Landlords’ “Super Priority” for unpaid rent of insolvent tenants


Landlords’ “Super Priority” for unpaid rent of insolvent tenants

Introduction

With the full impact of Stage 4 Restrictions on Victorian businesses yet to be felt, the Federal Court of Australia decision in Ford (Administrator), in the matter of The PAS Group Limited (Administrators Appointed) v Scentre Management Limited [2020] FCA 1023 (“Ford“), handed down on 21 July 2020, represents a significant win for landlords of insolvent companies.

The case settled an important question as to the priority of rent incurred during the period of an administrators’ statutory moratorium on liability (i.e. the “standstill period”), in circumstances where a company continues to use and occupy leased premises to carry on its business.

Ultimately, the Court decided that rent incurred in those circumstances would be properly incurred in carrying on the business of the company under s. 556(1)(a) of the Corporations Act 2001 (Cth), and prioritised over other unsecured debts in any subsequent liquidation, in accordance with the “Lundy Granite” principle.

Background

On 29 May 2020, PAS Group Ltd (“PAS Group”), an Australian-based fashion group, went into administration, primarily as a consequence of the COVID-19 pandemic and the collapse of Harris Scarfe.

Prior to administration, PAS Group leased 166 premises.  Following the administrators’ appointment, PAS Group continued to trade from all but 8 of the retail premises.

The administrators of PAS Group obtained an order to extend the “no personal liability period” for rent from 5 business days from 29 May 2020 to 22 June 2020 (“the “standstill period”).

The total unpaid rent incurred during the standstill period was approximately $1.385M. The PAS Group generated approximately $7.32M in revenue from trading from the leased premises during that period.

The administrators sought a declaration that rent incurred during the standstill period amounted to an unsecured debt, which was not entitled to priority over other debts in any subsequent winding up.

The declaration was opposed by Scentre Management Ltd (“Scentre”), the largest lessor of premises to the PAS Group.  Scentre argued that rent incurred during the standstill period should be treated as an expense properly incurred in carrying on the business of the PAS Group, within the meaning of s.556(1)(a) of the Act, and thus afforded priority in accordance with the “Lundy Granite” principle.

Lundy Granite principle

It has long been the case that expenses incurred to preserve, realise and get in property of a company, or to carry on a company’s business, are payable in priority in any subsequent liquidation.

The relevant principle, often referred to as the “Lundy Granite”[1] principle, operates in circumstances where an administrator (or liquidator) elects to cause a company to continue to have “beneficial occupation” of leased premises (i.e. the company continues to trade from those premises).  In those circumstances, the rent incurred during the period of beneficial occupation  is payable as an expense of the external administration, within the meaning of s.556(1) of the Act, and prioritised over other unsecured debts.

The rationale behind the principle is that an external administrator obtains a benefit for the company (and, by extension, its creditors) by remaining in occupation, and trading-on, from the premises.

The Court’s decision in Ford

In Ford, the administrators argued that:-

  1. A landlord’s claim for rent under a pre-administration lease was an ordinary unsecured claim against the company.
  2. The standstill period rent was not a debt “incurred” within the meaning of s.556(1) of the Act, because the administrators’ were not personally liable for rent in that period.
  3. The Lundy Granite principle had been supplanted by s.443B of the Act (which sets out the circumstances in which administrators are personally liable for rent) and should not be applied to expand what debts may be payable in priority under s. 556(1) of the Act.
  4. The voluntary administration regime is intended to balance creditors’ interests, and applying the Lundy Granite principle in the present circumstances would create a “super priority” for landlords.

The Court did not accept the administrators’ arguments, and their lack of personal liability for the standstill rent was considered to be irrelevant. Rather, the Court considered the only relevant question to be whether the rent was an expense incurred in carrying on the business of the PAS Group.

The Court considered the fact the administrators had operated the PAS Group on a “business as usual” basis, during the standstill period, to be clear evidence of their election to continue the company’s occupation of the premises. Consequently, the standstill rent was properly incurred in carrying on the business of PAS Group under s. 556(1)(a) of the Act.

Ultimately, the Court refused to make the declaration sought by PAS Group’s administrators, and accepted the unpaid rent owing to Scentre (and other landlords of PAS Group) would have priority over other unsecured debts in any subsequent winding up.

Consequences

The Ford case settled an important question as to the priority of expenses incurred during the period of administrators’ statutory moratorium on liability. However, there remain some areas of uncertainty for administrators, noting that the Lundy Granite is grounded in the idea of “beneficial occupation.”

We expect that the priority to be afforded to landlords’ unpaid rent will increasingly feature in upcoming external administrations. This is particularly so as the pandemic takes a toll on many businesses, and as the end of the moratorium introduced by the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) on statutory demands and bankruptcy notices on 15 October 2020 nears (although, some media outlets are reporting that the Commonwealth may extend the moratorium).

Mark Pennini
Lawyer

Emily Clapp
Graduate at Law


[1] Re Lundy Granite Co, ex parte Heavan (1871) L.R. 6 Ch. App. 462

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