Life on the street

Retail collapses in 2009 have soared as companies have fallen victim to
declining consumer confidence and the deteriorating financing environment.

The roll call of the fallen includes many familiar names (such as Woolworths,
Zavvi and MFI) with some forecasters predicting many more retail stores may
close in 2009. Those for whom the strain becomes too much will seek survival
through a formal insolvency procedure or a consensual out-of-court

If a company and its creditors can agree a plan to deal with the company’s
debts, a company voluntary arrangement could be appropriate. Under this process,
a debtor makes a proposal to its creditors, for example, to pay them back over a
specified period of time. If at least 75% in value of the debtor’s creditors
vote in favour then, subject to certain safeguards, the proposal becomes binding
on all creditors ­ including those who voted against the proposal (although
secured creditors need to consent specifically to a CVA in order for it to be
binding on them). CVAs are becoming more acceptable in the retail sector,
probably because landlords would rather have their claim against their tenants
reduced than risk their premises falling empty and generating no income at all.

Landlords vote down CVA
Stylo was an AIM listed footwear retailer which acted as the holding company to
a number of subsidiaries including Barratts, Dolcis and Priceless. It had a high
cost base, particularly high rents. Following losses of £12.5m in 2008, the
company appointed administrators in February 2009 and proposed a CVA to its
creditors and landlords. The CVA proposed that, in compromise of their claims
for rent arrears, the landlords would receive 3% of shop turnover for three
months, increasing to 7% for the remaining 11 month period of the CVA.

The CVA was voted down by the landlords since it would have put them in the
position of subsidising the other creditors. Commentators believe that the most
important reason for the rejection was that the landlords were concerned about
setting a precedent which other struggling retailers might follow. The property
industry sent a clear message to the retail sector ­ CVAs were not going to be
an easy way out.

Following the rejection, administrators were appointed and the core
profitable businesses were pre-packed to an entity owned by the chairman of the
Stylo group, with the non-profitable stores closing.

In retail there have been a number of pre-packaged insolvencies, such as
Whittards of Chelsea, USC and The Officers Club. Pre-packs enable
customer-facing businesses, where administration would devalue the brand, to
continue to trade seamlessly, transferring staff and salvageable assets to a new
corporate vehicle.

Criticism is often levelled at pre-packs, as the impression given is of a
company failing one day and then operating the next ­ with collapsed companies
being sold on as new corporate entities, stripped of their liabilities and
leaving creditors such as landlords and suppliers to suffer financial losses.
Often, the same management and owners who presided over the failing company buy
the new businesses, which has led to anger and widespread criticism of the
procedure. However, recent research has shown that the returns for creditors and
the success of the new enterprise in pre-pack situations compare favourably with
trading administrations.

CVAs come of age
JJB, struggling with a combination of a high cost base and low sales, proposed a
CVA to its creditors on terms that the landlords of closed stores would be able
to claim from a fixed pot of £10m and that the terms of the leases for the open
stores would be varied to permit monthly, as opposed to quarterly, rental
payments. The CVA was approved, saving the retailer from administration. Early
engagement with the landlords, and other creditors is said to have been the key
for the success of the CVA. It also showed that most landlords were coming to
the view that CVAs should not be rejected out of hand.

If time and financial resources permit, appointing administrators will allow
a business to continue to trade. Administrators will identify and negotiate with
prospective buyers and arrange an orderly disposal of the business or its

Trading administrations may allow an easier reduction in the workforce before
the sale of the business. Pre-packs do not have this advantage.

Administration still has a role
A combination of high rents and reduced trading made greeting cards retailer
Birthdays’ business uneconomical. It had to rationalise its store base but the
cost of doing so outside insolvency was prohibitive so it entered into
administration. The administrators traded the business for a month and sold a
proportion of its 330 stores as a going concern.

While economists’ predictions for the retail sector remain uncertain, there
is likely to be further insolvencies and more high street retailers struggling
to meet their overhead and rental obligations. It is likely that the formal
insolvency procedures and out of court restructurings described above will be
utilised, but, in particular we expect the use of CVAs to become more widespread
as they become more acceptable to stakeholders and creditors.

Michael Rutstein is business, restructuring and reorganisation partner at
law firm Jones Day.

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