UK: A ‘Guaranteed’ Future?

Landlords breathe sigh of relief as Court declares guarantee stripping unfair Landlords will be relieved by a High Court judgment handed down at the beginning of May in the much anticipated Powerhouse case. The Court ruled that a parent company guarantee could not simply be side-stepped by the entering into of a company voluntary arrangement (CVA). Had the decision gone the other way, the effect on the value of investment property, and in particular for landlords holding parent company guarantees for their tenants, would have been catastrophic.

Powerhouse's demise and effect on landlords

This case arose out of the collapse of Powerhouse, the electrical retailer. Powerhouse got into financial difficulties and in early 2006 the directors proposed a CVA. Under the terms of the CVA the institutional landlords would only get 8 or 12 months rent (depending on the lease term) on the closing stores at the rate of 28p in the pound. Also, Powerhouse was then to be released from further liability, but more importantly, the CVA also included the release of guarantees provided by Powerhouse's solvent parent company. The CVA was approved by a majority of Powerhouse's creditors, despite the fact that the institutional landlords, who had most to lose from this arrangement, voted against it, but were not collectively powerful enough to out-vote the other creditors (a CVA requires the approval of a simple majority of the members and 75 percent in value of the company's creditors present and voting at the creditors' meeting).

The institutional landlords brought the action with the aim of preventing other struggling tenants from using CVAs to enable a parent company to escape its guarantee liability.

The Court concluded the CVA as proposed by Powerhouse was invalid. This was because it ‘unfairly prejudiced’ the landlords who took the case to Court in the first place. The insolvency legislation specifically provides that a CVA, a procedure designed to help rescue struggling companies, should not unfairly prejudice any of the company's creditors. The judge had no hesitation in deciding that the release of parent company guarantees as part of the CVA was clearly unfair to those landlords who had granted leases in reliance on such guarantees.

Although the Court decided that a CVA could, in principle, be used to release parent company guarantees, where landlords oppose this it will not be difficult to demonstrate unfair prejudice and therefore have the CVA set aside. Landlords will have to move quickly in these circumstances because there is a 28 day time limit for challenging CVAs. This is good news for landlords who were worried that Powerhouse might set a precedent which could have made their guarantees potentially worthless.

Parent company guarantees remain the security blanket of choice when a landlord is granting a lease to a tenant with a weak covenant. The main advantage over other types of security, if drafted correctly, is that the guarantee will extend for the whole lease term and not be limited as to amount. However, landlords should consider the alternatives, such as rent deposits, bank guarantees or personal guarantees and need to evaluate the relevant factors including the identity of the proposed tenant and parent company, lease term and rent level (see box). A combination of different types of security may be a viable solution, if it can be agreed.

When the Powerhouse CVA first came to public attention there was concern that financially unstable tenants would be lining up to enter into CVAs just so that parent company guarantees could be released. This judgment puts paid to that idea. Tenants and their parent companies should only offer guarantees where they are prepared for them to be called upon in a default situation.

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