A CVA results in the rescue of a company supported by the vast majority of its creditors, or by abusive means is a 'fundamental reallocation of commercial risk' acting to the detriment of a minority class of creditor who unfairly shoulder the economic burden of the company's rescue; take your side in the great divide.
The Evolution of the CVA
The CVA was introduced as new company rescue process in the Insolvency Act 1986 and imposes within a statutory framework a compromise in satisfaction of debt or a scheme of arrangement between a company to its creditors; requiring 75% in value of voting creditors to approve and therefore bind dissenting and/or absentee creditors.
The process was initially little used, principally adopted to distribute realised assets to creditors in place of liquidation, or to provide a debt repayment programme. Innovation in the use of the process slowly developed and in a series of cases the Courts gave approval to proposals which involved different classes of creditor, receiving differing treatments where it was objectively justifiable and crucially which provided for the future claims of a creditor to be compromised within the terms of a CVA.
Well over a decade ago, recognising the flexibility offered by the CVA and the Court approach, proposals were developed to deal principally if not exclusively with leasehold property portfolio restructuring, where typically a large distressed retailer/hospitality operator was looking to reduce its costs of occupancy; the so called 'retail CVA'
The Great Divide
Battle lines between landlords and tenant have thus long been drawn, and although the use of CVA process was becoming increasingly controversial for a time this was often more due to the competitive advantage a tenant business could obtain over rivals, rather than landlord antipathy. Indeed, typically if a CVA proposal was rejected, it was due to the failure to obtain overall landlord support. If approved and an individual landlord did not want to accept the terms proposed typically, they could forfeit the lease and take back the premises to re-let.
Demographic social and culture changes have led to moves to on-line retail and a gradual decrease in footfall, meaning that business seeking to transition to a multi-channel sales model have needed less retail space and or margins needed to be maintained by seeking to decrease occupancy costs. In parallel this led to increasing numbers of voids in the high street and shopping centres as replacement tenants were becoming more difficult to find.
As a result, between 2017-2020 there was a flurry in the use of CVAs in the retail and leisure sector. The CVA in this phase of development often sought to remove the landlords right to forfeit replacing it with differing rights to terminate pursuant to the terms of the CVA and sought increasingly to make changes to rent post the terms of the CVA. In response landlords became increasingly vocal that tenant businesses were abusing the CVA process and unfairly treating landlords by re-writing the terms of occupation by means of votes obtained from other creditors, even worse where such creditors who were often unaffected by the proposal.
The first significant court challenge by landlords arose in the Debenhams CVA of 2019. From this case came a determination that a CVA could not interfere with a landlord's property right to the premises and therefore attempts to remove the right of forfeit for breach of lease would be struck down. An earlier court determination that the compromise of arrears within a CVA replaced the Landlord's right to contractual rent and thus no breach for failure to pay rent arose, was followed. Crucially however the landlords challenge that the proposal was unfairly prejudicial was rejected.
Covid-19 and the restrictions in the retail and hospitality sector has thus been an accelerator of change rather than the cause of these structural problems. Undoubtedly however the cessation of 'physical' as opposed to virtual trading activity resulted in huge revenue falls and a consequent cash flow crisis for many businesses; the non-payment of rent from March 2020 has resulted in an estimated £6bn of rent arrears. The Government support for the sector included from June 2020 the suspension of landlord's rights to forfeit and/or petitioning for the winding up of the tenant company. With these temporary suspension measures due to end on 30 June 2021 there is a cliffs edge approaching for tenant businesses.
It is against this background that we have a trilogy of court battles that will determine the landscape for restructuring of leasehold portfolios for years to come. Part one is the challenge by 4 landlords to the New Look CVA which was approved by 82% of the creditors. Part two concerns the use of a 'controversial' new company rescue procedure by Virgin Active; the restructuring plan. Part three the Regis CVA challenge is a re-match.
Tenants 1 Landlords 0
The Landlord's challenge in New Look was described as a 'root and branch attack on the use of CVA's' and was rejected on all grounds.
The New Look CVA like many other 'retail' CVA sought to distinguish sub-groups of unsecured creditors and outline how each sub-group would be treated. For most landlords, the proposal involved a move to turnover rent and regarding arrears, the entitlement to a share of a 600K fund. For a smaller class where the premises were not deemed necessary to the business, after 2 months payment of rent, service charge and insurance, rent was reduced to nil, likewise these landlords were given a right to share in the set aside fund. Both landlords and the tenant were given various rights to terminate.
Two-fifths of the Landlords voted against the CVA but were diluted by the other creditors including senior secured note (SSN) holders, who the Landlords argued have very different interests to other creditors in that they would obtain a debt for equity in a subsequent restructured group structure.
The most fundamental challenge to the CVA was the argument that the proposal was not a composition with the company's creditors but was in fact a separate arrangement with different groups of creditors and thus outside the scope and intention of the Insolvency Act CVA scheme. In addition to this it was contended that the granting of rights to New Look to terminate was an interference with a property right.
In a lengthy and careful judgment which looked at the pre-1986 position, the introduction of the CVA and case law development, the Court saw that the differing treatment of creditors as being a reason for inquiry but was not fatal on grounds of jurisdiction or unfair prejudice. The differing treatment could well be justifiable. The fact that the statutory majority was achieved by votes of creditors who were unimpaired or who would receive substantially different treatment was similarly not by itself sufficient reason to set aside the CVA.
As in the Debenhams case the ability for the Landlord to terminate and 'get off the bus' was seen to eliminate potential unfairness to the Landlord. Also important in fairness was the Company's argument that the replacement rent represented better than market rent. It should be noted that the Court held that the was not a rigid test i.e. that if market rent was not offered it was automatically unfairly prejudicial. The fact that for Class C rent was reduce in time to zero (and thus below market) was mitigated by the accompanying right of termination.
The Judge twice made the observation that the tenant's inability to pay future rent was not caused by the CVA but by its insolvency. The Landlords would receive less in an alternative liquidation process and attempts to argue that in an administration or scheme of arrangement the Landlords would be in a better bargaining position were speculative.
Tenants 2 Landlords 0
In the same week as the New Look failure came news that the Virgin Active restructuring plan would be sanctioned by the court, cramming down the dissenting landlord class.
The restructuring plan is a new procedure introduced in the Corporate Insolvency and Governance Act 2020 with similarities to the Company Act Scheme of Arrangement process but with the significant additional ability to 'cram down' dissenting creditors or classes of creditor (or member) and with Court approval, this cram down can be cross class.
Like a CVA a proposal is made by the Company but is not restricted to unsecured creditors but can be to reorganise the company share capital and included creditors with secured or other interests. As a result, separate meetings of classes of member/creditor with similar interest are held, each being required to approve the proposal by 75% in value. Where approval is obtained from at least one group who will receive payment or have genuine economic interest in a relative alternative then any dissenting class or classes can be bound to the proposal (crammed down) if the court is satisfied that the dissenting clauses would be no worse than would be the event if the relative alternative (likely to be liquidation).
The objections of Landlords who faced the write off of £30m in rent arrears were heard but ultimately the scheme sanctioned. As a result, for the second time a dissenting class of creditors was crammed down due to the cross-class support of the scheme.
Tenants 3 Landlord 0?
The result of the challenge to the Regis CVA is awaited. However, as the determination is by the same judge as heard the New Look challenge and the legal team for the landlords seeking to challenge the CVA's approval is the also same, it is highly likely that the challenge will fail.
They Think it is All Over?
Landlords have immediately gone to press criticising the decisions as 'outrageous', 'creating a dangerous precedent' and 'leading to inevitable world of hurt'. The ability to re-write leasehold terms and provide a take it or leave it ultimatums to landlords is seen to have huge impact on the balance of commercial negotiating power. Indeed while the legal interprepration is that the scheme does not vary the lease, simply prevents the enforcement of rights if the terms of the proposal are adhered to, this is of little practical comfort, particularly where the amended rent payable can be binding post the duration of the arrangement. How is this fair? The Court have placed great reliance on the termination right of the Landlord, if they do not like the terms and do not think thaey are getting market rent they can 'get off the bus.' In current market conditions however, Landlords do not want the premises back and thus the 'fairness' afforded by the right of termination is again of little comfort.
Surveying the wreckage Landlords may be feeling that with rent arears estimated to be in excess of £6bn they are likely to face a flood of CVA and restructuring plans and thus are better off attempting to negotiate what they can outside of any proposal. Whether this is with a weakened bargaining position is a key question.
It should be remembered that each case rests on its own facts, the Courts in both Debenhams and New Look were at pains not to set out tests for unfairness and instead only proffer what maybe deemed unfair. It is quite clear that the proposal to landlords must be better than the 'relevant alternative' a reassertion of the vertical comparator test. In addition, the right of the terminate and get off the bus is key to fairness, if the landlords think they can do better they can take back the premises. Admittedly this power to walk away from contractual commitment is a significant step but the use of insolvency processes is a balance of debtor v creditor and creditors as between themselves. It is indeed the insolvency of the tenant that causes the change of terms not the CVA or restructuring plan.
Lastly the Court in New Look looked at hypothetical situations where a proposal maybe deemed to be unfairly prejudicial. For example, where the claims of impaired (landlord) creditors are compromised by votes cast by non-impaired creditors, even if there was an objective justification for treating the non-impaired differently. In short, some shared pain must be evidenced, the proposal cannot be to the sole detriment of one sub-group, albeit it is recognised that impairment may be of a different nature and effect to different sub-groups of creditors. Furthermore, materiality is a factor, if the unimpaired creditor class is small in number and value, even if it was crucial in the voting scheme tipping the balance in favour of acceptance this is unlikely to be unfairly prejudicial. The court will also have regard to how members of the same sub-class voted i.e. was a significant majority of the sub-class opposed to the proposal.
In the face of the rejection of legal challenges it may well be that the landlord's option is to lobby for legislative change and protection against the fundamental change to leasehold terms. The three battles maybe lost but it does not mean that the war is over.