A Victory for Business Rates Mitigation Activity

This article, by real estate disputes partner Paul Henson, first appeared in Estates Gazette.

Good news for those looking to reduce their ratings liability has been delivered by the High Court, in Secretary of State for Business Energy and Industrial Strategy v (1) PAG Asset Preservation Ltd & Others [2019] EWHC 2890 (Ch). In summary, the decision found:

• against the secretary of state, who was petitioning to wind up companies engaging in business rates mitigation schemes, on the basis that they were subverting the purpose of insolvency legislation;
• “Scheme 3” – SPVs created under the third iteration of a mechanism devised by individuals behind the respondent companies to enable landlords to avoid paying non-domestic rates on their vacant commercial properties – were not to be wound up on public interest grounds;
•  the existence of a determination premium in the leases meant the appointed liquidators were obliged to continue the members’ voluntary liquidation (MVL) in order to try to recover the contingent liability; and
•  the Scottish and Welsh devolved governments are currently considering proposals allowing ministers to make regulations to prevent or minimise artificial arrangements such as this. There are no current proposals for England.

Scheme 3

Scheme 3 provided for a lease to be entered into by landlords with a special purpose vehicle (SPV) tenant incorporated for the sole purpose of taking such a lease. The effect of the lease is to transfer from the building owner to the SPV the responsibility for business rates. The SPV was then placed into MVL, which relieved it of such obligation pursuant to the exemption in the insolvency legislation.

The operation of scheme 3 was very similar in substance to that in scheme 2, where the secretary of state had successfully demonstrated that the purpose of the liquidations had demonstrated a lack of “commercial probity”, such as if it was just and equitable to wind up the companies. This was the finding of Norris J in Secretary of State for Business, Innovation & Skills v PAG Management Services Ltd [2015] EWHC 2404 (Ch); [2015] PLSCS 252 where it was held that, in relation to scheme 2, there was nothing improper in the use of corporate insolvency to achieve other purposes but “…the use of the company in liquidation as an asset shelter and the inherent bias toward prolongation of the liquidation… is subversive of the true purpose and proper functioning of insolvency law…”.

The purpose of scheme 3 (as admitted by the respondent scheme organisers) was to vary it in order to deal with Norris J’s criticisms of scheme 2. Scheme 3 was therefore very similar to scheme 2, and arranged such that:

1.  The SPV (tenant) was solely owned and controlled by the respondents;
2.  The owner of the building entered into a fee agreement with the respondents and also a three-year lease with the SPV company contracted out of the Landlord and Tenant Act 1954;
3.  It was intended that the SPV would then enter into MVL; and
4. The lease between the landlord and the SPV would continue until the expiry of its three-year term, or the landlord could terminate it early if it had found an alternative occupier or wished to sell.

The key difference, in the view of HHJ Stephen Davies, was that the scheme 3 leases provided for “a determination premium”. This was the payment by the landlord to the SPV to surrender the lease at any point and increased in value as the term continued. It was accepted at trial that this was an “uncommercial” term given that a lease is a wasting asset and its value to a tenant reduces as the term continues. 

The respondents further accepted that the determination term was artificial and only inserted so as to create something of value to the SPV, which would be of a purely contingent nature. This, in turn, meant that the liquidators who were controlling the SPVs during the MVL process were not required to disclaim the leases, and had a duty to maintain the MVL process for as long as possible so as not to lose this potential receipt of the determination premium.

The decision

The secretary of state petitioned for the winding up of the SPV companies on the basis that their incorporation with the intention being placed into MVL, and subsequent entry into leases with landlords with the intention of business rates avoidance meant that: “the companies lack commercial probity in their operation of scheme 3 which misuses and/or abuses and/or subverts the insolvency legislation process”.

However, despite the manufactured nature of scheme 3, it was the determination premium provisions that were crucial to its success. HHJ Stephen Davies stated: “In my judgment the existence of the determination premium provisions amounts to a substantial and a significant difference between scheme 2 and scheme 3 which justifies me reaching a conclusion different to that reached by Norris J in the PAGMS case”.

The key point was that the determination premium allowed the liquidators of the SPVs to continue the MVLs until the leases expired or were determined, as there was the possibility of a distribution once all liabilities had been obtained. This was not contrary to the general insolvency legislation, even though it was artificially designed.

Again, as the judge commented: “… although this is also again a wholly artificial process, where all involved are fully aware that the motive and effect is to avoid business rates, the liquidation is a genuine process whose purpose is indeed the collection, realisation and distribution of assets.”