There has been much debate in recent years around the use made of certain UK restructuring tools – the company voluntary arrangement and, more recently, the new restructuring plan – to restructure commercial property leases. Commercial tenants argue that compromise is necessary to address high fixed costs that are no longer sustainable, but landlords have often been critical of the approach taken. This debate has become more acute in the context of the pandemic, as many High Street businesses subject to mandatory closure have built up significant rent arrears that need to be addressed.
It is against this backdrop that the High Court has recently heard high profile landlord-led challenges to the New Look and Regis CVAs, and the Virgin Active restructuring plan. In a seminal week for the restructuring market, the High Court handed down its keenly awaited judgment in New Look on Monday 10 May 2021, followed two days later by the Virgin Active judgment (the Regis judgment is still awaited). Neither judgment has made happy reading for landlords, with all challenges dismissed in New Look and the restructuring plan sanctioned despite their objections in Virgin Active.
In the first of a series of blog posts on these three cases and their implications, we summarise the key takeaways from New Look.
Suffering from widespread sectoral decline and the impact of the COVID-19 pandemic, New Look, a UK high-street fashion business, faced an impending liquidity shortfall which would likely have led to it entering into administration where no material recoveries were expected for unsecured creditors. Therefore it proposed a restructuring of its significant secured loan, revolving credit, and senior secured note (SSN) debt, as well as its large portfolio of long-term property leases, on which significant rent, service charge and other amounts were owed to landlords.
The restructuring involved various interconditional aspects in addition to the CVA, including the consensual amendment and extension of the loan and revolving credit debt, as well as a scheme of arrangement of the SSNs.
As is customary in CVAs, New Look grouped its landlords into alphabetised categories, depending on their nature and proposed treatment. The CVA was voted on by these various landlord categories (Categories A to C), alongside other categories of unscured creditors. These included:
- the SSN holders who were entitled to vote on that portion of their claims that was “unsecured”, i.e. to the extent that the value of their shared security was insufficient to cover the secured liabilities; and
- other “ordinary unsecured creditors”, certain of which were deemed to be business-critical creditors which stood to receive full payment on their claims.
The Category A landlords were, for all intents and purposes, unimpaired, while landlords in Categories B and C together made up what were referred to as the “Compromised Landlords”, with varying levels of impairment including release of rent arrears and reduction of future rents. The Compromised Landlords were also granted certain new lease termination rights under the CVA. It was accepted that the CVA represented a better return to Compromised Landlords than they would achieve in the relevant alternative. The SSN Holders were not compromised under the CVA itself (other than by consenting not to enforce their security).
The CVA achieved the requisite statutory majorities, including 75% by value of all unsecured creditors voting. Of those voting, 100% of each of the SSN holders and the Category A landlords, and almost 100% of the ordinary unsecured creditors, voted in favour of the CVA. As regards landlord voting – turnout was high (81.4% participated in the vote), with a majority of Category B landlords voting in favour but 70% of Category C landlords voting against the CVA.
The challenge had three broad bases:
The jurisdiction challenge – namely that the CVA was not a composition or arrangement under the Insolvency Act, on the basis that (a) it involved separate arrangements on fundamentally different terms between different groups of creditors, (b) there was insufficient “give and take” as between New Look and its creditors; and (c) certain aspects involved improper interference with proprietary rights of certain landlords.
The unfair prejudice challenge – namely that it was unfairly prejudicial that (a) the requisite statutory majorities were obtained through the votes of unimpaired creditors (i.e. the SSN holders), (b) there was differential treatment as between compromised and uncompromised creditors, and (c) the terms of various lease modifications proposed under the CVA were unfair; and
The material irregularity challenge – namely that certain landlords’ claims were improperly calculated for voting purposes, and that there were other asserted omissions and inaccuracies in the CVA proposal.
The Court dismissed each of these challenges, making the following key findings:
Key takeaways: jurisdiction and unfair prejudice
- Differential treatment of different creditor groups is not necessarily unfairly prejudicial.
- Obtaining the statutory majority through the votes of unimpaired creditors is also not necessarily unfairly prejudicial.
- There are four key factors when considering whether unfair prejudice exists (which will depend on all the circumstances):
- whether there is a fair allocation of assets available within the CVA between the compromised creditors and the other sub-groups of creditors;
- the nature and the extent of any different treatment, its justification and its impact on the voting outcome;
- the extent that others in the same positions as objecting creditors approved the CVA (more than 80% by value of Compromised Landlords voted at the meeting, and, of these, more than 57% voted in favour); and
- a finding of unfair prejudice ought not to be precluded merely because the same result might have been achieved in a Part 26A restructuring plan.
- It is not the case (as had been suggested following Debenhams Retail Limited) that (i) a CVA would necessarily be unfairly prejudicial if it imposed a reduction of rent to below market rates and (ii) any interference in landlords’ rights must only be the minimum necessary to achieve the purposes of the CVA.
- To preclude a finding of unfairness, it is important to provide landlords with the right to terminate on terms that are at least as beneficial as in the relevant vertical comparator.
- The removal, in full, of rental obligations from the leases of Category C landlords did not amount to a lease surrender and so did not constitute a prohibited interference with proprietary rights under the CVA – there is no requirement under statute for a valid lease to include a rent payment obligation.
Key takeaways: material irregularity
- The 25% discount applied to landlords’ future rent claims for voting purposes was justified here.
- The chair’s duty is to place an estimated minimum value on any such claim, and the fact that there was no “exact science behind the adoption of a discount of 25%” did not itself constitute a material irregularity.
- It was correct that the discount applied to future rent claims was not applied to future claims under the SSNs as they were for a liquidated sum and not subject to discounting by means of an estimated minimum value.
As observed by the Court, the landlords’ challenge in New Look amounted to a “root and branch attack on the use of CVAs”. The early months of 2021 have seen a slowdown in the number of big-ticket CVAs which may be at least partly attributable to the legal uncertainty hanging over the process whilst the challenge was pending. The judgment has largely validated common market practice, subject to some honing, which may embolden businesses with a large physical footprint to force lease adjustments. Landlords may hope that the eagerly awaited Regis judgment (coming soon) may redress the balance a little, but the direction of travel seems clear.
Unsurprisingly, the landlords have also on 14 May been given permission to appeal the judgment to the Court of Appeal, with the judge noting that the points raised are of general relevance and not limited to the New Look CVA.
The judgment has largely validated common market practice, subject to some honing, which may embolden businesses with a large physical footprint to force lease adjustments