Posted by Richard Lake, Senior Associate
Q1 2018 in Retail and Leisure: CVAs, spectacular collapses and what they mean for landlords
The beginning of the year has seen a number of casualties in the retail and leisure sectors with numerous household names entering CVAs and, in the case of the retail giant Toys “R” Us, collapsing altogether. Various retailers and leisure operators are falling foul of an increasingly challenging and competitive marketplace but what are CVAs, why have there been so many, and how will landlords be affected by them?
What is a CVA and how do they affect landlords?
A CVA, or ‘Company Voluntary Arrangement’, is a process that allows troubled companies to reach agreement with creditors over the payment of its debts; more particularly, settling debts by paying back a proportion of the amount that it owes. It is a procedure that requires the approval of at least 75% (by value) of the company’s creditors and, once bound by it, prevents a creditor from taking action against the company for the recovery of any debt that falls within the scope of the CVA.
In addition to limiting the scope for recovering rent arrears, a CVA is of particular relevance to landlords because it offers the troubled company a mechanism for restructuring its rent obligations and even terminating the lease altogether. This places landlords in a helpless position with tenants once thought of as being impregnable who, in many cases, were granted long leases on the basis of their perceived strength of covenant and status in the market.
Depending on the terms of the lease, landlords generally retain their right to terminate the tenant’s occupation. This comes at a cost though; gaping voids in their portfolio and the expense of finding a new tenant mean that forfeiture is not always an attractive option for Landlords. In any event, a tenant is still capable of applying from relief from forfeiture and, in some circumstances, the CVA can expressly remove forfeiture rights altogether.
Why are so many companies in trouble?
For mid-market restaurants, the popularity of casual dining in recent years saw a flood of investment into the industry. The aggressive rate of expansion by outfits like Byron and the large-scale conversion of retail units into restaurant space in shopping centres up and down the country resulted in an oversaturation of the market, leaving consumers with too much choice and shrinking disposable income. All the while, rising food and labour costs (as a result of the drop in value of sterling and rise in the statutory minimum wage respectively) have pushed margins to the limit and, in the case of outfits like Jamie’s Italian and Prezzo, over the edge.
As for retailers, it is easy to point the finger at the ever-rising popularity of online shopping. The so-called ‘Amazon effect’ is undoubtedly the biggest threat to the bricks and mortar section of the industry but it does not explain why some retailers continue to prosper while others face growing challenges to stay afloat. Private equity has repeatedly had its name dragged through the mud in recent months with the Toys “R” Us collapse being attributed, at least in part, to an inability to service the mountain of debt created by a public equity acquisition some 13 years ago. Elsewhere, businesses like New Look – who plan to enter into a CVA and have placed 60 of their 593 stores on risk for closure – also suffer from an over-levered balance sheet (with debt in excess of £1.2bn) that has proven unsustainable in a market where consumer demands are the subject of tectonic change.
When you consider last year’s reassessment of business rates (according to Colliers International, Jamie Oliver Restaurant Group’s rates went up by 28%) and the rate at which inflation is outgrowing wages, it is obvious that there is no single cause of the recent spate of casualties. The reality is that a toxic mix of issues have collided to make the perfect storm and, with the next March quarter day fast approaching (when quarterly rent payments are due) and a football World Cup just around the corner (where pubs and bars typically distract footfall from restaurants and other eateries), the list is likely to grow.
For tenants of both sectors, we are likely to see a strategy of streamlining portfolios with companies like House of Fraser – who, at the time of writing, have not announced any plans to enter a CVA – recently confirming that they were having discussions with landlords about trimming down their rent bill and surrendering top and basement floors of their often sizeable retail units. Elsewhere, consolidation will be the order of priority with companies like Fulham Shore, the listed private equity owners of Franco Manca and The Real Greek, confirming that they will be halting expansion of both chains in order to try and secure better deals with landlords.
Invariably, winners will emerge from the mire. Where landlords take bets on the next big thing, independents and small chain start-ups will benefit from preferential deals in the units abandoned by the New Looks and Byrons of the world. Meanwhile, chains that can survive the turbulence, such as Nando’s and Wagamama (both of which recently announced year on year profit growth), will undoubtedly benefit from the reduced competition in the short to mid-term. Ultimately, the next six months will be a telling period for retailers and leisure operators alike as uncertainty continues to plague both industries.
If you are a landlord affected by tenant insolvency, or a tenant looking to streamline your portfolio, Royds Withy King’s Retail & Leisure team can offer advice on next steps and appropriate actions.
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