If a commercial tenant becomes insolvent, a lease can quickly turn from a valuable asset into an expensive ongoing liability. Disclaimer gives a liquidator - or a trustee in bankruptcy where the tenant is an individual - a statutory route for bringing the insolvent estate’s interest in onerous property to an end.
For landlords, tenants, subtenants and guarantors, though, that isn’t necessarily the end of the story. Disclaimer can affect who occupies the property, who can still be pursued for money, and whether someone else can ask the court to take over the leasehold interest. This guide explains how the process works and the practical choices you may need to consider.
If you’re dealing with an insolvent tenant or a lease that may be disclaimed, our experienced commercial property solicitors can help you assess the risks, protect your position and decide what to do next.
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
- Dealing with a disclaimer
What does it mean to disclaim a lease?
In an insolvency context, disclaimer allows a liquidator or a trustee in bankruptcy where the tenant is an individual, to bring the insolvent estate’s interest in an onerous lease to an end. 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. In practical terms, disclaimer brings the insolvent tenant’s interest and liabilities under the lease to an end, although rights and liabilities involving other parties may continue. This can of course have a profound impact on landlord’s expected rental income.
What is a vesting order for a disclaimed lease?
A vesting order is a court order that can transfer disclaimed property to an eligible applicant. It can be particularly important where someone else has an interest in the lease and wants to preserve that interest after the tenant’s insolvency.
The right to apply isn’t limited to someone who owns a proprietary interest. Broadly, an application can be made by someone claiming an interest in the disclaimed property or someone who remains subject to a liability relating to it. Depending on the circumstances, this can include an subtenant or mortgagee.
There are tight timescales. An application generally needs to be made within three months of the applicant receiving notice of the disclaimer or otherwise becoming aware of it, although the court has discretion to extend that period. If leasehold property is vested in an applicant, the court will determine the terms on which that happens. Anyone considering an application should weigh the value of preserving their interest against the liabilities they may assume.
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?
From the effective date of disclaimer, the insolvent company’s rights, interests and liabilities in the disclaimed lease are brought to an end. That removes the continuing leasehold burden from the insolvent estate and prevents further value being consumed by property which no longer benefits creditors.
The effect on other people is different. Their rights and liabilities aren’t automatically brought to an end simply because the tenant’s interest has been disclaimed.
That distinction is important. A landlord, guarantor or subtenant may still have decisions to make after disclaimer has taken place.
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?
Subtenants are one of the reasons the effect of disclaimer can become complicated.
Where the insolvent tenant has granted a sublease, disclaimer ends the insolvent tenant’s interest and, as a consequence, the sublease created out of that interest. However, that doesn’t necessarily mean the subtenant has to leave immediately.
The Insolvency Service explains that a subtenant can remain in possession for the term originally granted, provided the obligations corresponding to the head lease are complied with. If those obligations aren’t met, the superior landlord may have a right to re-enter.
The difficulty is that continued possession isn’t the same thing as having the head lease vested in the subtenant. Depending on what the subtenant wants to achieve, it may need to consider applying for a vesting order. The timing and terms of any application are important, so this is a situation where early advice can make a real difference.
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.
The landlord should consider potential recovery routes before taking steps that could affect those rights, particularly where significant arrears or valuable guarantees are involved.
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.
Dealing with a disclaimer
A lease disclaimer can remove a significant ongoing liability from an insolvent company’s estate, but its effects spread well beyond the tenant itself.
For a landlord, disclaimer may mean losing the right to future rent from the insolvent tenant and being left with an unsecured insolvency claim. But other rights may still remain - against a guarantor, former tenant or another party - and a subtenant may continue to occupy the property or apply to have the lease vested in it.
The important thing is not to assume that disclaimer automatically ends every relationship connected with the lease. If you’re a landlord, tenant, guarantor or subtenant affected by an insolvency, our commercial property solicitors can help you identify what rights and liabilities remain, assess the available recovery or occupation options and decide which route best protects your commercial position.
