It has been widely reported that lenders are expecting a rise in the number of homeowners handing back their keys as the cost-of-living crisis forces borrowers to default on their loans. Businesses, particularly SMEs, are also reported to be struggling to meet the business demands in a tightening market.
Defaults will not only be seen in relation to monthly mortgage and loan payments but also in relation to service charge and ground rents owed under leases for property. These are expenses that have increased significantly in the last couple of years. If these costs are not paid, the landlord can seek to forfeit the lease, which extinguishes the borrowers interest, and critically, removes the lender’s security. This would leave a lender with no property to repossess, or no asset to sell, in order to recover the sums owed.
Forfeiture
Forfeiture is the right of a landlord to terminate a lease in the event of a tenant breaching a covenant in the lease. This is commonly used as a remedy when the tenant has defaulted on monies due to the landlord, i.e., monthly rental payments, service charges and or ground rent monies. Other breaches could include failing to keep the property in a state of good repair and condition, which may be a consequence of limited funds being available to spend on maintenance.
Providing the lease allows for forfeiture, landlords can take the necessary steps to terminate the lease. This can be done by either court order or peaceable re-entry (for properties let other than a dwelling) to obtain possession of the property. Once the claim for possession has been issued, or the property peacefully re-entered, the lease is forfeited, i.e., it ceases to exist and the property reverts to the landlord’s ownership.
How can a lender protect their security?
Lenders are entitled to apply to the court for relief from forfeiture, but there is action that lenders can take before they get to this stage.
A common solution to protect the security and avoid forfeiture proceedings, would be to pay such sums that have accrued and to apply the same to the borrower’s mortgage/loan account. The mortgage/loan terms and conditions would need to be carefully considered but most have provisions that allow the lender to take action to protect their security and to pass these costs on to the borrower. This solution is only possible if the lender is notified, in advance of forfeiture, that these sums are outstanding. Unfortunately, this is not always the case.
A further consideration of taking this action, particularly in the current market, is that the borrower may become reliant on the lender to repeatedly pay such costs. This could have a significant impact on the equity available to repay the sums owed to the lender and impact on the borrower’s general affordability.
If pre-emptive action is not possible, and the lender learns that their security has been forfeited, then they must apply to the Court for relief from forfeiture. Once a lease has been forfeited, it cannot be reinstated without an order of the Court. The Court will usually only grant relief if the breach can be remedied, i.e., if outstanding sums owed are paid or if it can be shown that the landlord has waived their right to forfeit.
A lender, if applying for relief on behalf of the borrower, would usually have to be willing, and able, to remedy the breach (or argue waiver). If they are able to do so, the Court will likely grant relief on the condition that the breach is remedied within a set time period. This can be agreed with the landlord in advance, and a consent order filed, but it must be sealed by the court for the lease to be reinstated.
Alternatively, and once a lender becomes aware that the borrower is not meeting the demands under the lease, and their security is at risk, they can look to enforce the terms of the mortgage/loan themselves and look to realise their security - by way of mortgage possession proceedings, enforcing their power of sale, appointing Receivers of rent, etc. This will allow a lender to retain some control whilst preserving the security and ultimately recovering the outstanding debt owed.
What to expect
The moratorium imposed by the Commercial Rent (Coronavirus) Act 2022 has long since been lifted and we have seen the number of forfeiture instructions progressively increasing and accelerating since the start of the year.
The Supreme Court have recently issued a favourable decision for landlords to compel tenants to pay any service charge (following service of a service charge certificate) that is due straight away to comply with the terms of the lease (Sara & Hossien Asset Holdings Ltd v Blacks Outdoor Retail Ltd). This is true even if the tenant wishes to challenge the sums owed, e.g. if the landlord wants to carry out repair works to the property and the tenant doesn’t agree they are necessary and/or that they will cost what the landlord has forecasted them to cost, they will have to pay the sums regardless.
The tenant does not lose the right to challenge the sums, and indeed can do so, but this must be done after the payment has been made – a concept termed “pay now, argue later”. A failure to make the payment (however large it is) would be in breach of the lease and leave the landlord free to forfeit the lease. This could place a tenant in difficulty, if faced with a large service charge demand from their landlord, that they cannot afford and/or that they wish to dispute. In this situation, if a tenant does not pay, and the lender steps in, they would need to “pay now, argue later” which is no small undertaking for a lender.
Conclusion
Preserving their security is at the top of every lender’s to do list. Forfeiture poses a real risk to a lender’s security and is a tool used by landlords more frequently when the country is in a recession, or a period of economic difficulty. It is therefore something that a) in these uncertain economic times lenders must be alert to and b) if they find themselves in a situation where this threat becomes a reality, they must act quickly to seek legal advice in order to best protect and preserve the security held.
* Kate Rigby is a partner in the Dispute Resolution Group of London-based law firm Rosling King LLP, with particular expertise in the fields of commercial litigation and real estate litigation *
