Restructuring landlord liabilities after New Look and Regis
21 July 2021
It's been a disappointing few months for landlords. In May, we saw the High Court hand down three important decisions concerning the restructuring of landlord liabilities – New Look, Regis and Virgin Active. Despite winning, it was a mostly pyrrhic victory for the landlords in Regis, and the landlords were defeated in both New Look and Virgin Active, where their legal challenges failed to gain any real traction. A few weeks later, the Government extended the restrictions on landlords' key remedies for pursuing rent arrears and announced a new scheme that promises, when introduced, to force landlords and tenants who cannot reach agreement in relation to outstanding rent arrears for Covid closure periods into a new binding arbitration process (see our briefing here). For at least the short term, these events leave landlords with reduced leverage when faced with tenants in financial distress and/or proposing restructuring processes.
However, there are some positives for landlords to take from the New Look and Regis cases at least. The New Look decision should bring an end to landlord CVAs reliant upon the votes of a large group of truly unimpaired creditors to get them through. And, while many of the landlords' challenges to the Regis CVA failed, the CVA was ultimately revoked because the treatment of its shareholder under the CVA was found to be unfairly prejudicial to the landlords as creditors of the company. CVAs had been allowed to develop relatively unchecked by court scrutiny for more than a decade, but the Regis case comes as an important reminder to companies (and CVA supervisors) that the court can, and will, strike down a CVA in an appropriate case.
In this article, we consider the key takeaways from the New Look and Regis decisions from a landlords' perspective, before considering the factors that are likely to determine whether a tenant uses a CVA or the new restructuring plan to compromise landlord claims.
The three landlord challenge cases – in briefThe New Look CVA challenge was described by the judge as a 'root and branch' attack on CVAs, covering various grounds including jurisdiction, material irregularity and unfair prejudice. The challenges were all dismissed, with the judge finding that a number of the features seen in CVAs used to compromise landlord claims in recent years – for example, reductions in future rent payable to landlords (including moving to a turnover rent or to zero rent) in return for the landlords being given new termination rights - are not necessarily unfair. The landlords have obtained permission to appeal the decision, but, in the meantime, we expect the number of CVAs to increase. In the Regis CVA decision, the judge rejected the majority of the landlords' challenges, which were on similar grounds to those in the New Look case. However, the landlords succeeded on one key point: the judge found that the payment in full of debts owed to the company's shareholder was without commercial justification and therefore unfair to landlords, who were being significantly compromised. The judge proceeded to revoke the CVA on this basis (though this was somewhat of a pyrrhic victory as the CVA had been terminated when the company entered into administration 17 months before the challenge hearing). These judgments were handed down around the same time as the Virgin Active restructuring plan decision, in which the court approved a compromise forced on dissenting landlords by the votes of secured creditors (which would not have been possible in a CVA where secured creditors cannot vote their (secured) debt). In another blow to landlords, this decision all but wipes out any leverage of 'out of the money' creditors in a restructuring plan. 'Out of the money' creditors in this context refers to those creditors who would not get more than a minimal return1 in the most likely alternative to the restructuring plan, which is often an administration or liquidation. See our client briefing for further details on the Virgin Active decision. The findings in the Regis and New Look judgments provide some clarity to the market on what is, and what isn't, acceptable in a landlord CVA. Coming at the same time as the Virgin Active decision, which confirms that the new restructuring plan procedure is available for tenants needing to compromise landlord liabilities as part of a wider restructuring, these decisions are likely to give tenants more confidence in putting forward a restructuring (whether through a CVA or a plan) to deal with their property liabilities as we come out of the pandemic. |
What are the key takeaways from the New Look and Regis cases for landlords?
Landlords will be disappointed by the following findings:
- A CVA which allows a tenant to remain in possession on a reduced future rent is not necessarily unfair. Further, there is no general rule that a CVA must interfere with landlords' rights to the minimum extent necessary or pay landlords at least market rent beyond any termination notice period. Whether a CVA is unfair requires a consideration of all of the circumstances of the CVA (including any wider restructuring of which the CVA forms part) and, in particular, the landlords' termination rights; the justification for any differential treatment between creditors (known as the 'horizontal comparator' test); and whether the landlords are treated more favourably by the CVA than they would be in the likely alternative to the CVA, which is most often administration or liquidation (known as the 'vertical comparator' test).
- Generally, the answer to landlords' complaints about their treatment under a CVA is provided by the landlords' rights to terminate. As long as landlords are being offered a better deal under the CVA than they'd get in the likely alternative to the CVA, landlords have a choice to accept the offer or “get off the bus”. Where this is the case, the court will not carry out a commercial assessment of the fairness of lease modifications, leaving this instead to the company and landlords, who are better placed to assess this. Practically, the idea is that a company proposing a CVA should be incentivised to ensure that the modifications are as fair to landlords as possible if it wants to retain premises from which to trade and that, if a landlord disagrees with the tenant's assessment, the landlord can opt to terminate its lease and seek a better deal elsewhere. However, in the current market, this presents landlords with a stark (and uncertain) choice. And there does not appear to be anything preventing more unscrupulous tenants from offering landlords a low deal in the CVA, which can then be "improved" (through a separate private agreement with the relevant landlord) in order to retain landlords who threaten to terminate their lease.
- While a CVA cannot force a surrender on a landlord, a CVA can achieve substantially the same result through a carefully drafted 'termination right'. In New Look, the judge upheld a 'termination right' whereby New Look could offer to give up any right of occupation (though the relevant landlord was not obliged to accept that offer), with New Look being released from all liabilities in respect of rent, service charge, insurance and all other covenants under the lease on making the offer. While this termination right wipes out all economic return for the landlord under the lease, it will at least give the landlords the choice to allow the tenant to remain in occupation of the property to avoid the landlord becoming liable for empty business rates if a new tenant cannot easily be found.
Landlords will be encouraged by the following points:
- In New Look, the judge commented that there will be strong grounds to conclude that a CVA is unfair where it relies upon the votes of a large swathe of truly unimpaired creditors to compromise the claims of a sub-group of creditors, even if there is an objective justification for the treatment of the unimpaired creditors. In New Look, the judge found that the senior secured noteholders, whose vote (on the unsecured part of their debt) was critical to the approval of the CVA, were not truly unimpaired by the CVA. Although the noteholders' debt was not compromised under the CVA, they agreed to write off all of their debt in return for equity through a related scheme of arrangement, and it was necessary to look at the scheme and CVA together. This leaves open the possibility of a successful challenge to a CVA where the votes of a large group of truly unimpaired creditors are used to cram down landlords.
- These cases show that the courts will closely analyse the treatment of shareholders as part of the restructuring. In New Look, the existing equity was wiped out as part of the wider restructuring. While the existing shareholders were able to retain their equity in Virgin Active, it was material that the shareholders were putting in £45m of new money, which was considered to be a full and appropriate price for the retention of their equity. And in Regis, the CVA was revoked on the basis that it is unfair to repay shareholder debt in full at the expense of the other compromised creditors, where there is no commercial justification for this. In the judgment, the judge was critical of the nominees' conduct in their approach to the shareholder debt, and we can expect nominees to tread very carefully when considering shareholder treatment and critical creditors in future CVAs.
- After Regis, a blanket 75% discount on landlords' future rent claims will not generally be justified. To some extent, this finding had already been anticipated by the market (with many recent CVAs in the retail and hospitality sectors adopting a 25% or 50% voting discount), but it is helpful to have this expressly confirmed by the court. The approach to the voting discounts in the New Look CVA approved by the court was more robust: the company's advisors estimated the prospects of re-letting and likely rent for each property separately, and then applied a 25% discount to the figure produced for each property to identify the lower end of the possible range of each landlord's losses. This is likely to become the market norm going forward, increasing the landlords' voting power in a CVA.
- A CVA should give landlords a separate termination right for each property. The Regis CVA originally provided that a landlord could only exercise a right of termination in respect of one lease if it terminated all of its leases (though this was modified after the CVA was approved). The judge found that this could have led to the landlords being unfairly prejudiced by being forced to accept a reduction in rent for a particular lease without an unqualified option to terminate that lease – which, as we've seen above, is fundamental to the court's approach to the fair treatment of landlords under CVAs.
Compromising landlord liabilities – restructuring plans versus CVAs
As well as fairness discussed above, the key check on the deal which a tenant can propose using a CVA remains what unsecured creditors are prepared to vote for, and with commercial rent arrears at an all-time high, and landlords' future rent voting discounts reducing from 75% to around 25% or 50% (see above), this boosts the landlords' share of the vote. While this may increase the landlords' influence over the deal that can be offered in a CVA, the Virgin Active decision demonstrates that, in appropriate cases, a tenant could instead opt to propose a restructuring plan, where the landlords can be crammed down as a class, even where they vote strongly against the plan.
In Virgin Active, the court confirmed that there is no reason not to use a restructuring plan, rather than a CVA, if that appears more likely to achieve the restructuring, and after this case, we're likely to see more restructuring plans being proposed to compromise landlord claims. Why might a tenant consider using a restructuring plan, rather than a CVA?
| Restructuring plans… | CVAs... |
|---|---|
| …can be easier to impose upon dissenting landlords, due to the voting rules and the availability of cross-class cram down. Secured creditor and connected creditor votes count in full in a restructuring plan. With cross-class cram down, these votes can now be used to force a restructuring plan on classes of dissenting landlords as long as (a) the landlords are 'no worse off' than in the most likely alternative to the plan (which is often administration or liquidation), (b) one so-called "in-the-money" class has voted in favour of the plan and (c) the court, having considered all relevant factors, is willing to exercise its discretion to cram-down the dissenting classes. It is likely to be more straightforward for a company to use cross-class cram down where the landlords are 'out of the money'. | …are cheaper and more straightforward than a restructuring plan. Restructuring plans require two court hearings and have enhanced information disclosure requirements. In contrast, a CVA does not involve any court hearings unless it is challenged. |
| …provide challenge finality. The sanction hearing approving a restructuring plan is usually final, whereas CVA challenges can drag on. In this sense, the restructuring plan provides greater execution certainty. | …challenges can be settled after the event, without undermining the finality of the CVA. This practice was referred to in the recent (unsuccessful) application to strike out the challenge to the Caffè Nero CVA. The challenge is now proceeding to a full hearing in July this year. |
| …can be used to compromise financial and operational liabilities. Where previously a company would have dealt with these through a scheme of arrangement (or a plan) combined with a CVA, after Virgin Active, we can now expect companies to use a standalone restructuring plan instead. |
Given the above, we expect restructuring plans to be used for larger, complex restructurings dealing with both financial and operational liabilities. As noted above, they may be the only option for tenants effecting an operational restructuring where their creditor breakdown means that the landlords' voting power could block a CVA, and we may see this more in the coming months given the build-up of substantial rent arrears as a result of the Covid-19 pandemic. CVAs will still have their place, and we expect they'll continue to be used by SMEs and mid-market tenants looking to compromise leasehold portfolios.
What's next for landlords?
Looking forward, for so long as the rental market remains depressed and tenants need to restructure, it is likely to be a tough period for landlords. While the Government's restrictions on landlord remedies remain in place, landlords will have their hands tied in respect of accrued rent arrears, and tenants may only need to sweeten the deal offered to landlords under CVAs and restructuring plans once the market starts improving. The new arbitration scheme for Covid rent arrears could present another challenge to landlords. As with much about the scheme, it is as yet unknown how (if at all) an arbitration decision in respect of arrears of rent due under a lease might interact with a CVA or restructuring plan. It is hoped that the Government will factor this issue into its design, otherwise the landlords' incentive to engage in the process could be much diminished.
In the meantime, there is more court scrutiny of CVAs on the way. The Caffè Nero CVA challenge is currently due to be heard at the end of July this year in a seven day hearing. It will consider the duties of directors and nominees in relation to CVAs, together with how electronic voting (as the chosen decision-making procedure) interacts with late modifications to the CVA.
The increased court scrutiny of CVAs, and now restructuring plans, is to be welcomed. It provides legal rigour to a process that has been allowed to develop relatively unchallenged over the last decade. This legal rigour will provide better parameters for CVAs and restructuring plans going forward. But, for the main part, the New Look and Virgin Active decisions mostly sweep away many of landlords' unfairness arguments and vindicate the use of CVAs and restructuring plans as appropriate restructuring tools for tenants to use.
The fact that New Look and Virgin Active produced results largely unfavourable to landlords is a reflection of the current economic pressure on tenants, and not of an inherent procedural bias against landlords. As the judge put it in New Look, "the loss of future rent is not forced upon the landlords by the CVA, but is the consequence of the company's insolvency." The more severe the financial distress of the tenant, the more robust the restructuring needs to be in order to enable the tenant company to survive as a viable business into the future. The justification for a restructuring over an insolvency remains that it must produce a better outcome for its stakeholders than the likely alternative (which is usually an administration or liquidation). The treatment of landlords under any restructuring needs to be considered in this wider context, and where landlords sit in the insolvency waterfall.
Nevertheless, taking all this into account, the short-term outlook for landlords of tenants affected by Covid remains tough. It looks set to get worse before it gets better. Prudent landlords will communicate well, and early, with struggling tenants in order to get as much warning as possible of a CVA or a restructuring plan. Armed with good market information and a better understanding of the tenant's business, landlords will then be best placed to negotiate as strong a position as possible in the landlord class structure.
1. In the Virgin Active case, the evidence showed that landlords would get only a minimal return in an administration (the likely alternative to the plan) through the prescribed part. The prescribed part is a statutory fund set aside for unsecured creditors from returns which would otherwise go to floating charge creditors, capped (in the Virgin Active case) at £600,000 for each plan company.
