deserving creditors: never mind the expense?
There has been a recent trend for an increasingly diverse range
of claims to be paid, in whole or part, as "expenses" in formal
insolvency procedures. Where the creditor is able to bring itself
within this principle then this will not only be at the cost of
unsecured creditors generally, but normally also the insolvency
practitioner (IP), acting as administrator or liquidator, who will
have to accept that the creditor's claim has priority over his
remuneration. The difficulties which this poses for the "rescue
culture" ,and in particular for administration, has been
highlighted by R3 which is the professional association
representing insolvency practitioners.
In Re MK Airlines Property Ltd (16 May 2012), the
category of insolvency expenses was further extended where the
judge decided that the principle applies equally where a
provisional liquidator is appointed in respect of a company as it
does in the more usual case where a company is in liquidation or
administration. Whilst MK Airlines was another example of
the most common case where the creditor was a landlord, the judge
reiterated that the principle is of more general application. In
essence it can assist any creditor who has a claim under a contract
that was entered into before the commencement of the formal
insolvency. Whilst such a creditor is normally only entitled to
prove in any liquidation for its estimated future loss (ie damages
for the company's failure to pay rent, or otherwise honour its side
of a contract), more often than not this right to prove as an
unsecured creditor is of little or no value.
Where the IP, acting as provisional liquidator, liquidator or
administrator, decides that the company should continue to accept
the benefit of a contract because this will be of benefit to
creditors there is a long established principle that, during the
period for which such benefit is conferred and accepted, the
company must in turn discharge its obligations under the contact.
This is sometimes called the "Lundy Granite principle"; reflecting
the name of the nineteenth century case where the principle was
restated in the context of liquidation.
The most usual situation where a creditor under a pre-insolvency
contract can rely on the principle is when it is the landlord of an
insolvent company so that sums full due for payment under the terms
of a lease. However, as noted above, it is important to remember
that there could be other situations where the principle will apply
(eg an equipment lease or an intellectual property licence). In the
case of a lease of premises, the rule is that it is only fair and
equitable that if a company that is the subject of a formal
insolvency uses premises then any liability that accrues from such
use during the relevant period is to be treated as if it were an
expense of the insolvency and paid accordingly. For these purposes
it was explained in MK Airlines that the relevant period
is any time when the IP's motive was to retain the premises for the
convenience and benefit of the insolvency, provided that the
premises were in fact being so used at this time.
Whilst it is often a fine line, the distinction that is often
made is between an IP who allows a company to continue to trade
from the premises during the insolvency, which is clearly "using"
the premises, as compared with simply allowing equipment to remain
at the premises, which is not. It would also seem that premises are
being "used" where they are occupied by somebody with the IP's
consent under the terms of an informal licence that has been
granted without the landlord's permission, normally a buyer of the
company's business who may want to negotiate a formal assignment of
the lease if that's possible. The difficulty in drawing the line as
to when premises are being "used" can have significant implications
as the period of use also defines the period of liability and in
this respect the recent cases, including MK Airlines,
underline the potential for significant asymmetry.
Whilst it might be thought that in fairness an IP should only be
obliged to pay for the period of actual use by the company, the
judge in MK Airlines confirmed the strict rule that has emerged
from the recent cases that requires any liability that falls due
during the period of use to be paid as an expense. The harshness of
this rule is particularly well illustrated by leases and other
contracts that require payments to be made in advance. If such a
payment falls due during the period of use then it is payable in
full as an expense whether or not it relates to the period of use
(eg even if the IP stopped using the premises the day after a
quarter's rent falls due the full amount will still be payable as
an expense). Unless the creditor's agreement can be obtained to
some sort of pay-as-you-go arrangement (which used to be the
default position for landlords with tenants in administration),
this has the potential to drive uncommercial behaviours; for
instance, artificially timing administrations to commence just
after a rent quarter day and to vacate just before the following
quarter day on the basis that since nothing falls due during the
relevant period nothing is payable.
However, it is not just rent which the IP runs the risk of
having to pay. Arguably any sum that accrues due under a lease
during the relevant period could be an expense. Thus if the
landlord had a claim for breach of covenant that crystallised
during the period of use this should arguably be treated in the
same way. So for example it may be that a claim for breach of lease
covenant that arises during the relevant period should be treated
as an expense (e.g. the cost to the landlord of making good any
disrepair). Where it is possible to do so a landlord may therefore
be tempted to explore the possibility of accelerating claims under
the lease so that any amount that falls due can be claimed as an
insolvency expense; rather than waiting until the premises are no
longer being used at which point any remaining claim will be
unsecured. Indeed, it may well be sensible to review existing
standard form leases with just this possibility in mind.
