Uncertain insolvency landscape for UK landlords and tenants

Out-Law Legal Update | 07 Oct 2020 | 1:52 pm | 4 min. read

More high street retailers and restaurant chains risk administration or liquidation this winter due to a change in the rules around tax liabilities on insolvency.

The reintroduction of 'Crown preference' from 1 December 2020 means that any outstanding tax liabilities will need to be paid in full before a struggling business can have a company voluntary arrangement (CVA) approved, unless HM Revenue and Customs (HMRC) voluntarily agrees to discount the business' tax liability. Many businesses will simply be unable to pay their tax liabilities in full given the high level of tax liabilities they are likely to have accrued by the end of the year as a result of Covid-19 VAT and PAYE deferrals.

Crown preference rules will rank HMRC as an uncapped secondary preferential creditor in any insolvency process, meaning it must be paid before lenders under their floating charge, company pension schemes, suppliers and customers. Previously abolished in 2002, the government announced its intention to restore the rules in 2018.

Whatever happens over the next few months, landlords and tenants are both facing a fast changing insolvency landscape through no fault of their own and they could both end up being the unintended victims of a legislative change that was introduced in good faith to help balance the UK's books.

The growth of 'landlord only' CVAs

Pre Covid-19 there had been a spate of 'landlord only' CVAs put forward by retailers as a method of reducing rental costs, although these often failed to deal with other structural issues experienced by many retailers. These CVAs tended to compromise the tenant's obligations to landlords - often by way of rent holiday periods, significant discounts on annual rent and restrictions on landlord's contractual rights under leases – but did not compromise the tenant's obligations to its other unsecured creditors. Many 'landlord only' CVAs ultimately failed and resulted in the administration of many retailers and casual dining businesses.

Landlords and tenants could both end up being the unintended victims of a legislative change that was introduced in good faith to help balance the UK's books.

Businesses seeking 'landlord only' CVAs typically categorised their landlords based on the profitability of the premises, as follows:

  • Category A – profitable stores – leases unamended so rental liabilities remained at the existing level;
  • Category B – marginal stores – material amendments to leases including significant discounts on rent; and
  • Category C – unprofitable stores - premises vacated by the tenant and returned to the landlord.

There has been a further acceleration in the number of CVAs being put forward by tenants since the Covid-19 pandemic began, particularly by tenants in the retail, hospitality and leisure sectors - including well-known brands such as New Look, Jigsaw, Pizza Express and Frankie & Benny's. These CVAs continue to discount the claims of the landlords, however increased care must now be taken in the treatment of landlords following two recent High Court decisions which restrict the tenant's ability to impose a lease surrender on a landlord and restrict its ability remove or interfere with a landlord's right of forfeiture.

At the same time, a more active and informed landlord community has meant that it is vital to have active engagement with impacted landlords at an early stage, and also to open up a dialogue with the British Property Federation (BPF) and seek to comply with its best practice guidance.

These post Covid-19 CVAs differ from traditional CVAs in that they seek to also compromise the claims of other categories of unsecured creditors such as HMRC, employees and non-essential suppliers. It is now not only the landlords who are being asked to take the pain. The need to significantly reduce other liabilities is no doubt a symptom of the sudden material impact of the pandemic on these businesses' revenue streams, and the drastic measures needed in order for the tenant's business to be rescued as a going concern. These new 'all-encompassing' CVAs may ultimately prove to be more sustainable than many of the 'landlord only' CVAs that went before them.

Some of these CVAs have included innovative, and sometimes controversial, terms. New Look's CVA, which was approved by the requisite majority of its creditors on 15 September 2020, provides that 402 of its store leases will more to a turnover-based rent model despite opposition from certain landlords. A separate debt for equity swap within the group, involving significant losses for New Look's bondholders, was contingent on rent cuts being agreed. New Look's position was that, without a restructuring of this nature, it would have entered into an insolvency process.

The new restructuring landscape

The recently enacted 2020 Corporate Insolvency and Governance Act (CIGA) introduced two new restructuring processes for companies: a restructuring plan and a standalone moratorium.

For landlords, the effects of a restructuring plan will be similar to those of a CVA or a scheme of arrangement.

The standalone moratorium provides for a temporary stay on enforcement action by creditors, including landlords, and is intended to be for businesses that will be rescued as a going concern. In all likelihood, this rescue would take the form of a refinancing, a CVA or a restructuring plan assuming the financial position of the business does not deteriorate to the point that it needs to enter into an insolvency process such as administration or liquidation.

There has been limited usage of these two new processes to date. Virgin Atlantic recently obtained court approval for its restructuring plan, and Pizza Express has also proposed a restructuring plan to its creditors. There have also been only a handful of standalone moratoriums in the market to date, and none in the retail or casual dining sectors.

For landlords, the attraction of a moratorium is that their rent will need to be paid during the period of the moratorium, which can last for up to 40 business days or longer if ordered by the court. However, with landlords unable to serve statutory demands, forfeit or present winding up petitions before the end of the year, there is currently little need for tenants to seek a standalone moratorium as protection from landlord action.

Many in the market have assumed that there will be a greater use of standalone moratoriums and more CVAs proposed by tenant companies once the restrictions on landlords' recovery remedies have been lifted at the start of next year, but the re-introduction of Crown preference rules creates an additional complication.

It appears to us that an unintended consequence of the re-introduction of Crown preference is that many retail and casual dining tenants will instead go into administration or liquidation after 1 December 2020 as they will have such high levels of HMRC debt that they will not be able to satisfy them in full under any CVA. This cannot have been what the government intended when it sought the re-introduction of Crown preference.

We may also see a short-term spike in the number of CVAs being proposed before 1 December 2020, with tenants looking to take advantage of the opportunity to compromise tax liabilities owed to HMRC before the change in law.