JB Leitch’s Legal Director Phil Parkinson, with Associate Solicitor Katie Edwards, provide practical insight, advice and clarity on the complex issues surrounding the insolvency of Right to Manage (RTM) companies.

The legislation surrounding right to manage has correctly received a considerable amount of criticism in recent years. Putting to one side general issues relating to acquisition, scope and function, this article focusses solely on the legal position and related implications of an RTM Company becoming insolvent.

First Considerations

Initially, prior to any insolvency event, it is worth considering an RTM Company’s position should a statutory demand or winding-up petition be served on it. The presentation of a winding-up petition does not automatically deprive the RTM Company from trading but it is possible that the presentation of a petition will trigger contractual provisions entitling the contractual counter-party to terminate the agreement, for example a bank could freeze assets such as the RTM Company’s bank account. 

Additionally, no alteration of the status of the RTM Company’s members is permitted, unless subsequently validated by the Court, and the directors of the RTM Company fall under a general duty to act in such a way which would avoid any potential loss to creditors in the event that liquidation were to follow. Accordingly, full management responsibilities can be continued under the leases of flats at a building – indeed any failure to do so gives rise to a claim for breach of covenant by any lessee.

Taking the situation a stage further, the impact upon an RTM Company, should insolvency proceedings continue and it enters liquidation, is considerably different and serious. 

Any RTM Company’s entitlement to manage a building is borne solely from statute, under s96 of the Commonhold and Leasehold Reform Act 2002 (“CLRA 2002”). Consequently, an analysis of the statutory provisions are required in order consider the implications and s105 of CLRA 2002 provides that “the right to manage the premises ceases to be exercisable by the RTM company if – a winding up order is made”. 

Accordingly, any success by a party in bringing a winding-up petition against an RTM Company would result in an immediate cessation of management.

Confusingly, CLRA 2002 fails to set out the express consequences which would follow if the right to manage ceases by operation of s105. The generally accepted position is that the management obligations will simply revert to the party (or parties) which were responsible for providing the management functions prior to the exercise of the right to manage. This would vest the management functions and responsibilities immediately in the landlord or management company as per the leases.

The status of any contracts entered into by the RTM Company is also unclear. Such contracts could not be easily enforced against the landlord (or Management Company) as they were not a party to them. Additionally, there is no obvious case law on whether such contracts are frustrated by the RTM Company’s liquidation or whether any damages could be claimed by the contracting party against the RTM Company for breach of contract.

The Service Charge Funds

Usually the most important question asked upon insolvency of an RTM Company relates to the status of the service charge monies paid by the lessees and held by the RTM Company.

Any RTM Company would not beneficially own the service charges it receives, meaning that the designation of all such sums falls outside of the ‘company’s property’ for the purpose of any insolvency event. Further, the service charge monies would be held subject to the statutory trust created by section 42 of the Landlord and Tenant Act 1987 and, therefore, not available to a liquidator for distribution to the RTM Company’s creditors. On the contrary, the liquidator would likely be obliged to pay the sums held pursuant to the statutory trust to the landlord (or Management Company) who become responsible for managing the building due to the insolvency.

Whilst neither CLRA 2002, nor s42 Landlord and Tenant Act 1987, provide such an express obligation, it is almost certain that any court would deem the liquidator bound to pay the monies to the landlord upon the strict basis that the statutory trust continues to protect the full sums. Similar provisions operate in reverse upon the acquisition of the right to manage, by virtue of s94 CLRA 2002, and the legislation establishing the statutory trust for service charge monies includes a provision that the purpose of the trust is to ‘defray costs incurred in connection with the matters for which the relevant service charge were payable’ and, as a consequence of the insolvency of the RTM Company, the landlord (or management company) would be the only entitled party.

In conclusion, the position upon the insolvency of an RTM Company is complex but, upon an analysis of the statutory position, must impose rights of management on whomever was obliged to manage prior to the acquisition of the right to manage, the transfer of all uncommitted service charges to the landlord (or management company), the likely failure of all contracts entered into by the RTM Company and a reassuring continuation of the statutory trust protecting all accrued service charge monies irrespective of the incumbent managing party.