9 June 2020 by , , and Business Rescue, Restructuring & Insolvency Newsletter

Lease agreements revisited: The landlord’s hypothec in financially distressed times

In dealing with the affairs of financially distressed lessees, the question has been raised as to the rights of creditors, particularly landlords, in respect of outstanding rentals and fees.

The landlord’s hypothec

The landlord’s tacit hypothec is a form of real security. The hypothec secures the lessee’s obligation to pay rent in terms of the agreement of lease. It does this by allowing the landlord to burden the movable property present on the leased land or while in transit to a new destination subsequent to the removal from the land. What this means is that the landlord can obtain a lien or limited real right in the movable goods present on the property on the date that rent is in arrears until payment is made.

However, this right does not accrue to the landlord automatically, it must first be perfected. This involves the intervention of a court process.

In a situation where a lessee company is placed in business rescue, the landlord’s hypothec is affected by the general legal moratorium on civil proceedings in terms of section 133(1) of the Companies Act 71 of 2008 (the Companies Act). The moratorium prevents the landlord from taking legal action to perfect its hypothec after the commencement of the business rescue process, as this would constitute legal action in respect of company property which is prohibited by the moratorium, unless the business rescue practitioner or the court consents to the perfection.

It is highly unlikely for a business rescue practitioner to consent to the perfection of the landlord’s hypothec, as it may negatively impact on the successful business rescue of the company. In order for a landlord to perfect its hypothec (after business rescue proceedings have been commenced), it would have to approach the High Court (when the outstanding rental exceeds the monetary jurisdiction of the Magistrate’s Court and/or when the lease agreement provides for the High Court to have jurisdiction) on an urgent basis for the following relief:

  • for an order authorising it to institute legal proceedings against the company in business rescue;
  • for an order perfecting its landlord’s hypothec and authorising it to attach all movable assets at the leased premises.

It is important to take cognizance of the fact that a landlord cannot attach property that has already been encumbered by another creditor and therefore which property is subject to another creditor’s security. A landlord also cannot attach property where ownership of the property has been reserved to another creditor. In other words, a landlord is not entitled to perfect its hypothec over encumbered property (for example in the form of a notarial bond) or property where ownership has been reserved.

The ranking of a landlord’s claim in business rescue

Section 135 of the Companies Act deals with the ranking of creditors in business rescue proceedings. Section 135 sets out the order in which the claims of creditors rank during business rescue. In terms of this section, post-commencement financiers are preferred in the order of preference created by the Companies Act. This was confirmed by the court in Merchant West Working Capital Solutions (Pty) LTD v Advanced Technologies and Engineering Company (Pty) Ltd and Another (13/12406) [2013] ZAGPJHC 109 (10 May 2013) (Merchant West). The position pursuant to this judgment was that, even if a creditor has a secured claim against the company, post-commencement financing takes preference over those claims, whether the post-commencement financing is secured or unsecured.

The court in Diener N.O. v Minister of Justice and Others (926/2016) [2017] ZASCA 180; [2018] 1 All SA 317 (SCA); 2018 (2) SA 399 (SCA) (1 December 2017) limited this to the extent that the SCA ruled that business rescue proceedings do not dilute the security of pre-business rescue secured creditors in terms of section 134(3) of the Companies Act. Accordingly, the correct position is that post-commencement financier claims rank only in priority to all unsecured creditors and that pre-business rescue creditors’ rights to their security must be respected in terms of section 134(3) of the Companies Act and they can therefore not rank below any post-commencement financiers who hold no security.

Arrear rental, however, is currently not considered as post-commencement financing, as confirmed in South African Property Owners Association v Minister of Trade and Industry and Others (2018) 2 SA 523 (GP). Therefore, the landlord’s unperfected hypothec ranks as a concurrent claim in business rescue. Should the landlord however perfect its security by way of court order as explained above, the landlord’s claim becomes secured and will move up in ranking in business rescue proceedings, but will remain below secured post-commencement financiers’ claims.

Important considerations

Landlords need to be aware that it is not as simple and there is no ‘quick fix’ when it comes to enforcing their hypothec against financially distressed tenants (whether they be natural or juristic persons). Landlords need to understand that they do not have an automatic hypothec over property on which they can rely. Landlords first need to take steps to ‘perfect’ that hypothec (as explained above).

As already indicated, a landlord is also not entitled to perfect its hypothec over encumbered property (for example in the form of a notarial bond) or property where ownership has already been reserved to another creditor. It is likely that due to the very troubling times that South Africa finds itself in, and in particular the retail industry, that all stock or movable property situated on the leased premises may have already been encumbered to other financiers (or creditors generally). If this is the case, a landlord cannot simply attach those encumbered assets and the landlord would therefore have to explore other remedies to protect its rights. 

Our advice to our landlord clients is to consult with our Business Rescue, Restructuring and Insolvency team as soon as their tenants (whether natural or juristic persons) find themselves in financial distress, so that the necessary action can be taken to ensure that they are sufficiently legally protected (both before or after business rescue proceedings have commenced).

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