27th July 2018
CVAs – Deal or No Deal?
You would be forgiven for thinking that there is a recession on the horizon with headlines informing us that residential properties are being down valued so that buyers pay a larger deposit to give greater protection to the lender’s security if there is a downturn in the market, M&S are set to close 100 of their stores by 2022 and well known restaurant chains such as Gaucho have entered into administration. The number of FTSE-listed companies issuing profit warnings rose by 13 to 58 in the second quarter of this year.
What is surprising is that the companies we are hearing about are those considered well established businesses. The reasons given for the financial difficulties these companies are having range from the shift to more online shopping, business models are not what consumers want (people are looking for better shopping experiences) to an increase in overheads such as business rates, the National Minimum Wage and overexpansion resulting in high debt burden.
CVAs were first introduced by the Insolvency Act 1986 (“the Act”) as an alternative to liquidation or administration and so have been with us for a while now. In February 2010 the FT reported KPMG’s warning that there would be a “fresh wave of company voluntary arrangements from retailers” in the following months. In the same FT report, Mark Bowls, the property director for HMV was critical of CVAs stating that “they don’t offer everybody a level playing field and allowing firms to be released from lease liabilities is an inappropriate way to manage the situation”. In 2017, HMV went into administration and announced the closure of 66 stores.
At the beginning of the year Carpetright entered into a CVA on which Knight Frank’s head of retail research wrote a blog asking whether Carpetright’s CVA was “a genuine distress or a dive in the penalty box” referring to Carpetrights £14.4m pre-tax profits for the previous year. The post was subsequently removed after a warning from Carpetright’s legal director.
More recently in the headlines has been House of Fraser which has entered into a Company Voluntary Arrangement (“CVA”). The proposals provide for the closure of more than half of House of Fraser’s stores and a reduction in rents at several others. A number of the creditors have challenged the CVA claiming that there have been irregularities and unfair prejudice. A statement by the unhappy landlords’ representative states that they:
“strongly believe it to be unjust for the existing shareholder in House of Fraser to receive £70m of value, the details of which were not communicated initially, whilst certain landlord creditors are shouldering the financial impact of the process.”
This statement in part echoes the views made by the British Property Federation’s chief executive, Liz Peace, in 2010, following Blacks Leisure entering into a CVA arrangement when she stated:
“While the property industry has been much more responsible than in the past, it can’t be expected to bail out firms that have over-expanded or simply made bad business decisions. This growing resentment for CVAs may mean that others aren’t quite so lucky.”
Disgruntled creditors in a CVA are therefore not new but are on the increase as the preferred option to liquidation or administration as they allow the company greater flexibility to negotiate a reduction in the rent or even a surrender of the lease with the Landlord.
What is a CVA?
The Act described CVA as “a company’s proposal to its creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs”. Simply put it is a binding arrangement between a company (who, although not necessarily insolvent, is in financial difficulties) and its unsecured creditors with regard to payment of its debts.
As a CVA requires creditors support, the directors will be expected to explain to the creditors why the CVA would be more advantageous than other insolvency procedures and can include the possibility that liquidation could result in the creditors receiving nothing as opposed to something.
The proposals will be put forward to the creditors in a meeting for their approval and at least 75% of the creditors must be in support of the proposals. CVA proposals may include:
- The payment of the arears at a reduced amount.
- Payment of ongoing rent and service charge at a reduced amount.
- Where payment of rent and service charge is paid quarterly in advance, it may be paid monthly in advance.
- Surrender of leases coupled with the continuing requirement/ obligation to pay the rates, full service charges and insurance premiums until the date of surrender.
- For any adversely affected creditor, a share in any upturn of the company’s fortunes. This may be in the form of a payment linked to the Company’s performance over the course of the next few years.
However, unless expressly stated otherwise, the CVA proposal will not:
- Apply to any debenture holders and other secured creditors. They can therefore still take enforcement action.
- May not release guarantors and former tenants – these third parties would not, prime facie, be bound by the CVA.
If the CVA proposals are supported an insolvency practitioner will be appointed to ensure that it is implemented and the CVA lasts for a period of 3 to 5 years.
Once the CVA has been “passed” it may still be challenged by a creditor where there have been irregularities or unfair prejudice. Any challenge to the CVA must be made within 28 days of the approved CVA.
In 2010 the High Court rejected the CVA entered into by the owners of Miss Sixty concluding that the proposal was unfair to one of the Landlords, Metquarter Limited. The CVA had proposed relinquishing the Italian parent company’s guarantee in relation to two stores and in return would have offered a one-off payment of £300,000. Metquater Limited argued that its leases had five years to run and they would lose a rental income of about £4m. Mr Justice Henderson concluded that the CVA was prejudicial to Metquarter and had a few choice words for the administrators who were appointed to act as nominee in the CVA stating that they “….seem to have lost a proper sense of objectivity and they allowed themselves to side with Sixty against the interests of the guaranteed landlords of the closed stores”.
Once the CVA is entered into, all unsecured creditors are bound by its terms and cannot take any enforcement action to recover their debts. Therefore, as a landlord, you would not be able to forfeit the lease.
Is it all doom and gloom for the landlord?
A CVA may be a better outcome for a landlord than if the tenant went into administration or liquidation. However, this depends entirely on the proposals and although the landlord may be taking a risk, there may also be rewards. For example, a Landlord may be more willing to agree a CVA where the proposals contain a clawback should the company do well in the next few years whereas the alternative is liquidation and little of anything by way of dividends and possibly also having to pay rates until a new tenant is found. Where a company has a strong brand presence a CVA can be seen as a positive way to restructure the company.
Furthermore, as a CVA is more flexible, the types of arrangements that can be entered into are ones which are not available in liquidation or administration. It is also cheaper than administration resulting in more funds being available to pay the creditors. They can preserve job security and tax losses. However, unless a secured creditor has expressly agreed to be bound by the proposal, they can enforce their security which could diminish the prospects of the CVA succeeding.
CVAs are here to stay with the number of CVA’s growing, more landlords will be receiving invitations to attend a meeting to discuss CVA proposals. Take part in the meeting, have your say and consider carefully the proposals before agreeing – ask yourself: what are its effects, what are your risks and what are your rewards, if it all works out.