The Risks of Surrendering Business Assets to the Landlord Before Liquidation.
It’s becoming increasingly common for business owners when they get themselves into financial trouble to close the doors and walk away.
From the landlord’s perspective this can be ideal as they get left with a site that may be easier to lease due to existing fixtures and fittings for a similar type of business. They may have had to sacrifice some unpaid rent and a personal guarantee to gain control of the assets. From the director’s perspective they often see this as a solution where they can remove an ongoing obligation for the rest of the lease term and get out of a personal guarantee.
The issues arises when there are other creditors apart from the landlords unsecured creditors claim. For preferential creditors they would normally have an interest in any inventory or work in the progress of the company that is left behind. For secured creditors holding a general security when the assets of the business are “sold” to the landlord their remedy’s become limited. For unsecured creditors they will be left with little remedy against a company with no assets.
What we will often see next is that the company will be placed into liquidation by shareholder resolution or through the courts. When a company is insolvent, any transaction that allows one creditor to receive more than they would in a liquidation is potentially voidable. That includes surrendering assets to a landlord. If the company was unable to pay its debts at the time, and the landlord receives chattels, stock, or equipment that would otherwise have been available to all creditors, the liquidator will look to pursue the value or claw back the assets as an insolvent transaction or a transaction at undervalue.
One of the purposes of liquidation is to ensure that creditors receive their correct entitlement to the assets of the company based on their class of creditor. The assets are to be shared evenly as a percentage between the creditors in that class based on the quantum of their claim against the total creditor pool.
If there are three creditors with claims of $50, $150 and $300, the total creditor pool is $500. The assets of the company are valued at $250. Creditors should be receiving 50% of their claim back assuming that are all from the same class of creditors.
Claim % of total claims $250 available funds % claim
Creditor 1 $50 10% $25 50%
Creditor 2 $150 30% $75 50%
Creditor 3 $300 60% $150 50%
In situation where the landlord retains the assets of the company, they have effectively received an advantage over other creditors and as such the transaction can be looked at if within the 6 month and two-year periods prior to liquidation. That includes informal deals, verbal agreements, and even situations where the landlord simply refuses access and retains the assets.
Directors who enter these types of transactions may find themselves in breach of their director’s duties if the liquidator determines that the transaction was not in the best interests of creditors. If assets are surrendered for no consideration, or for less than market value, the liquidator may pursue recovery.
There’s also the issue for secured creditors. Many companies have a General Security Agreement (GSA) registered over their assets. That GSA gives the secured creditor priority over the assets not the landlord. Surrendering assets to a landlord can interfere with the rights of the GSA holder and may trigger legal action. Assets that the liquidators recover under their powers are often non included under the GSA so the recoveries under these powers are available for unsecured creditors.
It’s important to understand that a landlord’s rights under the Property Law Act do not override the rights of secured creditors or the statutory powers of a liquidator to recover the assets owned by the company. Landlords when presented with these options need to be mindful that by entering into these types of transactions can run the risk of having them reviewed by the liquidators and potentially losing the assets.
Once liquidation is imminent, directors must tread carefully. The best course of action is to seek advice before making any decisions about asset surrender. A formal liquidation process ensures that assets are dealt with properly, creditors are treated equitably, and directors avoid the risk of personal liability.