No “New Look” in the latest landlord challenge to a tenant CVA
The landlord challenge to the New Look retail tenant CVA has fallen short as Mr Justice Zacaroli found in favour of the New Look CVA in its entirety. The Judge disagreed that a CVA is automatically unfair if it: (i) provided for differential treatment between creditors; and (ii) was approved by unimpaired or less affected creditors. The Judge found that the assessment of whether there was unfair prejudice in a CVA turns upon the facts in each case and the approval of a CVA by unimpaired/less-affected creditors, whilst highly relevant, was not sufficient alone.
In a detailed judgment, which examines the history, development of and law surrounding CVAs, the Judge characterised a CVA as a flexible restructuring tool and found that the earlier Debenhams CVA decision did not set a rigid test as to what constitutes fairness. Whilst heavily fact-specific, the headline points of interest are explored below.
The New Look CVA formed part of a wider group restructuring of liabilities following the impact of the pandemic – it sat alongside a scheme of arrangement, which amongst other things included a debt for equity swap and new deal with Senior Secured Noteholders (SSN Holders).
The CVA split creditors into various categories and it was approved by a total majority of 81.6% of creditors. However, only 58.7% of votes cast by Category B Landlords were in favour and 70% of Category C Landlords voted against the proposal. The landlords in Category B and C were substantially impacted by the CVA proposals.
The key challenges advanced by the applicant landlords were:
- Jurisdiction - The CVA was not an “arrangement” under the Insolvency Act 1986 because it involved separate arrangements with different creditors on materially different terms. They argued that the CVA was essentially made up of 3 different and separate deals: (i) the SSN Holders who were not affected by the CVA and offered a different deal under a scheme of arrangement, (ii) Category B and C Landlords; and (iii) ordinary unsecured creditors and Category A Landlords who were to receive payment in full. Further, the termination rights granted to New Look interfered with the applicant landlords’ proprietary rights.
- Unfair Prejudice - It is inherently unfairly prejudicial to compromise sub-groups of creditors such as the Category B and C Landlords where the CVA is approved by creditors such as the SSN Holders, ordinary unsecured creditors and Category A Landlords who were either unaffected or received fundamentally different treatment under the CVA. Further, the modifications to the lease terms were unfair.
- Material Irregularity – There had been insufficient disclosure to creditors on the Proposal (such as to the arrangement struck with SSN) and the way in which landlord votes had been calculated was disputed.
The Judge dismissed all claims put forward by the applicant landlords.
Jurisdiction and Unfair Prejudice
The Judge determined that a CVA is entitled to treat varying sub-groups of creditors differently and this is not necessarily unfairly prejudicial. The Judge acknowledged that whilst CVAs were initially developed with a view to relatively simple cases, the procedure enacted by Parliament had “greater flexibility in mind” and did not for example exclude large companies or arrangements with different creditors or classes being treated differently.
The Judge accepted that the fact a CVA may be approved by the votes of creditors who are unimpaired/treated substantially different will be a highly relevant factor in determining whether there has been unfair prejudice, but did not accept this made the CVA unfairly prejudicial in the current case.
In reaching this conclusion, the Judge noted four points of relevance to the assessment of whether there is unfair prejudice:
- Whether there is a fair allocation of the assets available within the CVA between compromised creditors and other groups, including whether a different allocation would have been possible. The analysis will also consider the allocation of assets in the relevant alternative scenario (i.e. the vertical comparison between a proposed CVA and alternative insolvency procedure).
- The nature and extent of the different treatment, justification of treatment and impact on outcome for creditors. There would be strong grounds for a finding of unfair prejudice where a CVA, which compromises the claims of a sub-group of creditors, is approved only on account of votes cast by a large number of unimpaired creditors - even where there is an objective justification for those creditors not being compromised by the CVA. The Judge commented it is less likely to constitute unfair prejudice where CVA creditors are impaired but in different ways or where the unimpaired creditors are small in number and value (but nonetheless tip the balance on a vote).
- The extent to which others in the same position as the objecting creditors approved the CVA.
- A finding of unfair prejudice ought not to be precluded because the same result might have been achieved under a Part 26A plan as this is an entirely different process.
Modification of Lease Terms
The Judge dismissed the argument that the reduction in rent and modifications to the leases in changing to turnover rent was unfairly prejudicial. The Judge found that that the CVA presented the applicant landlords with a choice between (i) terminating their leases and accepting a financial return better than would be experienced under the relevant comparator, i.e. liquidation; or (ii) continuing the lease but on reduced rent and modified terms. The Judge found that it was not unfairly prejudicial to offer landlords this choice and nor were the rent reduction and change to turnover rent “forced” on the applicant landlords – the Judge emphasised that these changes only apply if the applicant landlords do not “opt to terminate” the lease.
The Judge declined to depart from Judge Norris in the Debenhams CVA decision and disputed that a “rigid test” existed requiring a CVA to include (i) at least market rent; and (ii) as minimum interference as necessary for the purposes of the CVA to avoid unfair prejudice.
The Judge further disputed that the CVA “unilaterally reduced rents”, arguing that without the CVA, New Look would not have had any ability to pay future rent. The Judge underscored that the CVA offered the applicant landlords the option to (i) continue to be paid “some future rent” at reduced rent; or (ii) accept a slightly better financial return than if New Look went into administration.
The Judge commented that practically, companies will need to ensure rent reductions and modifications are as fair to landlords as possible, as they will need sufficient support from landlords to “opt to continue” in order to continue trading from premises.
As to the question of the “fairness” of the modifications to the lease – the Judge commented that this was not a question for the court to evaluate, but rather a “factor which each landlord can assess in exercising the choice the CVA presents to it”. In a similar vein, the Judge disputed the argument that the termination rights granted to New Look interfered with the proprietary rights of the relevant landlords. The Judge argued that this was just one of the modifications to the lease that the landlords could “opt to continue” and that the fairness or reasonableness of the term was not a matter for the court to determine.
Differential treatment of SSN Holders
The Judge argued that the CVA had to be viewed as an “integral part” of the wider restructuring under which the SSN Holders were also substantially impaired by the CVA. The Judge highlighted the fact that the SSN Holders held partially secured claims further justified differential treatment. The Judge held that the differences in treatment did not mean the applicant landlords were unfairly prejudiced and rather argued that there was “more to unite than divide” both parties in ensuring New Look avoided formal insolvency which would have resulted in a worse recovery for SSN Holders and virtually no recovery for the landlords.
There are no new restrictions on the use of CVAs as a restructuring tool for distressed multi-site retail businesses as a consequence of Mr Justice Zacaroli’s judgment. The relatively recent line of case law in relation to retail CVAs including this decision further cements the concept of a retail CVA and the decision of Mr Justice Zacaroli provides useful guidance on how a CVA can be structured to avoid a successful unfair prejudice application.
This decision is the first of three cases and the outcomes in relation to the Virgin Active restructuring plan and Regis CVA challenge are awaited, as these will also be relevant to future restructurings of lease liabilities.