Twas was the week before Christmas when, many lightyears ago as kids, we ran joyously up and down the aisles of a Toys R Us store hoping Santa was going to deliver our selected gifts. Sadly those days might become a distant memory with the recent news that the struggling retailer is planning a largescale retrenchment in the UK.
Having filed for Chapter 11 bankruptcy protection in the US in September with roughly £3.6bn of debt, Toys R Us has announced a restructuring plan for the UK arm of its business, involving a proposed company voluntary arrangement (“CVA”), the failure of which is likely to result in the company falling into administration.
We consider below the proposed CVA and in particular the pivotal role being played within it by the Pensions Protection Fund (“PPF”).
- Background to the proposed CVA
Those of us fond of the Toys ‘R’ Us story will be familiar with its “warehouse-style” stores with toys in their millions all under one roof.
This kind of business model doesn’t work quite so well for the internet age. This is especially so when you add to the mix the reported difficulties faced by the business when dealing with the legacy of a US$7.5bn leveraged buyout in 2005 by private equity firms Bain Capital, KKR and property investor Vornado Realty Trust. A potential online tie-up, launched with Amazon in the early 2000s, ended rather abruptly in the courts.
And so the company has pinned its hopes of survival on a CVA with the stated purpose of making Toys R Us Limited’s (“TRU”) property portfolio more viable. The obvious impact is on store landlords who are being asked to vote on a reduction in rents, although all of TRU’s creditors are entitled to vote on the CVA.
- What are the key features of the CVA?
The original CVA proposal was made available to creditors on 4 December.
The focus of the proposal is to reduce the company’s “onerous rent agreements”. 26 UK stores are forecast to be closed during the first half of 2018. Other stores are expected to be downsized or rents reduced, with consequential redundancies. We understand that broadly speaking, landlords have been offered 80p in the £1 via the CVA proposal (a substantially better result than the forecast £12.5p in the £1 that has been talked about as being their alternative return in the event of an administration).
Creditors are due to vote on the proposal today and therefore we should learn the result either later today or tomorrow. In order to be approved, the CVA proposal must obtain at least 75% (by value) of the creditors, who are entitled to vote, to vote in its favour. In addition, if more than 50% (by value) of ‘unconnected’ creditors vote against, it will not be passed.
- Where does the PPF fit in?
The trustee of the Toys R Us Pension Scheme (the “Trustee” and the “Scheme” respectively) is one of TRU’s unsecured creditors and as such it gets a vote on the CVA. The CVA itself triggered an assessment period under the PPF’s procedures, whereby the PPF has a period of time to determine whether the conditions are met for the Scheme to, loosely speaking, “fall into” the PPF. The PPF has therefore assumed the creditor rights of the Trustee for the duration of the CVA – and potentially longer if the CVA is unsuccessful.
- What has the PPF’s position been so far?
In a letter dated 19 December 2017 from Alan Rubenstein, chief executive of the PPF, to Frank Field MP, Chair of the Work and Pensions Committee, Mr Rubenstein explained the PPF’s objections to the proposed CVA. Mr Rubenstein expressed the view that the PPF did not receive sufficient reassurance from TRU that the position of the pension scheme would not be potentially weakened by the CVA.
It was explained that the Scheme was insufficiently funded to cover the level of compensation that the PPF would need to pay in the event of the Scheme “falling into” the PPF. The deficit on this basis (the “PPF deficit”) is said to be circa £30m. As such, the PPF had to consider the impact of the deficit on its levy-payers. In order to “de-risk” the Scheme from any failure of the CVA to revive the company’s fortunes, the PPF required an accelerated payment of contributions already due to the Scheme over the next three years of £7.3m. Taken together with sums due to the Scheme in the first quarter of 2018, this amounted to just under £9m.
According to the latest reports, it seems that TRU may be attempting to negotiate concessions with the PPF in an attempt to persuade the PPF to vote in favour of the CVA.
- Why is the PPF’s position so complicated?
The PPF have a delicate position – on the one hand they have a duty to protect Scheme members, and on the other hand they need to contain potential costs to levy-payers (i.e. other employers who sponsor defined benefit pension schemes). As it stands, the PPF’s decision to vote against the CVA looks set to derail it. If so, it is highly likely the Scheme will fall into the PPF. However the PPF is concerned that the CVA will not ultimately improve TRU’s profitability and viability. In other words, if it were to vote in favour of the CVA, TRU may become insolvent at a later date and the PPF deficit would ultimately be greater than £30m. So while agreeing to the CVA would benefit Scheme members for the time being, because members benefits in the Scheme would be preserved and may therefore continue to grow (and corresponding levels of potential PPF compensation could grow), it would not necessarily help levy-payers in the long term.
It is also apparent from the CVA that a number of the landlords who stand to lose out are pension schemes themselves. Large pension schemes such as the Coal and Railways pension schemes appear to have invested in the TRU properties. The outcome of an unsuccessful vote and subsequent insolvency is likely to substantially increase their “haircut”.
- What’s next?
As said, voting on the proposed CVA takes place today and therefore we should learn the outcome either later today or tomorrow. We will share our thoughts on the outcome in the New Year as part of a wider commentary on the troubles currently faced by the UK high street and retail sector generally. So, watch this space!
Tim Carter
Matthew Padian