Rescue operations

The recession saw many companies go into administration. Looking set to continue, one legal case offers clarity on commercial questions administrators must consider.

8 April 2010

The credit crunch has seen a number of prominent companies go into administration and as the difficult conditions continue, it is likely that we will see many more casualties during 2010. Administration is a challenging regime, with under pressure administrators often having to do battle with commercial landlords who are either desperate to maintain their rental income stream or recover their premises.

Administration is a procedure under which a company that is, or is likely to become, insolvent can be reorganised (ie: rescued as a going concern) or have its assets realised for the benefit of creditors. 

When a company becomes insolvent, there is a prescribed order in which creditors are paid. In the case of administration, this is usually:
• “Preferential” creditors (such as employees’ wages);
• Creditors with floating charges;
• Unsecured creditors.

However, the Enterprise Act 2002 amended the Insolvency Rules 1986 to provide for the payment of the “expenses of the administration” from the company’s assets in priority to all of the above distributions (Rule 2.67).

Rule 2.67(1) sets out what debts will rank as expenses of the administration and their order of priority. Any expense falling into those listed in Rule 2.67 must be paid as an administration expense.

Whether to pay rent as an expense is one of the key commercial questions that administrators have to consider when appointed. An important recent case has brought some welcome clarity to this area of law. Goldacre (Offices) Ltd v Nortel Networks UK Ltd (in administration [2009] has confirmed, much to landlords’ relief, that where an administrator uses a company’s premises (even if only a very small part), the whole rent is payable as an expense of the administration.
Prior to the decision in Goldacre, the law on whether rent was in fact an administration expense was not clear. Although in practice most administrators were paying rent on premises that the company occupied, there was uncertainty as to the extent of their obligations. Further, in light of the “moratorium” that comes with an administration, the practice of some administrators was not to consider whether to meet rent as an expense of the administration until the landlord demanded rent or threatened to seek leave to forfeit the lease.
This was in contrast to the position in liquidation, where the Lundy Granite case (1871) had established that rent in respect of premises used or retained by a liquidator for the benefit of the liquidation is to be treated as an expense.

The Goldacre case
Nortel, the telecommunications manufacturer, was the tenant of premises under two long leases which pre-dated the administration. Since Nortel had been placed into administration, the administrators had been using the premises for the purposes of carrying on the administration (but only a small part of the premises) and rent had been paid to Goldacre, the landlord.

Both the administrators and the landlord wished to determine what liability there was to pay the rent. The landlord applied to court for an order that the administrators pay the full amount of the rent as it fell due as an administration expense. The administrators argued that the court had a discretion as to whether to treat rent as an administration expense and, as the administrators were using only a small part of the premises, any liability to pay rent should be limited to rent in respect of that part. The court found for the landlord and held:
• the Lundy Granite principle applies equally to administrations and therefore rent is payable as an administration expense. Such payment is mandatory and not subject to judicial discretion.
• the use of only part of the premises did not limit the application of the Lundy Granite principle and therefore the administrators could not pay only for the part of the premises which they were using.
• the administrators were obliged to pay the full amount of the rent (that is, in this case and in most modern leases, for the entire quarter payable in advance) as and when the rent became due and there was no scope to apportion the rent should the administrators vacate the premises before the end of the quarter. This is contrary to what has tended to be current practice.
• the characterisation of rent as an expense was not necessarily determinative of when the rent should actually be paid and the landlord enjoyed no right to immediate payment. This may be relevant where there are rental and other liabilities of similar priority.