In this guide, our experienced commercial property solicitors explain what it means to disclaim a lease and the impact it has on commercial landlords and tenants.
Contents:
- What does it mean to disclaim a lease?
- What is a vesting order for a disclaimed lease?
- Who can disclaim a lease?
- What are the legal grounds for disclaiming a lease?
- How does a disclaimer of a lease affect the tenant?
- What obligations remain for the tenant after a lease is disclaimed?
- What happens to subtenants when a lease is disclaimed?
- What is the impact of a disclaimed lease on the landlord?
- How do you disclaim a lease?
- What happens to a lease when it is disclaimed?
- Alternative options
- Summary
What does it mean to disclaim a lease?
To disclaim a lease means to renounce one’s claim over the leased premises. In the context of tenant liquidation or insolvency, disclaiming a lease refers to the process by which a liquidator (or trustee in bankruptcy for individuals) elects to renounce the lease agreement as part of winding up the tenant's affairs. This relieves an insolvent tenant of any ongoing rights, obligations and liabilities under the lease. Essentially, a disclaimer extinguishes a lease before its natural expiry. This can of course have a profound impact on landlord’s expected rental income.
What is a vesting order for a disclaimed lease?
This is a court order that third parties affected by the disclaimed lease can apply for so that it vests in their name (ie belongs to them). That said, it cannot just be anybody affected by the lease – in general, you must have a proprietary interest in the lease to be entitled to a vesting order, such as a subtenant, mortgagee or guarantor of the lease.
Who can disclaim a lease?
To answer this question, it is first worth visiting the difference between liquidation and administration. When a company goes into administration, the aim is to rescue the company by helping it repay its debts. Liquidation is very much the end of the road and aims to close the company. Unlike a liquidator, an administrator does not have the power to disclaim the lease.
Going into administration results in a moratorium imposed on legal action against the company. This gives it breathing space to get its affairs in order, if possible. When it comes to the lease, if administrators continue to use or occupy the premises for the benefit of the administration, then rent will continue to fall due as an administration expense. The administrator can choose to stop paying rent, but this leaves the landlord in a line of unsecured creditors to recover arrears.
What are the legal grounds for disclaiming a lease?
- Onerous property: to be able to disclaim property that an insolvent tenant has an interest in, it must bring with it some ‘onerous’ obligation. In this sense, liability for rent payments and performing other tenant covenants in a lease are considered onerous. That said, the liquidator should consider whether there is value in the lease exceeding any obligations attached to it and whether it is ready to sell.
- Whole lease: if a lease is to be disclaimed, it must be in respect of the whole lease and not part only.
How does a disclaimer of a lease affect the tenant?
As far as the tenant is concerned, they are absolved of all interests, rights and liabilities of the leased property once it is disclaimed (both as between themselves and their landlord and any tenant if the property is sublet).
What obligations remain for the tenant after a lease is disclaimed?
If the lease has come to a premature end, the tenant is released of liabilities in connection with the property. Any continuing or ongoing obligations would defeat the purpose of disclaiming the lease for an insolvent tenant in liquidation.
That said, a disclaimer does not absolve one of past liabilities and any obligations that arose before the disclaimer was made. This means that debts incurred prior to the start of liquidation must still be settled as unsecured debts. Similarly, debts that arise or accumulate between the commencement of liquidation and the date of the disclaimer also need to be settled.
What happens to subtenants when a lease is disclaimed?
Although the insolvent tenant’s rights and liabilities out of which a sublease is created are effectively ended when the lease is disclaimed, subtenants have a right to remain in possession for the term granted. This is provided they comply with the terms of the head-lease (ie the original and now disclaimed lease between the landlord and the insolvent tenant). The subtenant’s continued occupation of the premises is subject to their paying the rent due and performing any covenants set out in the disclaimed lease. If it fails to do so, the landlord can forfeit the lease.
It is important to note that the terms of the head lease disclaimed lease are not enforceable between the original landlord/freeholder and subtenant. Subtenants need to apply for an order that the lease vests in them for this to be the case.
What is the impact of a disclaimed lease on the landlord?
Once disclaimed, the rights and liabilities under the lease as between the landlord and the insolvent tenant come to an end. This means the landlord no longer has the right to receive rent, or any other sums due under the lease from the insolvent tenant or expect performance of tenant covenants. The landlord would be left to claim damages in liquidation as an unsecured creditor.
The same does not apply to the rights and liabilities of former tenants and guarantors. Depending on the terms of any agreement, a landlord may look to pursue such parties to pay rent and perform the tenant’s covenants under the disclaimed lease. Their liability will cease if the landlord decides to take back possession of the premises.
If there is a subtenant in the leased property, the landlord can expect to receive rent and observance of covenants from the sub-tenant in the same terms as the disclaimed lease.
How do you disclaim a lease?
There are strict notification procedures to disclaim a lease lawfully. In general terms, the liquidator must serve a prescribed notice as follows:
- The notice must clearly identify the disclaimed property.
- The notice must be authorised and dated by the liquidator.
- Copies of the notice must be provided to relevant/interested parties within seven business days, including a mortgagee or under-lessee of the tenant company.
The lease should ideally be disclaimed as soon as possible to preserve the insolvent tenant’s estate for distribution to creditors. It is worth noting that interested parties can make a request in writing to compel the liquidator to make a decision about whether it wishes to disclaim a lease or not (known as a notice to elect). If the liquidator does not then give notice of the disclaimer within 28 days of receiving this request – the right to disclaim the property is lost, unless an extension is applied by the court.
What happens to a lease when it is disclaimed?
The lease effectively comes to an end from the date of the disclaimer. Any rights, interests and liabilities in respect of the leased premises are terminated. It does not affect the rights or liabilities of any third parties connected to the lease, provided their rights do not hold the insolvent company liable. A few things can happen:
- An interested third party can apply for an order that the leased property vests in them
- A subtenant (if present) remains in occupation of the property and pays rent in line with the head lease to the landlord
- A former tenant under an authorised guarantee agreement or guarantor pays the rent and/or takes up the lease
- The landlord takes back possession and grants a new lease of the premises to a new tenant
Alternative options
- Selling the lease: a liquidator must first consider whether the leased property is valuable, saleable or readily saleable before issuing a disclaimer. Selling a lease refers to assigning it to another tenant to take over. In practice, most leases are disclaimed because the time and cost it takes to find a buyer to transfer the lease to eats into the insolvent tenant’s estate thus reducing the amount available to return to creditors.
- Forfeit the lease: most modern-day commercial leases provide that tenant insolvency is a forfeiting event that allows the landlord to take back possession of the property. If you are a landlord, be very careful here and take advice from a solicitor before taking any action in this regard. By forfeiting the lease, you will also forgo any rights against former tenants and guarantors, but this may be a good option if you have found a ready and willing new tenant to takeover.
- Surrender: in the case of an insolvent tenant, the lease can be surrendered for possession back to the landlord. A surrender is when the landlord and tenant voluntarily negotiate and agree to terminate the lease before its expiration date, thus relinquishing the tenant of their rights and obligations under the lease and allowing the landlord to regain possession of the property. In practice, a disclaimer is the more appropriate method of ending a lease that cannot be sold. It can be suitable in some certain circumstances, for example, if the landlord wants to prove a quicker outcome than waiting for the 28-day period associated with the notice to elect, for eg to relet the property or if he is willing to pay consideration for the surrender.
Summary
When there is no hope of rescuing a tenant company and it is put into liquidation, disclaiming the lease is often the logical thing to do. While it might seem all doom and gloom for the landlord, it does not necessarily have to mean you are out of pocket. Whether that means calling upon former tenants or guarantors, or a subtenant taking over direct payment of rent to you – it is crucial to talk with a commercial property expert as soon as possible to ensure you take the right steps.
