The effect of liquidation on leases

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Although a tenant's insolvency does not automatically terminate the lease or confer a right upon a landlord to cancel the lease, a landlord is not left without any remedies in the case where a tenant is in breach of the lease before the tenant is wound-up. In the recent judgment of the Supreme Court of Appeal (SCA) in the matter of Ellerine Brothers (Pty) Limited (Ellerine) v McCarthy Limited, the legal position was clarified.

The Ellerine case concerned the validity of a cancellation of a lease upon the insolvency of a tenant where the tenant was in breach of the lease. In this matter notice of cancellation of the relevant lease was given before the commencement of legal proceedings for the winding-up of the tenant, but the period provided for the tenant to remedy its breach, as required in terms of the provisions of the lease, had not yet expired when those proceedings commenced and cancellation of the lease followed thereafter. The question the court had to determine was whether the right to cancel was lost because of a concursus creditorum.

In terms of the relevant provisions of the Companies Act, 71 of 2008, the winding-up of a company is deemed to commence when an application for such winding-up is issued at court and not when a winding-up order is granted, which is also the date the concursus creditorum or, as described by the court in the Ellerine case, a community of creditors comes into existence.

Equal protection

The aim of the concursus, as confirmed by the court in the Ellerine case is "...to give equal protection to all creditors without undue preference and to preserve and distribute the estate to the benefit of all of them."

The case advanced by Ellerine in this matter was that as a result of the retroactive commencement of the tenant's liquidation, the right of Ellerine to cancel the lease had been lost. It was submitted that the estate of the insolvent tenant had been frozen when an application for its liquidation was lodged with the court; that the concursus interposed between the giving of notice to the tenant to remedy its breach of the lease and the expiry of the seven day period therein, and that the interruption of the required time period by the concursus prevented Ellerine from claiming any further performance from the tenant under the lease until the liquidator had elected to abide by the lease. This meant, so it was argued, that a condition for the existence of Ellerine's right to cancel the lease remained unfulfilled.

The High Court found that the lease was validly cancelled on the basis that Ellerine acquired the right to cancel the lease when, in compliance with the breach clause of the lease, it gave the tenant written notice to remedy its breach of the lease and the tenant failed to comply therewith. This judgment was taken on appeal.

Principles of common law

The SCA found that the conclusion arrived at by the High Court was correct. The SCA found that following on the insolvency of the tenant the position is governed by the ordinary principles of the common law which apply when a party to an executory contract goes insolvent.

In its judgment the SCA stated that: "As in the case of any other uncompleted contract, the liquidator inherits the lease in its entirety. The creation of the concursus creditorum therefore does not terminate the continuous operation of a lease agreement to which the insolvent is a party.
The concursus neither alters nor suspends the rights and obligations of the parties thereunder and the liquidator, as the universal successor, steps into the shoes of the insolvent and does not acquire any rights greater than those of the insolvent. This means that the liquidator must perform whatever is required of the insolvent in terms of the lease, including unfulfilled past obligations of the lessee."

The decision in the Ellerine case confirmed that when a tenant is in breach of its lease obligations prior to any application for its liquidation being issued, a landlord is entitled to call upon the tenant to remedy its breach in accordance with the relevant provisions of the lease and if an application for the liquidation of the tenant then follows within the time provided in the breach notice, the landlord retains its right to cancel the lease should the liquidator fail to remedy the breach of the insolvent tenant, within such period.

Although the landlord will only be left with a monetary claim for any damages suffered or unpaid rental against the insolvent estate of the tenant as a concurrent creditor, the landlord will be entitled to re-let the premises after the cancellation of the lease.

Landlord in a better position

This places the landlord in a much better position than it would be in if the tenant, at the time the winding-up process commences, is not in breach of the lease. In such event the SCA in the Ellerine case found that: "To give effect to the concursus, the liquidator must decide whether it would be to the benefit of the community of creditors to continue to perform the inherited obligations of the insolvent under an uncompleted contract. He may elect not to do so. In that event a consequence of the concursus is that the other party to the contract cannot demand performance by the liquidator of the insolvent's contractual obligations." ... "The act of the liquidator in deciding not to continue the lease constitutes '. . . a repudiation of the contract, which would have afforded the lessor . . . the right, concurrently with other creditors, to claim from the liquidator the payment of damages for the non-performance by the company of its contractual obligations'. The claims of the other contractant are therefore reduced by the concursus to a monetary claim and participation in the insolvent estate as a concurrent creditor, where it is treated on the same basis as all the other creditors in the insolvent estate."

In the latter scenario the landlord will have no alternative but to wait for the liquidator to exercise its election referred to in the Ellerine case, without having the right to cancel the lease and let the premises to a new tenant, while being left only with a monetary claim against the estate in due course.

This is the one (and possibly) the only instance when it will actually be better for a landlord to have its tenant be in breach of its (the tenant's) obligations in terms of the lease.