I will not bother to go into the detail of Good Harvest and what it means to both landlords and tenants as to do so would simply trod over such well-trodden ground that it is a bit of a quagmire.  I have read the decision of the Court of Appeal and, unsurprisingly bearing in mind the Court in this case was headed by the Master of the Rolls, LJ Neuberger, an exceptionally well respected judge with particular expertise in Real estate, it is a well reasoned decision.  In some ways what is most fulfilling about this judgment is that it has expressly been given to address the uncertainties created by the Newey J decision in Good Harvest.  In fact in one part of the judgment it reads:

“We would hope that those responsible for drafting leases are aware of these conclusions, and that, as a result, the 1995 Act should not lead to many practical difficulties of the sort discussed above.”

The Court is speaking to me and my peers and telling us clearly, “we have told you what the law means now you have no excuses for further screw-ups”!

The decision of the Court of Appeal provides much needed clarity and confirms the following:

1. Any agreement which seeks to require a guarantor of a tenant under a lease to guarantee the obligations of an assignee of the tenant will be void.
2. Even where a landlord merely require a guarantor of a proposed assignee and it is the assignee/assignor who suggests the current guarantor (i.e. the landlord did not require it) as a guarantor of the assignee, that will be void.
3. Any guarantee entered into as a result of an agreement along the lines suggested in points 1 or 2 will not be enforceable.
4. A guarantor can, where reasonable so to do, be required to guarantee the obligations of a tenant as assignor of a lease in an authorised guarantee agreement (the GAGA survives).

Of biggest comfort to landlords (and commercially minded tenants) will be point 4.  It had been suggested in Good Harvest that a guarantor could not be required to enter into an AGA.  If this view had been repeated then it would have resulted in landlords always insisting on the assignee being the most financially sound entity in any group.

The judgment did raise some issues which need to be considered practically so that practitioners seek to ensure that they do not run unnecessary risks with their drafting.  I would highlight the following:

1. Provisions in leases which effectively allow intra-group assignments where the TopCo remains on the hook cannot be made to work.  It seems to me that they simply become unenforceable since the tenant cannot comply with the obligation to provide the guarantee and without it one would revert to the usual consent provisions in the lease. So tread carefully here.
2. The Court has blessed the concept of the current guarantor guaranteeing the outgoing tenant’s covenants in the AGA. However, it did not bless a guarantor guaranteeing the assignee’s obligations directly but less this open.
3. A provision in the original guarantee which seeks to extend the guarantee to a guarantee of any covenants by the tenant in an AGA on an assignment may be vulnerable to challenge.
4. The court cast doubt as to whether a landlord can automatically require on any assignment the outgoing tenant to enter into an authorised guarantee agreement.  This is potentially interesting in the insolvency scenario where landlords often seek to rely on such provisions to refuse consent on the basis that an administrator will not enter into an AGA.

So, Good Harvest has been suitably tithed by the Court of Appeal.   The law has been clarified for the better and the investment community can sleep a little more soundly tonight.  However, a word of warning, there are many existing leases out there which will fall foul of the anti-avoidance provisions of the Landlord and Tenant (Covenants) Act 1995 even after this decision.  The clarity afforded by this decision means a discount in value must be applied to those leases that do.

My computer might have broadband but my brain is still on dial-up

I was chatting with a partner of mine last week who has been in practice for nearly 40 years. He made a comment which highlights a major issue facing lawyers the world over:

"Whilst the speed with which we can send and receive documents has increased thanks to the internet, the speed with which we can review them has not."

We now live in an instant society. Everything is "on-demand". Modern technology has allowed us to perform many more tasks in a much shorter space of time. Financial calculations which took hours 30 years' ago can now be done in seconds. However, one thing has not changed - the human mind cannot go through its thought processes any quicker. Despite what the Government might want us to believe, more A's at A-Levels does not mean the next generation are all super-computers.
However, it is a fact of life that clients expect that a document can be 'turned' quicker now than 30 years' ago. True, we get it quicker. True we can print it out quicker. True it is easier to create mark-ups and identify changes. However these are all time saving factors in terms of delivery and readability. It still takes the same length of time to read, digest and consider the implications of any given clause or amendment.
Modern technology is also one of the causes of another factor which affects documents of today - length. @LegalBizzle has often tweeted regarding the "mega-contract" which in his line of work does not surprise me. But even in Real Estate, contracts continue to get longer. 30 years ago the average lease was probably 10 or 15 pages maximum. Today it would be 50 pages minimum. Just reading it takes 5 times longer, never mind amending it.
So where do we go from here? Well forget about asking clients to relax.  They are under pressure internally to get the deal done and, frankly, they pay us to transact the deal for them.  But there are things that lawyers can do for themselves and here are my suggestions:

• Use plain english - too many contracts I come across continue to use complex terms for no reason other than to appear intelligent.  However, this inevitably increases the review time and the negotiation time.  Why are we so scared of using language which is intelligible to the average man on the street?
• Use punctuation - I cannot believe that there are still lawyers who believe that not using punctuation assists in interpretation.  Not using punctuation results in multiple re-reads of the same paragraph simply to grasp what it is trying to say.
• Use short sentences - there are no prizes for drafting the longest sentence in the world.  Each sentence should be trying to say one thing.  If it has to say more than one thing at least break it down using sub-clauses so that the drafting visually reflects the thought process.  This also means that any amendment can be more easily understood.
• Be collaborative - as per my previous post on the role of a transactional lawyer, our clients are paying us to get the deal done.  In most cases they view the other party as a partner in some shape or form and their aim is not to shaft them.  Therefore, drafting should be balanced and not seek to screw the other side.  If you adopt an unbalanced approach the other side will probably (i) spot the try-on anyway and (ii) adopt a similar approach resulting in entrenchment and the deal stalling.  A balanced draft is not a sign of weakness but rather a sign of comprehension and commercial nous.

We cannot turn the clock back to a time before everything became such a rush and we are not going to be able to act as if the time pressure does not exist.  So, if we are to avoid all checking in to the nearest facility for stress affected lawyers, we must find ways to reduce the time in negotiating documents.  There will always be negotiation but we should make sure that it is as straight forward and painless as possible.

Changes to Competition Law: An end to "good estate management"?

Many thanks to Adrian Magnus, a partner in BLP's EU and Competition Law practice for his input in this blog.

From 6 April 2011, the Chapter I Prohibition under the Competition Act 1998 will apply to land agreements.  This might come as a surprise to a lot of people.  What on earth does competition law have to do with the ownership of land and why have land agreements hitherto been exempt?


Another legal tightrope for Landlords?
Photo by Donald Judge



I do not want to carry out a detailed analysis of the history of competition law and land agreements.  In summary competition law should apply to any agreement the effect (whether intended or not) of which is to be anti-competitive.  This can, for example, be by creating barriers to entry by preventing competition or by two competitors carving up markets between themselves.  Up until 6 April 2011 land agreements were exempt from the legislation.  However, the Government, in its wisdom no longer sees any justification for such differentiation and so now all land agreements will be caught.

Be warned, this change is not forward looking only and does not have any grandfathering provisions.  Even an agreement entered into 100 years ago could be in breach.

One area of particular interest for the real estate industry is the management of large retail estates especially shopping centres and retail parks.  It is not uncommon in these estates to have leases which contain different restrictions including:

• very specific user covenants limiting the use to, say, a shoe shop or a coffee shop

• allowing the landlord a right to refuse changes of use in the interests of "good estate management"
• exclusivity arrangements whereby the landlord agrees not to let other units for a specific use or to specific identified entities

Are these restrictions in breach of the law? 
Can tenants seek changes of use and threaten the landlord with reporting them to the OFT if they rely on "good estate management" as a reason for refusing the change?

Thankfully, the revised guidelines published by the OFT is an improvement on and much clearer than the first draft.  It recognises the fact that there are many legitimate reasons why a land owner might seek to impose or agree restrictions on the use of land and that only a minority of such restrictions will infringe competition law.

The OFT Guideline specifically recognises the need for user restrictions in leases in order to ensure a good mix of tenants and notes that such provisions are unlikely to be in breach of competition law.  Therefore limiting use to or prohibiting use as, for example, a shoe shop or allowing the landlord to refuse consent to a change of use in the interests of "good estate management" should not cause concern.  There are exceptions to this especially where the owner of the land is also a retailer.  For example, if Boots owned a shopping centre and in all leases for that shopping centre had an absolute restriction preventing the sale of pharmaceuticals, perfumes or personal grooming items this is much more likely to be considered an infringement.

Furthermore, exclusivity arrangements which place restrictions on the landlord's ability to let other parts of the same centre or park to a competitor carry with them bigger risks.  These can take a number of forms.  Let's take the Boots example again (nothing personal I promise).  If in a lease to Boots the landlord covenanted that it would not grant any leases within the same centre to other chemists and/or would include in all other leases of the centre a restriction on the sale of pharmaceuticals, perfumes or personal grooming items then there is a real possibility of an infringement of competition law.  The reasoning is that if no one else can sell these items in the centre this will result in reduced choose, potential for higher prices and worse service; there is no competition to encourage best practice.

Whether or not such provisions do in fact infringe competition law is not a black and white call.  This will depend on a number of things including:

• the geographical area (market) affected - for example a shopping centre such as Bluewater or the Trafford Centre may well be considered differently to the shopping arcade at Bond Street Station
• the market power of the parties concerned - for example Boots as opposed to a 5 shop franchise

There are also exemptions which may be able to be relied upon which are relevant for the shopping centre/retail park scenario.  These are applied on a case-by-case basis if the criteria is met rather than being blanket exemptions for certain types of agreement.  For example, exclusivity being granted to an anchor tenant could be justified since without the anchor tenant the proposed centre/park would not be economically viable.  Of course, this does not give a blanket exemption and the specific provisions relating to the exclusivity being granted need to be carefully considered in context to ensure that they do not go further than necessary to achieve the desired results.

In summary, the removal of the exemption from land agreements of the effects of competition law have wide ranging implications for land owners.  Shopping centre and retail park owners should carefully review and consider their agreements and developers need to consider how to operate within the rules when setting up new developments.  The good news is that "good estate management" can continue but the ability to restrict uses for the benefit of certain occupiers or the landlord is severely restricted and has become another legal tightrope for landlords to walk if they are to avoid expensive and image-damaging litigation and negative publicity.

Lost in translation: The joys of international clients

I was talking to a friend who described to me a fascinating exchange he had had with a foreign client.  Below is a hypothectical (but based on real events) transcript of an exchange between a UK real estate lawyer and a South East Asian investor client looking at buying some pretty expensive real estate in London.

Client:  I need to understand the risks associated with tenants exiting the property?
Lawyer:  The lease is for a 20 year term and there are more than 17 years left to run so the issue does not really apply to this property.
Client:  I know the term has more than 17 years left but what if the tenant leaves early?
Lawyer:  If Leman taught us anything it is that no tenant is too big to fail but this tenant has a triple-A rating so it is very unlikely that it will fail in the short term.  The assignment provisions ensure that any new tenant would need to be at least A-rated.
Client:  But what if the Tenant just walks away?
Lawyer:  There are no break options in the lease so he cannot.
Client:  But what if he just does?
Lawyer:  It is a major listed plc, it would be easy to pursue it for the rent and liabilities.  It is very unlikely as there would be reputational damage to the tenant as well.
Client:  But what if he just tore up the lease?
Lawyer:  The tenant does not have any right to tear up the lease.
Client:  Yes he does, he has a right to walk away whenever he wants.
Lawyer:  There is no right in English law to walk away from a lease.
Client:  There is in South East Asian law.
Lawyer:  Okay, now I understand your concern.  You do not need to worry.  As this property is in England and there is no right under English law for a tenant to just walk away this is not a risk for you.
Client:  But in S.E.A. there is; how do we deal with this risk
Lawyer:  I'll get back to you.

Any suggestions for the poor lawyer how he should get his S.E.A. client comfortable that English law is relevant and that the risk he perceives to exist does not actually exist?

Real Estate investors and the VAT increase: a non event?

The great thing about value added tax (VAT) is that, unlike other taxes, for many involved in business the tax represents a cash flow issue as opposed to a hard cost.  The ability to offset input tax against output tax and recover your VAT means that for those providing B-2-B services the impact of the VAT rise on them and their customers is significantly more limited.
On the face of it the commercial real estate market should be similarly protected.  After all, once a property has been opted to tax the owner can charge VAT to its tenants and recover its VAT that it incurs from its suppliers.
But, as always with tax, the position is not quite so simple.
First of all it is not always possible to opt to tax and, in some cases, an option to tax can be disapplied.  Where this happens the owner of the property may not be able to recover its VAT costs relating to the building and where it has claimed it may be forced to pay the monies back to HMRC.
Secondly, there are certain classes of business that cannot recover VAT.  From the city perspective the one encountered most often is financial institutions.  This is a significant issue since for these class of tenants any VAT on the rent is a hard cost and not a mere cash flow issue.  Therefore before deciding whether to opt to tax a property (if the choice exists) it is important to consider what sort of tenant you are targeting.  In a mixed use scenario this can be quite complicated and you need to balance all the drivers before making a decision.
Another reason the VAT position will affect property is because stamp duty land tax is calculated on the VAT inclusive consideration.  So where a property is being acquired and it is not a transfer of a going concern (TOGC) SDLT will be calculated on the price plus VAT.  In that scenario the effect of the 2.5% increase in VAT is an additional SDLT liability.  In the lease context the effect is larger since you are considering the NPV of all future rental payments including the VAT element.  In both cases it does not matter that the buyer/tenant can recover the VAT.
So whilst the increase in the VAT rate on the face of it might not seem that important in the real estate context when you look at it in a bit more detail you realise that getting your VAT decisions right at the outset could have a significant effect on the financial performance of your real estate assets over the long term.

JJB warns of financial breach - a threat to the CVA model?

JJB warns of financial breach Online Property Week
This was the headline which is sending shivers down the backs of Landlords across the country whether or not JJB is actually a tenant of theirs for a number of reasons.

1. JJB, whilst not a bell weather for the retail sector per se, is a large enough retailer that if it is failing to perform it is indicative of issues in the market generally.
2. JJB, utilised a Creditors Voluntary Arrangement (CVA) to much fanfare in 2009 - one in a line of large retailers to do so.  At the time I considered the reasons why one CVA is successful whereas another is not.  Now that the outcome of that CVA is not looking positive Landlords may be concerned regarding the other CVAs which they approved.

As a real estate restructuring lawyer the potential failure of JJB to turn itself around despite the CVA creates an interesting dimension.  The whole argument of a CVA is that the creditors overall will get a better deal than if the company entered administration or liquidation.  Creditors are asked to forgo a proportion of their debt and/or agree revised payment terms in order for the company to continue trading.

For landlords the deal has always been a difficult one.  In a retail CVA there are always some properties the company wishes to exit and the landlord is forced to decide between accepting a liquidated damages offer or taking its chances in an insolvency.  It seemed that JJB (and others like Focus DIY and Blacks Leisure) had managed to work out the correct level of compensation to pay landlords to get them to agree the CVA.

However, if companies that have been through CVAs begin to fail again a couple of years later landlords are going to be left asking themselves whether the problems facing the company where not really the leases but rather the management or the business itself.  Bearing in mind the cost to landlords of considering the CVA terms one wonders whether some will come to the conclusion that it is just not worth it and refuse to back CVAs in the future.

Only time will tell but for now anyway, all JJB's landlords are not sleeping quite so soundly at present.

Redefining the landlord and tenant relationship - back to being radical again

In July 2009 I wrote a blog about how we need to be more radical in relation to Commercial Leases and the Commercial Lease code (see Commercial Lease Code: Let's Be Radical).  Therefore I was most interested to read a Property Week interview with Lawrence Hutchings, Hammerson's managing director UK retail in last week's Property Week in which Lawrence clearly argued for action to be taken "to satisfy both retailers and global investors in the UK retail property arena".

Lawrence specifically makes mention of how landlords negotiate with tenants and expressed a clear belief that "Changes in the landlord and tenant relationship will be structural".  Indeed Hammerson has altered its own internal structure to improve its relationship with tenants by delivering better service performance.

I continue to hold the view that creating an industry standard lease for lower value and/or smaller units would further help improve the landlord and tenant relationship.  It would reduce deal times, deal cost and deliver certainty for both parties.  I may be doing some lawyers out of work but, as I always say to my client, my job is to identify the best way for you to achieve your commercial objectives.  If there is a cheaper and quicker option that is the route my client should take even when the result is little or no work for me.

Anyone else interested?  Please let me know.

Good Harvest Take 2

As many of you know on 23 February 2010 Mr Justice Newey shook the foundations of Landlord and Tenant relationships with his first instance decision in Good Harvest Partnership LLP v Centaur Services Ltd. In that decision he held that certain provisions in the lease in question which sought to require the tenant's guarantor to guarantee the obligations of the incoming assignee were in breach of the anti-avoidance provisions of the Landlord and Tenant (Covenants) Act 1995. This limb of the decision was, in the large part, unsurprising.
However, in that decision he also cast significant doubt as to whether any obligation on a guarantor of a tenant to guarantee the obligations of the tenant pursuant to an authorised guarantee agreement (AGA) would be enforceable; this was not expected and has worried landlords and their lawyers.
There was, and is, a large body of opinion that the statements by Newey J were simply wrong and do not stand up to scrutiny. Hopes for a clarification from the Court of Appeal were dashed when, having appealed against the decision, Good Harvest settled just before the appeal was heard leaving the doubts unanswered.
On 1 November 2010 Mr John Randall QC sitting as a deputy High Court judge issued summary judgment in K/S Victoria Street v House of Fraser (Stores Management) Ltd and others ([2010] PLSCS 278) regarding the enforceability of provisions which provided that on an intra-group assignment the current parent company guarantor must stand as guarantor of the assignee. In line with the Good Harvest decision Mr Randall QC held that this requirement was in breach of the anti-avoidance provisions of the LTCA 1995 and should be struck out of the document.
However, interestingly, Mr Randall QC stated that he had come to the decision to follow the ruling in Good Harvest notwithstanding that the reasoning in Good Harvest was flawed.
Once again success for a tenant regarding the unenforceability of a provision seeking to keep a guarantor on the hook post assignment but once again a case which does not reflect the more common situation whereby a guarantor (as part of its original guarantee or as a condition of an assignment) guarantees the tenant (not the assignee's) obligations pursuant to the AGA. The view remains that certainly where the guarantee is contained in the original guarantee and probably where it is entered into at the time of the assignment such an arrangement should not fall foul of the anti-avoidance provisions of the LTCA 1995 and should survive a challenge. Of course the devil is in the detail.
Any ruling to the contrary would have a significant detrimental effect on the ability to rely on guarantors to prop up weaker covenant tenants.

McGoldacre: A Scottish lilt on rent and admin expenses

In January 2010 I posted a blog on the decision in Goldacre (Offices) Limited -v- Nortel Networks UK Limited (in administration) in which the High Court ruled that where an administrator uses a leasehold property for the benefit of the administration on a rent payment day then the whole quarter's rent is payable as an expense of the administration.
Now a court in Scotland has produced a carbon copy in slightly different circumstances. In its decision in Cheshire West and Chester Borough Council -v- Springfield Retail Limited (in administration) the in the Outer House of the Court of Session Lord Menzies held that the fact that the person in actual occupation was neither the administrator nor the company in administration but rather a licensee of the company in administration, was not relevant and that since the licensee had been let into occupation by the administrator as part of a sale of the business then the rent was due as an expense.
Frankly the decision does not come as a surprise. It would be strange if the court had held that administrators could allow a third party into occupation of a leasehold property and that in doing so they would not be liable for the rent as an expense. To do so would create a significant arbitrage opportunity whereby third party licensees could run businesses out of leasehold property of companies in administration where the landlord had no contractual right to rent from the licensee and only an unsecured claim against an insolvent company.
Therefore, in reality the case tells us nothing new and does not answer a number of fundamental questions which the decision in Goldacre raise including:

1. If the administrator goes into occupation the day after a rent payment day will none of that period's rent be payable as an expense?
2. Are dilapidations arising during the period of administration an expense of the administration?
3. If there is a sub-tenant in occupation who carries the credit risk of that sub-tenant defaulting? Does it affect the analysis if the company in administration does not continue to use the remainder of the premises?

Carbon Reduction Commitment: Another victim of the austerity budget

The Spending Review 2010 found some innovative ways to increase the Government's revenue by using the CRC Efficiency Scheme.
One of the tools to be used was a statutory scheme whereby all participants would initially buy their annual Allowance through a bidding process. Initially the number of Allowances was to be unlimited but then it was to be capped thus encouraging participants to reduce the Allowance they require and save them money.
The second part, and what might be called the carrot, of the scheme was that the revenue generated by the auction of Allowances would be recycled to the participants so that, as you might expect, the best performers would receive the reward in the form of cash back.
In the Spending Review 2010 two major decisions were revealed:

1. The first sale of Allowances will be in 2012 rather than 2011.
2. Revenue from the sale of Allowances will be used to support public finances rather than recycled back to Participants.

The second decision is a significant change as it means that the league tables to be produced will now only have a reputational impact as opposed to a financial and reputational impact. Whilst many owners and occupiers will be concerned regarding their reputation and green credentials the cost-benefit of reducing emissions becomes much harder to justify on a reputation only basis unless one is significantly behind ones peers.

A knock on effect for Landlords is that whereas before there was some possibility of recouping some of the costs of compliance by moving up the league tables and receiving the reward of "revenue" from the sale of Allowances; now compliance is a fixed cost with no direct financial return. Depending on the terms of service charge provisions in leases it may not be possible to recover the cost of compliance from tenants. This will create an irrecoverable cost which must be deducted from the "bottom line" meaning values will suffer.

All landlords should instruct their lawyers to review the terms of their service charge drafting to ascertain whether or not the cost is recoverable. If it was before the change announced in the SR2010 then nothing will have changed. If it was not it may be now.

Rent is an administration expense - but at what cost?

A recent decision in the High Court (Goldacre (Offices) Limited -v- Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch.)) has confirmed that where an administrator makes use of a leasehold property the rent reserved by that lease will be an administration expense. This is in accordance with most practitioners' prior views.

However, the case did decide some other related points which are, in some ways, surprising as follows:

1. the amount of rent which becomes an expense of the administration does not relate to the area occupied. Use of a small part of the premises demised will make the whole rent reserved an expense of the administration;


2. if the administrator is using the premises on the rent payment date then the whole period's (e.g. quarter's) rent will be payable as an administration expense even if the administrators' use ceases during the relevant period.

These two points could have interesting implications. The corollary of (1) might be that where the premises are part sub-let and the administrators continue to use the other part then it may be that the administrators are exposed to the credit risk of the sub-tenant default. The corollary of (b) might be that where the administrator is not using the premises on the rent payment date then there is no liability for the rent as an expense even if the premises are used for the remainder of the relevant period.

Neither of the above points were directly addressed in the judgment.

It should be noted that the fact that it is now confirmed that rent will be an expense of the administration if the administrators are using the premises does not mean that the administrators have to pay it on the due date and in full. This is still dependent on there being sufficient realisable assets out of which the rent can be paid. This was expressly confirmed in the judgement.

So whilst the case confirms a generally held belief it has muddied the waters for both landlords and administrators in some regards and altered the balance of power slightly but with the administrators arguably still holding the upperhand through the benefit of the moratorium.

Tenant CVAs - what makes them acceptable?

This year has seen a new phenomenon being cemented on to the toolkit of the struggling retailer which, in my opinion, was not anticipated prior to 2009 - the large retailer Creditors Voluntary Arrangement (CVA).

For those not necessarily in the know a CVA is effectively a binding agreement reached between a company and its creditors where the creditors will agree a delayed repayment and/or write-off of debts. The agreement is limited in time (a maximum of 2 years) and is monitored by an independent party. For creditors generally (and most importantly unsecured creditors) the process is preferable over administration or liquidation since in those processes the likelihood is that the unsecured creditors will get little or no p/£ of debt. The attractiveness for secured creditors is that it is cheaper than administration and thus should protect the value of the secured assets within the business whilst they retain their security over them.

The year started off very badly for the CVA when, in February, a CVA proposed by the administrators of the Stylo Group (then owner of the Barratts and Priceless shoe chains) was voted down by its creditors and most vehemently by its landlords. At that point one would have been forgiven for thinking that the view following the Powerhouse decision that CVAs were not appropriate where significant leasehold property interests were involved.

However, since the Stylo CVA proposal was defeated quite the opposite has occurred with successful CVAs being agreed on a number of large retailers including JJB Sports and Focus DIY. The latest instalment is a vote today by the creditors of Blacks Leisure on its CVA proposal. It is anticipated that it will be successful (see FT.com article).

The question is what is different about the post-Stylo CVA proposals that have made them successful where Stylo failed? Is it that the market has changed? Is it that Stylo simply broke a taboo and after venting their anger at Stylo landlords have since been more agreeable?

The answer is most likely a mixture but when you look at the detail of the proposals there is a fundamental difference between the unsuccessful Stylo proposal and the other successful proposals. That difference is money and control.

In Stylo every single landlord would have lost out as the proposal involved changing all rents to a turnover rent initially at 3% increasing to 7% (very low levels compared to normal turnover rents) and without a floor. Landlords were invited to seek to obtain better deals in the market and if successful Stylo could either match the deal or surrender their lease. The good news on the Stylo deal was that there was no landlord immediately facing a closed store with irrecoverable cost. The bad news was that the income landlords would obtain was totally dependent on the performance of the tenant. For stores with little or no likelihood of re letting in the medium to long term this was probably okay as at least void costs were avoided. But for landlords of stores that were in good areas the reduction in rent was unacceptable.

Moreover, Stylo was not guaranteeing that every store would then be safe as it sought an ability to surrender those stores it chose during the life of the CVA. There was to be no compensation to landlords for taking back their stores and no protection from void costs. It is probably this exposure that was the ultimate issue for landlords.

Compare that to the successful CVAs which have some or all of the following features:

• No additional store closures over and above those that had already closed (i.e. landlords knew if their site was closed)
• No rent reductions although movement to monthly rent payments
• On closed stores the tenant would continue to pay the rates (landlords were protected from this oppressive liability)
• A pot of money (normally equal to 6 months' rent) was distributed between the landlords of closed stores as compensation

The difference is huge. On the successful CVAs Landlords knew where they stood immediately. Closed store landlords knew that in an administration they would get nothing whereas in the CVA they would get compensation and be protected from void rates whilst the lease subsisted. Open store landlords were asked for concessions which they would probably have given without a CVA.

What the above highlights more than anything else is that timing matters. Clearly, for Stylo to have proposed a CVA along the lines of the successful proposals it would have required significantly more cash to cover the large expenses. This would have meant a CVA being proposed a lot earlier than it was. In the end the timing was wrong. To have a successful CVA you need to have sufficient funds to "buy off" the worst off creditors (i.e. landlords of closing stores). This requires the directors to be brave enough to recognise the issues and see the potential for a better result for creditors and stakeholders alike by taking early pre-emptive action when the company can afford it.

Whether the successful CVAs will actually result in successful companies in the future only time will tell but, at least for the landlords, the CVA was a less bitter pill in the short term.

FRI Leases in a recession - not always the protection you expect

The Financial Times reported today that "Maintenance Cuts threaten property values". For those who cannot be bothered the article what it says it that whilst UK property is generally let on full repairing and insuring tenant covenants landlords are cutting back on repair and maintaining those parts of the properties for which they have responsibility and for which they recover the cost through the service charge due to fears over whether the costs are recoverable arising from tenant default and increasing voids. Meanwhile, landlords are facing an increasing number of void units in disrepair due to tenants failing to repair and then becoming insolvent.

The failure by landlords to carry out anything but the most urgent of repairs is, of course, a double edged sword for a landlord. It exposes the landlord to the risk of tenants seeking to enforce landlords' repairing obligations (although this might be unlikely save where the disrepair is likely to damage the tenant's business). More importantly, it makes reletting the unit at the best rent very difficult since the centre in which the unit is quickly becomes dilapidated and less attractive to potential tenants. Hence, one could argue that failing to repair is only prolonging the pain for the landlord. In truth, however, landlords will probably wait until real signs that the market is picking up before deciding to carry out repairs. The timing does need to be right since if a competing location is in better repair and condition it may prove more attractive and take away potential new tenants.

Repair of individual units is even more tricky for landlords. Is there any point in carrying works of repair to a vacant unit with little chance of letting. On the other hand what chance is there of letting a unit in disrepair and what effect will this have on rent. Some landlords may opt to wait until a potential tenant is found and then agree to put the property in repair (or pay a reverse premium to the tenant to do this). This means that the level of rent should not be affected. However, a tenant looking to move in quickly (especially in the run-up to Christmas to make the most of the holiday trade) is more likely to opt for a unit ready to go.

Finally, all landlords (and tenants when landlords are carrying out works) would be well advised to check carefully the terms of service charge provisions in the various leases to check what works are recoverable and what are not. How are voids treated? What are the obligations in terms of repair?