Posted by Malcolm Gregory, Partner
Contributing authors: Stewart Wilkinson and
Company Voluntary Arrangement (CVA): the retail edition
The impact of the latest High Court decision, Discovery (Northampton) Limited and others v Debenhams Retail Limited  EWHC 2441 (Ch)
The High Court’s recent decision is the latest in the ever evolving model of “retail CVAs”. In this blog, we review the background to CVAs, the facts of the Debenhams case and what the outcome of this decision means for landlords seeking to challenge CVAs.
What are CVAs and how are they challenged?
A CVA is an agreement between an insolvent limited company and its creditors that allows the company to reorganise and repay its debts over a fixed period and continue trading. CVAs often prevent a company from being wound-up. Insolvent companies operating in the retail sector can benefit from a CVA as it enables them to reduce the cost of their leases and ‘overheads’.
CVAs are usually challenged on the basis of (1) unfair prejudice, and / or (2) material irregularity. Unfair prejudice means that creditors are treated differently and placed at an unfair advantage compared to other creditors. Determining whether unfair prejudice exists will depend on the terms of each individual CVA. Material irregularity arises out of the CVA proposals and includes irregularity in the value of a creditor’s claim.
Background and the facts of the Debenhams case:
Directors of Debenhams proposed a CVA to address ‘unsustainable property costs’ associated with a number of their stores by altering its future liabilities for business rates and rent. In the CVA, the leases were categorised according to the extent to which Debenhams intended to alter its obligations. This included some rent reductions of up to 50%. Other terms prevented landlords from exercising forfeiture rights triggered by the CVA and releasing liability from dilapidation claims. The CVA was approved at a creditors’ meeting in May 2019 by 94.71% of Debenhams’ creditors.
Six landlords challenged the CVA on the following grounds:
- ground 1: the CVA did not have jurisdiction over landlords. They did not have a claim for ‘future’ rent at the time the CVA became effective and were not ‘creditors’ within the meaning of s1 of the Insolvency Act 1986 (the Act);
- ground 2: reducing rent was unfairly prejudicial (under s6(1)(a) of the Act) which they referred to as the ‘Basic Fairness Argument’ and the CVA went beyond the jurisdiction conferred by s1 of the Act as it had the effect of changing the terms of the lease, the ‘New Obligations Argument’;
- ground 3: removing the right to forfeiture went beyond the jurisdiction of s1 of the Act;
- ground 4: they were treated less favourably than other unsecured creditors, without justification; and
- ground 5: the CVA did not comply with rule 2.3(1) of the Insolvency Rules 2016 as it failed to disclose potential claims under s239 and / or s245 of the Act in the event Debenhams were to enter administration. This was argued as a ‘material irregularity’.
The decision and the impact on the future negotiation of CVAs
Norris J rejected 4 out of 5 grounds, save for ground 3. The reasoning for each ground is summarised below:
Ground 1: a large section of the judgment focuses on the question of whether a claim for future rent constituted a ‘debt’ within a CVA. The definition of creditor can be construed widely and the court held that future rent is a pecuniary liability (despite it not being a ‘presently provable’ debt) which a company may become subject to in accordance with rent covenants, “the fact that in the future the landlord may bring the term to an end by forfeiture does not mean there is no present liability”.
Ground 2: on the question of whether the CVA breached the ‘Basic Fairness Argument’ proposed by the landlords by reducing the rent payable, the court held that a CVA was designed to be a more flexible route than liquidation or administration and there was no reason why leases could not be subject to a rent concession period. Common justice and basic fairness would permit landlords to receive “at least the market value of the property”. Any modifications should be limited to what is necessary for the purposes of the CVA and so a reduction in contractual rent will not automatically be unfair.
Ground 3: the court argued that removing the landlord’s right to forfeiture restricted their proprietary rights. As such the landlords succeeded on this ground. The court went further and stated that these provisions could be removed from the CVA without impacting the validity and enforceability of the rest of the CVA.
Ground 4: the justification of the court for finding no unfair prejudice included the fact that other unsecured creditors and suppliers in particular needed to be paid in full for business continuity because they were subject to competitive pressures and were providing goods at market rates. In comparison, the landlords were not being paid ‘below market rate’ rent.
Ground 5: the failure to disclose potential claims under s239 / s245 of the Act was overstated. A brief discussion of these issues in the CVA was found to be sufficient and the court noted in particular that so far as s239 of the Act was concerned, the CVA had the support of nearly 95% of the creditors voting.
Looking into the future of “retail CVAs”
Since 2009 there have only been 40 CVAs of this type and given the court’s findings, it is likely that this decision will be the subject of an appeal. However, the decision does set out some helpful guidance which companies and challengers to CVAs should bear in mind in the future:
- CVAs cannot compromise landlords’ right to forfeiture as this is a property right and not a security right;
- a landlord can forfeit for rent arrears due under the CVA but only in respect of the reduced rent payable;
- vertical comparisons: landlords should consider the position they would be in under a liquidation / administration compared to the CVA and provide evidence in support;
- horizontal comparisons: landlords should also consider their position under the CVA compared to other creditors of both the same class and other classes, again with evidence in support;
- clear arguments: in considering unfair prejudice, courts will take a firm stance on the reduction of contractual rent by distinguishing between ‘market value’ rent and any mark up on this. Challengers should therefore carefully consider whether reductions would be deemed unfair by a court; and finally:
- trade and service suppliers: there is good reason for allowing landlords to be treated less favourably.
If you would like any advice about the impact of CVA’s please get in touch with Stewart Wilkinson or Emma Hough in our Insolvency and Dispute Resolution team on :
01865 268 625 Email us
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