Recessions always lead to innovations and developments in insolvency law, as tools designed during periods of economic stability are exposed to the stresses of a financial crisis. One of the interesting developments to come from the recent recession has been the use of Company Voluntary Arrangements (CVAs) to vary lease payment terms.
While a CVA can be a useful tool for tenants, there are limits imposed by case law and commercial practice, which the tenants, their landlords and respective advisers need to be aware of.
What is a CVA?
A CVA is a proposal made by a debtor to its creditors which, if approved by the requisite majority of creditors (75 per cent by value) and members (50 per cent. by value), will bind all creditors. A CVA can, therefore, impose a contractual compromise between a company and its creditors without universal agreement.
Challenge
Once approved, the proposal can be challenged in court on the basis that:
- it unfairly prejudices the interests of a creditor; or
- there has been some material irregularity in relation to either of the meetings.
However, such challenge may only be made within 28 days of approval.
How have they been used?
A CVA is a very flexible tool and there is great freedom on terms to propose. Historically, they have been used to agree with outstanding creditors a partial payment in satisfaction of debts; a longer period to pay debts; or a standstill while a business is reorganised.
Is it legally permissible to use a CVA to vary lease terms?
Surprisingly, there is no clear statutory definition of "creditor" in this context, and so, it could be argued, that a landlord was not a creditor of his tenant in respect of rent falling due in the future.However, it is now clear (in the cautious language of multiple negatives used in legal judgments) that there is no legal impossibility in including liabilities to make future rent payments under an existing lease in a voluntary arrangement. This was established by Knox J in Doorbar v Alltime Securities [1994] for individual voluntary arrangements and then applied by the same judge to CVAs in Re Cancol [1995]. This position has since been accepted by a series of later judicial decisions. However, it is clear from Burford Midland Properties Limited [1994] that the words of a CVA proposal must be explicitly clear to either compromise the payment of, or to postpone, rent liabilities falling due after the date of approval of a CVA. General wording to catch future or contingent liabilities may be insufficient.
Tenants with multiple leases - Stylo Barratt
Over recent years this line of cases has been applied to retail tenants in multiple occupation, with dramatic results. One of the first to attempt this was the proposal by the Stylo Barratt group of shoe shops.In that proposal, payment terms for all of the group's landlords were to be changed so that:
- for the initial period of three months all landlords would be entitled to a 3 per cent. turnover rent increasing to 7 per cent. between the third and twenty fourth months;
- from the third to twelfth month the landlords would be entitled to market the leases and the tenant would have a right of first refusal if the landlord could obtain a higher rent from a new tenant for the relevant property; and
- from the sixth to the twelfth month, the tenant would also be able to terminate on one month's notice for no cost.
Although the company believed it would offer better returns for creditors as a whole, this would have represented a significant worsening of payment terms for most landlords, as well as putting them at risk of a tenant break. Landlords found this proposal insufficiently attractive and it failed to reach the requisite level majority to approve the arrangement.
JJB Sports
In light of this outcome, when JJB decided to propose a CVA to reduce rental spend on their portfolio of tenanted shops, the terms were far less painful to landlords. The portfolio contained a number of sites where stores had already been closed. There was, then, a natural distinction between closed and open stores. Landlords of the 250 open stores were to receive a nominal sacrifice of being paid monthly in advance (rather than quarterly in advance) for 12 months.Landlords of the 140 closed stores, however, were to receive a sum of cash calculated on a formula in the proposal which amounted to approximately six months' rent. This proposal was overwhelmingly supported by landlords and received a huge 99 per cent. of creditors voting in favour of the proposal.
Application of the JJB model
The JJB proposal has became something of a benchmark. Strikingly similar proposals were produced and approved in Focus DIY, where 38 stores out of a portfolio of 218 were closed. Again, landlords of open stores were paid monthly for 12 months and landlords of closed stores received a lump sum. Approval was reported at between 93 per cent. and 100 per cent. for group companies.Similarly, in Blacks Leisure there were 101 closed stores against 291 open stores. Landlords of open stores were to receive monthly rent for 18 months, while landlords of closed stores were to receive a lump sum roughly equivalent to six months' rent. Support of 97 per cent. was reported.A proposal on a similar (but not identical) structure was subsequently put forward and overwhelmingly approved in the CVA of Specialty Retail Group (the operator of the Suits You menswear chain).
Why were they supported? The Pre-Pack alternative
In each of the JJB style CVAs, landlords were posed with a stark choice. If the proposal was voted down, the company may have been forced into administration. While not a foregone conclusion, the outcome there was likely to be a pre-packaged sale (or Pre-Pack). This is a route which many ailing retailers have taken over recent years. A recent sample could include fashion chain USC, discount menswear retailer Officers Club, sofa chain ScS, furniture retailer MFI, tea seller Whittard of Chelsea, fashion retailer Envy, shoe retailer Faith, fashion group Ethel Austin and shoe retailer Stead & Simpson.In a Pre-Pack, terms of a sale are negotiated before the administrator's appointment and completed soon after he takes office. On completion of the sale, the buyer (usually a newly formed company, often formed by management) purchases those of the business assets which the buyer wants and, typically, goes into immediate occupation of the required premises under licence. In a retail group, this allows the buyer to cherry-pick between sites. Landlords of the more successful stores are then presented with a retrospective application to assign by the buyer (then in occupation). The starting point is the passing rent under the existing lease. However, the new tenant may seek a renegotiation of terms, the outcome of which would depend, largely, on the commercial strength of the parties. Any pre-appointment arrears may be lost as an ordinary unsecured claim (which in the JJB style CVA would usually be paid in full). Well advised landlords of open stores, if confident that their sites would be bought in a Pre-Pack will not, therefore, accept much sacrifice in a CVA (but could perhaps accept some pain to compensate for the uncertainty in a Pre-Pack, and the loss of any pre-appointment arrears). The landlords of the unsuccessful stores, will, however, in a Pre-Pack, usually receive nothing. For them, therefore, supporting a CVA with any material payment would seem obvious.The JJB style of CVAs also promises to pay the unsecured creditors in full, while in a Pre-Pack they would receive nothing.As long, therefore, as the pain to open store landlords was not too great and the benefit to closed store landlords was pitched as a sufficient incentive, there would seem to be a mutual interest of all stakeholders in supporting the CVA.
More elaborate proposals
This does not, however, mean that property based CVAs cannot move beyond the JJB model. One example with which the writer was involved, was the Orchard Care Homes CVA. The group operated from 28 leasehold premises when it ran into cash flow difficulties. It negotiated a CVA with its major stakeholder groups which included the following key terms for landlords:
- rents were reduced for a period of three years to what the company believed was sustainable based on projections, and paid monthly for three years;
- if the group outperformed its business plan, a top up payment would be given to landlords;
- at the end of that period the landlords would enter deeds of variation to re-gear rent, based on performance in the intervening three years;
- some landlords could call for transfer of their homes into separate subsidiaries over which they could take fixed and floating charge security (and a right to appoint their own administrator if the group ran into further difficulty); and
- opposing landlords would have a one month window to call for assignment of their leases to a new operator.
Meanwhile, mezzanine loan note creditors converted all of their notes into equity and compromises were reached with HMRC and other creditors.
Guarantee stripping - Powerhouse
Less successful have been the attempts to use CVAs to prevent landlords enforcing parent company guarantees.In Prudential Assurance v PRG Powerhouse [2007] a CVA was proposed by the Powerhouse electrical equipment retailer. Its financially solvent parent company, PRG, had guaranteed a number of its leases.The CVA proposal provided that in return for the dividend payment from the CVA (which would be calculated on the same basis for all landlords) the guaranteed landlords would be treated as having been released, and agreed to not enforce the guarantees. While the court held that there was nothing to prevent Powerhouse from enforcing this obligation, on the facts of this case the proposal was overturned as being unfairly prejudicial. The court was particularly concerned that the guaranteed landlords would be worse off than in liquidation (where the guarantees would continue) and that they received no compensation above other landlords.Powerhouse then left open the legal possibility of guarantee stripping as long as the unfair prejudice issues could be addressed.
Miss Sixty
Under this CVA proposal, the fashion retailer offered £300,000 to landlords of premises guaranteed by the retailer's parent in return for an effective release of the parent company guarantee. This payment, they said, represented 100 per cent. of the estimated liability to the landlords on a surrender. That would, therefore, seem to address some of the unfair prejudice concerns in Powerhouse. However, the landlords claimed that the £300,000 payment was insufficient and the judge, in a case decided in July, agreed. While there are significant problems with the case as a precedent (the judge was highly critical of the decision of the company and the CVA supervisor not to appear in the proceedings), the judgment stands. The judge, being prevented by the Powerhouse precedent from deciding otherwise, stopped short of preventing all guarantee stripping in CVAs, but set a high bar for showing fairness of compensatory payments. As he said: "At a time of market uncertainty it will be difficult, if not impossible, to determine what sum will fairly compensate the landlord for the loss of such rights, and in the absence of a compelling justification a landlord should not be forced to accept a sum which is based on numerous assumptions (for example about the landlord's ability to re-let the premises) which may or may not prove to be well-founded." This decision then leaves open the possibility of further attempts to use CVAs to strip guarantees but the threshold for disproving unfair prejudice is clearly high.
Future use of CVAs
CVAs, then, remain as a flexible tool for restructuring struggling companies. The cases above demonstrate certain legal and commercial benchmarks which may limit their use in some areas. However, with careful structuring and negotiation, CVAs can increase returns to creditors.Landlords and other creditors who receive a CVA proposal should remember that they will have very little time between receiving the proposal and the meeting of creditors, and then a narrow 28 day window to bring a challenge. Prompt action and advice will, therefore, be required to review the proposal and enforce the creditor's rights.
Jeremy Whiteson, Partner, Fladgate LLP (jwhiteson@fladgate.com)
