For some years, a pre-packaged administration sale (pre-pack) was the preferred option for distressed High-Street chains when the directors were considering restructuring options. However, recently, there has been an upswing in the number of companies with large property portfolios opting to utilise Company Voluntary Arrangements (CVAs) rather than undergoing a more formal insolvency procedure, such as administration or liquidation. This could be because, among other advantages, under a CVA the company retains its corporate identity, which is lost under an administration or an insolvent liquidation and therefore, there should have less impact on trading.
High-Street names such as Mamas & Papas (2014), LA Fitness (2014), Fitness First (2012) Travelodge (2012), Bella Italia, JJB Sports, Blacks and Café Rouge have all successfully completed CVAs in recent years. CVAs lend themselves particularly well to restructuring larger retail businesses with numerous outlets, some of which might be loss making.
What is a CVA?
A CVA is a statutory process available to a company which is suffering from financial difficulties to enable it to come to an arrangement with its unsecured creditors to restructure its business. However, there is no statutory requirement for the company to be insolvent or to be unable to pay its debts in order for it to enter into a CVA. A CVA is effected by way of a proposal and vote.
The process for implementing a CVA is set out in Part I of the Insolvency Act 1986 and the Insolvency Rules 1986. The CVA proposal needs to be approved by a simple majority of the shareholders and by the unsecured creditors’ in a creditors’ meeting by over 75% (by value) of the creditors attending the meeting in person or by proxy. There is a further requirement that over 50% of the creditors voting in favour of the CVA must be unconnected with the company. If there is a difference in the decision between the shareholders and the unsecured creditors, the decision reached by the unsecured creditors takes precedence, subject to any court order.
The CVA then operates as a contract between the company (debtor) and its unsecured creditors.
Once a CVA is approved it will be binding on all unsecured creditors even if they voted against it, did not vote, did not attend the meeting and will even bind those unsecured creditors who did not attend the meeting because they did not receive the notice of the meeting. However, unsecured creditors can challenge a CVA within 28 days of the CVA by applying for a court order revoking the CVA or convening further meetings to reconsider the CVA proposal if they think that they have been unfairly prejudiced by the terms of the CVA or that there has been a material irregularity in the process.
If a company is considering a CVA it is likely to be distressed and so administration or an insolvent liquidation are the realistic alternatives for unsecured creditors in such a situation.
Advantages of a CVA for the company are:
- it is flexible;
- it does not involve the court unless an application to challenge the CVA is made;
- it will ‘cram down’ the minority dissenting unsecured creditors; and
- the claims of the secured creditors are not affected by the terms of the CVA (which is why for leveraged companies a CVA usually needs to be run in parallel with a financial restructuring with the secured lenders).
To convince the unsecured creditors to vote in favour of a CVA proposal, the CVA proposal needs to provide a better option or a return for such unsecured creditors (including landlords) than they would have received on a winding up of the company.
Attractive offers to landlords (a class of unsecured creditor) under a CVA proposal may include some of the following: a staged return of the property over an agreed period of time; the prospect of a long-term tenancy with a replacement tenant; the provision of services of a property agent at the company’s cost and the benefit of any key operating contracts and assets; and a fund set aside to contribute towards landlords’ liabilities for business rates.
A further component of the increased popularity of CVAs is that the process has become more refined over time following certain key judgments (some of which are explored later in this article) which serve as a roadmap for companies wanting to enter into a CVA.
Be Fair
CVA proposals can be challenged by unsecured creditors who believe that they have been unfairly prejudiced by the terms of the CVA. A fair proposal under a CVA is a statutory requirement.
The concepts of unfairness and prejudice are separate considerations and are questions of fact. When deciding whether a CVA has been unfairly prejudicial, the court will assess the degree of prejudice between the unsecured creditors utilising both a vertical and a horizontal comparison:
- Vertical comparison: compares the current position of that creditor under the terms of the CVA against that of the creditor had the company gone into an insolvent liquidation. If the unsecured creditor has the benefit of a parent company guarantee, such unsecured creditor is often in a better position if the company goes into administration or insolvent liquidation as the unsecured creditor is able to prove against the debtor estate and then pursue the parent guarantee for recovery.
- Horizontal comparison: compares unsecured creditors against other unsecured creditors in the same class and how they are treated.
The fact that one creditor is in a worse position to another creditor is not sufficient to demonstrate unfair prejudice. The question of fairness comes down to whether the CVA offers the appropriate level of compensation for the prejudice suffered by a particular creditor.
In the context of a landlord and tenant, creditor and debtor relationship, if the obligations of a tenant under a lease are guaranteed by a parent entity, (this is common if the tenant entity is an SPV shell) the terms of the CVA proposal may seek to extinguish these guarantee claims against the parent in connection with the lease (‘guarantee stripping’). This practice has been held to be permissible and not to be unfairly prejudicial of itself, although companies taking this course of action should exercise caution as highlighted in the following two cases:
- Prudential Assurance Co Ltd v PRG Powerhouse Ltd [2007]; and
- Mourant & Co Trustees Ltd v Sixty UK Ltd (in administration) [2010].
The CVAs in both these cases were challenged in court on the basis of unfair prejudice. Under both cases a payment or dividend was paid to a landlord to extinguish the landlords’ claims against the parent guarantors. It was held in both cases that, while guarantee stripping was permissible by law, the debtor company had not assigned the appropriate value to the guarantees the landlords benefitted from and therefore the action was unfairly prejudicial.
It should also be noted that it is not unfairly prejudicial to divide or categorise similar unsecured creditors for the purposes of the CVA. For example, it is common for leases to be categorised according to their performance and the terms of the leases amended by the CVA as follows (and as also seen in Oakrock v TravelodgeHotels Ltd [2015], described in more detail below):
- Category 1 – top performing and profitable – rent is paid monthly rather than quarterly for 2-3 years.
- Category 2 – performing but rent paid does not exceed profit – rent reduced to 65-75% for 2-3 years.
- Category 3 – underperforming and unprofitable – rent reduced to 55% for 2-3 years.
This categorisation is common in CVAs, would bind dissenting minority unsecured creditors and would not ordinarily be deemed unfairly prejudicial by the court.
Watch the drafting of the CVA
Unlike an administration, the entry into a CVA does not automatically result in there being a statutory moratorium imposed which would prevent the creditors of a company from taking action to recover their debts or bringing any other claims against the company. (The exception to this is in relation to small businesses where a moratorium is imposed on the creditors of a small company which has entered into a CVA, if the CVA is combined with an administration. However, this procedure has technical difficulties and is rarely used.)
However, it is possible for the CVA to contain contractual provisions which would impose a moratorium on the unsecured creditors and which, if the CVA proposal is approved, would bind the creditors and be upheld by the courts. The decision in Oakrock v Travelodge Hotels Ltd highlighted the need for the drafting of the CVA to be very precise to ensure that all possible unsecured creditor claims are caught by the CVA contract in order to prevent the unsecured creditor from launching any claims against the debtor company.
Travelodge underwent a CVA procedure in 2012. Under the terms of the CVA the properties which Travelodge were renting at the time were graded depending on their performance and yield to the company. This case involved the landlord of a property which had been designated in category 2, which meant that under the terms of the CVA the rent payable by Travelodge was reduced to 75%. Under the relevant agreement for lease, Travelodge had undertaken to perform some refurbishment works. These refurbishment works were not properly carried out in breach of the agreement for lease and accordingly the landlord brought the following claims for losses:
- but for the poorly carried out works the property would have been deemed to have been in category 1 at the time of the CVA and 100% of the rent on the property would have been payable under the terms of the CVA rather than the 75% due to it being in category 2; and
- the terms of the CVA gave all landlords contracting with Travelodge the opportunity to vacate the lease rather than accept the reduction in the rent under the CVA. The landlord in this case claimed that, had the works been properly carried out in accordance with the terms of the agreement for lease it would have had an opportunity to rent the property to another tenant at the market rate. However, due to the breach of the terms of the agreement for lease in respect of the carrying out of the refurbishment works, the property was not suitable for rental at any sum higher than the 75% being received under the terms of the CVA and therefore, no notice to vacate had been served.
The CVA had imposed a moratorium on the unsecured creditors bringing any claim under the terms of the lease and accordingly Travelodge applied for a summary judgment that the landlord’s claims were barred by the terms of the CVA and therefore bound to fail.
The judge held that the first claim, for 25% of the balance of the rent based on the failure to carry out the works properly and thus downgrading the property to category 2, was caught by the terms of the CVA because they related to the terms of a category 2 lease.
However, in respect of the second claim, for the losses connected with the landlord being able to give notice to vacate and gain market rent for the property but for the failure to perform the refurbishment works, the judge held that this claim was not barred by the terms of the CVA and allowed to proceed for the following reasons:
- had a notice to vacate been given, there would not have been a lease in existence. Therefore the terms of the CVA could not apply to prevent a claim because there should not have been a lease; and
- a claim based on a breach of the agreement for lease was also not caught by the terms of the CVA. The CVA imposed a moratorium on the instigation of claims under the agreement for lease OR the lease itself. The judge held that because a lease had been entered into following the agreement for lease the ‘OR’ in the relevant provision of the CVA imposing the moratorium and describing what claims were barred excluded the agreement for lease and included the lease. This claim was being brought for losses incurred because of a breach of the agreement for lease not under the lease and so was not caught by the terms of the moratorium in the lease.
The practical lesson to be learned from this case is that a CVA needs to be drafted as widely as possible to legislate for a number of possible scenarios and therefore bar such claims being brought. In this situation the CVA did not catch claims arising under the agreement for lease as well as the lease itself. The terms of the CVA did not legislate for the terms of the agreement for lease having independent effect after the lease had been entered into and in particular in a circumstance where a notice to vacate could be given.
Stop Press
The Small Business, Enterprise and Employment Act (SBEEA) 2015 received Royal Assent on 26 March 2015.
This Act introduces a wide range of changes to the UK insolvency regime, in particular the SBEEA 2015 is important for unsecured creditors to note as it affects certain procedural aspects of a CVA, such as notice, meetings and voting. These provisions are designed to encourage more modern forms of communication such as e-mail for voting and also to decrease the administrative burden, and therefore, the cost, to businesses.