Room with a View - 2018: The year of the Company Voluntary Arrangement (CVA)

07 September 2018

Richard Eaton examines company voluntary arrangements (CVAs) and their growing use in the commercial retail property sector.

Are CVAs on the rise?

2018 has been hailed in the press as ‘the year of the CVA’. News of famous high street names, particularly in retail, and the restaurant sector entering into CVAs is commonplace. Government Insolvency Service figures record 102 CVAs in the first quarter of 2018, an increase of 18%. Whilst the retail sector is undoubtedly feeling the pinch, CVAs are potentially open to any company. The impact on the owners of property occupied by such businesses, can be significant and highly prejudicial.

What exactly are CVAs?

CVAs are an insolvency and rescue procedure provided for in Part 1 Insolvency Act 1986. They provide a framework for a statutory contract to regulate the rescheduling of an insolvent company’s debts or liabilities. 

The procedure leaves the company in place, run by its directors. The CVA is, however, supervised by a nominated person who must be a qualified insolvency practitioner, subject to professional regulation and required to certify that a fair balance between creditors is struck. The procedure can serve a useful function in cutting through competing creditors’ disputes to permit a company to trade its way out of trouble. The CVA terms can ride a coach and horses through the range of remedies that might otherwise be available to a creditor, imposing moratoriums on court action for example.

So how do they work?

A CVA may be proposed by the directors of a company in difficulty or, if the company is already in administration, by its administrator. A proposal is prepared upon terms that the nominated supervisor must report to the court about, indicating whether or not they are terms which they are prepared to recommend putting to creditors. 

Notice of a creditors’ meeting is then given to all creditors who are then entitled to vote on the proposal in a qualifying decision procedure. The chairperson of the creditors meeting must attribute voting weight (by value) to each creditor. The proposal must receive at least 75% support by creditors (by value) with at least half of unconnected creditors reaching voting in favour.

Why are landlords often against them?

The opposition from landlords is often because they may be the only creditors that are subject to ‘rescheduling.’ Rents are often the principal target for drastic reduction in the proposed arrangement. For example, the recent Homebase CVA proposed that 42 stores close and that the 70 remaining were subject to discounted rents of between 25-90%. Other creditors can be offered a full recovery and so are bound to vote for the scheme. If non landlord creditors are more than 75% in value of creditors, then the chance of not getting approval is slight. Most CVAs are passed. 

Judicial sympathy for the landlord’s position has been expressed. See Lord Justice Neuberger in Thomas v Ken Thomas Ltd {2006}  “… it would seem wrong that a tenant should be able to trade under a CVA for the benefit of past creditors to the present and future expense of the landlord.”

The CVA may also be criticised by landlords as being a ‘quick fix’ to reduce property costs whilst ignoring the wider trading mistakes or circumstances that gave rise to the financial difficulties.

The current environment may be considered a ‘perfect storm’ of adverse factors, including Brexit trading uncertainty, increase in on-line retailing, wage increase, spending retraction, increased business rates, etc. 

Part of the difficulty for landlords is the way in which the value of liabilities is calculated (see below).

How is the landlords debt calculated for the purposes of voting by value?

The landlords’ debt is comprised of three elements a) existing rent b) future rent and c) dilapidations.

The first element is fairly straightforward. The second and third elements are treated as unascertained or unliquidated sums and the troublesome starting point is to attribute a notional value of £1 to them unless the chair of the creditors’ meeting can be persuaded to attribute a higher, more realistic figure. The point was considered in R Newlands (Seaford) Educational Trust [2007] BCC 195. The landlord claimed a debt of £1.175m comprising £0.85 for dilapidation and £0.3 for future rent. The chair put a value of £1 on both these elements. On appeal the court declined to substitute a higher value. It found that there was simply no evidence before the chair to permit him, with any confidence, to substitute a higher value. The dilapidation claim is inherently uncertain due to potential for future challenge based on the true intentions of the owner or on whether any dilapidation exceeds the diminution in freehold value reduction. The schedule of dilapidation in this case was unquantified which further contributed to lack of certainty. 

What about calling on the guarantor?

It was established in what was known as the Powerhouse case (Prudential Assurance Company Ltd and others v PRG Powerhouse Ltd and others [2007] EWHC 1002 Ch.) that a CVA does not automatically, but could include a provision to knock out a third party guarantee. This may seem particularly disadvantageous to a landlord who would otherwise be able to rely upon it, just at the time it was intended to bite, and perhaps surprising when the guarantor is neither insolvent, nor a party to the CVA. 

Is there a right of appeal or challenge available to a landlord?

Yes, S.6 Insolvency Act permits any creditor aggrieved by a CVA to make a challenge to the High Court on the grounds of either ‘unfair prejudice’ or ‘material irregularity’. The challenge must be brought within 28 days from the date of the approval of the CVA. 

They are rarely brought. The recent House of Fraser CVA was the subject of a S.6 challenge by a collective of landlords (in the Scottish courts). The hearing was listed to be heard on 14 August but the matter was settled by consent on terms which are not disclosed.

The best example of the successful S. 6 challenge, is known as the ‘Miss Sixty Litigation’ (Mourant & Co Trustees Ltd and Anor v Sixty UK Ltd and Ors [2010] EWHC 1890 (Ch). The tenant entering into the CVA had several stores, some with good covenant strength guarantees from its Italian parent company. Disclosure revealed that the parent company had valued the potential exposure from the guarantee at £5m. The CVA attributed a sum in the region of £300,000 to the landlord. The landlord made the S.6 challenge. The court accepted (per Powerhouse) that the guarantee could be compromised by the CVA. However, the court found, with some ease, that there was unfair prejudice and levelled some severe criticism at the insolvency practitioners! The principles to apply when assessing prejudice are considered ‘horizontally’ and ‘vertically’. Horizontally, the court will compare the position of the challenging creditor to other creditors and consider whether its treatment is unfair. It is not necessarily the case that all creditors will suffer equally, as under a CFA some creditors may need to be paid in full to permit the company to trade. Vertically, the court will consider the outcome for the challenging creditor compared to the likely outcome in other insolvency procedures, such as an administration or liquidation. Critically here, the position of the landlord would have been significantly better in an administration or a liquidation as neither would have erased the third party guarantee.

What steps can a well advised landlord take if faced with a CVA proposal?

  1. Get in early and reserve the right to forfeit or terminate the lease in any CVA (usually granted on 30-180 days’ notice). A good recent example was in the retailer ‘New Look’ CVA. 

The 'next' lease - a sign of the times?

  1. Recent reports have identified a new term inserted into a lease for Next which facilitates a reduction in rent if an adjoining owners’ rent is reduced under a CVA! Landlords of seven of their properties in the CVA was so terminated to accommodate better terms negotiated with the likes of JB Sports, Mountain Warehouse and Iceland!
  2. When quantifying debt deriving from the lease, do supply good evidence of unascertained elements, e.g. a costed schedule of dilapidation, and/or a diminution in value assessment, and an expert report on likelihood of/timing of re-letting.
  3. Protect rights against the guarantor which the CVA may seek to compromise.
  4. Protect the right to recover full rent retrospectively, if the CVA fails – (see recent success in the BHS litigation – landlord fending off claim for full rent after collapse of CVA. Wright and Anor (Liquidation of SHB Realisations Ltd v) v The Prudential Assurance Company [2018] EWHC 402 (Ch).
  5. Be realistic, and consider whether some rent is better than none if a rent reduction is proposed? What is the risk of a vacant property if the company fails (the House of Fraser supervisor claimed publicly that the company would cease to trade if the CVA was not agreed).
  6. Consider a S.6 challenge. The business and property courts are demonstrably respectful of property interests (see Powerhouse and Miss Sixty) – in particular be alert to the use of CVAs as a means of profit optimisation when there is no genuine distress.

The ‘Next’ lease – a sign of the times?

Recent reports have identified a new term inserted into a lease for  high street retailer ‘Next’ which facilitates a reduction in rent if an adjoining owners’ rent is reduced under a CVA!

What are the British Property Federation saying?

Recently the BPF have called upon the government for an ‘urgent review’ of CVAs. In particular they propose an independent supervisor for CVAs involving more than five units, a codified good practice for voting rights and a requirement of the IP to have early engagement with the property owner. 

The content of this article is for general information purposes only. For further advice please contact a member of Birketts’ Property Litigation Team or Commercial Property Team.

This article is from the winter 2018 issue of Room with a View, our newsletter aimed at professionals within the property industry. To download the latest issue, please visit the newsletter section of our website. Law covered as at January 2019.

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