Briefings
Real Estate: All Wrapped Up?
Real Estate
Real Estate Dispute Resolution
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| July 2008 |
Many landlords will have reacted with dismay at the recent suggestions that our insolvency system does not afford enough protection to companies. The thought of more tenants going into ever increasing and easier administrations, or American style Chapter 11, will send shivers down the spine of most real estate finance directors. The 'rescue' of a company, made quicker, easier and cheaper by current legislation, more often than not results in landlords being left with the ‘fuzzy end of the lollipop’. There is perhaps no better example of this than the current fashion for pre-packaged administrations or pre packs.
What Is a Pre Pack?
Let's start with what it is not. It is not a term of law. In fact it is not to be found anywhere in the insolvency legislation. Nor does it offer any special exemptions from the normal duties of company directors or administrators. It is a term, a brand if you like, to describe a fast-tracked administration process that does away with the hawking of a failing business on the open market, with all the attendant disruption that this can cause, instead, lining up in advance a purchaser to take over the business, or parts of it, almost simultaneously with the placing of the company into administration.
Typically, a company in difficulties is told by its funders that they have reached the end of the road in terms of further financial support. The funder then approaches an insolvency practitioner (IP), with a brief to the IP to assess how quickly he could sell the business and assets and for how much. By doing this in advance, it saves the haemorrhaging of goodwill and key staff that can occur during more traditional trading administrations. Creditors are then presented with a fait accompli of an administration and immediate sale of (the profitable parts of) the business or assets. The remaining unwanted parts will typically drift into dissolution, leaving many landlords (and other unsecured creditors) with little.
Advocates sing its praises as the most effective way of preserving the goodwill of the business - avoiding all that nasty publicity and uncertainty and replacing it with a clean break and a new start. Detractors, many of them aggrieved landlords, dismiss this as no more than a smokescreen and a carve up, not least where the buyers of the choicest cuts are, in effect, often the very same individuals wishing to leave behind all the onerous responsibilities of the failed company simply to hive off all the good bits, debt free, into a phoenix to rise from the ashes.
What Happens to Landlords?
Even the luckier landlords who own properties wanted by the new business may be faced with unpaid arrears, an assignee of dubious quality and the occasional sourness of an ongoing relationship with the same management responsible for the failed former business.
The remaining landlords are left with an insolvent tenant, the usual options for pursuit of former tenants and an especially bitter taste associated with being well and truly trussed up by an arrangement many landlords complain is often aimed at ridding the business of onerous leases rather than obtaining best market value.
Can Anything Be Done?
Whilst often ignored by less punctilious IPs, there are some rules. To challenge a pre pack aggrieved landlords will need to commit their own funds and overcome significant hurdles. When the stakes are high enough and the grievance deep enough, especially in a worsening market, a class action by a landlord consortium cannot be ruled out. But it will need to be worthwhile.
What needs to be shown to prove foul play?
Firstly, for a lawful administration, the company must be insolvent, as measured by a number of statutory tests. These tests are usually met (even many well known actively trading companies would fail the 'balance sheet test' of liabilities greater than assets). This is important to bear in mind where there is a suspicion that a perfectly solvent company has sought to avoid its liabilities, such as a long lease term, by placing itself into pre packaged administration only to immediately reopen in a new guise.
Next, the administrator must get a fair price. In a conventional trading administration this is easier to demonstrate. The IP, often under the glare of publicity, can go in, get under the skin of a business and offer it fully to the market. Numerous offers can be compared and considered. It is difficult to criticise this sort of transparency. With a pre pack, much work is often done behind the scenes, but there's no public market testing. Where the slimmed down business is sold to its current owners, there is potentially a suspicion that some creditors have been treated more 'equally' than others.
Having overcome these hurdles, a landlord consortium can consider a court application but the odds are stacked against them. If there is serious and unfair prejudice (that is, not just bad news but unfairly bad news that singles landlords out) then a court may undo an administrator's action, including any asset sales. Ultimately, if there is evidence of a seriously undervalued sale, a landlord creditor can apply to discharge the whole administration. This would result in the company's liquidation, and a subsequent claim against the administrator.
A recently developing route is to challenge the administration as falling foul of the strict purposes allowed by statute. Stitching up a landlord is not a purpose of administration. If – and it is a big evidential if – it can be shown that a company singled out its landlords for unfair treatment, an administration can be overturned.
The upshot of all of this is threefold:
- There must be a clear irregularity to consider challenging a pre pack.
- It must be economical to mount the challenge, because more could be obtained for landlords on a liquidation 'fire sale' than the pre pack achieved.
- There must be a sufficient number of aggrieved landlords not only to spread the costs and risks, but prepared to pursue a matter of principle, whatever the gain.
With those barriers to challenge and the low cost and high speed of an administration, is seems a racing certainty that we will see more frequent pre packs as the downturn continues. Perhaps it's landlords and not their nimble-footed tenants who need a little more protection.