Mike Ashley, the chairman of Sports Direct and the high-profile purchaser of House of Fraser, recently commented that ‘greedy landlords’ were blocking attempts to renegotiate lower contractual rent terms across the HOF leasehold estate. In contrast, landlord stakeholders have suggested the CVA process appears to be an attempt by tenants to obtain significant compromises on their contractual lease obligations, specifically the payment of rent.
The problem has been brought to a head by the difficulties faced by multi-site occupiers competing across crowded retail and casual dining sectors. Many high street brands are currently owned by global private equity firms that committed substantial funds with leveraged finance to expand rapidly and reached the pinnacle of the investment cycle just as the sectors reported significant trading difficulties. The British consumer, less loyal to specific brands, has become extremely price-sensitive and has embraced online retailing. Increases in import costs, wages and business rates have exaggerated the problem and high-profile brands that have sought to agree CVAs with their creditor stakeholders have included New Look, Jamie’s Italian, Carluccio’s and Aldo.
A company does not have to be balance sheet insolvent to embark on a CVA strategy but does need to evidence that the underlying business is in financial distress or likely to become so without a restructuring process. The CVA process is expensive and can leave a company vulnerable to actions by its creditors. Therefore, a CVA strategy shouldn’t be undertaken lightly. Many businesses will seek to negotiate consensual compromises with creditor stakeholders without a CVA process being implemented. This option will save costs but requires open, honest and robust dialogue between all stakeholders.
When a company contemplates a CVA process, it will seek advice from both an insolvency practitioner and solicitor. If a compromise of its leased units is anticipated then property agents will also be engaged to conduct a review of the estate and determine what rent concessions should be sought from landlords. Prior to the circulation of the CVA proposal, the company and its advisors should seek the opinion of the principal creditor stakeholders. This may include the landlords directly or via engagement with the British Property Federation. Once finalised, the proposal will be circulated and should provide sufficient detail for the creditors to understand the reasons for the company’s current difficulties, the management’s turnaround plan and how specific creditor stakeholders will be affected and what funds will be made available to those compromised by the CVA. This ‘compensation’ may include a lump sum payment or voluntary contributions, which can be set or based on future profit.
There is a defined hierarchy of creditors. Firstly, secured creditors: those lenders that hold fixed and floating security over the business and assets of the company. Employees may have preferential claims for unpaid wages and holiday pay. Unsecured creditors sit above the shareholders in order of priority, with landlord stakeholders classed as unsecured creditors.
Where rent reductions and lease compromises are sought under the terms of the CVA, the company’s real estate portfolio will be divided into a series of categories depending on the profitability and strategic importance of a unit. The first category will be the units that the company wants to retain. The company is unlikely to seek a rent reduction but will switch to monthly rent payments to assist cash flow. Below the top category will be a number of bands with differing levels of rent reductions, dilapidation terms and landlord & tenant break options together with sites unidentified for closure.
If the CVA is approved, all creditors are bound and lease clauses changed by the terms of the CVA proposal. A landlord can reject the CVA proposal but may be outvoted by other creditor stakeholders. When the CVA proposal is formally considered by creditors, there are two voting stages. The first vote requires 75% of all creditors present or represented to vote in favour, which includes connected parties, such as intercompany and director-related votes. The second vote strips out connected parties and requires just 50% of all creditors present or represented to vote in favour.
A further issue faced by a landlord is the quantum for which it is allowed to vote. An unexpired lease can have significant periods to run when a landlord is faced with a tenant seeking to put in place a CVA. However, as the unexpired term of the lease represents an unliquidated monetary claim, the chairman of a creditors’ meeting is entitled to value that portion of the claim at £1. To date, this adjudication process has not been fully considered by the Court, specifically in instances where a CVA has sought to only compromise landlords, and for the time being will mean that landlords can have relatively little control over the ultimate outcome.
Should landlords consider changing the approach to new leases? Should terms be entered into with a new tenant at commercially lower rent levels with limited rent-free periods and no fit-out contributions? Recent FT data shows that over £2.5bn of retail property is currently available and being marketed for sale.
Does a tenant company emerge from a CVA in a stronger financial position and as a more viable tenant? It is difficult to judge the outcome as the majority of the multi-site operator CVAs agreed during 2018 will run for up to three years. According to the Daily Telegraph, Byron Hamburgers completed its CVA in July 2018 after seeking to close 19 restaurants and reduced the rent on a further five outlets, reporting that “trading conditions continue to be difficult as the new shareholders and managers restructure the cost base”. More evidence that CVAs are no panacea.
Director, Restructuring and Recovery Services
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By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.