Earlier this month, judgments were handed down in the landlord challenges to two Company Voluntary Arrangements ("CVAs"), New Look and Regis. The challenge to the New Look CVA was unsuccessful, although permission to appeal to the Court of Appeal has been given. Whilst the Regis challenge lead to the revocation of the CVA, the majority of the landlords' arguments failed. These judgments provide important guidance on the use of landlord CVAs and their terms. However, what constitutes a material irregularity or unfair prejudice is fact specific and will still need to be assessed on a case-by-case basis. Subject to outcome of the New Look appeal, CVAs remain for the time being an important restructuring tool for distressed companies with significant leasehold commitments, both as part of a large complex restructuring and on a standalone basis.
New Look Retailers Limited ("New Look")
On 10 May 2021, Mr Justice Zacaroli handed down his judgment in the challenge to the CVA approved by the creditors of New Look1. In an attempt to set a precedent for the use of CVAs going forward, the challenge which was brought by certain landlords was referred to in the judgment as a "root and branch" attack on the use of CVAs.
As is common in many landlord CVAs, the company's leases were split into categories which determined their treatment. The leases were divided into four categories, A to D (with Category B landlords were split into nine sub-categories). In Categories B and C, the rent arrears were released in full. The rent on Category B leases (being sites which would continue to trade) was moved to a turnover rent. The rent on Category C leases (sites which would be vacated) was paid in full for a period of two months and then reduced to zero.
Although the CVA was approved by 81.6% of creditors, only 58.27% of Category B landlords and 30% of Category C landlords voted in favour of the CVA. The CVA was linked to a wider restructuring of the business, including a debt for equity swap and extension of secured financing.
The challenges brought by the landlords on the grounds of jurisdiction, material irregularity and unfair prejudice can be broken down into the three following categories, all of which were rejected for the reasons set out below.
The landlords argued that the CVA did not constitute a composition or arrangement within the meaning of section 1(1) of the Insolvency Act 1986 ("IA"), that there was insufficient "give and take" between the tenant and its creditors and that the CVA interfered with the landlords' proprietary rights.
- Mr Justice Zacaroli held that a CVA that provides for differential treatment of different sub-groups of creditors is not for that reason outside the jurisdictional scope of s1(1) IA.
- There is sufficient give and take in an arrangement which "takes" from the creditors their contractual rights and "gives" them a return which is at least as good as that which the company could give in the relevant comparator situation (which in this case was administration). The right to terminate the lease afforded to landlords by the CVA was significant because, without it, the reduction in rent would preclude the compromised landlords from terminating the leases unless the new, reduced rent was not paid.
- It was common ground that a CVA cannot alter a landlord's proprietary rights and therefore cannot oblige landlords to accept the surrender of their leases. Mr Justice Zacaroli held that it is not an essential requirement of a lease that the tenant is obliged to pay rent and hence the reduction of rent to zero was not objectionable. The CVA did not therefore lead to the surrender of leases by operation of law.The CVA offered the landlords the opportunity to agree to a surrender of the lease, but did not require them to do so.
Material Irregularity Challenge
The landlords argued that there were material irregularities specifically in relation to the calculation of the landlords’ claims for voting purposes and by reason of omissions and inaccuracies in the CVA proposal.
- The application of a 25% discount for landlord claims was not objectionable and the application of that discount had no impact on the outcome of the meeting.
- Although the terms of the management incentive plan should have been disclosed to CVA creditors, on the facts, the non-disclosures did not constitute material irregularity. The provision of this information at the time would not have changed the votes.
Unfair Prejudice Challenge
The landlords contended that they were unfairly prejudiced because: (1) the requisite majorities at the creditors meeting were secured with the votes of unimpaired creditors; (2) creditors whose claims were compromised received differential treatment from those that were not; and (3) various modifications to the terms of leases were unfair (i.e. a change to turnover rent and continued reduction in rent beyond the expiry of the Rent Concession Period).
- Mr Justice Zacaroli held that a CVA which provides for different treatment of different sub-groups of creditors is not for that reason outside the jurisdictional scope of section 1(1) IA (see above) or necessarily unfairly prejudicial (although it might need to be justified); and that it is not necessarily unfairly prejudicial to a sub-group of compromised creditors that the statutory majority is achieved, in respect of such a CVA, by the votes of unimpaired creditors or those who receive substantially different treatment. That, however, will be a highly relevant factor in determining whether, in any given case, there is unfair prejudice.
- A CVA which provided for a reduction in future rent during a notice period before the landlord could terminate the lease was not necessarily unfairly prejudicial. It was also not unfair for the tenant to remain in occupation during the two-month period after the landlord had exercised its termination right.
- The CVA proposed long term lease modifications. As the CVA afforded that landlords the right to terminate, these modifications were not unfair - the terms offered on termination being at least as beneficial as the relevant vertical comparator.
- In this case the tenant was unable to pay rent in full as a result of its insolvency. The reduction in rent (and other modifications) contained in the CVA only applied to a lease if the landlord elected not to terminate it. In the circumstances, it was not unfairly prejudicial to offer the landlords that choice.
- The threshold for fairness (set out by the Court in Discovery (Northampton) Ltd v Debenhams Retail Limited2) was that a landlord should receive under the terms of the CVA at least the market value of the property and that its contractual rights should be interfered with as little as possible. However, the Court had to take into account all of the circumstances when applying this test. For instance, a CVA was not automatically unfair if it reduced rent below market rent if the landlord was afforded the right to terminate the lease and had not done so.
- Certain other creditors (the noteholders) had received incentives to vote in favour of the CVA which were not made available to the landlords. However, such difference did not mean that the compromised landlords were unfairly prejudiced by the fact that the noteholders' vote secured the statutory majority at the creditors' meeting.
Regis UK Limited ("Regis")
On 17 May 2021, Mr Justice Zacaroli handed down judgment in the challenge to the Regis CVA (Re Regis UK Limited3). He rejected all but one of the landlords' claims of unfair prejudice and material irregularity. The already terminated CVA was revoked on the basis that the treatment of Regis' sole member as a "critical creditor" was unfairly prejudicial.
In summary, on the key points, the landlords argued as follows:
The landlords contended that the Statement of Affairs and Estimated Outcome Statement were inaccurate, among other things, wrongly identifying administration as the relevant alternative.
- This did not amount to a material irregularity. In preferring the evidence of the nominee's expert, Mr Justice Zacaroli decided that it was reasonable in the circumstances and at the time of the proposal to identify the relevant alternative as a "shut-down" administration.
The landlords also contended that the nominees failed to disclose transactions which could have been challenged as antecedent transactions by office holders in an administration or liquidation scenario.
- Mr Justice Zacaroli found that, while the disclosure was inadequate, this did not amount to a material irregularity because the possible claims were of doubtful merit. As there were no sustainable claims, the creditors were not affected by the lack of disclosure.
The landlords argued that a 75% discount to landlord' claims for voting was too high.
- The imposition of a 75% discount was irregular (being significantly higher than the 25% discount in New Look), however ultimately it was not material.
The landlords also contended that two creditors who were classed as critical creditors under the CVA (leaving them largely unimpaired) were treated that way incorrectly.
- The court held that the treatment of Regis' sole member as a critical creditor was unfairly prejudicial. On the facts, there was no justification of the beneficial treatment of this creditor. It was on this ground that the CVA was revoked.
In respect of the allegations against the former nominees and supervisors, Mr Justice Zacaroli found that although the conduct of one of the nominees fell below that of a reasonable nominee in classing Regis' sole member as a critical creditor, it was only in this limited respect. Therefore it was not sufficient to deprive the nominee of his fees relating to services provided by him, which were not without value.