Thursday 31st July 2008
With the continuing economic downturn, Wayne Parker, newly appointed insolvency partner at Leeds and Bradford law firm Gordons, warns landlords to be vigilant to ensure tenants do not reorganise their way out of rental obligations.
The past 12 months have been difficult for pubs and nightclubs. The credit crunch, smoking ban and poor weather have dampened appetites for a night out, leaving previously profitable venues struggling and leading tenant companies to use increasingly complex means to avoid long-term rental liabilities.
One approach involves reorganising a tenant group by a series of name changes or transfer of assets and shareholdings. If such a process involves a parent company guarantor, its covenant strength can be weakened, thereby devaluing the strength of the guarantee and further jeopardising the landlord’s investment.
During a reorganisation, the rent may be paid by a group company. It is only when payment ceases that the landlord will discover its tenant has become nothing more than a shell. While there may be perfectly legitimate commercial explanations for such reorganisations, it is also possible that unscrupulous directors of tenant companies are looking to rid themselves of payments they cannot make.
If the tenant enters into an insolvency process, the landlord joins the list of other creditors seeking recompense and will be forced to challenge any reorganisation retrospectively under the provisions of the Insolvency Act 1986.
The risk of complex, multi-stage group reorganisations to remove the covenant strength of a tenant or a parent company guarantor means landlords are increasingly being advised to request rent deposit deeds, creating the additional burden on tenants of providing cash sums when they enter into leases.
A landlord without the benefit of a rent deposit should monitor which entity is paying rent in order to spot early warning signs.
It could be that the original tenant’s long-term plan might actually be to divest itself of its assets and leave a shell company behind. The landlord might be receiving rent from another company within the group, while the tenant divests itself of its own assets by way of a reorganisation.
However, landlords should be vigilant and watch out for subtle changes or telltale signs that its tenant’s assets are being dissipated, possibly for genuinely commercial reasons, but perhaps for more sinister purposes.