Insolvency Disclaimer of Lease UK — Liquidator Powers, Guarantor Liability, and Vesting Orders

The Liquidator's Power to Disclaim — Insolvency Act 1986 s.178

Section 178 of the Insolvency Act 1986 grants the liquidator of a company the power to disclaim 'onerous property' at any time: (a) What is onerous property?: s.178(3) defines onerous property as: (i) any unprofitable contract; (ii) any other property of the company that is unsaleable, or not readily saleable, or is such that it may give rise to a liability to pay money or perform any other onerous act; a lease is generally onerous property where the rent obligations exceed the market value of the occupation right — i.e. the company would have to pay more rent than a willing party would pay for an equivalent tenancy in the open market; the mere fact that the rent under the lease is above market rent is not automatically sufficient — the liquidator must also consider any other onerous obligations in the lease (repair covenants; reinstatement obligations; break penalty conditions); (b) Time limit for disclaimer: the liquidator must disclaim within 12 months of the date on which the liquidator was appointed, or (if later) 12 months from the date on which the property first came to the liquidator's knowledge; where the liquidator did not become aware of the lease until after appointment, the 12-month clock runs from the date of knowledge; there is no statutory provision allowing extension of the 12-month period — the liquidator who fails to disclaim within the period cannot disclaim at all; (c) Method of disclaimer: disclaimer is effected by giving notice in writing of the disclaimer; a copy must be given to every person who claims an interest in the property or is under liability in respect of it (s.178(4)); the notice must be filed at court and notified to the landlord and any known guarantors; (d) Effect of disclaimer on the company: on disclaimer, the property ceases to be part of the company's property and the company is not liable under any obligations in the disclaimed property from the date of the disclaimer; the landlord's right to recover rent from the company in liquidation ends on disclaimer; the landlord has an unsecured proof for the rent accrued to the date of disclaimer; (e) Administration: an administrator has equivalent powers to disclaim under IA 1986 Sch.B1 para.83.

• Onerous property: unprofitable contracts; unsaleable property; property giving rise to liability — a lease with above-market rent obligations qualifies
• 12-month time limit: liquidator must disclaim within 12 months of appointment or 12 months of becoming aware of the property (whichever is later); cannot be extended
• Method: written notice filed at court and given to the landlord, known guarantors, and all persons claiming an interest in the property
• Effect on company: company's obligations end on disclaimer; company is no longer liable for future rent; landlord's claim for future rent becomes an unsecured proof
• Administration: administrator also has disclaimer powers (IA 1986 Sch.B1 para.83); same mechanics apply

The Effect of Disclaimer on Undertenants and the Vesting Order

Section 178(4)(b) of the Insolvency Act 1986 provides that disclaimer does not affect the rights of any person other than the company and the liquidator 'except in so far as is necessary for the purpose of releasing the company and the property from liability'. This means: (a) Subtenants (undertenants) are not automatically evicted: an undertenant who holds a sublease from the disclaimed headlease does not lose their occupation right automatically on disclaimer; however, the legal basis for their occupation is affected — the headlease from which their sublease is derived has been disclaimed; the undertenant must apply for a vesting order to regularise their position; (b) Vesting order — s.181 IA 1986: any person who claims an interest in the disclaimed property, or who is subject to a liability in respect of the disclaimed property that is not discharged by the disclaimer, may apply to the court for a vesting order; the court has a wide discretion to make a vesting order vesting the disclaimed property in any person entitled to make an application; the court can impose conditions on the vesting, including requiring the applicant to assume the obligations under the disclaimed lease from the date of vesting; (c) Who can apply for a vesting order?: (i) any person who is entitled to the property or an interest in the property (a mortgagee; an undertenant; a beneficiary under a trust); (ii) any person who is under a liability that is not discharged by disclaimer (a guarantor; a former tenant); (iii) a person claiming under any of the above; (d) Time limit for vesting order application: the application must be made within 3 months of the applicant first becoming aware of the disclaimer; the court can extend this period in appropriate cases; (e) Terms of the vesting order: the court typically vests the disclaimed lease in the applicant on terms that the applicant takes over all the obligations of the company under the lease; the applicant obtains the full interest of the company under the lease; (f) Effect of vesting order on the landlord: where a vesting order is made in favour of an undertenant, the undertenant becomes the direct tenant of the landlord (or superior landlord) on the terms of the vesting order; the landlord's position is improved (a solvent tenant is substituted for the insolvent company); the landlord should consider actively encouraging a vesting order application where the undertenant is creditworthy.

• Undertenant not automatically evicted: disclaimer does not automatically terminate the sublease; the undertenant must apply for a vesting order to regularise their position
• Vesting order (s.181): court has wide discretion to vest the disclaimed lease in any qualifying applicant; applicant assumes the company's obligations from the date of vesting
• Who can apply: undertenants; mortgagees; guarantors; former tenants; any person with an interest or liability under the disclaimed lease
• 3-month time limit: vesting order application must be made within 3 months of first becoming aware of the disclaimer; court can extend in appropriate cases
• Landlord's benefit from vesting order: a creditworthy undertenant obtaining a vesting order gives the landlord a solvent tenant instead of an insolvent one — landlords should encourage vesting order applications where possible

Guarantor Liability After Disclaimer — Warnford v Duckworth

One of the most important principles in the law of lease disclaimer is that a guarantor (surety) of the tenant's obligations under the lease is NOT released by the liquidator's disclaimer. This was established by Brightman J in Warnford Investments Ltd v Duckworth [1979] Ch 127 and has been consistently followed: (a) The principle: disclaimer of a lease voids the lease as against the company and its liquidator. However, for the purpose of determining the guarantor's liability, the lease is treated as if it had continued and the company had not complied with its covenants. The guarantor remains fully liable for all obligations under the disclaimed lease as if the lease had continued; (b) The guarantor's claim in the insolvency: the guarantor who pays the landlord under the guarantee after disclaimer has the right to prove in the liquidation for the amounts paid (as an unsecured creditor) and to take an assignment of the landlord's proof; (c) The guarantor's option to apply for a vesting order: a guarantor who has paid under the guarantee, or who is at risk of being called under the guarantee, can apply for a vesting order under s.181 IA 1986 to take over the disclaimed lease; this is sometimes used by guarantors who are associated companies of the insolvent tenant and who wish to continue the business at the leased premises; (d) Duration of guarantor liability: the guarantor's liability continues for the entire remainder of the lease term that would have been left if the disclaimer had not occurred; the landlord can pursue the guarantor for rent for the remainder of the contractual term; (e) Guarantor insolvency: where the guarantor is itself insolvent, the landlord's remedy against the guarantor is equally limited to an unsecured proof in the guarantor's insolvency — the landlord faces a double insolvency scenario.

• Warnford Investments Ltd v Duckworth [1979]: disclaimer does not release the guarantor; the lease is treated as continuing for guarantee purposes
• Guarantor's full liability: the guarantor remains liable for all obligations under the disclaimed lease for the remainder of the contractual term
• Guarantor's proof in liquidation: guarantor who pays under the guarantee can prove in the insolvent estate as an unsecured creditor and take an assignment of the landlord's proof
• Guarantor's vesting order option: a guarantor who has paid or is at risk of paying can apply for a vesting order to take over the lease and continue the business
• Double insolvency risk: where both the company tenant and the guarantor are insolvent, the landlord faces double unsecured proof exposure; take security from guarantors that are independent of the tenant's group

Former Tenant Liability and the Landlord's Proof in the Liquidation

The landlord's recovery options after disclaimer depend on whether the lease is a 'new tenancy' (granted on or after 1 January 1996) or an 'old tenancy' (granted before 1 January 1996): (a) Old tenancies — privity of contract and former tenant liability: for leases granted before 1 January 1996, the doctrine of privity of contract means that the original tenant remains personally liable throughout the lease term, even after they have assigned the lease; where the current tenant (the insolvent company) has failed to pay rent after disclaimer, the landlord can serve a default notice on the original tenant under the Landlord and Tenant Act 1954 (as amended) within 12 months of the sum becoming due; (b) New tenancies — LTCA 1995: the Landlord and Tenant (Covenants) Act 1995 automatically releases an outgoing tenant from its obligations on assignment (s.5); the outgoing tenant's liability ends on the assignment date; however, where the outgoing tenant entered into an Authorised Guarantee Agreement (AGA) under LTCA 1995 s.16, the outgoing tenant guaranteed the immediate assignee's obligations; the AGA runs only while the assignee holds the lease — once the assignee further assigns, the AGA expires; (c) The landlord's proof in the liquidation: the landlord can prove in the liquidation as an unsecured creditor for: (i) rent accrued to the date of disclaimer; (ii) the loss of rental value for the remainder of the lease term (subject to the landlord's duty to mitigate by re-letting the property); the landlord's proof for future rent loss is a prospective or contingent claim; HMRC regards it as a single claim for the net present value of the lost rental stream; (d) Duty to mitigate: the landlord has a duty to take reasonable steps to mitigate its loss by reletting the property as soon as possible; the landlord's proof for future rent loss is reduced by the rental income (if any) that the landlord receives from any new letting; the landlord cannot simply sit on an empty property and prove for the full rent for the remainder of the term; (e) Priority of landlord's claim: the landlord's proof ranks as an unsecured creditor in the liquidation; it ranks behind preferential creditors (employee arrears; HMRC) and the costs of the administration/liquidation; recovery in practice is typically a small dividend (often nil in fully insolvent cases).

• Old tenancy (pre-1 January 1996): original tenant retains privity of contract liability throughout the term; landlord can serve default notice within 12 months of the sum becoming due
• New tenancy (LTCA 1995): outgoing tenant automatically released on assignment; AGA guarantees the immediate assignee only — expires on further assignment
• Landlord's unsecured proof: rent to date of disclaimer; net present value of future lost rent (less mitigation); ranks behind preferential creditors and liquidation costs
• Duty to mitigate: landlord must take reasonable steps to re-let; proof is reduced by rental income actually received after disclaimer
• Recovery in practice: unsecured creditors typically receive a small dividend or nothing in fully insolvent liquidations; the guarantee and former tenant routes are more commercially significant

Frequently asked questions