Tenant insolvency on the high street and the effect of company voluntary arrangements
04 / 07 / 2018
High Street retailers are under pressure from the internet, squeezed incomes, rising overheads, too many outlets and too much debt.
Since the beginning of 2018, Maplin, Toys-R-Us and Poundworld have entered administration, whilst House of Fraser, New Look, Mothercare and Carpetright are just some of the retailers to have entered into company voluntary arrangements (CVAs) with their creditors.
CVAs are a major concern to commercial landlords, not only because of the benefits they confer upon tenants (at the expense of landlords) but also because they are not always successful, for example in the case of Austin Reed and BHS which collapsed in 2015 and 2016, respectively.
There is further concern that the use of CVAs has a ‘snowball effect’. Next plc, for instance, is purportedly considering the inclusion of “CVA Clauses” within its leases to enable it to trigger a reduced rent if neighbouring stores enter into CVAs in an attempt to mitigate damage which it suffers as a result.
Why are CVAs attractive to companies in financial difficulties?
A CVA offers mechanisms for companies in financial difficulties to settle their unsecured debts by paying only a proportion of the amount they actually owe to their creditors or to come to alternative arrangements with their creditors in respect of the payment of their debts. They are an attractive option for retail businesses to reduce their outgoings, particularly and most notably by way of reduced rent payments or the surrender of leases of less profitable premises, while attempting to rekindle their overall profitability. In the event that the CVA is unsuccessful, which can often be the case, the company will either enter administration or liquidation.
What are the options available to landlords whose tenants have proposed CVAs?
Once accepted, CVAs bind all creditors who are entitled to vote in the decision procedure, including those who dissent and those who do not vote. It is therefore important for landlords to carefully review and analyse the terms of the CVA and take an active part in the proposal meeting and decision procedure as, once a CVA is in place, no steps can be taken to recover debts within the scope of the CVA (which will almost always include rent payments in the context of high street retail businesses). If there are other landlords who will be similarly prejudiced by reduced rent proposals and/or by the removal of their right to forfeit leases, it may be possible to act alongside these to reject or alter a company’s proposals.
In respect of participating in a CVA meeting, landlords should prepare evidence and reports as to the maximum value of any claims they have against the company, which may include current arrears of rent, future arrears, dilapidations and the costs associated with re-letting the premises if it is proposed that the company will vacate some of its premises. This can help to preserve landlords’ claims and prevent future arrears and claims from being undervalued (although it will not aid in securing priority if the company subsequently enters administration or liquidation).
If there are already concerns that a company is in financial difficulty, it is best to consider taking action to recover arrears or recover the possession of premises before a CVA is approved. This is important as this is unlikely to be possible (depending the terms of the CVA) once the CVA has been approved, although it is worth noting it may be possible to challenge such terms if a landlord feels there is “unfair prejudice” between itself and other creditors under the terms of the CVA.
What happens to the lease after a CVA?
After a CVA, the original terms of the lease will apply. The recent decision of the High Court in Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd focused on landlords’ claims for full rent after the CVA was brought to an end during the collapse of BHS. The CVA in this case entitled BHS to temporary rent concessions but the liquidators argued this continued after the company had entered liquidation and that the landlords would not be entitled to claim for the original rent amounts for the period which the administrators used the leasehold premises. In a welcome decision for landlords with insolvent tenants, the court disagreed, holding that once the CVA was brought to an end, the original rent under the leases would continue to apply.
Whilst operating like a contract, a CVA is not considered to be a formal contract between the debtor and its creditors and, as a result, the beneficial terms for the tenant do not operate as formal variations to the lease beyond the period of the CVA, which would require a deed between the parties.
What is the position where the tenant has entered administration or liquidation?
Turning to the potential ‘worst case scenario’, where a CVA is unsuccessful and the company subsequently enters administration or liquidation, as many landlords will be unsecured creditors, there is a concern that very little will be recoverable in the form of payments due under the lease. This is compounded by the fact that a moratorium will be in place when a company enters administration, preventing landlords from beginning or continuing proceedings.
Rent (and possibly other sums due under the lease) will still be payable, however, and if the administrator or liquidator is using the premises for the benefit of the creditors, it will be payable as an expense of the liquidation ahead of secured and preferential creditors.
An important point to note is that as long as the lease remains in force, the landlord will retain its rights over third parties despite the tenant’s insolvency, such as guarantors. This may be a far more convenient method of recovering sums due under the lease and may be the most favourable option for a landlord, assuming any guarantor is of good financial standing!
For further information please contact Brad Trerise.