High Court Decision upholds Debenhams CVA

Company Voluntary Arrangements (CVAs) have featured frequently in the headlines over the past few years. Household names in the retail and restaurant sectors have been using CVAs to jettison underperforming stores and reduce rents across their remaining property portfolio.

This form of “retail CVA” is deeply unpopular with landlords who suffer losses compared to other creditors of the company (such as suppliers), whose debts remain unaffected by the CVA.

Background

The Insolvency Act 1986 created the CVA, which is a formal proposal approved by a majority of creditors to form an arrangement for settlement of the company’s debts. Section 6(1) of the Insolvency Act allows for the CVA to be set aside based on the concept of “unfair prejudice”.

Despite the 40 or so retail CVAs that have been created since 2009, there have been few conclusive challenges in the Courts (with the likes of the 2018 House of Fraser CVA case settling out of Court).

The Debenhams CVA was approved on 9 May 2019 and a group of landlords (notably funded by Mike Ashley) promptly issued a claim challenging the CVA on the basis of unfair prejudice. On 19 September 2019 judgment was handed down in the High Court by Mr Justice Norris.

Unfair Prejudice

The landlord claimants set out various grounds to attack the legitimacy of the CVA. Firstly, the claimant landlords tried to establish that future rents owed by Debenhams to the landlords could not be covered by the CVA as the rents are not “debts” within the scope of Insolvency Act. However, the Court held that future rent is a financial liability which is within the wider meaning of “debt” and so is properly within the scope of the CVA.

The main force of the landlords’ arguments was based on the alleged unfair prejudice created by the reduction in rent compared against the other unaffected creditors. The landlords argued that it was unfair for all other creditors to be paid at the expense of the landlords and that if a tenant remained in beneficial occupation of a property, it should pay the full rent. These arguments received judicial sympathy in the past, however, in the present case it was admitted by both sides that the CVA properties were over-rented. Therefore, if the contractual rents exceeded the market rent and the other creditors supply goods at market price, then it would not be “unfair that a landlord might receive less than his contracted-for rent in such circumstances”.

Added to this, it was pointed out that the landlords that suffered reduced rents were able, under terms of the CVA, to unilaterally terminate the offending leases on notice and so “no landlord is compelled to accept the reduced rent”. The inference here is that if a landlord thinks it can obtain a higher rent with another tenant in the open market, then the landlord is free to pursue this.

The Court was careful to establish that the fairness in the different treatment of the creditors was based on the fact that, notwithstanding the rent reductions, the landlords would be receiving a market rent. It was held that the rent reductions placed the landlord on the same footing at the suppliers of goods whose prices were at market rates.

Forfeiture

Whilst the landlords were unsuccessful in proving unfair treatment under the CVA, they were successful in one ground of their case, which changes an established convention of CVAs.

CVAs often disapply a landlord’s ability to forfeit a lease based on the insolvency event of the CVA or on the grounds of reduction of rent. This disapplication tends not to be of much concern for those landlords with the ability to terminate the lease under the CVA provisions already. However, there will usually be a category of landlords whose properties are essential to the survival of the company’s business who will not face rent reductions but may, for example, have monthly rents imposed on them by the CVA. For those landlords, they will have no ability to terminate the lease under the CVA and will also be precluded from forfeiting the lease on the grounds of the CVA.

The landlords in the Debenhams case argued that forfeiture was a proprietary right (rather than based on any concept of reorganising debts) and so was outside of the scope of the Insolvency Act. The Court held that the landlord’s right to forfeit a lease has nothing to do with debtors and creditors and rather was a “right annexed to the reversion”. In other words, the right to forfeit the lease is not security for payment of rent but rather exists separately as a right for a landlord to get its own property back. The landlord’s right to forfeit will exist independently of any debts that may be owing and so a CVA and the Insolvency Act cannot disapply that right.

Conclusion

The High Court decision will not be welcomed by most landlords as it galvanises the legitimacy of retail CVAs which are designed to reduce rents and terminate leases for underperforming stores. The only caution in this approach is that the CVA must reduce rents with the purpose to establish a fair market rent for the affected properties.

The decision, which is fertile ground for an appeal, will be a relief to tenant companies but perhaps has a sting in its tail. With the disapplication of forfeiture being prohibited, landlords of well performing properties will now not only have leverage against CVA tenants but will also have the ability to take successful sites back to relet on more favourable terms on the open market.

For further information please contact Paul Jagger