25 April 2017

Romania: Tenant's Insolvency in Lease Agreements

From an economic perspective, especially in the current business environment, contractual freedom is the best legal method to satisfy the legitimate interests of individuals and to ensure the general benefit and, consequently, social progress.

From this point of view, in any activity, every business is seeking to make a profit. Achieving this depends on a series of determinant factors as well as a certain number of risks which any business should assume when implementing its objectives.

In a preliminary stage this is reflected by the necessity on the part of businesses to establish a headquarters. Later, when they expand to specific locations, premises often are rented from other legal entities owning commercial, industrial or office buildings. Usually the economic blockage is reflected in the business performance of the tenants. Thus the owner of commercial premises whose tenants have succumbed to pressure from creditors and the repercussions of excessive pecuniary obligations may decide to file for a reorganisation plan when no other alternatives are offered.

1. Ongoing agreements upon opening of insolvency proceedings

By the time insolvency proceedings are opened, the tenant is usually engaged in a series of contractual relationships aimed at achieving its business objectives, such as agreements with suppliers, owners of commercial premises, etc.

Under article 123 paragraph (1) of Romania's Law 85/2014 on insolvency prevention procedures and insolvency, as amended and supplemented (the "Insolvency Law"), agreements that are ongoing when insolvency proceedings are opened shall be considered maintained and any contractual clause regarding the termination of such an agreement, the revocation of the benefit period or the anticipated maturity date of the agreement, motivated by the commencement of the insolvency proceedings, shall thus be considered null and void.

At the opening date of the insolvency proceedings, the lease agreements for the premises in which the debtor operates are considered agreements with major importance, or even vital importance, for the debtor's recovery from economic loss. The judicial administrator/liquidator is responsible for analysing the opportunity of such contractual commitments, considering the new financial environment which the tenant confronts, and shall incur liability for the decision to maintain/terminate the agreements strictly based on the impact that such a decision would have on maximising the value of the debtor's assets, without considering the social or economic pressures exerted by the debtor's contractual partners.

In contrast to the repealed legislation, article 123 of the Insolvency Law expressly regulates, under the provisions of paragraph (4), the possibility of the insolvency practitioner to unilaterally terminate unexpired leases, as well as other long-term contracts, as long as these contracts have not been entirely or substantially executed by the parties involved. However, the insolvency practitioner must analyse the opportunity to maintain/terminate an agreement strictly in respect of the tenant's chances for a financial recovery, within a three-month period from the opening of the insolvency proceedings.

Unless the landlord demands the termination of the agreement due to the absence or wrongful performance of the obligations undertaken by the insolvent tenant prior to the commencement of the insolvency proceedings, the insolvency practitioner's decision to maintain the agreement means that the effects envisaged by the tenant and the landlord when the agreement was concluded shall be sustained. Moreover, if prior to the termination date the tenant has not duly paid the rent, the landlord may not use this to justify termination of the agreement. However, a contractual breach occurring after the insolvency practitioner's decision to maintain the agreement may be a valid reason for termination.

According to the provisions of article 87 corroborated by the provisions of article 123 of the Insolvency Law, within the observation period the debtor may only continue its current activity. Therefore, it is essential for the tenant to maintain the premises in which it currently operates, and the insolvency practitioner should consider this when deciding whether to maintain or terminate a lease agreement.

In practice, such a decision is usually taken by the judicial administrator/liquidator after consulting with the debtor. We believe that such a solution has a practical foundation considering the short amount of time in which the insolvency practitioner has to take a decision, as the debtor is the only one able to determine the economic relevance of each location where it operates.

Nevertheless, the duties of the insolvency practitioner are subject to some limitations. Therefore, it is not possible to only terminate certain clauses of a lease agreement that may not be interpreted in favour of the debtor or for the tenant to unilaterally modify the rent in order to create a more favourable situation for it. However, the possibility to renegotiate certain contractual clauses in the debtor's name is not excluded.

As mentioned above, in an agreement which provides periodic payments due for the debtor, the decision to maintain the agreement will not compel the insolvency practitioner to execute the residual payments. For these payments, the owner of leased commercial premises will be included in a list of creditors for the execution of the residual payments, although its debt will be unsecured.

2. The principle of maximisation of debtor's assets

The Insolvency Law departs from the common law principle regarding the binding power of a contract in order to give priority to the principle of maximising the debtor's assets.

If the insolvency practitioner ignores the principle of maximisation of the debtor's assets when deciding whether to maintain or terminate a contract, the creditors would be able to file a personal action against the insolvency practitioner in accordance with the provisions of article 58 of the Insolvency Law. If the insolvency practitioner decides to maintain the lease, it has the right to renegotiate the terms and conditions of the lease agreement in order to best reflect the debtor's interest in maximising the value of the assets.

Under article 123 paragraph (10) of the Insolvency Law, in order to maximise the debtor's assets or if the contract cannot be executed, the judicial administrator may assign ongoing contracts to third parties, provided that those contracts have not been concluded intuitu personae, according to the provisions of the Civil Code. As tenancy is not usually concluded based on the qualities of the debtor (in this case, the insolvent tenant), the insolvency practitioner may be able to find third parties willing to take over the contract. The judicial administrator/liquidator, however, only has the option and not the obligation to assign those contracts. Moreover, the principle on which the insolvency practitioner's actions are based is maximisation of the value of the debtor's assets, thus being more likely to terminate a disadvantageous tenancy.

3. Defence mechanisms against an insolvent tenant

Although upon a preliminary analysis of the provisions of the Insolvency Law it might appear inequitable for an economic risk deliberately assumed by the tenant and placing it in financial difficulty to be incurred by other legal entities acting in a related business environment, we believe that in such circumstances the legislator's intention was to grant priority to the general interest, which might have an impact on an entire business area, to the detriment of an individual interest.

However, the legislator has developed specific remedies for the counterparties of the debtor, which may be applied if the insolvency practitioner decides to terminate the agreement because it sees an opportunity to do so.

Therefore, if the tenant and the judicial administrator/liquidator take a passive approach, the Insolvency Law allows the landlord to react not by granting the landlord the possibility of unilateral termination, but to require the insolvency practitioner to decide whether to maintain/terminate the lease agreement. If the insolvency practitioner fails to respond, the insolvency practitioner will no longer be able to request the execution of the agreement, which shall be considered lawfully terminated. Moreover, if the insolvency practitioner chooses to maintain the agreement but, after the opening date of the insolvency proceedings, the tenant is no longer able to perform its contractual obligations due to its personal fault, the landlord may file a request to the bankruptcy judge to terminate the lease agreement.

As a remedy, the landlord is entitled to have its right of notice respected, and if the insolvency practitioner's decision to terminate the lease agreement causes damages, the landlord may file an action in front of the bankruptcy judge in order to determine the amount of damages to which it is entitled. However, the amounts granted as compensation will be considered unsecured claims and will follow the nature of this sort of debt when the assets comprised in the body of creditors are divided.

Along the same lines, it will prove useful to set out in the applicable law a series of criteria by which the amount of such compensation may be determined, considering both the principles of common law and the principle of maximisation of the value of the debtor's assets, or regulations establishing the nature of such compensation. This kind of provision is useful both for courts and insolvency practitioners, which can more precisely assess the impact of termination or maintenance of the lease on the debtor's property. Examples of such criteria would be the costs incurred by the owner in order to restore the area to its original state, the rent not received until the subsequent occupation of the space, and costs incurred mandating a real estate agency to identify another potential tenant.

Since the risk of insolvency of its counterparty is predictable, at least in theory, the landlord is allowed to request at the date of conclusion of the lease agreement independent and executable guarantees, such as letters of bank guarantee, security deposits, etc. Such guarantees have the power to "resist" the insolvency proceedings and may be used according to the purpose for which they were issued by the tenant. Thus, a letter of guarantee may be issued in favour of the landlord regardless of the insolvency state of the tenant, but will be subject to the conditions applicable according to the law agreed by the parties. A prudent and diligent landlord is therefore entitled to require certain legal instruments in order to ensure a certain level of protection against the effects of severe economic difficulties in which the tenant may find itself at a particular moment in time.


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