Southern Cross – a landlord’s perspective

06/08/2011

By Richard Ellard, Partner and Sarah Easton, Senior Associate in Commercial Property & Development. First published in Estates Gazette in August 2011.

Southern Cross Healthcare Group PLC (Southern Cross), operator of 752 care homes in the UK has become another casualty of the recession. Suffering from stagnant income partly due to a decline in local authority fees and inflation running at over 4% per year the company is unable to meet rental obligations exceeding £230 million.

It is reported that at a meeting of the landlords in July a 30% rent reduction was agreed over the summer months to give the company a platform to get its finances in order. Most well advised landlords would make this concession personal and time limited.

All 752 Southern Cross care homes are run from leasehold properties with 75% of those properties owned by just eight landlords. It is reported that many of the leases were originally granted for 25 years with a combined rent bill over the term of the leases of £5bn.

Landlord opportunity

Uniquely some of the Southern Cross landlords are in the healthcare sector, NHP and Four Seasons for example.

There are reports that some of these landlords are in discussions to take the businesses and leases back. The terms and structure of these deals are not known but these landlords may be able to take advantage of the current situation. This is unusual as most investor landlords are not in the same industry as their tenants and taking over a failing tenant’s business is not an option for them.

Tenant’s right to assign

Most leases permit a tenant to apply to the landlord for consent to either assign or underlet the lease thereby passing the obligations in the lease on to the assignee or under tenant. This seems like a perfect exit for a struggling tenant. However, two obvious issues make this a non-starter:

• Most institutional leases prohibit the assignment and/or underletting of a property where the tenant is in breach of the terms of the leases – non-payment of rent would frustrate an application for consent. There is also the question of the tenants ability to pay off any arrears;
• If the current business cannot sustain the level of rent  the chances of finding a willing assignee or under tenant are low.

Assignment of the lease would only be a solution to the current problems if the terms of the assignment dealt with any breaches of tenant covenants and re-geared the terms of the leases so as to make the business viable going forward.

Landlord’s rights

When a tenant fails to pay rent (or breaches other covenants), there are several options available to the landlord including forfeiture, distress, or suing the tenant for outstanding rent. Once the tenant becomes insolvent the options become more limited and often leave of the court is required before action can be taken.

Especially in the current commercial property market most landlords want to avoid taking a property back from a failing tenant.

The landlord’s concerns will include:

• the time and cost involved in getting the property fit for re-letting (the tenant’s fixtures, fittings and rubbish could remain);
• whether the tenant is good for outstanding rent, any other costs and a dilapidations claim;
• the costs of holding an empty property (including empty rates liability);
• the chances of successfully re-letting the property in the near future.

For the Southern Cross landlords the problem of vacant possession and getting the property ready to remarket will be increased because of the residents. Indeed, landlords are unlikely to act in a way that would prejudice vulnerable residents.

Commercial considerations

The attitude of a landlord to a failing tenant will depend upon the size and nature of the landlord, the location of the property and the local market.

If the landlord is lucky enough to have a versatile property that could appeal to a wider class of tenant, the landlord may be more comfortable taking the property back.

The landlord could accept a voluntary surrender but must be careful to have a binding commitment from a new tenant first to avoid becoming liable for empty property business rates.

When Woolworths went into administration landlords endeavoured to keep leases alive for as long as possible thus leaving business rates liabilities with the company.

Other considerations for landlords with tenants in financial trouble or administration include:

• The value of an authorised guarantee agreement on assignment to a new company. The landlord may have to agree to the assignment of the lease to a new company that does not have any trading history rather than taking the property back and trying to pursue the tenant for the debt. If an assignment does proceed there seems little point taking an authorised guarantee agreement from a failing company.
• There may be little on offer in terms of rent deposit or parent company guarantee. This is common in pre-pack administrations where phoenix companies are formed. 
• The landlord will often be asked to consider a reduced rent or rent free period to assist a struggling tenant or assignee taking over a failing tenant’s business. Again, a landlord is faced with Hobson’s choice – agree to the request or face getting the property back when the tenant fails. A well advised landlord may try and ask for something in return – perhaps an extended term so that if the fortunes of the tenant improve the landlord benefits. 
• Landlords may also be asked to consider agreeing to temporary arrangements. When Officer Club went into administration some landlords were asked to agree to short tenancies while the new entity tried to make the location work and ran stock levels down. 
• Check whether the landlord may be able to claim rent or other sums payable under the lease from a previous tenant – particularly where the lease pre-dates 1996. When First Quench were placed into administration, a number of landlords looked to Whitbread, as previous tenants, to pay the rent. Landlords should also check the worth of any guarantors and previous tenants under AGA’s.

Landlords must consider if there is any way of securing the position on dilapidations if a new lease or even temporary arrangement is granted to a new entity.

Lessons for the future

Some of the companies that have gone into administration in the last few years were not weak questionable covenants until the current economic downturn started e.g. Lehman Brothers, Focus DIY, Woolworths, Jane Norman and Habitat. Many of these names would have been prize tenants when the leases were granted

The Southern Cross situation highlights the importance of landlords seeking good advice when granting new leases. There are a number of things a landlord can do to try to protect himself against the risk of a tenant failing at some point during the currency of the lease.

Rent deposits, parent company or, personal guarantees from directors or a bank guarantee should be considered.

Proper due diligence into the tenant is essential, although a healthy balance sheet at the start of the lease is no guarantee that the tenant will remain financially sound. Even during a ten year lease a company can go from great to insolvent