Real Estate Dispute Resolution Outlook for 2023

Hello, my name's Chloe Meredith and I'm a senior associate in Ashurst's Real Estate Disputes Team. I'm joined today by my colleagues, Alison Hardy, who is the partner heading up our team, and senior associate Kim Clifford.

Hi, Chloe.

Hi, Chloe.

This time last year our team produced a podcast discussing trends that we thought were likely to unfold in 2022. And over the next 15 minutes or so, we're going to take a look back at what we got right, what we didn't get quite so right, and what we can expect from 2023.

Kim has recently returned from maternity leave, so she's going to be posing the questions whilst Alison and I update her on what we've seen in the last year.

Thanks, Chloe. So to recap, our headline points from last year concerned COVID rent arrears, tenant insolvency, dilapidations claims, energy efficiency standards, and restrictive covenants. If we take COVID rent arrears first, our forecast last year was that we expected to see landlords taking action to address the backlog of COVID rent arrears, although we weren't convinced that there would be a large take-up of the government's rent arbitration scheme, which came into force in March 2022 and ended in September. Have we seen much activity in this space?

Yes, there's been lots of activity in this space. As expected, the restrictions relating to non-COVID arrears were lifted at the end of March 2022. And since then, we've seen landlords reverting to serving statutory demands in order to make tenants reconsider whether they want to withhold rent. And that's been successful for quite a lot of our landlord spotlight more clients.

We're also starting to see landlords consider forfeiture for those tenants who've failed to recover following COVID lockdowns. And that might seem surprising given the current economic outlook and the usual desire for landlords to avoid business rates liability. However, a number of the clients that we've been working with who've chosen to pursue forfeiture have been confident that they'll be able to re-let their premises.

I'm expecting that we'll continue to see widespread use of statutory demands in 2023. Although, given the reasons we've just discussed, forfeiture may be a less attractive option for landlords. We've also seen activity in the court of appeal relating to renter arrears.

You'll remember that in 2021, some landlords brought debt claims against two cinemas, so that was Picture House and Cineworld UK, for failure to pay rent during periods of time that the cinemas were unable to lawfully operate their businesses due to government COVID restrictions.

We've also seen activity in the court of appeal relating to rent arrears. You'll remember that in 2021, landlords brought debt claims against two cinemas, so that's Picture House and Cine UK, for failure to pay rent during periods of time that the cinemas were unable to lawfully operate as businesses due to government COVID restrictions. The high court found in the landlord's favour and in 2022 the tenants appealed to the Court of Appeal. They sought to argue that the rent setter clause in the leash should apply, that there was a failure of basis as the tenants were unable to use the premises and that the term should be implied into the leases that rent should be suspended if the use of the premises became illegal.

Again, the court of appeal found in the landlord's favour. It found that the rent setter clause was only intended to cover physical damage to the premises, the tenants had not met the high bar for implying terms into leases, and that there was no failure of basis as the tenants still have the benefit of a 35-year lease with exclusive possession. So this judgement will provide landlords with confidence in the event of future disruptive events, pandemic or otherwise.

Thanks, Chloe. And what about the arbitration scheme? Alison, were we right to be skeptical about its uptake?

At the time of recording, we're aware of approximately 40 awards having been published, one of which of course we were involved in. The scheme ended at the end of September. So barring extremely complex cases or where cases have been stayed to attempt settlement, it seems unlikely that there will be many further awards, although I do understand that there are some working their way through the system.

But given how low that number of about 40 awards is in the context of the government's assessment, the scale of COVID rent arrears stood at £6.4 billion as of March 2021, I think we were right to question how widespread the scheme's use would be. I suppose some might say that the very fact that it was there might have led to some settlements. And as we discussed last year, part of the lack of take-up was because lots of landlords and tenants had been working together before the scheme was even introduced to negotiate a solution. We know that there are other landlords who simply bided their time, holding those arrears back and enabling claims to now be brought for those outstanding arrears.

Okay, thanks. So linking in with arrears, we thought last year we might see some more activity in the tenant insolvency and restructuring space. And in particular, that we might see tenants proposing CVAs in order to avoid being sucked into the government scheme, as disputes were ineligible for the scheme if the tenant had entered into an insolvency or a restructuring process. Has that actually occurred?

Yes and no. We didn't see a wave of tenants proposing CVAs in order to avoid the scheme. That might be because that arbitration scheme wasn't widely used of course. Or it might be because lots of high profile retail brands had already adjusted their portfolios through CVAs in 2018, '19 and '20, to reduce market rents or even turnover rents, leaving less scope for further reductions.
When you compare the ONS data for the first three quarters of 2021 with the data for 2022, overall the number of CVAs has been relatively stable, 82 in 2021, 86 in 2022. Of course, there were a lot more in 2019 with all the pandemic. And with CVAs impacting landlords making up for a small proportion of the overall number of CVAs that we are seeing.

However, we are seeing more queries coming across our desks about tenant insolvency and it's expected that given the OBR is projecting the UK economy will be in recession until the third quarter of 2023, that an increased level of insolvencies is reflected in what we're seeing in the ONS stats. The number of company insolvencies in the third quarter of 2022 was 40% higher than the number of company insolvencies for the same quarter in 2021. And we're largely seeing that through compulsory liquidations. It's at its highest quarterly levels since the start of the pandemic. So we are expecting more in this area in 2023.

Thanks, Alison. Now something we have seen in previous periods of economic uncertainty, which I therefore think we may see more of in 2023, is parties seeking to get out of contracts if they can. I'm expecting more breach of contract claims and clients asking what their options are for avoiding performance of agreements.

Yes, I completely agree about that. Another point we discussed last year was tenants looking to consolidate their property presence following COVID and more dilapidations claims as a result. Now we've been dealing with a lot of dilapidation settlements this year in connection with both retail and office premises. And this tallies with the Centre for Retail Researchers findings that more than 17,000 shops closed last year, which is the highest number in five years. It also reflects a trend of office tenants reducing their space as occupancy rates remain low following the pandemic.

Yes, something I've seen a lot of since coming back from mat leave, and I wonder whether this is a trend that's going to continue in this environment, is dilapidation deals being done upfront. So for example, a tenant would agree at the beginning of their lease that they'll pay a certain amount of money per square foot at the end of their lease, and that amount is then uplifted to account for inflation, rather than the usual situation of the tenant compensating the landlord for the breaches of covenant that they have actually occurred.

Yeah. And I think we're likely to see more of that in 2023 as well, as tenants want certainty as to what their liability is going to be at lease and. And one point I would flag with those types of deals is that the parties should think carefully about how the settlement sum is going to be uplifted in line with inflation. I've seen heads of terms which link the settlements sum to RPI. However, for longer leases that may not work as RPI is going to be phased out by 2030.

The next thing we mentioned in last year's podcast was that the minimum energy efficiency regulations are changing from the 1st of April this year, so that a landlord will be in breach of the MEES regulations for continuing to lease commercial properties with an EPC rating of F or G. We also discussed the government's aim of all buildings having an EPC of at least a B overall by 2030.
Our forecast was that there were likely to be disputes between landlords and tenants as to who should bear the brunt of upgrading buildings to meet these regulations. Has that occurred?

Well, we've definitely seen that parties are alive to this issue and we think the issue will only become bigger once the MEES regulations change and we get closer to 2030. We are seeing tenants negotiating clauses into leases, making it clear that they will not bear the cost of such works. And a colleague of ours, Joe Perry-Courtade, published an article in Property Week in 2022, which explored whether tenants might seek to use the landlord and tenant Act 1927 to carry out improvements themselves and then claim back the cost from the landlord.

There's certainly potential for there to be conflicts between service charge provisions in leases and tenants seeking to make improvements. So this definitely stays on my list as an area to watch. But we do need to see that draught legislation. It's a long time till 2030, but then there's a lot of things for parties to sort out between now and then if we're going to be able to achieve those objectives.

Indeed. Now, our final point from last year was that we expected claims from land owners seeking to remove or modify restrictive freehold covenants on the basis that they impeded a reasonable use of the land.

Yeah, and that is something that we've seen plenty of this year. For example, in HAE Developments Limited against The Croft Ealing Limited and others, the upper tribunal held that the restrictive covenant preventing use of land for anything other than a single dwelling provided no practical benefit in circumstances where the building on the land had already been converted into 11 flats and 22 maisonettes. Not terribly surprising outcome there.

And then in Mill Strand Developments Limited against Tap and others, a restrictive covenant requiring that land be used for agricultural purposes was modified to allow a site to be developed into five detached dwellings. So if the UK is in for a serious economic downturn, which has an impact on the amount of development, it might be that there are not so many of those restrictive covenant cases in 2023. But where sites have already been purchased and the modification of a covenant is key to unlocking the site's potential, then landowners may still choose to press ahead with those applications.

Okay, so to finish off, are there any other themes that you'd expect to see in 2023?

Alison
Well, our insolvency colleagues who we're regularly speaking with expect to see less CVAs in the coming year, probably about the same, potentially more administrations. Perhaps more of those new kids on the block, the restructuring plans, and they've mentioned quite a lot of liquidations. I've seen some property fraud in 2022, and it is often said that in a downturn you can expect to see more fraudulent activities coming to light as investments need to be enforced.

So there you have it. Those are our thoughts on the year just gone and 2023. Thank you for listening and Happy New Year to you all. If you'd like to discuss any of the points raised in this podcast, please get in touch with either Alison, Chloe or myself using the contact details provided on our website. Thank you.