Lease arrears: options for landlords in Scotland

Out-Law Guide | 28 Sep 2020 | 1:36 pm | 13 min. read

Notwithstanding the extensions to restrictions on some remedies, commercial landlords in Scotland still have a number of options available to them to deal with increasing levels of arrears. 

Restrictions on statutory demands and winding-up tenants have been extended to 31 December 2020. Restrictions on irritancy for arrears which were due to end on 30 September are likely to be extended to 31 March 2021 for all commercial leases.

However, many of the other options remain available and are unaffected by legislation and guidance enacted in response to the coronavirus.   

The options open to landlords in England and Wales differ from those in Scotland and are addressed in our separate guide.

Concessions

The evidence is that many landlords have reached arrangements with tenants for deferred rent payments and other concessions. The Code of Practice for Landlords and Tenants of Commercial Property is expected to remain in place until June 2021. Although not mandatory, the code is a useful addition to the landlord's arguments as it requires transparency from tenants on their financial position as part of any request for a concession for the landlord. This should be useful in flushing out 'can pay, won't pay' tenants.

Summary diligence

Parties to a lease can agree to an expedited means of enforcement of financial debts without the need for a court action – known as summary diligence. 

Within the body of the lease the parties must have confirmed their consent to "registration for execution" or "registration for summary diligence" and registration must have taken place in the Books of Council and Session. Most commercial leases in Scotland have been registered for execution in the Books of Council and Session.

The financial obligation must be either expressly set out in the lease itself or the mechanism for identifying the financial obligation must be ascertainable. 

Summary diligence will be executed on behalf of the landlord by officers of the court, who are sheriff officers for the Sheriff Court and messengers-at-arms for the Court of Session – for ease we will simply refer to sheriff officers in the rest of this guide.

At the start of the lockdown in March, sheriff officers were unable to carry out summary diligence, unless it was urgent, due to social distancing measures. Those restrictions have since been lifted and the sheriff officers are now able to offer a fuller range of services. However, it is possible that this position may change as we head into the winter months and so any landlord considering summary diligence as an option would be advised to take action sooner rather than later.

Summary diligence can take various forms, some of which can be performed simultaneously.

A proportion of the costs incurred in undertaking summary diligence will be recoverable from the tenant in addition to the arrears due, even where the lease does not specifically provide for reimbursement of the landlord's costs.

Charge for payment

This is often the first choice for many landlords and is a prerequisite for an attachment or money attachment. Sheriff officers serve a written demand for payment on the tenant. Following service, the tenant has a period of 14 days in which to pay. If they fail to do so, the landlord may take further steps to recover the debt. This option is quick, relatively inexpensive and is often very effective in securing payment.

Arrestment

This option secures money or moveable property belonging to the tenant in the hands of third parties. Most commonly it will be used to arrest monies in the tenant's Scottish bank account. Timing of the arrestment can be critical because it is only effective over money or property in the hands of the third party at the moment the arrestment is served. The third party is under a duty to disclose the nature and value of the property arrested within three weeks of the date of the arrestment. Sometimes the tenant will sign a mandate or formal authorisation to allow release of the arrested funds or property to the landlord. Failing which, any funds caught by the arrestment will automatically be released to the landlord after 14 weeks or a court action can be raised to authorise release of the property.

Attachment

This allows the landlord to "attach" goods and equipment belonging to the tenant in the tenant's possession. A sheriff officer will call at the premises of the tenant to value and "tag" items up to the value of the debt. Unless the debt is cleared, an auction will then be arranged to sell the tagged items to recover the monies due.

Before exercising this option the landlord must have served a charge for payment and the charge must have expired without the tenant making full payment. 

Money attachment

This secures cash, cheques or other payment instruments owned by the tenant and held on premises occupied by the tenant, other than their home. Sheriff officers can attend one or more premises occupied by the tenant and seize monies to the value of the debt. The attachment must be reported to the court within 14 days and then within 14 days of that, the landlord can apply to the court for transfer of the funds.

In the current climate, with many businesses preferring to be paid by card, this is unlikely to be a realistic option for recovery in most cases.

Inhibition

This is only appropriate if the tenant owns buildings or premises in Scotland. 

An inhibition is registered against the individual/company, so it may cover more than one property in Scotland if the tenant owns a number of properties.

An inhibition prevents title being transferred to a third party or security being granted over the property. If the property is being sold or a security being granted the purchaser or lender will want to see a discharge of the inhibition. The discharge would only be released by the landlord once full payment is received. In certain instances it is possible to partially release the inhibition to allow recovery of part of an outstanding debt and preserve the inhibition pending full repayment.

This process is unlikely to result in immediate repayment.

Debt proceedings

Landlords who are not in possession of a registered lease may wish to consider debt proceedings to recover the arrears. The reputational damage of such proceedings may be enough to encourage payment from high profile 'can pay, won't pay' tenants. In addition, the tenant will be liable for a proportion of the successful landlord's costs.

If the relevant lease contains an effective anti set-off provision, the tenant's defences to any claim for fixed sums such as rent, insurance premium contributions or service charge payments on account are likely to be spurious and ultimately unsuccessful.

There are currently no restrictions on landlords from pursuing court action. Whilst it is not yet business as usual, the courts continue to operate and a number of digital and remote business solutions have been implemented to allow cases to progress. However, some delay should be expected.

The following points are worth noting in the context of debt proceedings.

Pre-proceedings

Although there is no requirement for proceedings to be preceded by a letter before action, it can be helpful to issue a seven or 14 day demand letter before court action is raised. The letter can help to make clear to the tenant the consequences of non-payment: interest on arrears and liability for the cost of proceedings. This may be the point at which a 'can pay, won't pay' tenant decides to pay.

If the tenant genuinely can't pay, and the landlord is not aware of any alternative enforcement methods which might yield results, then the landlord should consider whether the cost of pursuing proceedings is appropriate. There may be a number of factors to consider here, for example reputational concerns.

Default judgment

If the tenant takes no action to defend the proceedings, the landlord will be able to apply for default judgment known in Scotland as a decree in absence.

Late defences by tenants are usually taken account of by courts and will prevent a decree in absence.

Irritancy

The landlord may only terminate a lease, known as irritating the lease, after it has given the tenant a period of time within which to remedy the breach.

The Coronavirus (Scotland) Act 2020 extends that period of time to 14 weeks for non-payment of monetary sums effectively creating a block on a landlord on terminating during that period. Previously the landlord only had to give 14 days notice before bringing the lease to an end.

There is no statutory relief from irritancy in Scotland so if the tenant does not clear the rental arrears within the 14 week period the landlord will be entitled to issue a notice to terminate the lease should they wish to do so.

A landlord is only entitled to irritate the lease for a non-monetary breach if, in all the circumstances, a fair and reasonable landlord would seek to irritate the lease. Where the breach is capable of being remedied the tenant must be given a fair and reasonable opportunity to remedy the breach. Whilst there has not been any legislative change to this remedy, a fair and reasonable landlord would take into account the impact of coronavirus and the government response to that in deciding whether to terminate the lease in the first place and also in assessing the tenant's ability to remedy the breach. 

Recovery from existing guarantors

Where the existing tenant’s obligations are guaranteed by a third party guarantor, a landlord may be able to recover rent arrears or other sums due under the lease from the guarantor. A landlord should check the wording of the guarantee carefully to see whether liability has been triggered, what steps must be taken and what options the landlord has under the guarantee. For example, a landlord may only be able to call on a guarantee in particular circumstances, for a specified period or only after the tenant itself has been pursued. In some guarantees a landlord will have the option to require the guarantor to take a new lease and, if well drafted, the rent under the new lease will be backdated to the service of a trigger notice on the guarantor.

When agreeing any rent concession letters, landlords should check the guarantee provisions do not operate to release guarantors where such concessions are given. Most provisions are drafted to avoid this risk.

Rent deposit

Many commercial leases require the tenant to pay a rent deposit. There are no coronavirus-related restrictions on recourse to a rent deposit. However, whilst the UK government code of practice acknowledges that landlords can draw on rent deposits, it suggests that it is on the understanding that they will not require them to be topped up before it is "realistic and reasonable" to do so.

Whether a landlord is able to draw down on the deposit will depend on various matters, including most importantly the terms of the deed governing the deposit and how the deposit is held. If the tenant has entered an insolvency of some kind then there may be restrictions on drawing down on that deposit, although well drafted rent deposit deeds will avoid such restrictions by giving the landlord control of the deposit.

If there is any ambiguity about the drafting of the deposit deed in the event of tenant insolvency and tenant insolvency is anticipated, landlords could consider drawdown where they have the right to do so to avoid any risk that they will be unable to do so if the tenant does enter an insolvency procedure.

Landlords should also be aware that where a tenant is in administration, rent and other sums may be payable by the administrator as an expense of the administration and rank in precedence to claims of other unsecured creditors. If a landlord has recourse to the rent deposit rather than requiring the administrator to pay rent or other sums as an expense of the administration, the administrator will not, in line with recent case law, be subject to any obligation under the deposit deed to 'top up' the deposit following a withdrawal. In that situation it may be better to preserve the deposit to meet other potential claims, such as dilapidations, which do not qualify as expenses of the administration.

Statutory demands

The Corporate Insolvency and Governance Act 2020 (CIGA) prohibits the presentation of a winding-up petition based on an unsatisfied statutory demand served between 1 March 2020 and 31 December 2020.

So, whilst these can still be served, no winding-up petition can be presented for failure to make payment of the sums demanded before 31 December 2020.

Winding-up petitions

Under CIGA it is still possible to present winding-up petitions if the landlord creditor is able to show reasonable grounds for believing that coronavirus has not had a financial effect on the tenant company or that the tenant company would have been unable to pay its debts regardless of the financial effect of  coronavirus. For these purposes the 'financial effect' test will be met "if the company’s financial position worsens in consequence of, or for reasons relating to, coronavirus". It is likely in practice that it will only be possible to present a winding-up petition for debts which pre-date the coronavirus crisis and where it can be shown the tenant company was unable to pay its debts regardless of any financial impact of coronavirus.

Tenant insolvency

If the tenant enters an insolvency process before or during any attempts to recover arrears, this may affect both the options available to landlords and the likely outcomes of those options.

The impact of insolvency will depend on the nature of the insolvency proceedings, as follows:

  • administration – the statutory moratorium which applies on administration will prevent any form of diligence, irritancy and the commencement or continuance of court proceedings without the consent of the administrator or the leave of the court;
  • liquidation – once a winding-up order is made, the court's permission is required to carry out any form of diligence or to commence or continue court proceedings. If a tenant enters into a creditors' voluntary liquidation (CVL) there is no moratorium preventing the commencement or continuance of proceedings, but the tenant's entry into CVL means it is likely to have limited financial means to satisfy any judgment obtained against it;
  • company voluntary arrangement – once the CVA is in place, the options will depend on the terms of the CVA. While the CVA proposal is being considered, the tenant may seek to obtain a moratorium under CIGA (below);
  • moratorium under CIGA – this new form of insolvency process allows directors to trigger a moratorium period for an initial period of 20 business days, which may subsequently be extended, on confirming the company is or is likely to become unable to pay its debts and that the moratorium will, in the monitor's view, likely result in the rescue of the company as a going concern. During this period, landlords may not undertake diligence, irritate the lease and proceedings cannot be commenced or continued without the permission of the court;
  • restructuring plan under CIGA – previous rights will be extinguished by a restructuring plan, limiting the landlord's remedies to the quantum of any compromised amount of its claim.

Some other considerations for landlords to bear in mind on tenant insolvency include:

Landlord's hypothec

Hypothec is a right in security afforded to Scottish landlords over the entire moveable property owned by the tenant within the leased property for rent arrears.

Hypothec provides the landlord with a preferential claim upon insolvency over the moveable property. This right arises by operation of law and ranks as a fixed security – i.e. it ranks ahead of any floating charge.

Insolvency practitioners should be reminded of any claim to hypothec at the earliest opportunity and the landlord should attempt, as best it can, to find out what moveable property is held on the property and make attempts to ascertain its likely value.

The insolvency practitioner ought not to dispose of the property without a court order or the consent of the landlord, although the court order is likely to be granted if the court is satisfied the disposal has been, or will be, made at market value and that the proceeds will be put towards the arrears.

Rent and other sums due under lease as expense of an administration

Where tenants are in administration, rent and other sums due under the lease are payable as an expense of the administration – i.e. ahead of other creditors – where the premises are used for the benefit of the administration. It is clear this is the case where the tenant continues to operate its business from the premises whether because it is being sold, stock is being sold or the business is winding down in an orderly fashion. The rent for these purposes is payable as an expense of the administration for the period of such occupation only and treated as accruing on a daily basis.

During the coronavirus period where rented premises are forced to close, the question arises whether rent should be an expense of administration where, although closed, stock and equipment remains on the premises and there is an intention that the premises will re-open.

The coronavirus-related restrictions have not removed the liability to pay rent and so it continues to be due. Where premises are being used to store stock, furniture and equipment, where the tenant intends to re-open them or to sell them as part of any sale of its business and where employees have been furloughed – which requires there to be an intention to re-hire them – then it is likely rent continues to be an expense of any administration of the tenant. However, there has been a recent Australian case where it was held rent was not an expense of the administration for a brief period of closure related to coronavirus. In that case the court took account of the benefit to creditors of a potential sale and that rents due could form part of a negotiation around this.

Protecting landlord's voting rights on a CVA

Where landlords agree concessions with tenants, whether by way of deferral or reduction of rent payments, they should ensure that any side letter recording such arrangements makes provision for those arrangements to automatically terminate wherever a proposal for a CVA is submitted to creditors of any tenant company to vote on. This will mean that in any vote on the CVA proposals the landlord’s voting rights will be by reference to the full rent and other sums due under the lease.