Retail Company Voluntary Arrangements (CVAs) are becoming an increasingly popular means of minimising liabilities and creating breathing space for tenants during a difficult trading environment on the High Street. Where does this leave landlords?
Most landlords have limited options to protect their asset when faced with a CVA, as demonstrated by the recent judgment in the Debenhams case, Discover (Northampton) Limited and others v Debenhams Retail Limited and others  EWHC 2441 (Ch). The High Court has held that, "[Under a CVA] landlords should receive at least the market value of the property he is providing. He should not subsidise other creditors but nor should they be compelled to overcompensate him."
Here, we summarise the key points for landlords to consider when seeking to argue that a CVA should not stand because of "unfair prejudice".
Company Voluntary Arrangements (CVAs) were introduced as a flexible option in the case of corporate insolvency. A CVA allows a company to restructure its debts and liabilities while it continues trading. Importantly, this is supposed to benefit creditors as a whole, as the alternative may mean creditors realising even less of their debts.
In recent years, CVAs have become more mainstream - this can be a problem for all creditors, but particularly landlords. It is common for landlords to argue that they are poorly treated under an insolvency process that hits the value of their asset and significantly reduces the contractual returns agreed at the start of the lease.
The Debenhams CVA was approved on 9 May 2019 by almost 95% of creditors. Overall, the effect of the CVA for landlords was: proposed store closures, reduction in rent, prohibition on a landlord exercising right of re-entry (forfeiture) triggered by the CVA, and a release of Debenhams from any liability under dilapidations' claims. Landlords had limited rights to terminate the leases.
A legal challenge by a group of landlords ("the Landlords"), opposed the CVA on five grounds. One ground was that the landlords were "unfairly prejudiced" compared to the other creditors. Whilst this challenge failed to strike down the CVA, the court gave helpful guidance on what it meant for a landlord to be "unfairly prejudiced".
What can a landlord do when faced with a CVA that dramatically reduces rental income? A challenge may be possible under section 6(1) of the Insolvency Act 1986, if:
- The CVA unfairly prejudices the interests of a creditor, member or contributory of the company;
- There has been some material irregularity at or in relation to the meeting of the company, or in relation to the relevant qualifying decision procedure.
Here we consider what is meant by 'unfair prejudice', with reference to the Landlords in the Debenhams case.
Is the CVA "unfairly prejudicial"?
To prove this ground, landlords should consider both the "vertical comparator" and the "horizontal comparator".
Does it pass the Vertical Comparator Test?
Compare the projected outcome of the CVA with the projected outcome of a realistically available alternative process (e.g. liquidation). This alternative process sets the "lower bound" below which a CVA cannot go. If the CVA does go below this lower bound, there could be grounds for challenge.
For example, if a CVA could fail this test - and so be unfairly prejudicial - it would prevent landlords relying on parent company guarantees, but this right would have been unaffected if the tenant company had instead entered liquidation (Mourant & Co Trustees Limited & another v Sixty UK Ltd (in liquidation) & others  EWHC 1890 (CH)).
In contrast, a CVA will pass this test if it can be shown that the CVA will ensure better returns for creditors (as a whole) than the alternative process.
Does it pass the Horizontal Comparator Test?
Is the treatment of the different creditor groups fair? With good reason, landlords can often feel that they are being made to bear the financial brunt of a tenant's CVA. Importantly, differential treatment of creditors is allowed - for example, reduction of rent by itself does not make the CVA unfair. However, such differential treatment must be justified. This justification must be considered on the basis of the particular facts of each case.
This was one of the landlords' grounds of challenge to the Debenhams' CVA - which was unsuccessful. Whilst the CVA did reduce rent payable, the reduction was justified. Significantly, the court noted that the landlords did not argue that the rent reduction under the CVA meant the landlords would therefore receive below market-value rent. However, the Court accepted that if the CVA had meant that the rent was below market value there may, in principle, be an argument as to unfairness.
The landlords sought to argue that reducing rent payable under leases was automatically unfairly prejudicial to a landlords. If Debenhams was making use of the premises, it should pay the full contractual rent. It was not fair that a tenant could trade under a CVA for the benefit of past creditors at the present and future expense of its landlord. The Court rejected this argument - some creditors may be "one-off' contracts that reflected the current market price. In contrast, the landlord may have been able to fix a rent under a lease at a historic high or which automatically escalated so it exceeded the true market rent. It was not therefore unfair that rents were reduced under the CVA which may properly reflect the market price (albeit it diverged from the contractual price under the lease).
Significantly, the Court noted that many Landlords seemed disinclined to forfeit the leases on the basis of insolvency. This could indicate that the current market rent for vacant department stores was not particularly attractive.
Can I Forfeit Instead?
Many landlords will consider forfeiture a more attractive option than the CVA terms. In the Debenhams case, the CVA provided that any provisions in the Leases which allowed for forfeiture or early termination as a result of the CVA (e.g. on the basis of insolvency) were waived by Landlords. In their place, the CVA introduced limited break rights. The Applicants argued that the right to forfeit could not be altered by a CVA.
The Court agreed with the Applicants - the right to forfeit (also known as 're-entry') was a property right that could not be modified by a CVA. It arose from the relationship of landlord and tenant and was not dependant on any state of indebtedness between the parties. The CVA could only modify the pecuniary obligation (e.g. rent payable) upon which the right to re-entry may be exercised, but not modify the right to re-entry itself.
Therefore, the forfeiture provisions in the Debenhams CVA were deleted.
Taking into account the above, landlords would be well-advised to:
- Review CVA proposals at any early stage to determine "unfair prejudice";
- Does the CVA give a better result than an alternative process (e.g. liquidation)?
- Is one group of creditors treated unfairly without justification?
- Test the market for rent levels as evidence for any challenge on the basis of "unfair prejudice";
- Ensure any challenge is made within 28 days of CVA approval;
- Consider forfeiture and whether this right has ostensibly been waived under the CVA;
Consider legal challenge alongside negotiations - a further legal challenge by another group of landlords to the Debenhams CVA was withdrawn following negotiations between the parties.