In recent years, retailers have increasingly used the restructuring mechanism of a Company Voluntary Arrangement (CVA) to reduce their lease liabilities (reducing rents, writing off arrears and closing stores) with a view to returning their business to profitability. Often, that seems to be for the benefit of their shareholders, finance creditors and trade suppliers at the expense of landlords.
With the number of landlord CVAs having continued to rise in recent years (including 33 new CVAs in 2020 alone), some of the biggest commercial landlords in the UK applied to the High Court to challenge what they identified as the worst excesses of the landlord CVA.
In Carraway Guildford (Nominee A) Ltd and others v Regis UK Ltd and others [2021] EWHC 1294 (Ch), the applicants won a rare victory for landlord creditors and the judge set some clear parameters for how far future landlord CVAs can go without being deemed unfair.
Unfair to favour shareholders at the expense of impaired landlords
Under the terms of the Regis CVA, landlords’ rights were significantly impaired. Rents were reduced by between 25% and 75%, and arrears compromised at just 7% of their value. For the purpose of the vote at the creditors’ meeting (at which a majority of 75% of creditors by value had to approve the CVA) the value of landlords’ claims was reduced by 75%. In contrast, a long list of “critical creditors” – including the company’s shareholder, International Beauty Ltd – were left entirely unimpaired by the CVA.
The judge, Mr Justice Zacaroli, observed that “IBL was… wholly owned by Regent, a global private equity firm… and to the extent that the company’s debt burden, in particular to landlords, was reduced, Regent as equity holder stood to benefit”. As an unimpaired creditor, IBL would receive payment in full of a £600,000 debt. To put that in context, a compensation fund of just £330,000 was provided to meet the claims of all impaired creditors.
The judge held that compromising IBL’s debt would not have jeopardised the effectiveness of the CVA, so there was not sufficient justification for leaving IBL unimpaired. It appeared to have been given favourable treatment only because it was the company’s shareholder, rather than for any objectively justifiable reason. This was unfairly prejudicial against the impaired creditors, including the applicant landlords. On this basis, Zacaroli J held that the CVA should be revoked, meaning that it should be treated as never having taken effect.
Zacaroli J also said that the absence of a profit share fund under the CVA, from which impaired creditors can share in future profits of the business, is not automatically unfairly prejudicial, but is something to weigh in the balance when looking at the differential treatment of creditors. Zacaroli J decided that he did not need to consider whether the existence of only an “illusory” profit share fund under the Regis CVA was unfairly prejudicial, having already ordered that the CVA be revoked.
A landlord break option will sometimes negate the unfairness of lease modifications
In addition to the preferential treatment of shareholders and other creditors, the landlords complained that long-term lease modifications imposed on them by the Regis CVA, including rent reductions, were unfair.
Echoing his earlier decision in relation to the CVA of New Look – Lazari Properties 2 Ltd and others v New Look Retailers Ltd and others [2021] EWHC 1209 (Ch); [2021] PLSCS 96 – Zacaroli J said that where a CVA introduces a lease termination right for landlords, it gives the landlord a chance to “get off the bus” rather than bear the effect of lease modifications under the CVA. He held that the termination right can therefore negate the unfairness of any lease modifications in the CVA, on the basis that the landlord can exercise the termination right and avoid such unfairness.
However, if exercising the termination right results in a lower return from the tenant company than the landlord would have received if the company had instead gone into a formal insolvency process then that will not negate any unfair lease modifications. This is what is known as the “vertical comparator”. The new termination right must be capable of putting the landlord in no worse a position than if the CVA had not been approved, otherwise it will be scant consolation for having to bear the effects of the CVA.
Where the vertical comparator is liquidation followed by an immediate disclaimer of the lease then this should be relatively easy to satisfy. However, if it is an administration, such as a pre-packaged sale of the business, then it may be more difficult.
Breach of professional duty by CVA nominees
In addition to criticising the terms of the CVA, Zacaroli J held that the conduct of the CVA nominee fell below the professional standards required of him. The nominee is an insolvency practitioner appointed by the company to supervise the implementation of the CVA. The judge did not accept the nominee’s submission that he was “not responsible for the proposal, only for his report”. The creditors are entitled to rely on the fact that an independent professional nominee has applied an appropriate level of scrutiny to the proposal. In this case, the nominee had made no attempt to question or investigate the propriety of IBL being left unimpaired and being paid in full. The judge was critical of the nominee for having allowed that to go unchallenged.
Notwithstanding the finding that the nominee had breached his professional duty, the judge declined to make an order under s6(6) of the Insolvency Act 1986 for repayment of the nominee’s fees to the company. There have been no recorded cases of such sanctions being made against CVA nominees, and Zacaroli J said that it is a penalty reserved for cases of particularly egregious conduct, fraud and bad faith.
An arbitrary discount on landlords’ voting power is irregular
In another win for the landlord community, Mr Justice Zacaroli held that discounting by 75% all landlords’ claims for voting purposes at the creditors’ meeting was irregular. The argument by the nominees that this was “typical market practice” was rejected.
When it comes to discounting landlord claims for voting purposes, a blanket discount may be justified if it constitutes a reasonable method for estimating a minimum value for landlords’ claims (as was the case with the 25% discount applied in the New Look CVA).
If the discount was both irregular and capable of having a material impact on the outcome of the vote, it would be grounds for revoking the CVA. On the facts of this case, the judge found that the irregularity was not material, but the judgment as to what will amount to an irregular discount will be welcome news for landlords.
What is the future for landlord CVAs?
The Regis decision represents a rare victory for landlords when it comes to CVA challenges and provided valuable lessons for future CVAs.
In order to avoid future CVAs being revoked, companies will have to steer clear of terms which leave shareholders and group companies entirely or substantively unimpaired, especially when they are likely to benefit from the future success of the business as a result of the impairments imposed on other creditors.
We should see far fewer cases of large discounts being applied to landlords’ claims for voting purposes and, in turn, that should make it more difficult for companies to impose CVAs on dissenting landlords. It is still possible to discount landlord claims for voting purposes, but the discount must be a reasonable method for estimating a minimum value.
One of the most significant and over-arching points to come out of Mr Justice Zacaroli’s judgments in New Look and Regis is that, where lease modifications at the landlords’ expense have the effect of increasing value for the benefit of shareholders, that benefit should be shared with the impaired landlords to avoid unfair prejudice.
A previous version of this article appeared in EG on 7 June 2021.
Authored by Tim Reid.
