A Company Voluntary Arrangement (“CVA”) is not a new challenge for landlords. While the last five years have seen relatively few CVAs, they have previously been widely used and were once promoted as a positive form of insolvency because of the creditors’ approval process.
Often, when a company is in administration or liquidation, creditors see very little recovery of their debt. The CVA mechanism (enshrined in law in Part 1 of the Insolvency Act 1986) aims to ensure that creditors receive something back. Under the CVA procedure companies may be able to avoid potentially terminal insolvency proceedings by coming to a binding agreement with their unsecured creditors.
While there is still a view that for many creditors a CVA puts them in a better position than administration or liquidation, CVAs can be problematic for landlords who may have little control over the CVA. Our top tips for managing this year’s resurgence of CVAs are at the end of this briefing.
How does a CVA impact a lease?
In order to put a CVA in place a company must make proposals in respect of its financial liabilities to its creditors. These proposals must then be approved by 75% of the creditors to be implemented.
Typically, this results in the company’s leases being put into three categories:
- Group A – profitable stores – leases left intact, at current rents, or subject only to minor amendment
- Group B – marginal stores – these have substantial renegotiation of the leases, including sizeable rent reductions, and
- Group C – unprofitable stores – these will be closed, and the premises returned to the landlords, albeit preferably with some agreement in terms of compensation/retention of rent by the landlords.
The CVA proposals as to compromised obligations will take effect for a period of two to five years. They are flexible and the proposed compromised obligations for each category may change from proposal to proposal, and can include break options, rent payments being made monthly rather than quarterly and compromises on tenant’s dilapidations obligations. Needless to say that landlords of Group C stores shoulder the highest risk of low recovery.
How does a CVA impact a guarantor?
Tenant financial difficulties are not an unforeseen event in the context of a lease and tenants with weak financial covenants may have provided a guarantor at the start of the lease. Landlords might therefore assume that they can turn to a guarantor in the event of a CVA to meet the full obligations under the lease.
However, the CVA may have an impact on the liability of the guarantor, either explicitly or by implication. The use of CVAs as a vehicle for "guarantee stripping" was the subject of much debate in the last round of CVAs. Guarantee stripping was argued to be an example of unfair prejudice (a permitted ground of challenge).
In the 2007 ‘Powerhouse’ case the court held that a CVA could not, as a matter of contract, operate as a direct release of a guarantor as the guarantor was not a party to the proposal. The Court also looked at the issue of unfair prejudice and found in favour of some of the landlords. However, the question of whether guarantee stripping could ever be "fair" was left open, not least because each CVA must be considered on its terms and facts.
The Court went further in the 2010 ‘Miss Sixty’ case stipulating that it could not envisage any circumstances where a CVA would operate to fairly release a guarantor unless the relevant landlord agreed to the release. It also stated that it was hard to see how payment of a stipulated sum would be adequate compensation as the value of a guarantor's obligations would vary depending on market conditions.
While these cases were helpful in setting some ground rules for guarantee stripping they do not exclude it as a possibility. Landlords should therefore be alive to the fact that a CVA may impact their recourse to a guarantor.
How does a CVA impact administrators?
One of the major criticisms of CVAs is that they often don’t resolve the company’s financial difficulties and the company ends up in another insolvency procedure.
BHS is one of the most recent examples of this. Shortly after the approval of the BHS CVA in 2016 the company went into administration and then subsequently transitioned into liquidation. The CVA was therefore terminated, following which the landlord demanded the full rent rather than the rent set by the CVA.
The liquidators resisted the increased rent demands and took the matter to court to seek a determination of the contractual and other arguments raised. It was determined that a CVA does not permanently vary the terms of a lease (variation of a lease must still be by deed) and that following termination of a CVA, the landlord is entitled to claim the full amount of outstanding rent by reference to the lease (less any amounts received under the CVA), and is not restricted to the lower compromised rent.
While this is positive news, the BHS case, as always, turned on the wording of the CVA. A number of CVAs approved following the BHS decision expressly extend the compromise of rents beyond the term of the CVA. While this seems to be a clear case of unfair prejudice and inconsistent with the basic principle of a CVA (i.e. being a bargain between a specific company and its creditors (in our case landlords)) the enforceability of these provisions remains untested.
Why can’t landlords resist?
It is the value of debt owed to the creditor which determines the voting power of the creditor. Whilst ascertained arrears are given actual value, unascertained or unliquidated sums (e.g. future rent and dilapidations) carry a value of £1 for voting purposes unless the meeting chair agrees a higher value. Consequently, most landlords have limited voting rights compared to other creditors.
Landlords recognise that where there is a genuine need for a CVA there is a need for compromises to be made all round with a view to managing financial difficulties. However, they fear that retailers are using CVAs to discard badly performing shops, to improve profits by reducing rents or to enable a larger corporate play. Landlords argue that this is unfairly prejudicial and the implications are hitting the finances of landlords, many of whom are pension funds.
This year has seen the strongest response from landlords with the launch of a legal challenge to the House of Fraser CVA on grounds of unfair prejudice and material irregularly. It was hoped that this challenge might tackle some of the undecided issues in respect of guarantee stripping and ongoing effect of CVAs, however the case has now been settled as between the challenging landlords and House of Fraser. While the details of the settlement itself have not been disclosed it signals the increasing strength of landlords.
Take-aways for Landlords
- Think about whether you would like the property back – the implementation of a CVA is a ground for forfeiture in many leases and this may present an opportunity to regain control of a property
- While it is unlikely that landlords will relish the prospect of bringing an action against a CVA (not least given the likely costs of doing so) it is important to review the proposed terms of the CVA as each is unique and could contain unfairly prejudicial terms against you as against other creditors which would warrant a challenge.
- Act promptly – creditors meetings are called at short notice (ensure your registered address is regularly checked and kept up to date)
- Obtain advice on the nature of your claim to maximise your ascertainable claim and increase your voting strength
- Stay alive to changes - while a CVA is put in place for a term of years subsequent events can take over, as was the case with BHS and Toys R’ Us which both transitioned into administration
- Can you get ahead of the CVA? Many tenants will approach landlords in the run up to a CVA. While a CVA can (in theory) override side arrangements it may well be that a compromise can be agreed with a tenant company to provide temporary concessions which will improve the position under the CVA e.g. a rent concession which allows lease to be placed in category A rather than category B, and
- Think about any security arrangements which can be exercised. As set out above, the position on guarantee stripping remains uncertain. In the run up to a CVA a landlord would therefore be well advised to exercise its rights against guarantors as soon as practicable to try and avoid arguments of compromise once the CVA is in place.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, August 2018