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Death of the big shops and the rise of CVAs

Posted: 02/07/2018

The earth has not been hit by a meteor but over the last ten years we seem to have witnessed the extinction of the dinosaur of the British high street. The department store has breathed its last in many British towns. And the owners of big retail spaces have faced hard decisions in how best to minimise their shared financial pain at the end of the store’s financial life. There are fashions in how the end of a company’s life is managed; in the 2000s it was generally by an administration while in 2017 and 2018 it has been through a company voluntary arrangement (CVA).

There has been much written in the press of late about the alleged 'abuse' of  CVAs by retail companies, as a raft of high street names including House of Fraser, Mothercare and New Look have gone into CVAs.

We are not privy to what went on in those creditors’ meetings but the reports suggest that other creditors have acted in concert to approve CVAs where the main function of the CVA is to introduce variations to the company’s lease obligations to reduce its liability to its landlords. A CVA which is approved by 75 per cent of the company’s creditors by value is binding on all of the unsecured creditors. The unsecured creditors are bound whether or not they consented to the CVA or were even given notice of it. Unsecured creditors include landlords who are owed rent and service charges.

CVAs are designed to be 'flexible' and proposals may include variations to many lease terms, for example, reduction of rent, reduction of the length of term, removal of a guarantee and the removal of the right to forfeit. It is suggested that some or all of these have been included in some of the recent retail CVAs.

A landlord is not without remedy in the face of (such a blatant set up) a disadvantageous CVA. A CVA can be challenged within 18 days of being approved by an application to the court. There are only two grounds for a challenge, material irregularity and unfair prejudice.

Recent cases suggest that it is only where the outcome for the landlord is worse under the CVA than it would be in a liquidation that there has been unfair prejudice. Removal of a guarantee clause has been held to meet the criteria.

Why, if they are so unfair, are landlords not challenging CVAs or agreeing to be bound by them?

The reason may be that when faced with an insolvent tenant there is often no good alternative.

If the tenant goes into liquidation, then the liquidator will disclaim the lease as an onerous asset and all lease obligations, whether, rent, service charge or repairing obligations, will cease. The only light in that tunnel is that the obligations of a guarantor survive the insolvency process. So if there is an 'all tenant obligations' guarantee, the guarantor is liable not only for rent to the end of the fixed term, but for service charges and damages for breaches of the tenant’s repairing covenant.

If the tenant goes into administration, there is an automatic moratorium created on any action by the landlord to recover rent arrears or service charge arrears including any steps to forfeit the lease.

In a buoyant market a landlord who gets a hint of a CVA in the offing might want to “get in first” and forfeit the lease. Canny tenants however pay their rent and have a meeting to approve the CVA before the next quarter’s rent falls due. So the landlord is reliant upon the forfeiture clause being wide enough so that discussions in contemplation of a CVA amount to an 'insolvency event' within the terms of the forfeiture clause of the lease.

If it can be achieved, forfeiture gives the landlord back control of the property, even if it brings the tenant and the guarantors’ ongoing rent obligations to an end as from the date of forfeiture. Discussions for a CVA create no moratorium against enforcement action, except in the case of small companies which can make an application to court for a moratorium to be imposed.

But if there is no market for your ex-department store and no good parent company guarantor, then a CVA which keeps at least some rent coming in, for a time, may be a least worst option.

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Penningtons Manches Cooper LLP