Out-Law Legal Update 2 min. read

BHS to repay rental discounts says High Court

LEGAL UPDATE: The High Court has said that BHS cannot challenge the terms of its own company voluntary arrangement (CVA) as unenforceable contractual penalties. The case provides guidance as to how CVAs operate post termination and the payment of rent as an expense of a company's administration in priority to other debts.

In March 2016 BHS entered into a CVA with its creditors which reduced rents by up to 75%. The CVA said that if the CVA was terminated the rental discounts would be treated as if they has never happened in order to allow landlords to claim the full sums due from BHS.

In April 2016 BHS entered administration. The CVA and the administration process ran in parallel. The administrators traded the BHS stores with a view to selling the business and during this period paid the reduced rental payments as set out in the CVA. When no buyer could be found, BHS entered liquidation in November 2016.

BHS's liquidation triggered the right to terminate the CVA. Following notice by one of BHS's landlords, the CVA was terminated in December 2016.

Prudential, the landlord of stores in Chester and Southend, argued that it should be paid the full rent as an administration expense, not the reduced rent under the now-terminated CVA. This should relate to the period the administrators occupied the properties, it said.

The liquidators asked the High Court to establish whether they were obliged to pay the "substantially increased" rental payments. The liquidators argued that the termination provisions in the CVA amounted to an unenforceable contractual penalty and, therefore, the increased rental payments were not due.

The court decided that the rule against contractual penalties did not apply to CVAs, that the full rental payments were due to the landlords and that they should be paid as an expense of the administration. The court said: 

  • a CVA is a "hypothetical contract" imposed on the parties by a statutory process, rather than one that is agreed by negotiation. It is, therefore, unnecessary and inappropriate to consider the usual principles of contract formation;
  • it is impossible to apply the rule against penalties as it was not designed to apply to hypothetical contracts; the fact that a CVA has contractual effect does not mean that every principle of contract law can be applied to it;
  • it is "equally impossible to see how a proposal put forward by or on behalf of the company in the interests of itself, its members and creditors, approved by a statutory procedure and having effect by the statutory hypothesis, can somehow be said subsequently to have oppressed the company in some respect";
  • assuming a challenge based on the law of penalties was in scope it would be bound to fail. On the facts, the landlords had a legitimate interest in the CVA’s success or failure and it was not "exorbitant, extravagant or unconscionable" for them to be returned to their pre-CVA position if the CVA should fail;
  • the termination of the CVA in effect simply brought to an end the rent concessions and restored the original rent. No new liability was imposed on BHS, as the liquidators contended. As a result it could not be said that the termination of the CVA increased the landlords' claims in the administration or liquidation of BHS and the principle that creditors should be paid on a pro-rata basis, the 'pari passu' principle, had not been breached;
  • the clear intention of the CVA was to ensure that landlords were not disadvantaged if the CVA was terminated, by being forced to accept a concession which was expressly provided to be conditional on the CVA remaining in force;
  • the administrators have to pay amounts accruing in respect of any period during which they used premises as an expense of the administration. This included sums that were only contingent or yet to be ascertained at the time, such as an uplift under a rent review. This applied equally to clauses such as the termination provision in the CVA, which had the effect of restoring the rent payable under the relevant lease with retrospective effect.

This decision will be welcomed by landlords whose tenants have entered into similar CVAs, particularly in the challenging conditions currently faced by high street retailers.

Ainslie Benzie is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com

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