The Court comments on the ‘standard form retail CVA Proposal’

by | Nov 12, 2019 | CVAs | 0 comments

2019 was reported by the British Retail Consortium to have been the worst year ever for retail.

Some years ago I worked the other side of the insolvency fence, in a retailer, trying to turn it around.  It was an interesting time, the company’s cost structure like most retailers very different from almost all other businesses, property costs forming a very large, seemingly immoveable, chunk of the outgoings.  It showed me that, for retail turnarounds to work, reducing rent charges was a vital if not the most important ingredient.  Since then we have seen several large, high profile insolvencies of retailers, sometimes using administration in what is little more than a stock realisation exercise, others using CVA to try to save as much of the business as possible.  CVA has tended to be the option of first choice, but will it continue to be so?  A case has clarified, at least for now, some of the uncertainties there was in many landlords’ and retailers’ minds over the form of a standard form CVA Prposal, the issues not having been tested before.

In this case a group of landlords challenged the Debenhams’ CVA. This is a case that is of interest to landlords and companies contemplating going into CVA.

The case, answered several questions:

  1. Can a CVA bind a landlord in respect of future rent?
  2. Is the landlord a creditor in the CVA for future rent?
  3. Can a CVA modify / remove a landlord’s right of forfeiture?
  4. Is it fair to see trade creditors paid in full in a CVA while at the same time compromising the future rent payable to landlords?

The Facts

Debenhams’ CVA Proposal was approved by 95% of its unsecured creditors, but a consortium of disgruntled landlords challenged the CVA on two grounds, firstly that it was unfairly prejudicial to them and secondly, on the basis it had a material irregularity because:

  1. They were being forced to reduce the ongoing rent by up to 50%.
  2. The CVA sought to prevent them from forfeiting the leases, such right of forfeiture having been triggered by the CVA.
  3. Release the Company from any dilapidations claims and
  4. Significantly shorten the terms of some leases.

The Proposal gave all landlords an opportunity to terminate the lease, but this was exercisable only once, and in some instances gave the landlord and Debenhams a right to terminate on certain dates.

There was nothing unusual about these CVA terms – they are typical of retail CVAs – so this case was a test of retail CVAs generally, as they most currently stand.

For the landlords:

  1. Some, but not all, had the right to terminate on certain dates.
  2. All can elect to terminate now and take the property back, or accept a much reduced rent. If they elected not to terminate, they cannot later forfeit.

The outcome was:

  1. Landlords are creditors in respect of their future rent, and are bound by the CVA.
  2. Future rent can be compromised in a CVA, rent reductions can be imposed on landlords.
  3. CVAs cannot modify or remove landlords’ right of forfeiture under the terms of the lease, for example as a result of being triggered by an ‘insolvency event’ such as CVA or the non-payment of post CVA reduced rent. It is worthwhile noting that this right arises out of the lease, not the CVA.
  4. CVAs can give landlords an ‘additional right’ to terminate the lease at pre-determined times, as the CVA did in Debenham’s case – in that instance at the beginning of the CVA as a one off exercise and in the case of some specific leases, at pre-set times. This right of termination is one granted by the CVA, not by the lease itself (ie the opposite of 3.).

What does this mean?

Landlords have to choose whether or not to forfeit the lease as a result of an insolvency trigger event eg insolvency or non-payment of rent, or terminate the lease in accordance with any provisions set out in the Proposal – potentially leaving them with an empty property, no rental income and an ongoing business rates bill – or instead to accept the lower rent.  If they do the latter, they will still be able to forfeit the lease later on only if rent payable under the CVA is unpaid.

So what is a fair rent?

Landlords often seem to take more of the pain in retail CVAs than the trade creditors, who might even be paid in full. In the Debenhams’ case, landlords were being asked to accept rent reductions of one third to 50 percent, how’s that fair?

In the Debenhams’ case, rents were already well above market rate, and none of the consortium of landlords claimed that their reduced rent in the CVA would be less than the current market rent for them.  That’s to say, the rents were merely being brought back in line with current market rents.

The judge said ‘the landlord should receive at least the market value of the property….. He should not subsidise other creditors but nor should they be compelled to overcompensate’ and ‘There would have been unfairness if landlords were expected to take reductions in rent to below the market value.  He added that the contractual rent saying that ‘should be interfered with to the minimum extent necessary in the circumstances, the modification being limited to what is necessary to achieve the purpose of the CVA’.

So is it OK to treat creditors differently?

In the Debenhams’ case the judge was satisfied that the non-payment of trade creditors would lead to lead to major supply problems which would severely damage the business.  He therefore agreed that it was ok for the CVA to treat suppliers better than landlords. The facts justified this in this instance, but the judge recognised that it might not always be the case.

 

What does this mean for CVA Proposals? 

  1. No provision should be included in the Proposal which seeks to alter or remove the landlord’s contractual rights eg of forfeiture. But it’s OK to have additional termination rights in the CVA.
  2. It’s always a good idea to have a severance provision in the CVA, enabling the removal of any unworkable provisions. In the Debenhams’ case, there was such a provision and this enabled the removal of the provision seeking to modify the landlord’s right to forfeit. Had there been no such severance provision, the CVA could have failed.
  3. The Proposals should be seek an appropriate right balance between the hurt felt by differing categories of creditors. One category of creditor should not overcompensate for others.
  4. It’s OK to reduce landlord’s rent in a CVA, but not below market value. The IP needs to have evidence supporting his proposed reduction, this means getting agents’ advice on what is current market rent.

Final Comment

This seems to me to be a sensible decision, but whether it gets appealed remains to be seen.

 

Here’s a link to the decision.