CVAs: short-term sticking plaster or long-term rescue remedy?

United Kingdom

Company voluntary arrangements (CVAs) were a creation of the Insolvency Act 1986, introduced as a “simple” procedure for companies in distress to create a statutory binding contract to compromise debt and vary contractual rights and obligations with unsecured creditors.

Thirty years on, modern-day CVAs are anything but simple. Proposals are extremely long, complex documents, often compromising vast property liabilities, and requiring input from accountants, surveyors and lawyers.

In essence, CVAs can be a very flexible tool for a company to cram down creditors and escape future liabilities; but potentially unattractive for creditors. However, it’s worth remembering that it may be the company’s only option to avoid insolvency, keep the company alive, save jobs and help landlords (or at least some of them) avoid an empty property.

With any rescue remedy, there is bound to be some pain. But it is the relatively recent trend by some retail tenants for what has been termed “landlord-only CVAs” - a CVA which compromises debt and future lease obligations of the company’s properties, but leaves the company’s other creditors (for e.g. trade) completely untouched, receiving 100% of debt – which has triggered major concern among landlords and the property industry generally.

CVAs which seek to compromise landlord debt and future lease obligations whilst leaving every other creditor untouched feel fundamentally unfair. In these CVAs, landlords bear the brunt of the company’s poor financial health, including any bad decision-making or mismanagement. Leases of low category properties are generally terminated with limited liability for dilapidations and any other lease obligations. Claims against any guarantors or other third parties can often be limited in return for very minimal payment in the CVA. For landlords whose leases remain on foot at a reduced (future) rent, the compromise effectively helps fund payment by the company of pre-CVA debt and future liabilities to other unsecured creditors and the recovery of the company without any of the upside. Some CVAs have included provision for a future pool for landlords to share in, though the level of recovery is limited.

Headlines frequently shout “greedy landlords” and complain about high rent, but the company freely enter into these contractual arrangements, and the reality is that many landlords are pension funds investing pensioners’ money, or property companies with their own financial commitments, liabilities, employees and shareholders.

Whilst recent CVAs have caused consternation, there is unlikely to be appetite for legislative change, with the Government supporting a rescue culture. Although there was a consultation paper in 2016 which considered extending the availability of a moratorium but giving creditors the right to request information to enable better decision-making, the Government is currently otherwise occupied. CVAs are here to stay, so what is involved and what action should landlords consider.

Proposing a CVA – first steps

A CVA is proposed by the company’s directors (or by a company’s administrator or liquidator) and is put together with a licensed insolvency practitioner (IP) who the company appoints as its independent nominee.

The proposal (amongst other things) must include a comparison of outcomes between a CVA and other insolvency processes though the company does not have to prove insolvency. The very nature of a CVA is that the company will continue to exist and trade, under its current directors, with the objective of bringing the company back, eventually, to rude health.

The IP is required to consider the CVA proposal and a statement of affairs of the company, and report to the court on whether the proposals should be put to creditors (and members) for approval and whether it believes there is a reasonable prospect of it being approved and implemented.

Notice is then given to the company’s unsecured creditors calling a meeting to approve the CVA proposal. The shareholders’ meeting takes place after the creditors’ meeting.

The Creditors’ Meeting

Creditors are almost always given the minimum 14 days period of notice for calling the meeting. Typically, companies in financial difficulties are treading a fine line between retaining the support of lenders, minimising damage to their brand and getting a CVA approved, hence the desire for a short notice period.

This presents a real challenge for creditors, who have very little time to review and take advice on a proposal, particularly where these are increasingly long and complex documents. It is therefore essential to act on a CVA proposal as soon as it’s received.

The CVA will be approved if 75% (by value) of unsecured creditors vote in favour, provided that at least 50% voting in favour are unconnected with the company.

A landlord’s voting power is calculated by reference to a) debt; and b) future rent and other lease liabilities. The latter is treated as a future unascertained (and unliquidated) debt. The Chairman of the meeting can value this claim at £1, or agree to put a higher value on it.

If approved, the CVA will bind all unsecured creditors (but not secured creditors unless they agree to be bound), whether or not they voted for or against, and whether or not they received notice of the meeting. Given the major impact a CVA can have on a landlord’s future relationship with the company, including the basis for termination of the lease, analysing the CVA proposal on receipt is essential.

Landlords’ Action Plan

  1. Which category?
  2. The obvious starting point for landlords is to check which category a property falls into, and how that will be affected by the CVA. Unless the property is in the top category, there will be any number of changes to the parties’ relationship under the lease, including reduced rent which can sometimes extend even beyond the life of the CVA, discounted claims for dilapidations, a right to determine the lease (by the landlord or company) and a moratorium on certain action against the company. If the CVA is unclear, or the mechanics of the proposal do not work, it is far better to seek clarification and possibly modification of the CVA before it is approved.

  3. Future prospects?
    • What detail is (or is not) given about the company’s business?
    • How will it be financed going forward?
    • What fundamental changes is it making to turn the business around other than cost cutting under the CVA?

    BHS is a prime example of a CVA which was clearly destined to fail, going from a CVA approved on 23 March 2016 to administration one month later on 25 April 2016, and finally liquidation in December 2016. Landlords, with their accountants, should scrutinise proposals, demand information and challenge the company’s statements in a proposal where these don’t stack up.

  4. Voting rights?
  5. Recent CVAs have included a formula for landlords to calculate the value to be placed on future liabilities under the relevant lease for voting purposes. As the value of the (collective) landlords’ voting power might affect the vote, checking the formula, calculating the landlords’ claim and raising any issues with the company and nominee prior to the meeting is crucial to ensure the landlord gets full value for its voting power.

    The formula applied is an adaptation of that used for calculating claims in a liquidation for the loss arising from a disclaimer of the lease. In summary, this includes an assumption that there will be a hypothetical re-letting of the property on certain terms, and discounts the claim for early receipt. The company takes surveyors’ advice on the formula, for example on the relevant void to be applied. However, this generic approach does not have regard to individual properties, locations, specific market conditions or the profit/loss of a particular store if it’s a retailer. The landlord’s own analysis may enable it to challenge the formula and/or calculation for voting purposes. Even if challenging the formula used for calculating future debt is difficult, as the Nominee must simply show it has acted in good faith, the calculation may be wrong. There may also be an opportunity to persuade the Nominee to modify the proposal before the meeting.

  6. Effect on guarantors, other parties liable?
  7. How will the CVA impact on the landlords’ rights against other parties? If the CVA purports to limit such rights, it should give valuable consideration in return. If not, a challenge based on unfair prejudice may be available to the landlord.

  8. Challenging the CVA
  9. A creditor can challenge a CVA within 28 days after the Nominee reports its implementation to the court on grounds of i) material irregularity, for example if claims for voting purposes have been included incorrectly or miscalculated; or ii) unfair prejudice.

    Whether there is unfair prejudice will be fact specific, but in the Powerhouse and Miss Sixty cases, group landlord actions successfully challenged the CVAs where the company had attempted to strip the landlords of the benefit of parent company guarantees without adequate compensation, which placed the landlords in a different position to other creditors and constituted unfair prejudice. Creditors recently challenged the House of Fraser CVA but this was settled out of court. It was reported in the press that the landlords believed they had been unfairly prejudiced during the CVA process.

    The court will undertake a comparative analysis:

    Vertical comparison – looks at the position of the company on a winding up. This is highly material. Would the creditors claiming unfair prejudice do better if there were no CVA?

    Horizontal comparison – compares the position of the claimant creditors against other classes of creditors to see if they are treated fairly. Any different treatment of similar creditors must be justified by objective criteria and reasoning, but the mere existence of different treatment is not enough and is usually necessary for the company to ensure it can survive. So, for example, trade creditors may have to be paid in full so they will continue to supply the company post-CVA.

    Different treatment of landlords has been held not to constitute unfair prejudice, but a material consideration in the case was that the landlord retained a right to forfeit once the full rent was not paid. In most recent CVAs, there may well be grounds for landlords to challenge.

Companies may still use CVAs to push the boundaries, but the increasing noise and action of some landlords, no longer content to simply accept the terms of any proposal, may help to create a more considered approach to their treatment, which could benefit landlords and the company.