Lessors’ Priority Preserved: Implications for Post-Appointment Trading and DOCAs

In its recent judgment involving the PAS Group of companies[1], the Federal Court held that rent payable by the PAS Group during an extension of the period in which an administrator had been excused from personal liability (Standstill Period) is an expense properly incurred by a ‘relevant authority in carrying on the company’s business’ and is therefore a priority debt under s 556(1)(a) of the Corporations Act 2001 (Cth) (Corporations Act). 

Background

The PAS Group is a fashion group with a large retail footprint of 161 stores. The administrators had successfully obtained an order for a Standstill Period of approximately three weeks. The administrators caused the PAS Group to continue to occupy and trade from all but eight of the retail stores during the Standstill Period and sought a declaration that the related rent was a merely unsecured debt or claim in the administration and was not entitled to priority under section 556(1)(a) of the Corporations Act.  These orders were challenged by Scentre Management Limited, being the largest lessor of premises to the PAS Group. 

Decision

In refusing to grant the declaration sought by the administrators, the Court emphasised that the leased premises were used by the administrators to actively trade the PAS Group on a “business as usual” basis so as to facilitate a going concern sale and to generate over $7 million in revenue. This conclusion was based on the Court’s affirmation of the Lundy Granite principle, namely, that rent in respect of premises leased by the company prior to liquidation but used or retained by a liquidator for the benefit of the liquidation is to be treated as an expense of the liquidation and paid in priority to all other unsecured debts. The Court held that the provisions of section 443B of the Corporations Act regarding an administrator’s liability do not affect either the Lundy Granite principle or the section 556 ranking of claims in a liquidation.[2]

Consequently, it followed that in any liquidation of the PAS Group, the Standstill Period rent would be payable as an expense properly incurred in carrying on the business of the PAS Group within the meaning of section 556(1)(a) of the Corporations Act.[3]

Key takeaways

1. While the PAS Group decision concerned the treatment of rental payments under real property leases, it has broad application to payments under equipment leases and contracts for goods and services during a Standstill Period (Standstill Period Debts). 
2. The primary impact of this decision is likely to be felt in relation to insolvencies of groups with a substantial leasehold footprint or that have a heavy reliance on equipment leases (e.g. airlines, mining services businesses and retail or hospitality groups) where the quantum of the Standstill Period Debts may be sufficiently substantial to materially alter distributions to other creditors. In such a context, the PAS Group decision introduces a significant additional consideration into an administrator’s deliberations as to whether continued post-appointment trading of a business is in the best interests of all creditors. This may in turn disincentivise restructuring efforts where continued trading is an integral component of the proposed restructure. 
3. While a DOCA may exclude the operation of clause 4 of Schedule 8A of the Corporations Regulations 2001 (Cth) and therefore the priority waterfall in section 556 (as well as 560 and 561) of the Corporations Act[4], a DOCA that does so and delivers an inferior outcome for creditors to whom Standstill Period Debts are owed (when compared with the priority return in an immediate winding up) is susceptible to challenge on the grounds that it is oppressive or unfairly prejudicial to, or unfairly discriminatory against, those creditors.[5]
4. In applying to the court for a Standstill Period and electing to keep certain real property or equipment leases or service contracts on foot during that period, administrators will need to carefully assess any potential deed proponent’s capacity and willingness to fund Standstill Period Debts and whether any proposed DOCA affords those debts the priority that they would enjoy in a liquidation. This last consideration will be particularly significant in circumstances where the body of unsecured creditors features a significant proportion of creditors to whom Standstill Period Debts are owed, particularly from the perspective of ensuring that an administrator’s recommendation of a DOCA to creditors is resistant to subsequent challenge or criticism. In such a scenario, it is more likely that a viable DOCA may need to provide for priority treatment of Standstill Period Debts.