Company Voluntary Arrangements still in fashion in the UK
In the hotly anticipated judgment of Mr Justice Zacaroli in the case of Lazari Properties 2 Limited and Ors and New Look Retailers Limited  EWHC 1209, new Look has successfully defended a challenge to its Company Voluntary Arrangements (CVA), by a group of its landlords, on the grounds of jurisdiction, material irregularity and unfair prejudice.
In this commentary, Jonathan Dunkley, managing associate (Restructuring and Insolvency) in the retail sector team at law firm Womble Bond Dickinson, provides his takeaways from a real estate perspective:
New Look proposed its CVA on 24 August 2020 as part of a wider group restructuring. The purpose of the CVA was to help the Group restructure its liabilities which included rent due under its leases. The CVA was approved in September last year and enabled New Look to switch to turnover-based rents at 402 of its UK stores with its remaining 68 branches not being charged rent.
The CVA was subsequently challenged by a group of landlords. Of particular interest to the real estate sector will be the challenge mounted on the ground that the CVA was unfairly prejudicial to the landlords being compromised as:
- creditors whose claims were not compromised accounted for a material part of the vote approving the CVA; and
- a number of the proposed modifications to leases including, principally, moving to a turnover rent below market value, was inherently unfair.
In his judgment, Mr Justice Zacaroli rejected each of the heads of challenge.
The key points to note for landlords and tenants alike are:
- Landlords need to be aware that CVAs continue to be a powerful means for tenants to restructure their rent debts and that, in particular, using them as a means to implement a turnover based rent model is not inherently unfair.
- The previous authority from the Debenhams case should not be construed as applying a rigid test that a CVA can only escape a finding of unfair prejudice if at least market rent was paid and the interference of lease terms proposed is the minimum necessary to achieve the purposes of the CVA.
- If landlords have the option to terminate leases where the rent imposed by the CVA might fall below market value, that will generally answer any suggestion that the rent terms imposed are unfair. In particular where it is also ensured that the outcome for landlords would be no worse than the alternative insolvency outcome (i.e. administration or liquidation) which might lead to the end of a lease or little to no prospect of the landlord recovering rent in any event (i.e. the vertical comparator test).
- It remains common ground that CVAs cannot alter a landlord’s proprietary rights and that as such they cannot oblige landlords to accept surrenders of leases. The practice of offering landlords the opportunity to agree a surrender in a CVA does not constitute an alteration of proprietary rights as there is no obligation to accept the surrender, albeit the landlord may then be left with a reduced rental liability (which it could avoid by accepting the offered surrender). Equally, removing the obligation for tenants to pay rent does not constitute a surrender by operation of law as the underlying lease and its terms remain on foot (i.e. there is no automatic alteration of proprietary rights either).
- The chairperson of a CVA has a wide discretion on what value to ascribe to landlords’ future claims under leases for the purpose of weighting voting rights but is only obliged to place a minimum estimated value on a claim if there is sufficient evidence to enable to them to do so. In this case a discount of 25% which was calculated on the basis of expert evidence was considered appropriate.
- The supervisor of a CVA has a wide discretion on what value to ascribe to landlords’ future claims under leases for the purpose of weighting voting rights on whether the CVA should be passed at all.
Commercial tenants, particularly those in the retail sector, will no doubt be breathing a collective sigh of relief at the outcome of this judgment as it validates what appears to be a shifting of the market approach towards the use of turnover based rents in CVAs and in so doing paves the way for other retailers to use CVAs to tackle the impact the pandemic has had on their business.
This will undoubtedly, however, deepen the already tight tensions between retailers and their landlords. We await the outcome of the Government’s call for evidence on a solution for ongoing discussions between landlords and tenants as restrictions on enforcement by landlords are eased at the end of June.
This judgment may well mitigate against the risk of future challenges being mounted on similar grounds. The courts have been clear to express, however, that while there are underlying principles. there are no hard and fast rules as to what will constitute unfair prejudice in any given case and this will fall to be assessed looking at all the circumstances of the relevant case. This point may well arise, therefore, in future cases.