UK: CVAs – Retail's Flexible Friendship Continues

Last Updated: 3 October 2019
Article by Camilla Eliott and Margaret Kemp

On 19 September 2019, Norris J handed down judgment in the challenge brought by six landlords against the Debenhams Retail Limited (Debenhams) company voluntary arrangement (CVA) which was approved by 94.71% of Debenham’s unsecured creditors on 9 May 2019. The challenge been watched with significant interest, particularly by the landlord community, which has for some time expressed increasing concerns regarding the use of CVAs as a mechanism to commute leasehold liabilities while other unsecured creditors’ rights remain unaffected. While CVAs have been the subject of legal challenges previously, the Debenhams challenge is the first time certain key elements of CVAs in play in the market have been tested before the court. Norris J’s decision provide welcome clarification on a number of key issues concerning the treatment of leases in retail CVAs.

The grounds for challenge and the decision

CVAs were introduced in the Insolvency Act 1986 (the Act) as a more flexible restructuring option than administration, receivership or liquidation. Under a CVA, the directors of a company can make a proposal to its creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs. Creditors have 28 days after the CVA has been approved at the creditors’ meeting to challenge the CVA on the grounds of unfair prejudice or material irregularity.

The applicant landlords (the applicants) claimed unfair prejudice and material irregularity under Section 6(1) of the Act and, in addition, claimed that the CVA went beyond the jurisdiction conferred by Part 1 of the Act. They requested that the court make a declaration that the decision of the creditors’ meeting was void for want of jurisdiction and/or an order revoking the decision of the creditors’ meeting under section 6(4)(a) of the Act.

  • Claims for future rents

The applicants argued that future rents could not be compromised under a CVA. The Act provides that the directors of a company can “make a proposal.. to the company and its creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs”. “Creditors” and “debts” are not defined. The applicants contended that future rent was not a ‘debt’, since rent is only payable as it falls due and may never become payable at all (Re Park Air Services plc [2000] 2 AC 172 at 181). If future rent was not a debt, the applicants could not be “creditors”. Accordingly, the jurisdiction had been exceeded and the decision of the creditors’ meeting was void.

Norris J disagreed. The term “creditor” had a wide meaning, but a creditor must have a “debt”. While future rent may not be a provable debt, there was no clear requirement that “creditors” for the purposes of CVAs should be restricted to persons with provable debts. Future rent was at least “a pecuniary liability to which the company may become subject in the future by reason of an existing obligation“. Where the lease was being continued, future rent could therefore be considered as a contingent debt and the applicants as creditors in relation to that debt. As a matter of jurisdiction, future rent could be included in (and compromised under) a CVA.

  • Waiver and release of forfeiture rights

The applicants argued that the CVA could not compromise landlords’ proprietary rights. They argued that the waiver and release of landlords’ rights of forfeiture contained in the CVA amounted to an abrogation of proprietary interests, which was outside the jurisdiction conferred by Part 1 of the Act. They relied in support on the decision in Re Lehman Brothers International (Europe) [2010] Bus LR 489, in which the court confirmed that a scheme of arrangement could only affect the rights of creditors in their capacity as such, and could not be used to modify proprietary rights.

Norris J agreed. A right of re-entry was a proprietary right which could not be varied by a CVA. While a CVA can vary any pecuniary obligation upon breach of which the right of re-entry may be exercised, it cannot vary the right of re-entry itself.

  • Variation of rent

The applicants raised two arguments concerning variation of rent: that it was automatically unfairly prejudicial (referred to as the “basic fairness argument”) and, in the alternative, that it imposed ‘new obligations’ which were outside of the jurisdiction of S. 1(1) of the Act (referred to as the “new obligations argument”). Both arguments failed.

o Basic fairness

The basic fairness argument rested on the principle expressed in Re Lundy Granite (1870-71) LR 6 Ch App 462, that a company which makes beneficial use of a premises let to it must pay the full contractual rent. The applicants pointed to the fact that in both administration and liquidation, a company remaining in occupation post insolvency is required to pay rent in full as an expense.

Norris J confirmed that whether or not the CVA was ‘fair’ needed to be considered in the round. He considered that “basic fairness” required that the landlords should receive at least market rent for the property they were providing. The valuation advice received by Debenhams indicated that all the stores were over-rented. In addition, as all landlords were able, under the CVA, to terminate the relevant leases within a certain period, no landlord was compelled to accept the reduced rent under the CVA. On that basis the Court found that the reduction in rent was not ‘unfairly prejudicial’.

The applicants also argued that the “vertical comparator” used in the CVA proposal (comparing the projected outcome of the CVA with the projected outcome of a realistically available alternative process – here administration) was wrong as it did not take into account the fact that a landlord which terminated a lease would have to pay business rates, a liability that would not be incurred if Debenhams went into administration. Norris J disagreed. Debenhams could not be expected to anticipate all financial consequences to each creditor for the purposes of constructing and applying the vertical comparator to the scheme as a whole. Debenhams had argued that a CVA should be automatically fair if the correct vertical comparator was used, but interestingly Norris J did not accept this position.

o New Obligations

Norris J found that the variation of rent was a variation of existing obligations which were ‘arrangements’ for the purposes of S.1(1) and not an imposition of new obligations. The variation was therefore within the jurisdiction of Part 1 of the Act.

  • Unfair treatment

The applicants argued that they were treated less favourably than other unsecured creditors without proper justification (in other words, the “horizontal comparator” was not satisfied).

Norris J disagreed. After hearing evidence that the properties were over-rented, and that there was a concern that compromising trade suppliers would have led to significant issues for Debenham’s business, he held that “The differential treatment of landlords (providing long-term accommodation at above market rates) from suppliers (providing goods and services on an order-by-order basis which, given competitive pressures, are likely to be at market rates) is justified by the need for business continuity” [paragraph 110] .

  • Material irregularity

The applicants’ key grounds for alleging material irregularity concerned information provided in the CVA proposal regarding potential challenges to security arrangements entered into by Debenhams in March 2019. Additional funding had been provided to the Debenhams group. Debenhams granted fixed and floating security in favour of its lending group, securing both the new funding and existing indebtedness. The applicants alleged that the grant of the security was susceptible to challenge as a preference pursuant to s.239 of the Act and a voidable floating charge pursuant to s.245 of the Act. If the company entered into administration or liquidation and the challenges succeeded, there was the possibility for sums to be ‘clawed back’ for the benefit of the company’s unsecured creditors, including the landlords.

The applicants argued that Debenhams had failed to comply with rule 2.3(1) of the Insolvency 2016 Rules, which provides that the CVA proposal must set out the risks of such challenges being brought should the company go into administration or liquidation. However, although he agreed that the description could perhaps have been clearer, Norris J was not convinced that the risk of claims under s239 and s245 of the Act had been insufficiently described in the proposals. He confirmed that whether an irregularity is ‘material’ will depend on whether, objectively assessed, it would be likely to affect the outcome of the vote. On the facts, he did not consider that had creditors been given more information about the possible challenges they would have been likely to oppose the CVA.

The Court ordered that the forfeiture restraint provisions be deleted from the CVA, and as so modified, the CVA is valid and remains enforceable. Whether or not the applicants will take forward an appeal remains to be seen.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kirkland & Ellis International LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kirkland & Ellis International LLP
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions