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Will longer landlord lockouts become the new norm?

26 May 2020

#Dispute Resolution & Litigation, #Property & Real Estate, #COVID-19

Kim MacKay

Published by Kim MacKay

Will longer landlord lockouts become the new norm?

In two recent decisions, the Federal Court has allowed administrators to continue to occupy leased premises rent-free for an extra month. Should landlords be worried that this trend will continue? Whilst the decisions were undoubtedly made in the extraordinary circumstances of COVID-19, it is not difficult to see a precedent being established with similar orders being made more frequently in the future.

The usual deal: Five free days

Under the usual statutory timeframes, an administrator appointed to a company has five business days to decide whether to continue to occupy leased premises[1]. After these five business days, the administrator becomes personally liable for rent and outgoings. To avoid personal liability, the administrator can issue a notice to the landlord within the first five business days of the administration and inform it that it no longer proposes to exercise rights in relation to the property. This notice does not automatically terminate the lease. However, in most cases, it will allow the landlord to terminate the lease and retake possession of the property (though landlords need to be careful to strictly adhere to their contractual rights and should seek legal advice before doing so). If the landlord does not retake possession, the unpaid rent will be treated as an unsecured debt of the insolvent company. 

The administrator’s job is to administer the business, property and affairs of an insolvent company in a way that maximises (as much as possible) the chances of the company continuing in existence or, if that is not possible, resulting in a better return for creditors and members than an immediate winding up[2]. In some cases, five business days may be more than sufficient for an administrator to determine whether the company’s viability or best outcome can be achieved by continuing to lease premises. However, the period is very short and for administrations, where the affairs of the insolvent company have any level of complexity, five business days is unlikely to be sufficient. 

The five-day period can be extended by the Court in two ways:

  • s447A of the Act allows the Court to make such orders as it thinks appropriate about how the administration rules should operate for a particular company
  • s443B(8) of the Act allows the Court to make orders relieving an administrator from personal liability for rent.

In deciding whether such orders should be made, the Court needs to determine[3]:

  • the extended rent-relief period is in the interests of the company’s creditors and consistent with the objectives of maximising the company’s chance of survival or the return to creditors
  • the proposed orders will enable the company’s business to continue to trade for the benefit of creditors
  • the creditors of the company are not prejudiced or disadvantaged by the orders sought and stand to benefit from those orders
  • notice has been given to those who may be affected by the orders.

The Court found these circumstances existed in two recent cases.

Collette Group[4]

The Collette Group, a mid-market handbag and jewellery retailer, was operating from over 100 stores before entering administration on 31 January 2020. Upon appointment, the administrators commenced a sale process. However, all prospective buyers withdrew following the impact of COVID-19 on retail operations. The administrators wished to keep open 93 stores, but they were unable to negotiate any meaningful rent relief from landlords. They then turned to the Federal Court of Australia for relief. 

The administrators sought, and obtained, relief from personal liability for rent for the 93 stores from 1 April to 14 April 2020. In a further hearing on 15 April 2020, the rent-free period was extended for a further three weeks until 6 May 2020. 

To establish that the orders were in the best interests of creditors, the administrators presented and modelled five different scenarios. Whilst the financial modelling was kept confidential, the Court confirmed that the scenario providing for a “mothballing” of the stores for two months (during COVID-19 lockdown) followed by a four-week trading period would likely result in the best outcome to creditors. This is because it would allow the administrators to re-engage with potential purchasers post-COVID to facilitate a sale or recapitalisation or, alternatively, undertake a managed wind down of the business. 

On the other hand, the Court considered there was little to no detriment to the creditors, including the landlords of the 93 stores. In respect of these landlords, the Court pointed out:

  • it was unlikely the landlords would be able to re-lease the premises during the affected period given the COVID-19 impact on retail trading
  • if the administrators were able to secure a sale, there was potential for the landlords to maintain tenanted stores and any outstanding amounts could form part of lease renewal negotiations.

The Court was careful to point out that circumstances were extraordinary and that the administrators found themselves in an ever-changing environment brought about entirely by external factors. 

Virgin Australia[5]

Three weeks later, the same insolvency firm brought an application to the same Court seeking similar relief. 

Administrators were appointed to Australia’s second largest airline operator following the dramatic shutdown of international and domestic air travel due to COVID-19. Hopes for the survival of the airline are high, with significant interest in the administrators’ sale campaign. In order to allow the business to be sold on a going concern basis, the administrators have sought to continue to operate “business as usual”, as much as that is possible in the COVID-19 environment. However, given the travel restrictions in place, it is likely that the Virgin companies would continue to generate losses throughout the administration period. The administrators sought orders from the Federal Court for rental relief for a one-month period. This extension would afford them an opportunity to determine which leases (of both real property and chattels, including aircraft) should be retained and to avoid personal liability for the costs incurred in the meantime.

The Court acknowledged that the Virgin Group makes up a very significant enterprise with substantial operations, complex affairs, considerable assets and a very large number and type of creditors. In addition, the COVID-19 pandemic has made the administrators’ task more challenging. In these circumstances, the Court considered it was not surprising that additional time was required to identify and retain assets necessary to preserve and enhance the value of the Virgin Group’s operations as part of a positive restructure of the business. 

The Court accepted that, in determining the application, it was important to balance the interests of different creditors. In the present case, the Court held that the extension would be in the best interests of creditors given the extension would maximise the prospect of preserving the business of the Virgin Group with a view to a sale or restructure of the business as a going concern. Specifically for the landlords, the Court pointed out that the extension would increase the prospect that there will remain a counterparty in place with respect to existing leases. 

Is COVID a catalyst or an exception?

In both cases, the Court was keen to identify the COVID-19 pandemic as an extraordinary event causing great disruption to the economy and to operations. Whilst laws still need to be followed, the Court considered it appropriate to be flexible in the application of those laws and to exercise discretion in favour of supporting the Australian community and economy during these times[6].

Whilst COVID-19 is certainly extraordinary, it is easy to envisage that administrators in other situations may also be able to establish that, due to the complexity of the insolvency and uncertainties around sale processes, the interests of creditors would be better served by extending the rent relief period. A five business day period, in many cases, will be inadequate for the administrator to make an informed decision about whether leasehold assets should be retained for the benefit of a sale or to allow an orderly wind down. 

Landlords should be prepared for administrators to more frequently seek such orders from the Court and for the Court to make those orders. In light of this, landlords would be well advised to engage proactively with administrators and seek negotiated outcomes that balance the best interests of all creditors with their own interests.

Author: Kim Mackay

[1] Section 443B of the Corporations Act 2001 (Cth) (Act).
[2] Section 435A of the Act.
[3] Mentha, in the matter of Griffin Coal Mining Company Pty Ltd (administrators appointed) [2010] FCA 1469 at [30].
[4] Re CBCH Group Pty Ltd (No 2) [2020] FCA 472.
[5] Strawbridge, in the matter of Virgin Australia Holdings Ltd (in administration) & Ors [2020] FCA 571 (Virgin).
[6] Virgin at [5].

Disclaimer
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.

Kim MacKay

Published by Kim MacKay

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