It can feel like barely a month goes by without a high street retailer proposing a CVA. The recent judgment on the challenge brought by landlords in respect of the Debenhams CVA highlights some major issues for landlords of retail premises, as well as elucidating the case law on CVAs.
Perhaps it is the flexible format of CVAs, combined with the ability to focus on one type of creditor (often landlords) that has led to the increase in their use. Restructuring via a CVA is particularly interesting in light of the rise of the “loan-to-own” strategy, whereby an investor may make funds available to a struggling business in anticipation that the debt owed to them would ultimately be converted into an equity interest – and a seat at the restructuring table. Avoiding a more stigmatising process such as administration or liquidation may be a motivating factor for such an investor. Indeed, the arguments raised in the Debenhams case identify loan-to-own as a potential reason why the Debenhams CVA challenge was funded by Sports Direct – being a majority shareholder in rival department store House of Fraser.
This aspect highlights the major issues faced by high street retailers in a difficult market – and the landlords of their premises. We see no slowing down in the use of CVAs in the retail industry, particularly as regards leasehold premises: the judgment confirms that “future rent” can be included in a CVA.
Mr Justice Norris noted that there was justification in treating landlords differently to other suppliers – for example, landlords typically have the benefit of long-term leases with upward-only rent reviews where the market might in fact show a downward trend in rental values, whereas other suppliers were more likely to react to market rates on a day to day basis. Accordingly, on his assessment of the “basic fairness test”, Mr Justice Norris rejected the landlords’ ground that it was unfair for the CVA to reduce the rent payable under the leases as he reasoned that the rent reductions proposed in the CVA did not fall below market value. Does this imply that the landlords would have succeeded on this ground if the proposed rent reductions in the CVA fell below market value? This is yet to be tested, albeit how “market value” would be determined in a retail landscape teeming with CVAs and demands for turnover rents presents a challenge in itself.
The court did uphold the landlord’s contention that the right to forfeit could not be altered by the CVA. Landlords can therefore exercise their right of re-entry under a lease even if a CVA attempts to compromise it. This is because a forfeiture right is a proprietary interest in land and hence a right between landlord and tenant, not creditor and debtor.
But how helpful is this decision likely to be for landlords going forward? Legally it allows a landlord to exercise its right of re-entry if a tenant breaches its contractual obligation to pay its rent, but only the reduced rent set out in the CVA, not the unpaid rent due under the lease. As such, the right to forfeit is dictated by the terms of the CVA rather than the terms of lease. In most cases a forfeiture clause in a lease also allows a landlord to exercise its right of re-entry where the tenant is insolvent, which would apply here. However, in the current market, commercial realities are likely to prevail over legal rights; a landlord will probably be more inclined to accept reduced rent payments under a CVA than exercise its right to forfeit and risk having an empty property altogether. This has been seen in other retail CVAs, where landlords have supported the proposals even when this will result in substantial rent reductions.
Tim Carter, co-head of Restructuring & Insolvency and Helen Wheddon, head of Real Estate Disputes at Stevens & Bolton, comment:
This case provides a useful confirmation of the law as to the ability to include future rent in a CVA, underscoring the likelihood of continued retail CVAs for well-known high street brands.
Whilst helpfully confirming that the right to forfeit continues to be available in a CVA context, the fact that landlords might not wish to exercise that right in the current high street market is an unfortunate reflection of its economic climate. Hence whilst this legal remedy remains available, it may do little to alleviate the woes of some high street landlords.
We will be interested to see how the retail CVA landscape develops over the next year – watch this space for our report(s) on any further developments.