Rental income – how should administrators treat this?

If a company owns property, it is often financed by a loan from a lender supported by way of security (usually a legal mortgage and/or debenture). If that property is tenanted, then there is usually a provision in the security document that provides for the lender to have a fixed charge over the rental income, with a floating charge as back up. In the event of the company entering administration, the approach commonly applied by the industry has been that the lender will be entitled to the rental income from those properties as fixed charge realisations. But is this really the correct approach?

Following the decision in Re Atlantic Computers, the position was that rental income is to be treated as caught by the fixed charge provisions in the security, the argument being that because the lender has a fixed charge over the properties which generate the rental income, such income represents the fruits of the mortgaged property and is therefore caught by the provisions of the fixed charge. In light of the subsequent Re Spectrum Plus decision, is this still the correct analysis?

Despite any provisions in the security documentation requiring rental income to be paid into an account held with the lender or held on trust for the lender, unless the lender operates a blocked account (prohibiting the company from having any access to the monies therein without specific consent from the lender), then there is a powerful argument that the purported fixed charge over rental income fails because the lender has exercised no control over that asset. In this situation, this leaves the lender having to rely on the back up floating charge provisions in the security, and therefore being subject to a diluted priority position.

So, what are the alternatives for a lender? Well drafted security documents usually give the lender a right to appoint a fixed charge receiver or to take possession of the properties itself in the event of a default. The lender does not lose this power if a company enters administration, although they do require the administrators’ consent or the permission of the court to enforce such provisions (with weight to be given to proprietary interests). In such circumstances, the lender then becomes entitled to the rental income collected as mortgagee in possession or by the fixed charge receiver.

Another option for the lender is to rely on any assignment of the rental income in the security documentation which operates to transfer the legal or beneficial title to the rental income to the lender. In such circumstances, it does not seem likely that serving notice to convert an equitable assignment into a legal assignment would contravene the moratorium on enforcement on the basis it is simply an administrative step.

Whilst there is clearly scope for a court to specifically consider a dispute between a lender and office-holder as to the correct characterisation of a charge over rental income, there is a compelling argument that it should only be treated as a fixed charge if there is in fact a valid fixed charge created over the rental income. This would be in line with the Re Spectrum principles, i.e. the lender truly has sufficient control over the income by way of a blocked account or similar, so simply being the fruits of a fixed charge asset is insufficient. In the event that the fixed charge provisions fail, then the rental income will still be subject to any floating charge contained in the security, although payable in accordance with diluted priority.

However, a lender can still circumvent any arguments regarding fixed and floating charges by appointing a fixed charge receiver or collecting rent as a mortgagee in possession itself, or by relying on any assignment provisions in the security. For more information or advice, please contact either Alan Meiklejohn at [email protected] or Deanne Hamilton at [email protected].