Pandemic forces retailers to use CVAs, landlords cry foul

Pandemic forces retailers to use CVAs, landlords cry foul

Successive lockdowns have hammered retailers, with some turning to CVAs when landlords refuse to budge

Pandemic forces retailers to use CVAs, landlords cry foul

Despite the Office of National Statistics (ONS) reporting the UK economy shrank by 9.9 percent in 2020, insolvencies remain low, according to the latest quarterly report from the Insolvency Service.

The report found there was a 16 percent drop in the number of administrations and a 55 percent decrease in compulsory liquidations in 2020. Government support in the form of furlough, rate holidays and a moratorium on statutory demands have helped to keep many businesses afloat.

Businesses in the retail and hospitality sectors have bore the brunt of the economic fallout caused by government-imposed lockdowns.

With shops either closed or seeing reduced footfall, retailers have been negotiating rent reductions or payment holidays with landlords.

“Coronavirus has seen the majority of landlords and tenants reaching some sort of new rental arrangement for periods of closure,” says Dominic Curran, property policy adviser at the British Retail Consortium (BRC).

He estimates that up to 80 percent of retailers have reached an agreement with their landlord but still around a fifth to a quarter have still not reached a deal despite a year of closures.

“Outside of a bilateral negotiation, there isn’t really any mechanism to [renegotiate]. What we’re seeing is a situation where rents, especially if you take out long leases, are falling rapidly.”

Some retailers who have been squeezed by the pandemic and unable to reach an agreement with their landlords have been using Company Voluntary Arrangements (CVA) to “compromise” landlords and force them to accept new terms.

“A tenant will normally seek consensual deals with its landlords. On the whole, you would expect an agreement to be reached. One that will work with the company’s cash flows and be acceptable to the other stakeholders in the business,” says Kevin Ley, head of corporate creditor services at Smith and Williamson.

“There are issues where deals can’t be struck and that is probably what leads to the majority of the CVAs. There are just some landlords, you can’t get over the line on a consensual deal.”

CVAs during the pandemic

The CVA process allows for unsecured creditors, in which landlords are one, to be compromised in order to restructure the business. It requires the approval of 75 percent of unsecured creditors and that no more than 50 percent of unconnected parties vote against it. There is also another vote for shareholders requiring a simple majority but in a case of differing results, the creditor vote prevails.

Though overall insolvencies remain below pre-pandemic levels (except December), a report by PwC has found that there has been 375 percent rise in the number of CVAs launched by businesses in the retail, consumer, hospitality and leisure sectors, between June to November 2020 compared to the same period a year prior.

The report found that nearly 65 percent of landlords were compromised in CVAs compared with only 43.3 percent of CVAs surveyed pre-pandemic.

“CVAs have been used to either amend leases or cut off the sort of worst performing sites. That has been amplified as a result of coronavirus because there are more businesses that are being forced to take a long hard look at their trading footprint,” says David Baxendale, partner at PwC.

Landlords feel unjustly targeted, with interviewees noting that in most CVAs, landlords are usually the key compromised stakeholder.

In a letter to the parliamentary undersecretary of state, Martin Callanan, the British Property Foundation’s chief executive, Melanie Leech wrote: “The UK’s insolvency framework is renowned the world over for its flexibility and low cost. However, in recent years this flexibility has allowed for an abuse of the CVA process – namely the widespread use of ‘landlord CVAs’ where there are only one or two compromised classes of creditors, but other, largely unaffected creditors approve the CVA.”

Some high profile CVAs spurred by the pandemic include retailers like Clarks, New Look and Café Nero. In all three, landlords claimed they were being treated unfairly. Despite all three companies receiving creditor approval, landlords for New Look and Café Nero are challenging the CVAs in court.

“The challenge that is raised is, why in a lot of CVAs are primarily lease liabilities being compromised and not other forms of liability,” says Lindsay Hingston, partner at Freshfields Bruckhaus Deringer.

CVAs allow for differential treatment of unsecured creditors but that there must be objective commercial rationale for it.

“It has been recognised in some cases that, [leases] are over rented,” she says. “Compromising a supplier who is supplying on market terms, because that contract comes up for renewal regularly is different to compromising a landlord where you’re on a 30-year lease and there’s no ability to move to market terms.”

As the challenges to the CVAs move through court, Richard Tett, also a partner at Freshfields says judges will be looking at two aspects: vertical fairness and horizontal fairness to determine whether differential treatment is justified.

“Vertical fairness is what do I get here, compared to what I’m getting in the relevant alternative, which would be insolvency typically. I have to be being paid more than I would be paid in the relevant alternative. I can’t be made worse off, only better.”

Landlords themselves are not treated all the same and properties are often categorised into a three-tier “RAG” system (red, amber, green). One where a site’s rent stays the same, another where rates are reduced or altered, and a third, where a location is closed.

“Horizontal fairness is between all the landlords (and other unsecured creditors). You have to explain why it is that horizontal differences occur,” says Tett. “The theory is easy. The practice becomes much harder because it becomes a very factual question.”

Generally, it comes down to the profitability of a location. The PwC report found that for sites affected by CVAs in Greater London, less than 20 percent closed. The majority (80 percent) of leases were preserved though on different terms such as reduced rates or a switch to turnover rents.

Curran says turnover rents which are calculated based on revenue raised on site and standard in shopping mall leases will be the new norm for high street properties.

“I don’t see any retailers signing a lease that isn’t at least part based on turnover.”

End of government support

The government has started legislating to allow for the further extension of the moratorium on statutory demands and winding up petition. The new amendment would theoretically allow the government to extend the moratorium until March 2022.

These measures are currently set to expire at the end of March 2021.

Regardless of the end date, Curran expects once the moratorium ends, many landlords will be filing.

“We are going to see a lot of landlords, taking enforcement action for debts accrued. Not universally, the argument being that a sensible landlord wouldn’t necessarily want a void property.

“But I do think that there will be enough of a wave of landlord actions to recover debts, if not full evictions, and certainly things like statutory demands to push [businesses] over into a CVA process or an administration.”

Other interviewees echoed similar sentiments.

“There’s a lot of talk about CVA’s definitely,” says Tett. “Every tenant retailer with rent arrears will be looking and considering CVAs; whether they use it is another matter, but they will be looking at CVAs because they need to work out what their business model is going forward.”

Given the number of challenges that are being issued by landlords by CVAs, insolvency practitioners and businesses may also utilise other tools, such as pre-packs or the restructuring plan, which was introduced last year in the Corporate Insolvency and Governance Act.

“In my view, we may well have seen the plateau of CVAs purely because of the risk of challenge from a creditor stakeholder”, says Ley. “We may will see a different strategy adopted of potentially pre-pack administrations or the restructuring plan being implemented, where you can cram down the claims of specific creditor groups. That may well negate and mitigate challenges from creditors stakeholders.”

While a CVA can force some creditors to take a haircut, no business enters one lightly and when they do, its often as a tool of last resort. Even if a CVA is approved and executed, a business may end up ultimately failing. Arcadia, which entered into a CVA in 2019, ended up in administration a year later and is expected to be liquidated.

“CVAs, whilst consensual, will still generate press and publicity. They are a fairly public sign that you need to do something with creditors,” says Baxendale. “When used appropriately, CVAs are a highly credible and reliable tool to restructure businesses that delivers the best outcome for creditors.”

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