Out-Law News | 11 May 2021 | 3:11 pm | 7 min. read
The test case on CVAs provides long-awaited guidance for corporate landlords and insolvency practitioners on the legality and fairness of their use by insolvent retailers to restructure lease liabilities.
The decision will be viewed as a major setback by institutional landlords who have tried to challenge and supress the use of CVAs as a restructuring tool. It suggests that the use of CVAs as a rescue mechanism is far from over.
The New Look challenge was heard after the CVA challenge of Regis by the same applicants, both by Mr Justice Zacaroli during March 2021. Judgment is awaited in the Regis case, which also considers the role of the nominee or supervisor and their duties.
A CVA is a form of UK insolvency process used by distressed businesses as a restructuring tool to compromise liabilities over a period of time. It is proposed by a company to its creditors and shareholders, who must then consider the proposal and vote on it at a creditors’ meeting. If the vote at the meeting achieves a 75% majority of creditors by value in favour, then the CVA is approved. Creditors are bound by the CVA whether or not they voted in favour.
The decision and the CVA terms can be challenged within a short, 28-day window after approval, by a creditor who considers that there has been unfair prejudice or material irregularity.
‘Landlord only’ or ‘retail’ CVAs have been used for a number of years by both retailers and others to compromise the levels of rent that the company is obliged to pay over a particular period. The terms vary by each company, but often lease liabilities are compromised while other, ‘critical’ creditors are not substantially impaired by the terms proposed.
Challenges to this type of CVA had been relatively rare until around two years ago, when a challenge to the Regis CVA was issued. A similar challenge was brought against the Debenhams CVA.
The applicants in this case are landlords of properties from which New Look Retailers Limited (New Look) continues to trade, or of properties that New Look wishes to exit.
This test case on CVAs provides long-awaited guidance for corporate landlords and insolvency practitioners on the legality and fairness of their use by insolvent retailers to restructure lease liabilities.
New Look entered into a CVA in September 2020 as a result of the trading difficulties experienced during the Covid-19 pandemic. It did so as part of a wider restructuring exercise, which also involved a scheme of arrangement of its finance creditors. The CVA is New Look’s second, following a CVA in 2018.
The 2020 CVA was challenged by the New Look landlords in October 2020, and was progressed by the courts on an expedited basis. Lazari Properties 2 Limited reached an out of court settlement agreement with New Look ahead of the trial, and is no longer a party to the proceedings.
The landlords sought to challenge the CVA on the following grounds:
The jurisdictional grounds focused on arguments that:
The landlords argued that the CVA was inherently unfair because of the differential treatment of types of creditors within the CVA. They argued that using the votes of unimpaired creditors to pass the approval binding the creditors impaired by the CVA was unfairly prejudicial.
The landlords also alleged that the CVA was inherently unfair taking into account a number of factors including the treatment of critical creditors and lease modifications imposed on landlords. These modifications included:
The landlords claimed there was material irregularity in the way in which the CVA was approved because:
New Look argued that it is not the role of the court to determine the jurisdiction question as the insolvency legislation in relation to CVAs permits differential treatment of creditors and those creditors were all voting as one class; and that adequate give and take was provided by the CVA, as a comprehensive break right was offered in return for the lease modifications.
New Look’s position was that there was no unfairness in the terms of the CVA as it satisfied both the vertical and horizontal tests of fairness. It also said that there was no material irregularity in the presentation of the proposals or the voting process.
Ultimately, the High Court rejected the challenge on all the grounds identified above.
On the jurisdictional grounds, the judge held that the interpretation of the legislation by the landlords was incorrect. The introduction of the legislation in 1986 was an important moment in corporate insolvency and for providing a framework for company rescue. CVAs were not limited to small companies and could provide for differential treatment amongst creditors voting as one class. Differential treatment of creditors did not in itself render a CVA unfair.
The judge then considered the question of one class of creditors receiving different treatment being used to achieve a vote. He did not want to set an all-encompassing test, and indicated that fairness depends on the circumstances of the case. However, he said that there are four main relevant factors, assuming that the ‘vertical’ test of fairness – whether the creditors will receive a better outcome under the CVA – is satisfied. These are:
New Look was able to satisfy each of these points, so the fact that votes of a connected secured creditor voting as unsecured were used to approve the CVA was considered fair.
The judge found that the CVA did have adequate give and take. It did not compromise proprietary rights by reducing rent to nil, as the lease itself remained in place unless terminated by the landlord.
On the other unfair prejudice grounds – those relating to lease modifications – the judge held that any potential prejudice was sufficiently addressed by offering a termination right in the CVA proposal in return for imposing lease modifications, provided that the terms offered for the notice period were better than the alternative the landlord would receive on an administration or liquidation. Landlords were afforded a choice: whether to stay with the CVA terms or to take the property back.
The judge considered the decision in the Debenhams CVA case, linked above. He decided that the judge’s decisions in that case that a CVA should not compromise rent to below market rent, or should only compromise to the extent necessary to give effect to the CVA, were not a rigid rule on the fairness of lease modifications and were concerned only with the short notice period that followed a landlord termination notice.
On the material irregularity issues, the judge held that the 25% discount on landlord votes that was to be applied to their claims at the creditors’ meeting to approve the arrangement was consistent with the duty to place an estimated minimum value on a claim and was not materially irregular, as a different discount would not have changed the outcome of the meeting.
Although this will differ from case to case, certain information that was not disclosed within the proposal was not sufficiently material to have changed the outcome of the decision at the creditors’ meeting. There was therefore no material irregularity on the part of New Look.
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