CVAs and landlord interests: when unequal is not unfair

The High Court has found in favour of UK retail chain New Look in the challenge brought by its landlords to its company voluntary arrangement (“CVA”): Lazari Properties 2 Ltd v New Look Retailers Ltd [2021] EWHC 1209 (Ch). This test case on CVAs provides long-awaited guidance for corporate landlords and insolvency practitioners on the legality and fairness of their use by insolvent retailers to restructure lease liabilities.

It will be viewed as a major setback by institutional landlords who have tried to challenge and suppress the use of CVAs as a restructuring tool. It suggests that the use of CVAs as a rescue mechanism is far from over.

The New Look challenge was heard after the CVA challenge of Regis by the same applicants – which also considers the role of the nominee or supervisor and their duties – both by Mr Justice Zacaroli during March 2021. (The Regis case was subsequently also decided against the landlords in that case, and is discussed by the authors at this link.)

What is a company voluntary arrangement?

A CVA is a form of UK insolvency process used by distressed businesses as a restructuring tool to compromise liabilities over a period of time. It is proposed by a company to its creditors and shareholders, who must then consider the proposal and vote on it at a creditors’ meeting. If the vote at the meeting achieves a 75% majority of creditors by value in favour, the CVA is approved. Creditors are bound by the CVA whether or not they voted in favour.

The decision and the CVA terms can be challenged within a short, 28-day window after approval, by a creditor who considers that there has been unfair prejudice or material irregularity.

“Landlord only” or “retail” CVAs have been used for a number of years by both retailers and others to compromise the levels of rent that the company is obliged to pay over a particular period. The terms vary by each company, but often lease liabilities are compromised while other, “critical” creditors are not substantially impaired by the terms proposed.

Challenges to this type of CVA had been relatively rare until around two years ago, when a challenge to the Regis CVA was issued. A similar challenge was brought against the Debenhams CVA: [2019] EWHC 2441 (Ch).

The New Look CVA challenge

The applicants in this case were landlords of properties from which New Look continued to trade, or of properties that New Look wished to exit.

New Look entered into a CVA in September 2020 as a result of the trading difficulties experienced during the COVID-19 pandemic. It did so as part of a wider restructuring exercise, which also involved a scheme of arrangement of its finance creditors. The CVA was New Look’s second, following one in 2018.

The 2020 CVA was challenged by the New Look landlords in October 2020, and was progressed by the courts on an expedited basis. Lazari Properties 2 Ltd, the first claimants, reached an out of court settlement agreement with New Look ahead of the trial. The other landlords sought to challenge the CVA on the following grounds:

• the CVA proposal did not constitute a composition or arrangement within the meaning of s 1(1) of the 1986 Insolvency Act (“the jurisdictional challenge”);
• there were material irregularities; and
• the landlords suffered unfair prejudice.

Jurisdictional grounds

The jurisdictional grounds focused on arguments that:

• the New Look CVA was not a CVA within the meaning intended by the insolvency legislation, because there were different classes of creditors who received different treatment and who ought to be treated as separate classes;
• the CVA was not a true “arrangement” because it did not contain give and take between the parties;
• a CVA cannot modify landlords’ proprietary rights or impose new obligations on landlords. This involved consideration of whether a clause in the CVA reducing certain rents to nil successfully avoided infringing a previous decision by the same judge, Re Instant Cash Loans Ltd [2019] EWHC 2795 (Ch), that a surrender of a lease could not be forced on a landlord by a scheme of arrangement, because it was not possible to compromise proprietary rights.

Unfair prejudice grounds

The landlords argued that the CVA was inherently unfair because of the differential treatment of types of creditors within the CVA. They argued that using the votes of unimpaired creditors to pass the approval binding the creditors impaired by the CVA was unfairly prejudicial.

They also alleged that the CVA was inherently unfair, taking into account a number of factors including the treatment of critical creditors and lease modifications imposed on landlords. These modifications included:

• moving rents to “turnover” rents, and the imposition of those terms on some landlords after the CVA had concluded;
• a three-year rent concession period, to allow New Look to have sufficient cash to trade throughout the CVA; and
• the release of “keep-open” covenants.

Material irregularity grounds

The landlords claimed there was material irregularity in the way in which the CVA was approved because:

• not enough information about the restructuring was disclosed to the creditors in the CVA proposals; and
• an unpopular discount on landlord votes, common to retail CVAs, was applied to their claims at the creditors’ meeting to approve the arrangement.

New Look argued that it was not the role of the court to determine the jurisdiction question, as the insolvency legislation in relation to CVAs permitted differential treatment of creditors and those creditors were all voting as one class; and that adequate give and take was provided by the CVA, as a comprehensive break right was offered in return for the lease modifications.

New Look’s position was that there was no unfairness in the terms of the CVA as it satisfied both the vertical and horizontal tests of fairness. It also said that there was no material irregularity in the presentation of the proposals or the voting process.

What did the court decide?

Ultimately, the High Court rejected the challenge on all the grounds identified above.

On the jurisdictional grounds, the judge held that the interpretation of the legislation by the landlords was incorrect. The introduction of the 1986 Act was an important moment in corporate insolvency and for providing a framework for company rescue. CVAs were not limited to small companies and could provide for differential treatment amongst creditors voting as one class. Differential treatment of creditors did not in itself render a CVA unfair.

The judge then considered the question of one class of creditors receiving different treatment being used to achieve a vote. He did not want to set an all-encompassing test, and indicated that fairness depended on the circumstances of the case. However, he said there were four main relevant factors, assuming that the “vertical” test of fairness – whether the creditors would receive a better outcome under the CVA – was satisfied. These were:

• whether there was a fair allocation of assets between compromised creditors and other sub-groups of a CVA. For example, a secured creditor voting as unsecured was unlikely to be unfair, but critical creditors being paid in full while others were not would require further scrutiny and consideration of whether the assets could have been allocated in different proportions;
• the nature and extent of the differential treatment, the justification for that treatment and its impact on the outcome of the meeting. A large swathe of creditors receiving more return swamping the vote might be unfair, but creditors who did not have a significant share of the value of the voting receiving more might be fair;
• the extent to which other impaired creditors voted in favour – so, whether a majority of other landlords in the same position approved the proposal; and
• if a restructuring plan would have been able to impose the outcome on the same creditors, that did not automatically make the CVA fair.

New Look was able to satisfy each of these points, so the fact that votes of a connected secured creditor voting as unsecured were used to approve the CVA was considered fair.

The judge found that the CVA did have adequate give and take. It did not compromise proprietary rights by reducing rent to nil, as the lease itself remained in place unless terminated by the landlord.

On the other unfair prejudice grounds – those relating to lease modifications – the judge held that any potential prejudice was sufficiently addressed by offering a termination right in the CVA proposal in return for imposing lease modifications, provided that the terms offered for the notice period were better than the alternative the landlord would receive on an administration or liquidation. Landlords were afforded a choice: whether to stay with the CVA terms or to take the property back.

The judge considered the decision in the Debenhams CVA case, linked above. He decided that the judge’s decisions in that case that a CVA should not compromise rent to below market rent, or should only compromise to the extent necessary to give effect to the CVA, were not a rigid rule on the fairness of lease modifications and were concerned only with the short notice period that followed a landlord termination notice.

On the material irregularity issues, the judge held that the 25% discount on landlord votes that was to be applied to their claims at the creditors’ meeting to approve the arrangement, was consistent with the duty to place an estimated minimum value on a claim and was not materially irregular, as a different discount would not have changed the outcome of the meeting.

Although this will differ from case to case, certain information that was not disclosed within the proposal was not sufficiently material to have changed the outcome of the decision at the creditors’ meeting. There was therefore no material irregularity on the part of New Look.