The Debenhams legal challenge – retail CVAs explained
The rise in recent months of the company voluntary arrangement (CVA), particularly in the retail and casual dining sectors, has led many (and particularly landlords) to question the CVA model itself. There is a growing sense among landlords and competitors that ‘retail CVAs’ are being used primarily to restructure property portfolios, and less because of actual debt problems.
Very broadly, retail CVAs (also referred to as landlord CVAs) typically provide for a reduction in rent at certain loss-making stores, and even the option to leave other stores early without penalty, whilst the majority of other creditors may be paid in full. In those circumstances, it is not hard to see why landlords might be aggrieved.
Set against the frustrations of landlords, however, is a perception amongst occupiers that landlords’ expectations of rental values are too high, that there needs to be a revaluation of property and rental values and that landlords need to realise that the retail environment has changed, and be more realistic about what rents are achievable in the current and future retail climate.
With that in mind, the recent challenge to the Debenhams CVA was watched closely by landlords – not least because successful challenges to CVAs can be few and far between. In order to succeed with such a challenge, it is necessary to show either a ‘material irregularity’ in the proposal, meeting or approval of the CVA, or that a creditor or member of the company has been unfairly prejudiced. However, the test of unfairness is hard to satisfy – most CVAs are necessarily unfair to certain classes of creditors, the key is whether they are sufficiently unfair, and the usual test is whether or not the creditor is in a worse position as a result of the CVA, than they would be in either an administration or liquidation of the company. This test of unfairness was one of several grounds upon which the Debenhams CVA was challenged.
Debenhams entered into a CVA on 9 May 2019, and both Sports Direct (as a creditor of Debenhams) and the landlords of six Debenhams stores submitted separate challenges to the CVA in June. The Sports Direct challenge was later withdrawn in July (because they had been paid in full under the CVA), although Sports Direct agreed to fund the landlords’ challenge.
While there were a number of issues that were considered and addressed within the Judgment, the key points were:
- future rent can be compromised by a CVA – Whilst the clarification was necessary as the legislation governing CVAs does not define ‘debts’, this decision was generally expected because, as the Judge (Mr Justice Norris) commented, the insolvency rules that apply to administration and winding up define a debt as including future debts/liabilities incurred as a result of pre-existing obligations. Whilst this might have been expected, it is a blow to landlords generally, as it supports the premise of retail/landlord CVAs;
- CVAs cannot alter proprietary rights, such as removing the right to forfeit a Lease because those rights enable a landlord to get his own property back – This was the only part of the Judgment decided in favour of the landlords but, unfortunately for the landlords, the Judge was able to strike it from the CVA without the rest of the CVA being invalidated.Nevertheless, landlords will be interested to ensure that future CVAs do not attempt to remove their proprietary rights; and
- if a CVA reduces rent to below market value, that might be unfair in certain circumstances – Whilst Mr Justice Norris did make this observation, he also confirmed both that he was satisfied that differential treatment of landlords from other creditors was justified by the need for business continuity, and that the rent reductions imposed on the six Debenhams landlords bringing the challenge were not below market value: they did not dispute the evidence of the CVA supervisors that their properties were ‘over-rented’ prior to the CVA.
Ultimately, as the challenge failed in all but one respect (which was dealt with by removing the offending provision), the Debenhams CVA remains in effect and this challenge will not have provided the result that landlords more generally might have hoped for. They may, however, take some small level of comfort from the suggestion that rent reductions should be tied to market value, rather than what is sustainable for the tenant. Indeed, Companies and insolvency practitioners proposing CVAs will no doubt now be careful to ensure that any rent reductions are supported by appropriate valuations.
Unfortunately for landlords, however, it seems that landlord/retail CVAs remain a viable restructuring tool for businesses with high rental costs, and so are likely to continue.