CVAs: the retailer's saviour?

The retail market in the UK is changing. As market fluctuations quicken, tactical priorities and cost-saving programmes have never been so important. Reducing capital expenditure is no longer a shelved matter that is picked up in the next financial year – it is front and centre. The industry is undergoing a renovation, new channels are driving growth and old channels are being reinvented.

Change is good – it reinvigorates a sector and forces it to evolve; online activity continues to thrive and this pipeline of commerce is displaying no signs of slowing down. That is excellent news for the internet world, but consumer goods need to be stored and shipped and people still like to go shopping. In the bricks and mortar world, rent and repair lease obligations have come to blight the sector. Many retailers find themselves in the financial red zone no matter how swiftly the products fly from the shelves.

A good thing?

Many retailers are turning to company voluntary arrangements (CVAs) to resolve their financial troubles. There has been something of a flurry of high-profile CVAs in recent times, the main compromise being lease liabilities. The CVA can act as a vehicle for retailers to reduce their annual rent, minimise their repair obligations and allow them to walk away from a premises with next to no liability.

Good or bad? That depends. Most retailers would say it is a good thing to be able to gain some liquidity and focus on business needs without an onslaught of financial liabilities; without a CVA many retailers and businesses would enter administration. Creditors might contest that CVAs are unfairly prejudicial to their business needs and are putting them in a precarious financial position. Both positions have valid points to make, and it would be wrong to assume that all landlords scorn at the mention of a CVA – many are practical in their approach, realising that without the CVA they would get nothing and would lose a household name as a tenant.

Brief overview

The CVA procedure allows a company to avoid terminal insolvency proceedings by having a legally binding agreement with unsecured creditors under part 1 of the Insolvency Act 1986. Most CVAs require a minimum of 50% of stakeholders and 75% of creditors to agree to the terms of the CVA before it passes. If a creditor is in the percentage that did not vote for the CVA then tough luck. A unanimous vote is not required.

The CVA effectively places a legal force field, often referred to as a moratorium, around the company. It prevents creditors from attacking the company for outstanding debts. The company can repay some of its historic debts from future profits over a period of time that is compatible with its new and improved business model. 

This provides a solid advantage to companies. When the CVA is approved by the requisite majority of creditors, it binds all creditors, irrespective of whether or how they voted, subject to a creditor’s right to challenge the CVA. It is not even a prerequisite that the company should be insolvent or unable to pay its debts before making a CVA proposal, albeit this tends to be necessary to demonstrate that the company will likely fail should the proposal not be approved.

Once the CVA proposal is approved, the CVA terms automatically bind all creditors who were entitled to vote. The CVA, however, cannot compromise the rights of a secured creditor. It also cannot compromise certain creditors who by statute are afforded special priority in a formal insolvency: this can come into play for example in relation to pension schemes. CVAs are not immune, however, from being challenged by creditors, not least on the grounds that there is a material irregularity or an unfair prejudice.

How can you challenge?

Section 6 of the 1986 Act provides that you can challenge a CVA on the grounds of a material irregularity or unfair prejudice. The application to the court must be made within a 28-day period – this is often defined in CVAs as the “challenge period”. The 28-day deadline begins from when the CVA is approved; there is a notice of effectiveness providing details of the CVA and the date of approval for all holders of the CVA claims against the company.

A typical challenge might be that a notice of the decision procedure to approve the CVA was not given to the creditor, thus allowing them to apply to the court to challenge the decision within a 28-day period after they have become aware of the CVA. There is no strict test for judging unfairness; the case law establishes that it is necessary to consider all the alternatives available, coupled with the practical consequences of a decision confirming or rejecting the arrangement, as shown in SISU Capital Fund Ltd v Tucker [2005] EWHC 2170.

The court will typically look to what have become known as “vertical” and “horizontal” comparisons. The former consist of comparing the position a creditor has under the CVA and the position they would be in if the company were to be liquidated. The latter principle compares the position the creditor has under the CVA with the position of other creditors.

Challenge after 28 days?

Formal challenges to CVAs have been unusual in comparison to the number of CVA proposals, but informal challenges can be frequent. It is often the case that a creditor will challenge the CVA outside the 28-day period but not immediately through the courts. This is normally done by the creditor’s solicitors writing to the company’s solicitors challenging the validity or applicability of the CVA. They might, for example, put forward that their client is not bound by the terms of the CVA on the grounds that the wrong entity was listed in the CVA or the registered office has since changed. Such challenges can have significant consequences for the company and often require an immediate and robust response.

The majority of retail CVAs have been concerned with compromising property lease obligations and not overly concerned with comprising other creditor liabilities such as pension schemes. There has been an increasing frustration amongst landlords that other creditors should share more of the burden. This was one of the main disputes in Discovery (Northampton) Ltd v Debenhams Retail Ltd [2019] EWHC 2441 (Ch), in which the CVA was challenged on the ground, among others, that landlords were treated differently to other unsecured creditors. Much to the relief of retailers around the country, the court did not concur with this argument and found in favour of Debenhams.

Business not quite as usual

It remains to be seen what long-term effect CVAs will have on the retail sector as a whole. To the everyday consumer, it looks like business as normal, but underneath the shop front exterior is an increasing void between landlord and tenant. Keeping retailers alive can only be a good thing for both the average shopper and the economy, and most landlords probably understand that without the CVA they would likely get nothing and lose more money. Certainly from a legal perspective, things will remain interesting.