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Retail CVAs – update for landlords

Carpetright, the UK flooring company, has announced that it is considering a Company Voluntary Arrangement with the aim of “rationalising the company’s property portfolio in order to improve the long-term prospects of the business”.  This is expected to enable the business to close unprofitable shops and reduce their rent bill.  With 409 shops across the country, any proposed CVA is going to have a significant impact on landlords.  This announcement comes on the same day that creditors voted and approved a CVA proposal issued on behalf of New Look, which itself has 593 stores across the country, which proposes to stem losses by closing 60 stores.  The CVA also includes revised lease terms ranging from 15 to 55% across 393 stores over the term of the 3 year CVA.  The New Look CVA importantly has the backing of The British Property Federation, who are influential amongst landlords and who have been critical of CVAs in the past.  Whilst different landlords will always have their own interests to consider, such as pension providers looking after the interests of investors, engagement with professional bodies is always helpful in assisting the CVA process.

The above follows on the back of Byron Hamburgers’ closure of 20 stores as part of its approved CVA in January 2018; not to mention the impact on landlords felt by the closures of Toys R Us and Maplin.  It is fair to say that Q1 2018 has exposed retail landlords to significant insolvency and restructuring-related issues and it is likely that this will continue throughout 2018 as Moss Bross and Kingfisher, the owner of B&Q, both reported deteriorating sales; Mothercare has also announced it is in discussions with lenders over a refinance package.  Chief executive of Carpetright Wilf Walsh complained of being “burdened with an oversized property estate consisting of too many poorly located stores on rents which are simply unsustainable”.  This is a familiar complaint even in non-distressed companies such as Pets at Home who have recently closed down their upmarket, dogs-only grooming and accessories chain, Barkers, four years after opening its first shop.  A Pets at Home spokesperson commented “that although the products and services had been popular among customers, the cost of renting high street stores meant they were not profitable.

Efforts to close underperforming stores at Carpetright had been hampered by the fact that many had long leases and “the board is therefore exploring the feasibility of a CVA in order to expedite the rationaisation of its property portfolio, with the clear objective of establishing a right-sized estate of contemporary stores, on economic rents, complimented with a compelling online offer.”  The current level of commercial rent is clearly an issue for UK based retailers but trying to align the interests of commercial landlords and retail tenants interests has not always been possible as was the case when Stylo plc had its CVA proposal rescue strategy rejected by creditors.  Nevertheless, the number of retail CVAs being proposed show that they are here to stay and remain a useful tool to those tasked with restructuring complex retail sector businesses.  With this in mind, landlords would be well advised to keep up to date on relevant developments in retail restructurings, including the recent decision in Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd [2018] EWHC 402 (CH) which is commented on below:

Case Facts

BHS Limited (later renamed SHB Limited) (“BHS”) agreed a CVA with its creditors and members in March 2016.  As is the case with Carpetright and many other retail CVAs, a principal purpose of the CVA was to reduce the amount of rent payable in respect of certain BHS stores.  Whilst BHS secured support for rent reductions of up to 75% at 87 shops, the proposal was reliant upon the company raising £100M for continued trading via various means.  This funding did not materialise and BHS subsequently entered administration on 25 April 2016.  After administrators were unable to achieve a sale of the business, the company finally moved into creditors voluntary liquidation on 2 December 2016.

Legal Issues

Upon the failure of the CVA, The Prudential Assurance Company Ltd, as one of the BHS landlords, sought to invoke a provision (clause 25) in the CVA which stated that if the CVA was terminated, the reduction of the rent would be deemed never to have happened and the relevant landlords would be able to claim for the full rent that would have been due but for the CVA, less any payments made under the CVA.  This rent was claimed as an expense of the administration as the properties were used during this period for the benefit of the administration.  The subsequently appointed liquidators (who were the joint administrators) asked the Court to decide whether the full rent could be recovered in this way, presenting arguments in the alternative as follows:

  1. Penalty Clause –  it was argued that the CVA provision allowing the landlords to claim for the full rent due was unenforceable as it was a penalty payable for breach of the CVA;
  2. Pari Passu – it was further argued that the same provision, which effectively increased the Company’s liabilities to the landlords after the start of the liquidation, breached the pari passu principle of distribution;
  3. Administration Expense – it was also argued that the full amount of rent due for the period of the administration did not effectively accrue until the CVA was terminated, which was after the end of the administration (although deemed to have retrospective effect) so could not be treated as an administration expense.

The High Court rejected the above arguments and held that the CVA provision that reinstated the landlords’ rights to the full rent amount upon the termination of the CVA as if the CVA had not been agreed was effective and not a penalty based on the following reasoning:

1.Was clause 25 a Penalty Clause?

No.  In many ways CVAs are contractual in nature but not every principle of contract law applies to them and ultimately the CVA was brought about by a statutory procedure.  The law on penalties was not designed to apply to the circumstances of a CVA.  The law on penalties examines oppression and considers factors such as the bargaining power of the parties in their negotiations.  The CVA is not negotiated as such.  Whilst creditors have the right to put forward amendments, this is done via a statutory procedure.  Further, the proposal was put forward in the interests of the company and cannot subsequently be said to have oppressed it.

Clause 25 did not create a new liability if the CVA was terminated and the reduced rents came to an end. The reinstatement of the landlords’ full rights to rent upon breach of the CVA was part of the commercial proposal put to the landlords and had to be read together with the proposal to reduce rent during the CVA.  The reinstatement of the full rent upon breach of the CVA was therefore not a standalone clause.  Ultimately the landlords had a legitimate commercial interest in the CVA’s success or failure, and it was not an exorbitant, extravagant or unconscionable provision for them to be returned to their pre-CVA position if it failed.

2.Did clause 25 infringe the pari passu principle?

No.  The reduction of the rent effected by the CVA did not constitute a variation of the underlying leases.  A variation of a lease has to be done by deed, which a CVA is not (it operates for these purposes as a contract).  Accordingly, the rent accruing on the relevant leases had not been permanently varied to the reduced rent.  This in turn meant that there was no breach of the pari passu principle as there was effectively no later increase in liabilities to the Landlord.  The rent reduction and the subsequent increase on a breach were part of the same clause and had to be read together.  The provision did not increase the creditor claims in administration or liquidation; its clear intention was to ensure landlords would not be disadvantaged in an administration or liquidation if the CVA was terminated.

3.Was some of the outstanding rent payable as an administration expense?

Yes.  Clause 25 restored the rent payable retrospectively as if the reduced rents never happened and the landlords had the claims against BHS that they would have had if the CVA had never been approved.  As such, the additional sums falling due to the respondent landlord on termination of the CVA were payable as an expense of the administration for the period that the administrators were in possession of the premises for the benefit of the administration.

Summary

This case provides a useful reminder of the principles underlying any challenge to a CVA, particularly in the retail sector.   The High Court reminds us that CVAs are founded in statute and that the basis upon which a CVA can be challenged is dictated by statute under section 6 of The Insolvency Act 1986 and not general contractual provisions.  The options to challenge under the Insolvency Act 1986 are limited in nature (unfair prejudice and material irregularity) and it is important to bear this in mind when considering any challenge to a CVA.

The decisions in Prudential Assurance Company Ltd & Others v PRG Powerhouse Ltd and Others [2007] EWHC 1002 (Ch) and  Mourant & Co Trustees Limited and another v Sixty UK Limited (in administration) and others [2010] EWHC 1890 (Ch) have long established the principle that creditors will be deemed to have been unfairly prejudiced if a CVA provision prejudices them and inadequately compensates them for the loss of certain rights (in those particular cases the loss of a guarantee). Wright v The Prudential Assurance Company Ltd assists by drawing attention back to the statutory requirements for a successful challenge.  This is useful to know from a landlord’s perspective as they do not want to vote in favour of a CVA and accept terms that are successfully challenged at a future date.  The judgment also includes a number of subtleties, such as reinforcing the fact that if the intention is to ensure a variation of the lease, then separate deeds of variation should be entered into outside of the CVA as the CVA does not achieve this.

Cathryn Williams also contributed to this post. 

© Copyright 2019 Squire Patton Boggs (US) LLP

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Amanda Banton, Squire Patton Boggs, Australia,Restructuring attorney
Partner

Amanda Banton is a partner in, as well as leads, the Restructuring & Insolvency Practice Group in the Asia Pacific region.

Amanda leads one of the largest private practices in Australia, including 12 professional staff. Amanda’s practice encompasses a broad range of corporate and commercial litigation matters, with a particular emphasis on matters relating to the corporations legislation, insolvency, state and federal trade practices legislation, negligence and contractual disputes.

Amanda has been involved with a number of high-profile insolvencies...

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Nava Hazan Bankruptcy Restructuring Lawyer Squire Patton Boggs
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Nava Hazan is a partner in the Restructuring & Insolvency Practice Group located in the New York office and is the co-chair of the firm’s Cross-Border Restructuring Practice.

Nava's practice involves the representation of debtors, foreign liquidators and administrators in Chapter 15 cases and other cross-border proceedings. She also represents debtors, creditors’ committees, and secured and unsecured creditors in Chapter 11 cases in various industries.

Experience

  • Represented debtors, liquidators and administrators in Chapter 15 cases with foreign proceedings in Canada, the UK, Spain, the British Virgin Islands, Saint Vincent and the Grenadines, and Antigua.

  • Represented foreign liquidators and administrators in numerous US proceedings in federal and state courts and out-of-court.

  • Represented debtors in Chapter 11 cases, including mining companies (with cross-border ancillary proceedings), a manufacturer of confectionery products, a dairy producer, an apparel manufacturer and an airline company.

  • Represented the Official Committee of Unsecured Creditors for an oil and gas company, steel manufacturing companies, a mining company, a telecommunications company, a publishing company, a satellite and cable television company, and a manufacturer of cameras and instant film.

  • Represented a private equity firm in a loan-to-own transaction in the Chapter 11 case of a copper mining company.

  • Represented DIP lenders and plan sponsors in the Chapter 11 cases of a manufacturer of light aircraft, a manufacturer of refractory products and a mining company.

  • Represented successful bidders in section 363 sales.

  • Represented large creditors (and members of creditors’ committees) in Chapter 11 cases.

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Susan Kelly, Squire Patton Boggs, Restructuring Lawyer, Insolvency Attorney
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Susan leads the Restructuring & Insolvency practice group in the UK and Europe and is based in our Manchester office.

She worked in London for the first half of her career and although now based in Manchester she spends time in London, Europe and further afield in her capacity as co-chair of the Cross Border Restructuring group.

Susan's expertise covers a broad range of domestic and international insolvency (both contentious and non-contentious), lender security reviews and enhancement, restructuring, turnaround and...

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Stephen Lerner, Squire Patton Boggs, insolvency attorney, debtor lawyer
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Stephen Lerner is chair of our Restructuring & Insolvency Practice Group. He has an extensive national and cross-border restructuring practice in which he represents debtors, committees of unsecured creditors, secured and unsecured creditors, equity interest holders and acquirers of troubled businesses in Chapter 11 reorganization cases, Chapter 15 cross-border cases, Chapter 9 municipal restructurings and out-of-court restructurings throughout the United States. 

Stephen has led the representation of clients in the Chapter 11 bankruptcies...

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G. Christopher Meyer, Squire Patton Boggs, Bankruptcy Lawyer
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Christopher Meyer concentrates his practice on bankruptcy and insolvency issues. He has significant experience in workouts, restructurings and bankruptcy reorganizations including representing both debtors and creditors in commercial cases. Chris also has experience in general real estate and commercial lending and in troubled loan issues. Chris’s recent experience includes representing debtors and creditors in Chapter 11 reorganization cases, secured creditors in loan workouts and parties proposing acquisitions and other business transactions with troubled businesses...

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