New Look CVA - grounds of challenge rejected by the High Court

On Monday, the High Court handed down its decision in (1) Lazari Properties 2 Limited, (2) The Trafford Centre Limited, (3) LS Bracknell Limited and 10 Others and (4) Fort Kinnaird Nominee Limited and 20 Others v (1) New Look Retailers Limited, (2) Daniel Francis Butters and (3) Robert Scott Fishman [2021] EWHC 1209 (Ch) considering the various grounds of challenge raised by the applicants in relation to the New Look CVA. Mr Justice Zacaroli rejected each of the grounds of challenge leaving the New Look CVA intact.

Whilst a disappointing decision from landlords’ perspective, on a number of points the case turned on its own facts. Particular comments made by the Judge make clear that, in certain circumstances, a CVA may be unfairly prejudicial. In particular, where the requisite majority to approve a CVA is only achieved by virtue of a large swathe of creditors unaffected by, or treated differently in, the CVA, voting in favour to compromise the minority, this should be closely scrutinised; depending on the circumstances, it may well constitute unfair prejudice. This should also deter companies from compromising landlords without carefully considering their approach with other creditors.

The Grounds of Challenge

The applicants’ challenge was put on three broad bases:

1. The applicants were unfairly prejudiced (the “Unfair Prejudice Challenge”) by the CVA.
2. The CVA proposal, or aspects of it, did not constitute a composition or arrangement within the meaning of section 1(1) of the Insolvency Act 1986 (the “Jurisdiction Challenge”).
3. There were material irregularities in the calculation of voting rights and in the disclosure (or lack of disclosure) of relevant information (the “Material Irregularity Challenge”).

Unfair Prejudice Challenge

The decision relating to the Unfair Prejudice Challenge was perhaps the most keenly awaited. The challenge was brought on 3 grounds:

1. the approval of the CVA by the votes of unimpaired creditors;
2. that different sub-groups of creditors had been treated differently; and
3. that changes to the terms of leases, including a switch to turnover rent, imposed by the CVA on landlords were unfair.

1. The requisite majorities at the creditors’ meeting were secured with the votes of creditors whose claims against New Look were unimpaired by the CVA.

REJECTED:

• It is not necessarily unfairly prejudicial if the statutory majority is achieved by the votes of unimpaired creditors.
• However, this will be a highly relevant factor, based on the facts of a given case, in determining whether there has been unfair prejudice.
• For example, the court will look to determine whether it can be said that the vote of the compromised creditors was “swamped” (e.g. have only 20% of compromised creditors voted in favour) by unimpaired creditors.

2. Creditors whose claims were compromised received differential treatment from those that were not.

REJECTED:

• The aim of a CVA is to provide a flexible procedure which facilitates the rescue of a company.
• Although the differential treatment of different groups of creditors is a cause for enquiry, which needs to be justified, it is not inherently unfairly prejudicial.
• An important consideration is the nature and extent of the different treatment, the reasons justifying that treatment and the impact on the outcome of the creditors’ meeting. Where a CVA which compromises creditors is only achieved by the votes of a large number of unaffected creditors, even where there was objective justification for that different treatment, the Judge noted there would be strong grounds to conclude the CVA was unfairly prejudicial. He did not reach that conclusion on the facts of this case.
• Where votes of creditors offered preferential treatment in previous cases have been disallowed, there was something more beyond the preferential treatment which constituted a breach of good faith.

Whilst the votes of the compromised creditors (if taken separately) would not have achieved the statutory majorities, the majority of compromised creditors (including category B and C landlords) voted in favour of the CVA.

3. Various of the modifications to the terms of leases were unfair e.g. a switch to turnover rent.

REJECTED:

• The CVA offers landlords the choice between (1) terminating their leases and accepting a financial return better than the vertical comparator (here administration); or (2) continuing their leases but on reduced rent and modified terms.
• New Look’s inability to pay contractual rent was a consequence of its insolvency, not the CVA, and landlords were not forced to accept modifications as they could terminate their leases.
• It was not accepted that Debenhams had laid down a principle that modifications to a lease could not reduce rent below market rates (albeit it was not shown that the turnover rents proposed would have been less than market rate).
• The Judge considered that from a practical perspective a company proposing a CVA would need to ensure any rent reductions and modifications were as fair as possible, otherwise landlords would exercise their termination rights and the relevant company would have no premises to trade from. The “fairness” of the modifications was purely a commercial question and not one to be considered by the court.

Jurisdictional Challenge

The Jurisdictional Challenge was made on 3 grounds:

1. The CVA proposal did not constitute a composition in satisfaction of the company’s debts or a scheme of arrangement of its affairs, by reason of the fact that on a true analysis it involved separate arrangements (on fundamentally different terms) with different groups of creditors

REJECTED:

• A CVA can provide for groups of creditors to be treated differently.
• There is nothing inherently unfairly prejudicial in doing so and such an arrangement would fall within the jurisdiction of the Insolvency Act 1986.

2. There was insufficient “give and take” as between New Look and various of the creditor groups.

REJECTED:

• There is sufficient give and take in an arrangement which “takes” from the creditors their contractual rights and “gives” them a return which is as least as good as that which they would have got in the relevant vertical comparator e.g. an administration of the company.
• The giving of a new (and distinct) right to terminate a lease prevents a compromised landlord from being precluded from terminating a lease unless and until the new, reduced rent, due under the CVA is not paid.
• That some creditors are paid in full where there are commercially justifiable business continuity grounds to do so cannot cause a CVA to fail the requirement for there to be sufficient “give and take”.
• The effect of a wider restructuring scheme (which applied here) can be taken into account when considering whether there has been sufficient “give and take”.

3. The new termination right granted to New Look in respect of leases with Category B and Category C landlords improperly sought to interfere with property rights of those landlords.

REJECTED:

• The new termination rights proposed provide that New Look offers to relinquish its right of occupation (with no obligation on the relevant landlord to accept possession ) and for New Look to be relinquished of its liabilities in respect of rent, service charge, insurance and all covenants under the lease.
• It is not a requirement of a lease that rent be paid. Therefore, the release of an obligation to pay rent is not akin to a surrender by operation of law. The lease would remain on foot, for example, the business rates obligation would remain with New Look.

Material Irregularity Challenge

The Material Irregularity Challenge was made on 2 grounds:

1. In relation to the calculation of the landlords’ claims for voting purposes, the applicants argued that the 25% discount applied to the claim of all landlords for voting purposes was not justified.

REJECTED:

• The starting point is that a claim for an unliquidated or unascertained amount is to be valued at £1 unless the chair decides to put an estimated minimum value on it for voting purposes.
• Here the 25% discount was held to constitute a proxy for identifying the lower end (the minimum) of a complex range of values developed with the assistance of expert advice.
• Whilst a different percentage could have been used, the use of 25% was not considered a material irregularity.

2. There was material irregularity by reason of omissions and inaccuracies in the CVA proposal, particularly in relation to the disclosure of the broader restructuring scheme.

REJECTED:

• The CVA proposal noted that certain secured creditors had signed up to a lock up arrangement (“LUA”) as part of the broader restructuring scheme. This obliged them to support the restructuring including the CVA.
• It was not accepted that it was material for creditors to know whether certain senior secured note holders (“SSN Holders”), in respect of which New Look was guarantor and who held substantial secured and unsecured interests, had entered into the LUA.
• It was agreed that the equity interest SSN Holders would receive was relevant information that should have been disclosed. However, it was deemed unlikely that, had the creditors been informed of the range of equity values, they would have voted differently.
• Similarly, the failure to disclose the exit process for equity holders and the management incentive plan were not deemed material.

Conclusion

This is yet another disappointing result for landlords who continue to face the brunt of CVAs aimed at rationalising lease liabilities.

However, absent the CVA, New Look would have faced an administration in which the assets of New Look would be realised for its secured creditors, leaving nothing for unsecured creditors other than the prescribed part. New Look’s case was that the CVA allows landlords to achieve a better result than they could have expected to receive if it had not been approved.

There is also the suggestion that on a different set of facts e.g. where the votes of affected creditors are outvoted by a large swathe of unaffected creditors, a different conclusion might be reached. That is, however, not the case for the New Look CVA.