The Impact of Insolvency on Leases

Sustained inflation, interest rate rises, and a challenging economic environment have shot the impacts of corporate insolvency on leases to the forefront of landlords’ and tenants’ minds alike.

Reduced consumer spending and the geo-political changes throughout the backend of 2024 into 2025 have led to higher financial stress across businesses.  In these conditions, it can be common for landlords or tenants to experience a rapid decent into insolvency as supply chains are affected and financiers withdraw their support.

It is as important as ever to be aware of the potential impacts of insolvency on landlords and tenants of commercial and retail leases, as well as the tools to successfully navigate such challenging times.

Insolvency and Leases

In the context of lease arrangements, insolvency of the tenant or the landlord can create many issues.  Most tenants under commercial or retail leases are corporate entities, so the focus of this article will be on the effect insolvency has on corporate tenants under a lease arrangement.

It is important to know the basics of insolvency.  Insolvency, under section 95A(2) of the Corporations Act 2001 (Cth) (Corporations Act), occurs when a company cannot pay all its debts as and when they become due and payable.  This is a cashflow test, not an asset test.  A tenant may have assets but if it does not have the cashflow to pay its debts as and when those debts fall due for payment, the tenant will be insolvent.

When a company becomes insolvent, there are a few courses of action that may occur:

• the company may enter into voluntary external administration, where an insolvency practitioner (an administrator) is appointed to take control of the company to maximise the company’s ability to continue to trade or, at least, provide a return for its shareholders and creditors;
• the company may be placed into receivership, where a receiver or receiver and manager is appointed over the company by a secured creditor to collect and sell assets to repay the debt owed to that secured creditor; and
• finally, the company may undergo liquidation, either voluntarily or by way of court order, where an independent liquidator is appointed to take control of the company to wind up its affairs in a fair way for the benefit of all creditors.

For a landlord who experiences a tenant becoming insolvent, the landlord may face difficulties including (but not limited to):

• recovering rent from the tenant;
• ensuring that the lease remains on foot;
• enforcing personal/directors guarantees under the lease;
• re-entering the leased premises; or
• commencing or continuing legal proceedings against the tenant.

Impact of Insolvency on Landlord Rights/Abilities

Specifically in relation to common rights and abilities of a landlord under a commercial or retail lease agreement, the differences that each type of formal response to insolvency can have are summarised as follows:

Tenant’s obligation to pay rent

Voluntary administration:

• If a notice under s 443B(3) of the Corporations Act is not issued within five business days of the administrator being appointed and the administrator continues to occupy and use the premises, the administrator becomes liable for rent and other monies owed under the lease.
• If the notice specifies that the administrator does not intend to exercise  any rights in respect of the leased premises, the administrator is not liable for the payment of rent in respect of those premises.
• The administrator is not liable for the rent during the five business days it has to determine if the administrator will not exercise rights in respect of the leased premises.

Receivership:

• Section 419A of the Corporations Act provides that the receiver is liable for so much of the rent or other monies payable by the tenant under the lease:
  • from seven days after the control date; and
  • if the receiver continues to use, occupy, or be in possession of the premises.
• The receiver may within seven days after taking control of the company’s affairs, notify the landlord that it does not intend to exercise any rights in respect of the leased premise. The receiver is then not liable for the payment of the rent in respect of those premises.
• The receiver is not liable for the rent during the seven days it has to determine if the receiver will not exercise rights in respect of the leased premises.

Liquidation

• If the lease is not disclaimed, the payment of rent during the period of liquidation receives priority over the debts of the unsecured creditors..
• If the lease is disclaimed, the liquidator is not liable for rent under the lease.

Recovery of rent following appointment of insolvency practitioner

Voluntary administration

• If the landlord enters into a deed of company arrangement, the landlord is bound by the terms of that deed of company arrangement.
• If the period of administration ends (without a Deed of Company Arrangement being entered into) and the tenant continues to trade the tenant will remain liable for the rent.
• If the tenant is wound up, a liquidator will be appointed, and the recovery of rent will depend on whether the lease is disclaimed (see comments in respect of liquidation).

Receivership

• If the tenant continues to trade after the receiver has retired and the landlord has not terminated the lease, the tenant will be liable for the arrears on rent.
• If the tenant is wound up, the landlord must prove its outstanding rent with the other creditors. In most cases, the landlord is an unsecured creditor.

Liquidation

• If the lease is disclaimed, the landlord becomes a creditor of the tenant. The landlord can claim for its loss under the full term of the lease.
• If the lease is not disclaimed, the landlord’s right for rent during that period of liquidation receives priority over the debts of unsecured creditors.

Enforcing a bank guarantee or claiming on a security deposit

Voluntary administration

• A bank guarantee or security deposit held by the landlord can be enforced or used at any time by the landlord.

Receivership

• A bank guarantee or security deposit held by the landlord can be enforced or used at any time by the landlord.

Liquidation

• A bank guarantee or security deposit held by the landlord can be enforced or used at any time by the landlord.

Ability to disclaim the lease

Voluntary administration

• Although an administrator has no ability to disclaim the lease, the administrator avoids personal liability by giving notice under section 443B(3) of the Corporations Act stating that it does not intend to exercise any rights in respect of the leased premises.
• A section 443B(3) notice does not affect the landlord’s rights against the insolvent company.

Receivership

• A receiver has no ability to disclaim the lease.

Liquidation

• Section 568(1A) of the Corporations Act allows a liquidator to disclaim the lease.

Enforcing a personal/director guarantee

Voluntary administration

• Personal/director’s guarantees can only be enforced after the administration of the tenant has been completed, unless the guarantees are from an unrelated third party.

Receivership

• Personal/director’s guarantees can be enforced against the tenant during receivership.

Liquidation

• Personal/director’s guarantees can be enforced against the tenant during liquidation.

Re-entering the premises

Voluntary administration

• Section 440B of the Corporations Act prevents the landlord from re-entering the premises during administration (despite any provisions of the lease giving the landlord a right of re-entry) without the consent of the administrator or leave of the court.
• This does not apply to where the lease has already ended by the time the administrator is appointed and the landlord has already entered into premises.
• The landlord should, however, still issue a default notice and notice of termination, as the landlord will be able to resume possession of the premises once the voluntary administration ends, unless the lease is assigned with the landlord’s consent as part of the administration process.

Receivership

• Provided there is a proper basis, a landlord may terminate a lease and re-take possession of the leased premises except in circumstances where the receiver continues to pay rent. In circumstances where the receiver is still paying rent under the lease and is in possession of the premises (pursuant to a registered security) the receiver has a right to retain possession.
• There is no statutory moratorium against recovery of possession of the premises during a receivership. In many situations of company receivership there is also the appointment of administrators at the same time. In those circumstances there will be a statutory moratorium on taking possession during administration. Whether a receiver has been appointed ‘over the top’ of an administrator will not preclude the effect of the statutory moratorium.

Liquidation

• If the lease permits, the landlord may terminate the lease and re-enter the premises.
• A liquidator may also vacate the premises at any time.

Assignment of the lease

Voluntary administration

• Subject to the provisions of the lease and any possible security over the lease, the administrator has the ability to assign the lease.

Receivership

• Subject to the provisions of the lease and any possible security over the lease, the receiver has the ability to assign the lease.

Liquidation

• Subject to the provisions of the lease and any possible security over the lease, the liquidator has the ability to assign the lease

Enforcing rights against the tenant

Voluntary administration

• Under section 440D of the Corporations Act, subject to the administrator’s consent or leave of the court, there is a moratorium on proceedings against the insolvent tenant and its property whilst it is in administration, excluding criminal or prescribed proceedings.

Receivership

• There is no moratorium on the landlord enforcing rights against a tenant.

Liquidation

• Under section 471B of the Corporations Act, subject to leave of the court, there is a moratorium on proceedings against the insolvent tenant and its property whilst it is in liquidation.