As retail and hospitality businesses continue to struggle in the aftermath of the coronavirus pandemic (although at the time of writing there are signs that we may not yet have reached the aftermath), the implications of Brexit and what may be irreversible changes to our shopping and dining habits, it seems inevitable that we will see many more CVAs (Company Voluntary Arrangement) in this sector and that the law in this area will be subject to further judicial clarification.
The most recent decisions in this area are Lazari Properties 2 Limited and others v New Look Retailers Limited, Butters and another [2021] EWHC 1209 (Ch) and Carraway Guildford (Nominee A) Limited and Others v Regis UK Limited and Others [2021] EWHC 1294 (Ch).
New look
On 15 September 2020 New Look entered into a CVA. However, this was subject to challenge by a group of landlords on grounds of unfair prejudice and material irregularity. At a hearing on 10 May 2021 the challenge was rejected by Zacaroli J but on 14 May 2021 permission to appeal was granted.
Background
The directors believed that the effect of the pandemic on the retail sector would be long lasting. They concluded that New Look could not survive without a restructuring which addressed both its financial obligations and reduced its long-term rent obligations, and predicted that it would run out of cash by October 2020. Secured creditors amounted to approximately £595m (although in respect of one class of secured creditor being the holders of Senior Secured Notes (SSN creditors)) there was an estimated shortfall of £273m) and other unsecured creditors including landlords exceeded £300m.
The CVA was part of a wider restructuring that included a Scheme of Arrangement comprising a debt for equity swap involving the SSN creditors and an agreement with secured lenders to extend funding arrangements.
Had the company gone into administration there would have been a dividend of 0.1p in the pound for unsecured creditors.
The terms of the CVA were complex and different proposals were offered to different classes of creditors. In simple terms the Category B and C Landlords were the store landlords. The category B stores were still occupied by New Look whereas the category C stores had already been vacated. In each case the claims for rent arrears were compromised in full. Category B Landlords were offered a turnover rent payable monthly in arrears for up to three years and an option to terminate the lease on 60 days’ notice in the first 150 days and in years two and three. New Look was also given the right to terminate if turnover had not reached 85% of pre-pandemic levels after 3 years. Similar termination rights were offered to Category C landlords.
The proposals provided for Ordinary Unsecured Creditors to be paid in full because the directors deemed that they were critical to the continued operation of the business. SNN creditors would also be paid in full.
At the creditors meeting, 100% of the SNN creditors voted for the proposals. They were obliged to do so as part of the wider restructuring plans.
Virtually 100% of the Ordinary Unsecured Creditors voted in favour of the proposals. 58.27% of the Category B landlords voted in favour as did 30% of the Category C landlords. All together 81.6% of unsecured creditors voted in favour of the proposals.
Grounds of challenge
A group of landlords who voted against the proposals challenged the outcome of the meeting on the following bases.
- The Proposal, or aspects of it, did not constitute a composition or arrangement within the meaning of Section 1(1) of the Insolvency Act 1986 (the "Jurisdiction Challenge"), specifically because:
- (a) it did not constitute a composition in satisfaction of the company's debts or a scheme of arrangement of its affairs, by reason of the fact that on a true analysis it involved separate arrangements (on fundamentally different terms) with different groups of creditors;
- (b) there was insufficient "give and take" as between New Look and various of the creditor groups; and
- (c) the new termination right granted to New Look in respect of leases with Category B and Category C landlords improperly sought to interfere with property rights of those landlords;
- There were material irregularities (the "Material Irregularity Challenge"), specifically:
- (a) in relation to the calculation of the landlords' claims for voting purposes; and
- (b) by reason of omissions and inaccuracies in the Proposal; and
- (3) The Applicants were unfairly prejudiced (the "Unfair Prejudice Challenge"), because:
- (a) the requisite majorities at the creditors’ meeting were secured with the votes of creditors whose claims against New Look were unimpaired by the CVA;
- (b) creditors whose claims were compromised received differential treatment from those that were not; and
- (c) various of the modifications to the terms of leases were unfair.
The jurisdiction challenge
The judge found that there was no reason why a CVA proposal could not propose a different outcome for different categories of creditor. There was no inherent unfair prejudice in doing so and such an outcome was not precluded by the Insolvency Act 1986.
The judge also rejected the “give and take” argument on the basis that the landlords were in at least as good a position as they would have been in had the company gone into administration.
The judge also rejected the contention that the new termination rights granted to New Look after three years amounted to an interference with the Landlords’ property rights. He found that it is not an essential requirement of a lease that the tenant is required to pay rent and as such the non-payment of rent did not automatically amount to a surrender. The new termination rights given to New Look did not amount to a requirement to accept a surrender, merely an opportunity to do so.
The material irregularity challenge
The nominee had applied a blanket discount of 25% to the claims of landlords for voting purposes. No similar discount was applied to the votes of SSN creditors notwithstanding that their claims were also contingent.
Rule 15.31(3) of the Insolvency Rules 2016 states that a claim of an unliquidated or unascertained amount is to be valued at £1 unless the chair decides to put upon it an estimated minimum value for voting purposes.
In this case the Chair took advice from experts in arriving at the discount of 25% and no alternative figure was advanced by Landlords at the meeting. The Judge therefore held that while there was no particular science behind the adoption of a discount of 25%, as opposed to 10% or 20%, he did not regard that as a material irregularity. The number and range of uncertainties involved in estimating the quantum of future liabilities is such that identifying the appropriate discount is not an exact science. The 25% discount was applied to all landlord claims and the aggregate value of landlords who voted in favour was more than those who voted against. As such even if there was an irregularity it was not material and had no effect on the outcome of the meeting.
The other alleged material irregularity was the failure to disclose in the CVA proposal certain aspects of the wider restructuring plans including the Scheme of Arrangement and the refinancing arrangements. However, on the facts, the judge disagreed that there had been any material omissions or that the additional information would have altered the creditors’ assessment of the CVA proposals.
The unfair prejudice challenge
The judge noted that when considering whether an arrangement is unfairly prejudicial, and while recognising that it is necessary to have regard to all the circumstances of the case, the courts have developed two tests known as the "vertical" and "horizontal" comparators: see Prudential Assurance Co Ltd v PRG Powerhouse Ltd [2007] EWHC 1002 (Ch). The vertical comparator compares the outcome for creditors against the minimum return creditors could expect if the CVA was rejected and the company therefore went into liquidation or administration. However, beating the vertical comparator does not of itself guarantee that the proposal is not unfair. The horizontal comparator must also be considered and this compares the outcome of creditors as between themselves.
- The requisite majorities at the creditors’ meeting were secured with the votes of unimpaired creditors
The judge found that there was no inherent unfairness simply because the statutory majority required to approve the CVA was achieved by the inclusion of votes of unimpaired creditors. Although it would be a relevant factor, something more was required such as bad faith which was absent in this case.
The Corporate Insolvency and Governance Act 2020 introduced Part 26A of the Companies Act 2006 which included the concept of cross class cram down such that the Landlords cannot establish that that there is an unarguable principle that one class of creditor should not have their claims compromised by a majority which included unimpaired creditors.
Differential treatment
The judge held that the mere fact that classes of creditors were treated differently in the proposals was not enough to establish unfair prejudice. In reaching this conclusion he reviewed a number of authorities on the issue and noted that the pari passu principle is not an absolute rule because Section 4 of the Insolvency Act 1986 already provides for secured and preferential creditors to be treated differently.
The fact that SSN were treated differently did not render the proposals unfair because as part of the wider restructuring SSN were giving up their security. In an administration secured creditors would enforce their security over the company’s assets leaving no dividend for unsecured creditors.
Unfair modifications to leases
The judge noted that New Look’s inability to pay contractual rent was caused by its insolvency and not the terms of the CVA. The landlords had a clear choice under the proposal. They could either agree to accept monthly rent in arrears calculated on a turnover basis or they could terminate the lease. The right to terminate undermined any argument that the payment of turnover rent was unfair.
Permission to appeal
On 14 May 2021 three of the landlords were granted permission to appeal on the following grounds.
- The jurisdictional challenge that a CVA cannot compromise the claims of different groups of creditors on different bases.
- There was insufficient give and take and the judge was wrong to have taken into account the terms of the parallel Scheme of Arrangement in considering the give of the SSN creditors.
- Vote swamping generally. Whenever the requisite 75% majority is achieved with the votes of unimpaired or differently treated creditors, there should be a finding of unfair prejudice.
- Vote swamping and the position of the SSN creditors. The court should not have found that the SSN creditors were in the same class as compromised landlords because they would receive an equity stake as part of the parallel Scheme of Arrangement.
- Where a tenant is permitted under the terms of the CVA to remain in occupation, any rent reduction is inherently unfair.
- If the argument in v. is unsuccessful then in any event because of the notice periods built into the proposal, the termination rights granted to landlords do not mitigate unfairness because they do not place the landlords in the same position as in the relevant vertical comparator, which in this case was an administration.
Regis
On 17 May 2021 Zacoroli J handed down his judgment in the case of Carraway Guildford (Nominee A) Limited and Others v Regis UK Limited and Others. In this case, the compromised landlords also sought to challenge the CVA on grounds of material irregularity and unfair prejudice even though the company had subsequently exited into administration. It was also alleged that the nominees acted in breach of duty in recommending the proposals to creditors. The grounds relied upon were too numerous to cover in this article in their entirety.
Similar arguments were run by the compromised landlords as were run in New Look that it was unfair for the company to be allowed to remain in occupation of the premises while paying a turnover rent. Unsurprisingly this argument failed for the same reason as in New Look, namely that the termination rights granted to compromised landlords mitigated against any unfairness. The fact that landlords were bound to continue accepting turnover rent during the notice period did not undermine this view when taking into account the position of landlords in the appropriate vertical comparator.
In Regis, the company’s parent owned various intellectual property rights and was therefore categorised as a critical creditor entitling it to receive payment in full under the terms of the CVA proposals. This was justified on the basis that if it did not receive payment in full it had the power to terminate various licence and franchise agreements which would inhibit the ability of the company to trade.
However, the judge found this this was wrong as there was no evidence that the parent company would terminate the agreements and the nominees had failed to make proper enquiries to establish the risks of termination.
The landlords also succeeded in challenging the decision to apply a blanket discount to the landlords’ clams for future rent. Unlike in New Look the judge found that there was inadequate evidence to justify a blanket discount of 75% and in this case one category of landlords was adversely affected in terms of their voting power.
The judge concluded that the CVA proposals were unfairly prejudicial, that there had been a material irregularity at the creditors ’meeting and that one of the nominees had acted in breach of his duties in recommending the proposals to creditors. The CVA was therefore revoked, notwithstanding that it had already terminated upon the commencement of the administration but the judge declined to order the nominees to repay their fees on the basis that the services they had provided as nominees and supervisors were not without value.
Comment
The outcome of the New Look appeal will be awaited with interest. For the time being though the concept of different outcomes for different classes of creditors in a CVA will not be deemed automatically unfair or beyond the scope of Section 1(1) of the Insolvency act 1986. Furthermore, following the introduction of the concept of cross class cram down in Section 26A of the Companies Act 2006, introduced by Section 7 and Schedule 9 of the Corporate Insolvency and Governance Act 2020, a CVA will not be deemed automatically unfair by reason of the requisite majority being achieved with the votes of unimpaired creditors.
On 15 September 2020 The New Look CVA was approved. Landlords were given the option to accept rent based on a percentage of turnover or take the premises back.
The case was heard by Mr Justice Zacaroli, who stated in his judgment:
“I do not accept that “arrangement” in section 1(1) IA 1986 is to be construed…. so as to limit a CVA to an arrangement in which the rights of all creditors are such that they can consult together with a view to their common interest.”
The judge stated that a finding of unfair prejudice ought not to be precluded merely because the same result might have been achieved in a Part 26A restructuring Plan (199).
Requisite majorities at creditors’ meeting secured with votes of unimpaired creditors In the Court’s view, the fact that the statutory majority to approve a CVA is achieved by the votes of unimpaired creditors or those who receive substantially different treatment is not necessarily unfairly prejudicial to a sub-group of compromised creditors (though it is a highly relevant factor in considering unfair prejudice). The case law illustrates that to be unfair there must be “something more” than just differential treatment (e.g., bad faith).
