Failure of a company voluntary arrangement (CVA) and rental payments

Overview

As recent headlines have shown, the increase in retail CVAs being proposed and/or entered into in the current market show that they are considered by many to be a useful tool in restructuring retail businesses with New Look, Carpetright and Byron Hamburgers being a small sample of companies exploring and/or entering into CVAs. This makes it a key area in which landlords would be wise to keep up to date on relevant developments given that indications are this trend will continue.

In the recent case of Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd [2018] EWHC 402 (Ch) the High Court has helpfully reviewed the basis on which rent (including service charge and other supplemental sums) can be claimed as an administration expense, considers the key principles of a CVA and provides a reminder of the grounds and timescales for challenging a CVA.

In this case, the High Court upheld a provision in the CVA which stated that, in the case of failure of the CVA, certain landlords would have their entitlements reinstated as if the CVA had not existed resulting in any additional sums falling due upon the termination of the CVA being payable as an administration expense or administration expenses for the period during which the administrators were in possession of the premises for the purposes of the administration.

Background

BHS Limited (later renamed SHB Limited (the Company)) agreed a CVA with its creditors and members in March 2016. A key aim of the CVA was to reduce the rent payable by the Company across its portfolio. The Company’s properties were divided into three categories, with the most viable stores continuing to receive 100% of the rent, while the least viable would receive only 20%. The Company was to continue to pay 100% of any contractual amounts in respect of insurance and service charge.

Two stores (Chester and Southend) were owed by The Prudential Assurance Company Ltd (Prudential). Under the CVA they were to receive 75% of the rent payable under the leases.

The drafting of the provisions reducing the rent in the CVA included a provision stating that:

“Upon a termination…the compromises and releases effected under the terms of the CVA shall be deemed never to have happened, such that all Landlords…shall have the claims against [the Company] …that they would have had if the CVA proposal had never been approved (less any payments made during the course of the CVA).”

It became clear that the Company did not have the funds to continue trading, even with the CVA in place and the Company went into administration on 25 April 2016. The CVA did not automatically terminate upon the appointment of the administrators and ran in parallel with the administration. On 22 July 2016 the Liquidators were appointed to carry out investigatory work with the original administrators remaining in office to “conclude trading activities and assist realisation ahead of creditors’ voluntary liquidation”. The Company was formally put into creditors’ voluntary liquidation on 18 November 2016 and the Liquidators were appointed as joint liquidators on that date.

The liquidation led to one of the landlord’s affected terminating the CVA.

In dispute

Following the termination of the CVA, Prudential brought a claim in respect of the stores at Chester and Southend stating that:

• it was owed the full amount of the outstanding rent payable under the relevant leases (giving credit for the amounts actually received during the currency of the CVA), and
• part of the outstanding balance was payable as an administration expense for the period during which the original administrators continued to trade from the premises the subject of those leases in furtherance of the aims of the administration (the period being from 25 April 2016 to 03 August 2016).

The Liquidators challenged this claim on the basis that:

• the obligations to pay additional sums upon a breach of the CVA were unenforceable as a penalty payment
• the effect of these provisions in the CVA was to breach the pari passu principle and substantially increased the Company’s liabilities to Prudential. The pari passu principle states that all unsecured creditors must share equally (in proportion to the debts due to each creditor) in any available assets of a company in an insolvency situation, and
• prudential were unable to claim the outstanding sums (should these be found to be payable) as an administration expense as they had only fallen due after the period during which the original administrators were trading from the relevant premises and were payable by virtue of the provisions of the CVA rather than the leases.

Outcome

Penalty payment argument

The High Court held that although a CVA does have contractual effect, not every principle of the law of contract applies to a CVA. A CVA is a ‘hypothetical’ contract containing a “statutory hypothesis” or deeming provision which operates to bind anyone entitled to vote on it. This results in it being “unnecessary and inappropriate to consider any of the usual principles of contract formation…all of which are irrelevant”. The High Court held that it therefore impossible to apply the law as to penalties as this is not designed to apply to hypothetical contracts of this kind. The only way to challenge a CVA is on one of the limited grounds set out in the Insolvency Act 1986 (being unfair prejudice to the interests of a creditor, member or contributory of the company or material irregularity at or in relation to one of the meetings) within 21 days of approval. The High Court further commented that it was unable uphold the Liquidators argument that the proposal should be set aside on public policy grounds stating that it was “impossible to see how a proposal put forward by or on behalf of the company…can somehow be said subsequently to have oppressed the company in some respect”. This confirmed that the company who is the subject of the CVA has no standing to challenge the terms of the CVA.

The CVA further contained a clause imposing a stay or moratorium on legal processes and other remedies available to landlords “(including, for the avoidance of doubt, under the terms of the leases as modified or varied by the CVA)”. The judgment states that the Liquidators placed great emphasis on the underlined words. However, the High Court held that the leases were not permanently varied as, at law, any variation of a lease granted by a deed needs to be by deed. As the CVA did not constitute a deed the CVA could not effect a variation. The judgment also commented that to give effect to only one of the clauses of the CVA in exclusion of others (with a particular focus on the termination provisions) would “rewrite” the terms governing the rent concession period. The High Court further commented that if the rents had been permanently varied, by way of a deed of variation, the Liquidator’s arguments may have been more successful.

In conclusion, the High Court held that the Liquidators could not argue that the clause was an unenforceable penalty as the reinstatement of the full rent upon termination had to be read in conjunction with the clause reducing the rent payable. The landlords should be returned to their pre-CVA position should the CVA fail.

The High Court held that the Liquidators could not argue that the clause was exorbitant and/or unconscionable nor that it was an unenforceable penalty.

Breach of the pari passu principle

The High Court also held that there was no breach of the pari passu principle.

If this were to have been breached there would have had to be a permanent reduction in the Company’s liabilities to the landlords. Given the reinstatement of the full rent upon termination of the CVA this was not the case and this argument was rejected.

The administration expense issue

Finally, the High Court held that the full rent accruing during the administration was payable as an administration expense with the High Court making it clear that, for any period during which administrators used leasehold premises, they were liable to pay as an expense “all sums payable for the premises in respect of that period, even if they are only contingent or yet to be ascertained at that time”. The judgment confirmed that these expenses would apply to supplemental rents and other incidental payments which were attributable to the use of the property. Although not an issue in this case, the High Court further commented that any uplift in rent yet to arise from a rent review would also be caught.

Comment

The reminder that a CVA is a statutory mechanism and that not all the usual contractual principles may apply is an important one. This case acts as a useful confirmation that the only way to challenge a CVA is under the limited grounds set out in the Insolvency Act 1986 with short timeframes for doing so. One important note, is in future, it may be that variations to leases should be insisted upon as part of the CVA though commercially this may not be possible. Equally, in order to protect their position, landlords may wish to consider whether the CVA contains provisions limiting the landlord’s exposure as set out above.

Insolvency practitioners should also note the obligation to pay expenses (including rent and other payments under a lease eg service charge and other supplemental charges) which is confirmed by this case and the lack of exclusion from liability even if the expense is not ascertained until after the property has been vacated. This express confirmation has been missing from previous caselaw and therefore is extremely helpful.