Insolvency Law and Lease Agreements – What Every Landlord Should Know
A practical short guide to understanding the legal effects of the insolvency of tenants and the protections available to landlords under South African law.
Introduction
South African insolvency law is a complex and nuanced area of legal practice. The Insolvency Act 24 of 1936 (“the Act”) generally governs insolvency proceedings in a truly remarkable and diligent fashion for a piece of legislation of its age (with some help from the new Companies Act). Commentary on the Act and judicial interpretation have only added to its complexity, and the issues arising from insolvency can become highly complex, requiring the advice of an attorney.
Scope of this Article
This article focuses specifically on the effects that the insolvency of a lessee (“tenant”) has on a lease agreement that it has concluded with a lessor (“landlord”), and the ways in which landlords can protect themselves from the adverse consequences of such insolvency.
The Legal Framework: Section 37 of the Insolvency Act
The legal consequences of a tenant’s insolvency on a lease agreement are governed by Section 37 of the Act. This section specifically provides that the insolvency of a tenant does not automatically lead to the cancellation or termination of the lease agreement. Instead, the trustee appointed to administer the insolvent estate may make a written election to either cancel or continue with the lease agreement.
Should a trustee fail to make such an election within three (3) months of their appointment, the lease agreement will, generally, be deemed to have been cancelled after such period in accordance with section 37 of the Act. Should the trustee elect not to cancel the agreement, arrear rental may be due and payable to the landlord from the costs of administering the estate (these costs are, generally, paid out before all other creditors are paid). It is critically important to note that the landlord should prove this claim at a meeting of creditors once the estate has been declared insolvent. While this affords the landlord a degree of comfort, it remains limited in scope.
There is a chance that the trustee can elect to continue with the lease, but the chances hereof are slim, as the trustee would have to be of the opinion that the continuation of the lease would be to the benefit of the general body of creditors of the insolvent estate, and the payment a recurring fee for the lease of property which does not generate revenue would scarcely justify such a decision.
Practical Protections Available to a Landlord
There are three primary mechanisms that a landlord can rely on to protect their interests where the insolvency of a tenant becomes a risk. While the list is not exhaustive, the following measures are recommended for their practicality and relative ease of implementation.
- The Landlord’s Tacit Hypothec
One of the oldest principles in South African law, the Landlord’s Tacit Hypothec, grants a landlord a limited real right over the movable property situated on the leased premises (belonging to the lessee), as security for arrear rental payments. This right arises from the date on which the lessee takes occupation and fails to pay rental and is specifically confined to amounts owing for rental.
While this mechanism is strong in itself, it may be strengthened by perfecting the hypothec. This is done by obtaining a Court Order confirming the hypothec and having the movable property attached, which converts the limited real right into an enforceable and legally recognised real right in the context of insolvency. This perfection is a highly recommended course of action, as it provides the landlord with a legally recognised, and more robust claim over the movables.
- Suretyship Agreements
A landlord may require that a third party stand surety for the payment of rental obligations under the lease agreement. In the event that the tenant defaults, the landlord will be entitled to claim the outstanding rental from the surety, the tenant or both. Suretyship agreements are relatively straightforward to conclude and can be readily incorporated as ancillary agreements to most lease agreements. This provides an additional layer of financial security to the landlord and operates independently of the tenant’s solvency.
- Swift and Decisive Action
The most practical recommendation is also the most straightforward: address payment defaults before the situation escalates to the point of insolvency. It is not uncommon for landlords to delay action (often out of a reluctance to pursue formal proceedings), while a tenant accumulates several months of arrear rental. The formal eviction process can take several months or longer, during which the costs of maintaining the property continue to accrue while no rental income is received.
It is therefore strongly advisable for a landlord to issue a formal breach notice as soon as even a single month’s rental is not paid, whether such notice is delivered personally or through an attorney (which is preferable). While this approach might not be universally welcomed, it sends a clear message regarding the landlord’s expectations and creates a formal record of the tenant’s fulfilment/non-fulfillment of their obligations.
Where the tenant remedies their breach, the matter is resolved. Where the defaults continue, the landlord (and their financial position) will be grateful for their swift and decisive action when legal action becomes necessary.
Conclusion
A tenant’s insolvency presents a genuine risk to landlords, but these risks are manageable when the right protection mechanisms are implemented. Understanding the operation of the Insolvency Act, perfecting the tacit hypothec, securing suretyship agreements, and acting promptly on defaults are all measures that can drastically reduce a landlord’s exposure when a tenant is declared insolvent. By approaching their leases with diligence and legal foresight, landlords will be best positioned to navigate the complexities and risks that insolvency can bring.
Disclaimer: This article is intended for general information purposes and should not be accepted as legal advice. You are advised to seek specific legal advice based on your specific circumstances.Prepared by Ruan Hogendoorn from Bruno Simão Attorneys.