We’re increasingly seeing residential developments have commercial units within them, such as shops, gyms, offices etc, who are also required to contribute towards service charge. However, if/when commercial tenants fall into service charge arrears, they can be approached differently to residential leaseholders.
Within this article Zaynah Younis, one of our litigation solicitors, details the differences in approach between residential arrears and commercial arrears, before providing information on the different options available for tackling commercial arrears.
What is the difference between how a managing agent and/ or landlord approach commercial service charge arrears in comparison to residential arrears?
The tenants of commercial properties do not benefit from the same level of statutory protection as their residential counterparts. For example, a court or tribunal determination is not required ahead of a freeholder exercising their right to forfeit a commercial lease when the tenant is in breach of the same.
The approach to service charge recovery from commercial tenants can therefore be very different to that of recovery from residential leaseholders and below we detail the most common options taken by freeholders when looking to recover rent and service charge arrears from commercial tenants.
Forfeiture of the lease
More often than not the most impactful option available to a freeholder is going down the route of forfeiture of the lease. Forfeiture of the lease brings the lease to an end.
As long as the freeholder has not waived their right to forfeit by acknowledging the continued existence of the lease, which could be done by continuing to issue demands for sums due under the lease or accepting payments, the lease can either be forfeited by peaceable re-entry or court proceedings.
Waiver is a complex concept and therefore advice should be sought if forfeiture is contemplated.
Peaceable re-entry
This is where a freeholder changes the locks to the premises. Best practice is for the locks to be changed whilst the premises are unoccupied, for example first thing in the morning or late at night whilst the tenant is not trading. Additionally, it is advisable for the freeholder and/ or managing agent to instruct an experienced bailiff, as well as a lock smith, in case a tenant is unexpectedly at the premises when the locks are changed.
Whilst peaceable re-entry can be a quick solution, it is quite a severe option to choose, as the tenant will more than likely arrive at the premises to open for business and find the locks changed. Furthermore, the locks being changed does not necessarily signify the end of proceedings, as the tenant can apply to the court for relief from forfeiture, generally, within 6 months of the date of re-entry. If the tenant gets relief and agrees to pay all arrears and costs, then the lease will continue as before.
Forfeiture by court proceedings
Instead of physically re-entering the property as detailed above, this approach involves the freeholder issuing and serving court proceedings on the tenant following the service of a Notice of a Notice pursuant to S.146 Law Property Act 1925, with the lease being forfeit upon service of the papers to the tenant.
There is a period of time between the claim being served and a hearing to finally determine whether the forfeiture has been successful, and to consider any application from the tenant for relief. During this period the tenant will not be required to fulfill their responsibilities within the lease, however the freeholder still remains liable to perform their own covenants.
The hearing of the claim will normally take place between 4-8 weeks after the claim is issued in the court, but court timetables will vary across the country, which could impact timescales. If the tenant does not file, or no viable defence to the claim is made, a possession order will likely be made at the first hearing.
This approach tends to be deemed a fairer approach, as it reduces the potential shock to the tenant and provides them with time to deal with the matter without having to deal with significant disruption to their business. This route also tends to be preferred when there is an element of dispute involved.
Freeholder considerations
Before potentially selecting one of the above, there are some practical considerations we advise freeholders to make:
- Is the market rent level lower than the rent currently being paid, therefore meaning you are likely to generate a lower rental income from new tenants following forfeiture.
- If your current tenant is no longer able to trade, they are even less likely to be able to pay their arrears.
- Have you got a new tenant lined up, as you will have to cover any costs associated with the property until a new tenant is found.
- Due to the tenant’s right to apply for relief from forfeiture, you may not be able to re-let the property for a period of at least 6 months.
Commercial Rent Arrears Recovery
This option does not typically involve the courts, as it is started by a freeholder instructing bailiffs to recover the arrears or goods to the value of the rent arrears. This must be pure rent and will not include any other sums owed by the tenant However, the courts do still have the power to intervene should the tenant apply for an order.
The CRAR process comprises of bailiffs giving tenants 7 days notice and if the arrears are not paid the bailiffs will arrive at the property to seize goods within it for the sale at auction to clear the arrears. However, whilst this may sound a swift and effective process, there is no guarantee that goods within the premises will cover the arrears, as only goods that are owned by the tenant can be seized, which rules out any leased items. Additionally, the freeholder can only recover rent, not including VAT and service charges.
Money Judgement
This is where a freeholder applies to the court for a debt seeking a money judgement against the tenant, which once gained and if the arrears remain unpaid, can be enforced by the freeholder. However, this can take anywhere between 12-24 months if the Court proceedings are defended, during which time the rent and service charge will more than likely remain unpaid.
Statutory Demand
A statutory demand is a step in the insolvency process and gives the tenant 21 days to pay the amount claimed, which must be more than £750 if they are a company or £5,000 if they are an individual. If following the service of a statutory demand the tenant has still not paid, the freeholder will need to consider whether or not to issue a bankruptcy or winding up petition. This would not necessarily result in the arrears being settled in full, particularly if the tenant has a number of creditors and limited assets. Additionally, if the freeholder suspects there may be a dispute in relation to the arrears it would not be wise to issue a statutory demand as it may be set-aside if the tenant sets out a dispute, with the freeholder liable to cover any costs incurred by the tenant.
Withdraw from the rent deposit
Usually, rental agreements begin with a tenant entering a rent deposit deed. If the terms of the lease and the ‘triggering’ events for when a freeholder can withdraw the deposit allows it, the freeholder may cover the outstanding arrears using the deposit. Whilst this is a quick and simple process, it does not increase the likelihood of the tenant making future payments and it doesn’t aid the removal of the tenant, should that be the ultimate aim.
Guarantors
Most people are familiar with guarantors and with the majority of commercial leases including them, the freeholder can consider court proceedings for a Money Judgement or Statutory Demand against the guarantor, as well as the tenant. However, before doing so the freeholder should get advice on whether any liability under the guarantee has been triggered by the tenant’s default, as there will often be strict criteria in the lease.
Conclusion
It is safe to say there are a number of options available to freeholders when looking to deal with commercial arrears, and no one size fits all approach. However, before looking into which approach maybe the most effective and efficient for a scenario being faced, it is very wise to take it account the freeholder considerations within this article, as whilst removing a tenant may seem the logical next step, it may actually leave freeholders in a worse position.
