Rent-free periods, liquidators’ liability for rent, and the Lundy Granite principle
Under the Corporations Act, administration triggers a “stay” which prevents landlords from enforcing against leased property while the administration is on foot. The flipside is that administrators are personally liable for rent or other amounts attributable to the administration period (apart from a 5 business-day (“rent-free”) period at the start of the administration – to allow the administrator time to decide what leased property to retain before incurring personal liability). While administrators can satisfy such liabilities from the assets of the company to which they are appointed, they remain personally liable for any shortfall.
In other words, the administrator can cause the company to continue in possession of the property, if they have sufficient funds to pay rent and other outgoings (and it is in the interests of creditors to do so). Alternatively, they can formally notify the landlord that the tenant does not propose to exercise rights in relation to the property, however, that notice must be given within the “rent-free” period. Such a notice terminates the administrator’s personal liability (but the liabilities of the tenant under the lease remain, albeit subject to the proof of debt regime). Additionally, for most leases entered into after 1 July 2018, in addition to the stay on enforcement actions, the landlord cannot terminate, or enforce any other right under the lease, if the trigger for doing so is merely the appointment of an administrator to the tenant.
This is the conventional position. However, in recent years, largely driven by extended pandemic lockdowns, administrators in larger and more complex administrations have increasingly sought to (further) limit their personal liability by obtaining Court extensions in the Federal and State Supreme Courts of the “rent-free” period before they incur personal liability or must relinquish the leased property. In fact, the number of reported extension applications in the two years since 2020 exceeds the number of reported applications in the decade between 2010 and 2019.
The graphic below identifies the incidence of reported “rent-free” extension applications in Australia’s Federal Court and State Supreme Courts over the 2010-2022 period.
The length of the extensions granted by the Courts have varied, depending on the circumstances of the relevant administration. The applications decided during the pandemic reveal that the Courts were far more willing to grant extensions of the “rent-free” period to administrators at that time, than pre-pandemic. They also reveal the Courts’ readiness to grant longer extensions (of weeks or even months, rather than days) to allow administrators to assess a company’s position in respect of leased assets. The table below sets out some key data in respect of a selection of pre- and post-pandemic extensions.
While many of the applications in 2020-2021 cited pandemic-related factors to justify the extension sought (such as the uncertainty for retail businesses created by Government imposed lockdowns), the Courts have shown a willingness to grant such relief in any circumstances where “the administrator has had insufficient time to conduct the necessary investigations to decide whether he or she thinks it best to retain or give up possession of leased property”. The grants of relief in 2022 – at a remove from pandemic-related difficulties – suggest that applications of this nature will become more common where administrators are faced with a large number of leases and wish to preserve the business and associated options for potential purchasers, but cannot assume the significant financial exposure associated with the leases while lease diligence or sale options are explored.
A related development has been the emergence of claims made by landlords and lessors that, even where the administrator has been relieved of statutory personal liability, rent during the administration period should be paid in priority to ordinary unsecured creditor claims, pursuant to the so-called “Lundy Granite” principle (arising from a 19th Century English liquidation case of the same name). This principle had previously only been recognised in liquidations, applying where the liquidator “elects to cause the company to continue in occupation of leased premises”. In the PAS Group administration, the companies leased a total of 166 premises, including 161 retail stores. The administrators obtained an order extending the “rent-free” period while they continued to trade from most of the stores through the administration period. They generated gross revenue of $7.32 million from trading from leased premises. The total rent for all 166 properties for the extension period was $1.385 million. In giving directions as to what priority should apply to the unpaid rent in a (hypothetical) winding up, the Court found that, according to the principle in Lundy Granite, the unpaid rent should be accorded priority above the companies’ other unsecured creditors.
There remain, however, a number of uncertainties as to how the Lundy Granite principle will be applied to Australian administrations. In proceedings brought by 11 aircraft lessors against the former administrators of Virgin Australia Airlines, the administrators (for whom the authors acted) successfully argued that the principle did not apply where the companies were not in liquidation, but rather had executed deeds of company arrangement (DOCAs) with creditors’ claims (including those of landlords and owners of leased aircraft) being dealt with pursuant to the terms of a creditors’ trust. While there have been some English cases which extended the principle in English administrations, the English administration regime has at least one critical difference to Australia’s voluntary administration regime: the former provides for the distribution of assets within the administration (under rule 4.218 of the Insolvency Rules 1986 (UK)), the latter does not. Where it applies, the Lundy Granite principle affects the order of priority on distribution. Where there is no statutorily prescribed order of priorities on distribution (as in an Australian administration), until an Australian court finds otherwise, the correct position is that the Lundy Granite principle has no work to do.
Where the administrator elects to retain property during the administration period, the best outcome is usually for the administrator and the landlord to negotiate a mutually acceptable arrangement in respect of rent to avoid any later uncertainty or dispute as to their respective entitlements and obligations. There is nothing in Australian law which prevents the parties from entering into such an arrangement and, as found by the NSW Supreme Court in the Virgin Australia Airlines proceedings, no Corporations Act preclusion on the administrators negotiating a compromise or standstill of their statutory personal liability for rent.