8 September 2021 by , and Business Rescue Restructuring & Insolvency Newsletter

Collateral damage – the landlord’s rights during business rescue and liquidation proceedings

It seems strange to think that we have been living with an imposed curfew for more than a year now. The economic consequences of this, and other lockdown related restrictions, have seen most companies suffer a hard financial blow. As a result, many companies have been faced with the harsh reality of liquidation or business rescue proceedings. Whilst this is a difficult situation to navigate for these companies, the creditors of such companies have in most cases become collateral damage. Landlords, as creditors of commercial tenants being liquidated or commencing business rescue, are no exception.

Distinguishing between liquidation and business rescue

Liquidation is a process whereby both solvent and insolvent companies are wound-up, either voluntarily or as a result of a court order or creditor’s resolution. Although the winding-up of solvent and insolvent companies are regulated by different pieces of legislation, the legal consequences are mostly the same. The company ceases to operate, and its creditors are paid in accordance with their ranking. The company’s legal existence is terminated, along with any and all of its obligations or liabilities.

On the other hand, business rescue is a process that seeks to prevent the liquidation of a company, or at least ensure a better return for the creditors in the event that the company cannot be rescued.

Business rescue is defined in section 128(1)(b) of the 2008 Companies Act, as a procedure to facilitate the rehabilitation of a company that is financially distressed, by providing for:

  • the temporary supervision of the company, and of the management of its affairs, business and property;
  • a temporary moratorium on the rights of claimants against the company or in respect of property in its possession; and
  • the development and implementation, if approved, of a plan to rescue the company by restructuring its affairs, business, property, debt and other liabilities, and equity in a manner that maximises the likelihood of the company continuing in existence on a solvent basis, or if it is not possible for the company to so continue in existence, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company.

Landlord’s rights during liquidation

The winding up of a company does not automatically terminate an agreement of lease, notwithstanding the provisions of the agreement of lease. Section 386(4)(g) of the 1973 Companies Act, read with section 37 of the Insolvency Act 24 of 1936 affords the liquidator the election to keep a lease agreement in force, or to cancel a lease agreement by notifying the landlord in writing. If the liquidator fails to exercise such an election, the lease agreement automatically comes to an end after 3 months.

In the event of the liquidator electing to keep the lease agreement in force, the liquidator would remain liable for the payment of rental, which will form part as the costs of liquidation. In the event that the liquidator elects to cancel the lease agreement, the landlord retains a common law damages claim against the insolvent estate for loss of profit for the remainder of the lease period, subject to the landlord’s obligation to mitigate its damages. For the period up to the liquidator exercising its election, the rental payable in terms of the lease agreement will also form part of the costs of the liquidation

It is common to include a clause in an agreement of lease which provides that “the insolvency or liquidation of the tenant constitutes an event of default” and is thus a breach of the lease agreement. Despite this, the provisions of South Africa’s insolvency legislation override any contractual rights that a landlord has in terms of the lease agreement.

The court dealt with the landlord’s right to cancel an agreement of lease, in the event of the tenant being wound up, in Ellerine Brothers (Pty) Ltd v McCarthy Limited and held that only if the breach notice by the landlord was sent to the tenant prior to the institution of liquidation proceedings, due to a breach event or failure to pay rental (i.e the right to cancel the agreement of lease having accrued prior to the liquidation proceedings being commenced), will such a cancellation be valid.

In many respects the landlord’s hands are tied, and it will be up to the liquidator to decide whether to maintain or cancel the agreement of lease, and whether to keep paying the rental amounts due.

Landlord’s rights during business rescue

Similar to liquidation proceedings, the effect of section 136(2) of the 2008 Companies is that a contract concluded prior to the commencement of business rescue proceedings, is not suspended or cancelled by virtue of the business rescue, but the business rescue practitioner may suspend, or apply to court to cancel, any obligation of the company under the contract.

Section 133(1) of the Companies Act provides that during business rescue proceedings, no legal proceeding, including enforcement action, against a company, or in relation to any property belonging to the company, or lawfully in its possession, may be commenced or proceeded within any forum, except (a) with the written consent of the BRP; or (b) with the leave of the court and in accordance with any terms the court considers suitable.

The Supreme Court of Appeal in Cloete Murray and Another NNO v FirstRand Bank Ltd t/a Wesbank held that that the cancellation of a contract does not constitute “enforcement action” prohibited by section 133(1) of the Act, and that a creditor can therefore lawfully and unilaterally cancel a contract that it had concluded with a company under business rescue, prior to the latter being placed under business rescue. One of the reasons provided by the SCA for the aforementioned conclusion, is that the terms “enforcement” and “cancellation” are mutually exclusive, and not interpreting them as such would be contrary to the language, context, provision and purpose of section 133(1) of the Companies Act.

However, if a landlord cancels an agreement of lease during business rescue proceedings, they might not be able to enforce the cancellation in so as far as it pertains to regaining possession of the leased premises, if this can be regarded as enforcement action. This is especially true if such lease is material to the operation of the company under business rescue and an ejectment order could potentially result in the failure of any attempt at rescuing the business. In that instance, a court is unlikely to enforce the cancellation, as it is likely to defeat the purpose of the business rescue proceedings.

Conclusion

The landlord’s position in both instances discussed above is far from ideal and may result in the landlord losing out on several months of rent, either because of the lease premises standing empty, or because of the tenant occupying the property without paying the full rental amount. In both instances, the landlord’s claims for outstanding rental ranks relatively low compared to other creditors. Under liquidation, the landlord will only have a preferred claim for three months outstanding rental if rent is payable on monthly basis, whilst the rest of the claim will be a concurrent (unsecured) claim. Under business rescue, the landlord may be able to recover some of the rental that became due after the business rescue proceedings commenced, but prior outstanding rental will be ranked along with other unsecured claims.

The economic consequences of the series of lockdowns experienced in South Africa has not only toppled previously solvent companies, but it has also placed many landlords in a precarious and uncertain financial position. In many instances, a landlord’s hands are tied and they have no option but to wait and see what the liquidator or business rescue practitioner decides to do with respect to its lease agreements.

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