Administrators and leases: obligations and options

Next year will be voluntary administration's 20th birthday.

Although it was subject to some tidy-up amendments in its late teens, Part 5.3A is still substantially the same as it was in 1993. It has been applied in thousands of situations in that time – and been considered in hundreds of court cases.

That being the case, it is surprising just how many legal aspects of voluntary administration remain unclear. The scope and outer limits of section 447A are still being tested.^[1]Although more prosaic, leases also present another area of recurring uncertainty. When an administrator takes control of a company which leases property, what are his/her obligations and options?

Investigation

Immediately upon appointment, an administrator will set about investigating whether the company or its business can be saved. That investigation will quickly lead to one of three conclusions in relation to the company's leased property:

• the company's business is wholly or partly salvageable or saleable, and retaining some or all of the leased property is essential to that process;
• the company is doomed, and there is no point in continuing any leases; or
• more time is needed to arrive at a conclusion.

In the first situation, the Corporations Act 2001 (Cth) provides some protection for the lessee company, by restricting the power of a lessor to resume possession of the property during the voluntary administration period. This restriction is not an unqualified one. A lessor may resume possession with the administrator's consent, or, as recently happened in Re Colorado Group Limited [2011] VSC 552, with the leave of the Court. A major factor in the Court's grant of leave to the lessor of the Colorado premises was that the company's unsecured creditors would not receive anything from the administration: everything would go to the secured creditor. Other factors were:

• the shops were only two of almost 282 owned by the company, and there was no evidence of how financially significant they would be to any restructure of the company's operations;
• because the two leases had expired, there was no goodwill that could be sold to any purchaser of the business; and
• the lessor's inability to lease the shops to other (identified) tenants who were willing to pay higher rents was causing financial loss to the lessor.

In terms of the third situation – where more time is needed to arrive at a conclusion – voluntary administration is intended to be a brief, interim regime. Perhaps underestimating the popularity of the regime, the architects^[2] anticipated that schemes of arrangement (rather than voluntary administration) would be preserved for, in particular, larger private or public companies. Bucking the anticipated trend, large corporations have, in insolvency, opted for voluntary administration more frequently than schemes of arrangement.

In the ordinary course, administrators are expected to have formed a view, and to report to creditors on the company's future within 20 business days of appointment. It is often difficult in that short period to make a conclusive decision about the company's continued occupation of leased premises, particularly in the administration of large complex corporate groups. It may be difficult, in that short period, to conclusively forecast, for example, how marginal retail premises might fare under a different group structure or adjusted cost-base; or whether custom-fitted premises might ultimately prove to be a key drawing card to a prospective purchaser of the business. That uncertainty has led to applications for extensions of the convening period under section 439A(6) of the Act becoming more and more common, particularly in complex administrations. Nonetheless, the ability of an administrator to retain leased property during an extended convening period is open to challenge – see Re ABC Learning Centres Limited; application by Walker (No. 8) [2009] FCA 994 – and may be qualified.

Where the company is doomed, and there appears to be no point in continuing any leases, the situation is also more complicated than it might appear.

"Disclaiming" a lease

When a company goes into liquidation, it is on a one-way path to dissolution and deregistration. Among other things, liquidators are given the power to facilitate that journey by disclaiming unprofitable contracts and leases (section 568 of the Act).

While there is no statutory equivalent of section 568 in Pt 5.3A, it is not uncommon to hear parties speaking of an administrator having "disclaimed" a lease or even for administrators to purport to do so. The fact that insolvency practitioners exercise the disclaimer power regularly as liquidators has the potential to blindside them when they put on their administrator's hats. Lessors, unfamiliar with the nuances of the regimes, often think insolvency, administration and liquidation are synonymous and do not appreciate the different powers and obligations of administrators and liquidators.

This is not just a matter of nomenclature: leases are treated quite differently under Pt 5.3A than in a liquidation, in at least two important respects.

The first is the statutory timeframe.

A liquidator may disclaim onerous property (including unprofitable contracts) at any time. In contrast, the appointment of an administrator starts the clock running for a decision on leased property. Section 443B(2) of the Act gives the administrator a grace period of five business days before he or she incurs personal liability for rent under pre-appointment leases. During those five days, the administrator can give the lessor a notice that the company does not propose to exercise rights in respect of the property (section 443B(3) of the Act).

The second important difference lies in the effect of a section 443B(3) notice. Unlike disclaimer, it does not terminate the lease. In Silvia v Fea Carbon Pty Ltd (ACN 009 505 195) (Administrators Appointed) (Receivers and Managers Appointed) [2010] FCA 515, the Court held that, by itself, a section 443B notice was not a repudiation:

"What is at the heart of a repudiation is that a contracting party has acted in such a way as to lead the other party to the conclusion that the first party will not fulfil his part of the contract...

By the service of a subsection (3) notice the administrator does no such thing. The notice need only state that the company will not exercise its ‘rights’ in relation to the property. The notice only applies, at most, during the period the company is in administration, and as subsection (5) shows, may apply for an even shorter period. Further, subsection (6) makes clear that the mere fact that the company remains in occupation or possession of the leased property does not amount to exercising rights in relation to the property.

It is impossible to hold that a lessee has repudiated its lease simply by its administrator serving a notice under subsection (3) which says nothing about, and does not preclude the company from, continuing to occupy or possess the premises. Moreover, the notice relates to the ‘rights’ of the company and is not concerned with the performance by the company of its obligations. As subsection (4) makes clear, the service of a notice does not affect those obligations."

A section 443B(3) notice merely relieves the administrator of any personal liability for lease payments once the five day grace period has lapsed (section 443B(4))^[3]. That liability remains with the company.

The reason for these differences, particularly the timetable, emanates from the policies behind liquidation and administration. Although it is desirable that a company should be liquidated expeditiously, it is more important that it be done comprehensively, with no loose ends. For that reason, liquidation cannot be subjected to a strict timetable. By contrast, putting a company into administration rather than liquidation implies that there may be a possibility (however faint) that the company or its business can be saved. In that situation, time is of the essence;^[4] both the legislative timetable and the fact that what is at stake is the administrator's personal liability are designed to keep administrators focused on that fact.

So the lesson for administrators is: do not delay in issuing a section 443B(3) notice – unless you are confident that the company has sufficient funds to indemnify you for the ongoing lease payments.

Admittedly, this does appear to put administrators in a difficult position. This is partially relieved by two caveats:

• a section 443B(3) notice is not irrevocable – once given, it can be revoked at any time by written notice to the lessor (section 443B(5)(a) of the Act); and
• in the worst case, an administrator who has failed to give a notice may seek relief from the Court for personal liability for the lease payments, under section 443B(8).

Neither, of course, is ideal. It appears that, once a section 443B(3) notice is revoked, the provision has no further operation (ie. the administrator cannot later lodge a fresh notice). Section 443B(8) involves a degree of risk for the administrator, as noted below, as well as involving the expenditure of time and costs inherent in a court application.

Forgot to give notice?

What happens if an administrator inadvertently omits to give a section 443B(3) notice within five business days?

The first – and most important – point is there is no provision for late service. A notice served out of time would appear to be a nullity.

However, as noted above, an administrator can still obtain the same effect (relief from personal liability) by seeking an order from the Court excusing him or her from liability under section 443B(8).

One word of caution: a section 443B(8) application is unlikely to be simply rubberstamped by the Court. That is evident from Nardell Coal Corporation (In Liq) v Hunter Valley Coal Processing [2003] NSWSC 642, an application by a receiver under section 419A(7) (the receivership equivalent of section 443B(8)). [Moreover, applications under section 443B(8) are rare and require a good justification for omitting to serve the notice].

Nardell Coal is the locus classicus on this issue. In it, the NSW Supreme Court indicated that an application for relief from liability would depend on the answers to the following (paraphrased) questions:

• has the [administrator] engaged in conduct which, if a [section 443B(3)] notice had been given, would have had the effect of ending the [section 443B(3)] notice?
• has the [administrator] deliberately refrained from giving the notice (in order to keep his options open, for example)?
• would excusing the [administrator] prejudice another person (such as the lessor)?

In relation to the last point, the Court commented that excusing the receiver [administrator] would leave the lessor in the position of being an unsecured creditor in the company's liquidation. Campbell J observed that this was "nothing more than the working through of a risk inherent in [the lessor's] original decision to enter into a lease with a limited liability company, without taking security for its performance".

A practical alternative to going to Court to avoid personal liability is simply to cause the company to quit the premises and to give notice confirming the company's intention not to honour the terms of the lease. This will constitute a repudiation of the lease by the company. It will also bring to an end the administrator's personal liability under the lease. Note that it is essential for the voluntary administrator to both give notice of the company's intention to terminate, and to cause the company to vacate the leased premises (and return the keys) because section 443B(2) renders the administrator liable for as long as the company uses or occupies the premises.

The downside to this approach, of course, is that it excludes the property from any potential rescue or workout plan for the company.

It also does not address the administrator's liability for any unpaid rent for the period between the five days of grace and the date on which the property is returned to the lessor. An administrator in that situation has the choice of paying the rent or applying to the Court for a retrospective order under section 443B(8).^[5]

Part-rent and other costs

Another issue about which there appears to be a lack of clarity is the administrator's section 443B(2) liability for rent after he or she has caused the company to vacate the leased premises (other than by a section 443B(3) notice).

If, for example, rent is payable monthly and the administrator provides vacant possession and abandons the lease part-way through the month, is he or she liable for rent until the end of the month or only until the date of vacation?

There appears to be no authority directly on this point. However, the wording of section 443B(2) suggests that the administrator is only personally liable for rent up to the date of vacation.

The administrator's liability is imposed by statute, rather than under the lease (the lease imposes obligations only on the company). That being the case, the administrator's liability is determined by reference to the wording of the statute, rather than the lease. Subsection 443B(2) of the Corporations Act provides that the administrator is personally liable "for so much of the rent ... as is attributable to a period ... throughout which the company continues to use or occupy ... the property".

Therefore, regardless of the payment terms of the lease, the administrator would only be liable for so much of the rent as related to the number of days that the company actually occupied the property – "as is attributable to a period". This reasoning is consistent with the obiter statement of the NSW Court of Appeal in De Vries and Another (as joint administrators of Rildean Pty Ltd) v Rapid Metal Developments (Aust) Pty Ltd (2011) 84 ACSR 261 in relation to whether liability to pay for lost rental equipment fell within the section 419A liability for "the rent or other amounts payable by the corporation under the agreement”. The Court of Appeal said (at [161] and [162]) that it did not, because the liability only arose at the end of the rental period:

"161 In my opinion, the language of s 419A(2) is not apt to extend to a liability to make payments under a hiring agreement between an owner of goods and a corporation, when the liability is not incurred or is not enforceable until the end of the period of hire. I do not think that it can be said that the liability imposed on Rildean by cl 22(b) of the Hiring Agreement was to make payments attributable to the period of hire or to the use of the goods during that period. Rildean's liability was to replace all lost or damaged goods at RMD's ruling list prices. The liability to make payments calculated in this way was attributable to Rildean's failure, for whatever reason, to return the hired scaffolding to RMD in good condition, as required by s 419A(2). The amounts payable by Rildean were not attributable to a period, but to its failure to return the scaffolding in good condition.

162 If RMD's submissions are correct, it is difficult to see what purpose is served by the words " as is attributable to a period " in s 419A(2). If the drafter intended s 419A(2) to cover all liabilities that are incurred during or at the end of a hiring agreement, it would have been simple enough to say so."

Non-rent costs

Another interesting liability issue for administrators is non-rent costs. It is not uncommon for a lease to require the tenant company to pay make-good and similar costs when it vacates the property. Section 443B(2) renders the administrator liable for rent "or other amounts payable by the company" under the lease. Are make-good costs "other amounts payable by the company" under the lease?

A number of authorities have considered whether this, and, in particular, the words "other amounts" in the section (and in section 419A(2) of the Act) extends to make-good or one-off termination payments in circumstances where the administrator causes the relevant lease/contract to terminate during the relevant period.

The first instance decision in Rildean^[6]threw up some ambiguity in relation to the long held principle that administrators are not personally liable for make-good costs.^[7]However, in the appeal from that decision, as noted above, the NSW Court of Appeal took the opportunity to reaffirm the pre-existing law. Although the above extracted comment was obiter, the fact that the Court of Appeal went out of its way to make it position clear indicates that it is intended to be an authoritative statement.

The same principle can be applied in relation to an administrator's liability for the costs of make-good, removal of fittings and de-branding/removal of signage under the lease. A lessor who wants to claim those costs would have to lodge a proof of debt in the DOCA or any liquidation of the company.

Conclusion

Speed is the big selling point of voluntary administration. It is, we are told, the key to preventing the value destruction that accompanies the appointment of a liquidator or receiver.

Speed has costs as well as benefits, of course. One cost faced by administrators is the risk of increased liability as a result of decisions made within a very tight timeframe – decisions about leases, for example.

Although the Court has wide powers to relieve them of liability, administrators would agree that it is preferable to avoid going to court in the first place. An understanding of the peculiar and very specific requirements governing leases will help achieve that objective.

This article was first published in the Australian Insolvency Journal [2012] Vol 24 No 2

^[1]See, for example, the decision of the NSW Court of Appeal in BE Australia WD Pty Ltd v Sutton (2011) 256 FLR 67; [2011] NSWCA 414 which is now the subject of an application for special leave to appeal. ^{Back to article}

^[2]Australian Law Reform Commission’s 1988 Report on its General Insolvency Inquiry (ALRC 45) (the Harmer Report, named after its principal author (and Commissioner-in-charge of the reference), Mr R W Harmer) ^{Back to article}

^[3] Provided, of course, that the circumstances in section 443B(5) – in which a section 443B(3) notice ceases to have effect – have not arisen. ^{Back to article}

^[4] Although the regularity with which Courts nowadays grant extensions of time for the second creditors' meeting arguably suggests otherwise! ^{Back to article}

^[5]The Court in Nardell said that section 443B(8) can be used to excuse past liabilities as well as prospective liabilities. ^{Back to article}

^[6]Rapid Metal Developments (Aust) Pty Ltd v Rildean Pty Ltd (No 3) [2010] NSWSC 7 ^{Back to article}

^[7]See Branson J's decision in Molit (No 55) Pty Ltd v Lam Soon Australia Pty Ltd & Anor (1996) 14 ACLC 1,371. ^{Back to article}