Property Litigation column: CVAs and restructuring in a post New Look and Regis world: what is left for landlords? (first published by Practical Law on 10th June 2021)

This article by Evie Barden was originally published by Practical Law on 10th June 2021. Evie Barden, a barrister at Landmark Chambers, discusses the recent challenges to the company voluntary arrangements in Lazari Properties 2 Ltd v New Look Retailers Ltd [2021] EWHC 1209 and Carraway Guildford (Nominee A) Ltd and others v Regis UK Ltd and others [2021] EWHC 1294, and the further arguments that may still be open to landlords to run in the future, including a consideration of how the grant of new termination rights by a CVA interplay with the termination provisions of the Landlord and Tenant Act 1954. ---------------------- The judgments recently handed down by Zacaroli J in Lazari Properties 2 Ltd v New Look Retailers Ltd [2021] EWHC 1209 (Ch) and Carraway Guildford (Nominee A) Ltd v Regis UK Limited and others [2021] EWHC 1294 (Ch) have left landlords and those who advise them with some despondency as Zacaroli J rejected the "root and branch" attack on CVAs by landlords. Where do landlords find themselves now? Are there any options left for challenges? Before thinking about those questions, it is important to look in detail at what was decided in each of the cases. New Look Although the New Look CVA was proposed, came into force and was challenged long after the one in Regis, the decision was handed down first in time due to the CVA continuing whereas the CVA in Regis had long since terminated by the company going into administration. In New Look, the CVA was part of a wider package of restructuring measures, including extension of the term of facilities and a scheme of arrangement between another group company whose liability New Look Retailers Ltd (New Look) had guaranteed and the creditor in which the noteholders released their claims in return for 20% of the equity in New Look’s parent and an entitlement to participate pro rata in a new loan in return for a pro rata share in 80% of the equity in the parent. The CVA proposal carved out different categories of creditors, including:

• Category A creditors who were the landlords of the premises which were the company’s distribution centre in Newcastle-under-Lyme. Those premises were considered critical to the company’s continued operation so their position was largely unimpaired by the terms of the CVA.
• Category B landlords where the property costs of the stores were above market or where moving to turnover rent was critical for assisting cash-flow and making the stores viable in light of the COVID-19 pandemic. All claims for rent arrears were released in full. Going forward, the company’s obligation to pay rent was replaced with an obligation to pay turnover rent (monthly in arrears) based on a fixed percentage of net sales during the "Rent Concession Period", being the earlier of 3 years from the effective date of the CVA or termination of the lease. The landlords were given the right to terminate their leases on or before an "Initial Break Date" (150 days after the effective date), by giving not less than 60 days’ prior notice. They had further rights to terminate on the first or second anniversary of the Initial Break Date or on the "Final Break Date" being the day before the third anniversary of the effective date. New Look was also given a right to terminate those leases.
• Category C landlords where the stores had already been vacated or New Look would be vacating, because they were significantly underperforming and were considered to have no prospect of being restored to viability. Those arrears of rent were compromised in full and, from the effective date, the landlords were entitled to receive rent, service charges and insurance payments at the contractual rate for two months, after which they would ceased to be entitled to any rent or service charge. The landlords were granted a right to terminate the lease at any time after the effective date by giving not less than 60 days’ notice. New Look was also given a right to terminate the lease on 60 days’ notice. The Category B and C landlords were the "Compromised Landlords".
• The noteholders whose rights were not compromised by the CVA.
• Ordinary unsecured creditors whose rights were, broadly, not affected by the CVA.

The grounds of challenge were three-fold:

• The proposal was not a composition for the purposes of section 1(1) of the Insolvency Act 1986 (IA 1986) because it involved separate agreements on fundamentally different terms with different groups of creditors; there was insufficient give and take between New Look and various creditor groups; and the termination rights granted to New Look in respect of the Compromised Creditors improperly sought to interfere with the property rights of those landlords.
• There were various material irregularities in relation to the calculation of the landlords’ claims for voting purposes and by reason of omissions and inaccuracies in the proposal.
• The landlord applicants were unfairly prejudiced by the proposal because the requisite majorities at the creditors’ meetings were secured with the votes of creditors whose claims were unimpaired by the CVA; creditors whose claims were compromised received differential treatment from those whose claims were not; and the modifications to the terms of the lease were unfair.

All grounds were rejected by Zacaroli J. As a matter of principle, it must be remembered that in considering whether an arrangement is unfairly prejudicial, the Court must consider all the circumstances of the case, but in particular will have regard to "the horizontal" and "the vertical" comparators. The vertical comparator is the "irreducible minimum" that a return in a CVA can go when compared with the creditors’ position in the event that the CVA was not approved (likely to be liquidation or administration). It is not enough that the vertical comparator is satisfied. It is also necessary to consider the position between creditors, being the horizontal comparator. The mere fact of different treatment between classes does not establish unfair prejudice. Thus, it is necessary for the Court to consider the following: the unfairness must be caused by the terms of the CVA; differential treatment of creditors in a CVA does not establish unfair prejudice but may give cause for inquiry and require an explanation; it is necessary to consider all the circumstances including the alternatives proposed; differential treatment might, in some circumstances, be required to ensure fairness. Unsurprisingly, thus, Zacaroli J rejected the first plank of the landlords’ jurisdictional challenge holding that a CVA which provides for different treatment of different sub-groups of creditors is not for that reason outside the jurisdictional scope of section 1(1) of the IA 1986 or necessarily unfairly prejudicial. In addition, Zacaroli J held that there was sufficient "give" from New Look for the CVA to constitute a compromise because the company was "giving" the Compromised Landlords as good as that which the company could give them in liquidation, being the relevant vertical comparator. As to termination rights, it was argued that the company had given the landlords nothing as they already had rights to terminate the leases. Zacaroli J held that the new termination right was properly to be seen as part of the package of new rights granted by it saying, at paragraph 275:

"Without it, the reduction in rent imposed by the CVA would preclude the Compromised Landlords from terminating the leases unless the new, reduced, rent was not paid. The new termination right thus counterbalances that by enabling Compromised Landlords to terminate notwithstanding that the reduced rent continues to be paid".

Zacaroli J also rejected the argument that the release of all liability to pay rent and other sums under the Category C leases had the effect of operating as a surrender, such that there was no interference with the landlords’ proprietary rights under the CVA. He held that it was not an essential requirement of a lease that a tenant pay rent and that, while the CVA offered the landlords the opportunity to agree to a surrender of the leases, it did not require them to do so. So, jurisdictionally, the proposal was capable of constituting an arrangement for the purposes of the IA 1986. On the second line of attack by the landlords, Zacaroli J held that there was no material irregularity in applying a 25% discount to the claims of all landlords for voting purposes. He noted that the calculation of the likely shortfall between the net present value of a landlord’s right to future rent for the remainder of the lease and the net present value of the likely rent that the landlord could recover in the market over the same period in the future was inherently uncertain, and the chair’s duty was to place an estimated minimum value on the claim. The advice obtained about the prospects of re-letting and likely rent achievable identified a single value. Zacaroli J held that that could be taken as a mid-point within a range such that a discount of 25% could be used as a proxy for identifying the lower end of the range. That was, in his view, consistent with the duty to place a minimum value on the claim and did not involve double-counting. On non-disclosure, Zacaroli J held that there was nothing which had been omitted which if, had the truth been told, would have been likely to make a material difference to the way in which the creditors would have considered and assessed the terms of the proposed CVA, such as to meet the threshold required for material irregularity on that basis. So, too, the challenge on grounds of material irregularity failed. Finally, as a matter of principle, Zacaroli J restated the position that it is not necessarily unfairly prejudicial to a sub-group of compromised creditors that the statutory majority is achieved by the votes of unimpaired creditors or those who receive substantially different treatment. That will be a highly relevant factor, however, in determining in any case whether there is unfair prejudice. A glimmer of hope for landlords comes from Zacaroli J’s rejection of the argument by the respondents (the company and supervisors) that a CVA approved where the vote was carried by the unimpaired creditors would not be unfairly prejudicial if the differential treatment was objectively justified; the vertical comparator was satisfied; and a reasonable and honest person in the position of the applicant could have approved the CVA. Zacaroli J, instead, held that:

"…where a sub-group of creditors is compromised by a CVA and their vote is swamped at the creditors’ meeting by the votes of those who were unimpaired by the CVA, I do not think that it is necessarily enough to avoid a finding of unfair prejudice that the differential treatment of others was objectively justified … and the compromised creditors are treated more favourably than they would be in the relevant vertical comparator.

Whether unfair prejudice exists depends on all the circumstances…

Without attempting to define what all the circumstances might in any case might be, I make the following four points…

First, … whether there is a fair allocation of the available assets in the CVA between the compromised creditors and other sub-groups of creditors. That will include considering the source of the assets … and whether they would or could have been made available to all creditors in the relevant alternative…

Second, … will be the nature and extent of the different treatment, the justification for that treatment, and its impact on the outcome of the meeting. There would be strong grounds to conclude it was unfairly prejudicial where a CVA, which compromises the claims of a sub-group of creditors, is achieved only because of the votes of a large swathe of creditors who are unaffected by the CVA, even if there was an objective justification for those creditors being unaffected by the CVA…

Third, it is also relevant to have regard to the extent to which others in the same position as the objecting creditors approved the CVA…

Fourth, a finding of unfair prejudice ought not to be precluded merely because the same result might have been achieved in a Part 26A plan… "

(Paragraphs 190 to 199.)

In respect of unfair prejudice, first, Zacaroli J declined to depart from the decision of Norris J in Discovery (Northampton) Ltd v Debenhams Retail Ltd [2019] EWHC 2441 (Ch) and hold that a CVA cannot operate to reduce future rent while permitting the tenant to remain in possession because it is inherently unfair on the landlord. So, Debenhams remains good law. Zacaroli J, however, did say obiter that there was considerable force in the contention that a permanent or long-term reduction in rent imposed on landlords without the option to terminate would be inherently unfairly prejudicial, certainly if achieved by the votes of other creditors who did not suffer the same treatment. Second, the argument that the modifications to the leases were "unfair" on the facts was rejected. Zacaroli J held that there were no objective criteria by which it could be assessed whether the modifications were unfair per se and, crucially, that there was no test laid down by Norris J in Debenhams that the modifications must interfere with the landlords’ rights only to the minimum extent necessary to achieve the objectives of the CVA. Further, he held that the answer to whether the modifications were unfair was found in the landlords’ right to terminate the leases, provided that the terms offered to the landlords on exercise of that right were at least as beneficial as in the relevant vertical comparator. On the termination rights themselves, Zacaroli J held that they were new rights, which were distinct from the existing rights that the landlords had to forfeit the leases for non-payment of rent. Further, the absence of a rolling termination right was held not to be a matter for the Court to determine but a factor that the landlord could assess in exercising the choice the CVA presented to it. Zacaroli J also held that the absence of mitigating factors, like a profit share fund, did not render the CVA unfairly prejudicial. Comparison with other CVAs was of no assistance and it was not a case where the creditors’ rights were being compromised in order to benefit existing equity holders. Last, Zacaroli J rejected that it was unfairly prejudicial to treat the noteholders differently in the CVA. Zacaroli J held that while the scheme was independent of the CVA, the two were practically interdependent and it would not have been possible to compromise the rights of a secured creditor, such as the noteholders, without its agreement. Given that any benefit received by the noteholders was referable to their position as secured creditors and the secured assets were made available for the benefit of the CVA creditors, there was objective justification for the differential treatment. So, the unfair prejudice challenge also failed. Regis The decision in Regis was handed down seven days after New Look, with significant overlap regarding the issues for determination. Again, the CVA proposal for Regis UK Limited (Regis) split the landlord creditors into various categories, where their claims were compromised in different ways. The landlords in categories 2 to 5 were to receive a percentage of future rent as well as having a right to terminate the leases on notice, differing depending on the category the landlord was in. Certain other creditors were unaffected by the CVA and were to be paid in full, including Regis Corporation (Regis Corp) and International Beauty Limited (IBL). Prior to October 2017, Regis Corp had been the ultimate parent of Regis. After October 2017, IBL purchased the shares held by Regis’ parent and became its sole shareholder, being itself ultimately owned by a private equity group called Regent LP. Before the share-sale, a number of assets formerly owned by Regis, including valuable franchises and intellectual property rights were transferred (for nominal consideration in certain cases) to related companies in the Regis Corp group. After that share-sale occurred, IBL became the franchisee of certain of those businesses for monthly fees. Regis then continued trading under those brands. In 2018, a dispute arose between Regis Corp and IBL and they entered into a settlement agreement whereby IBL executed a promissory note with a maturity date of August 2020. Under that note, if no default occurred, then the note would be converted into a contingent payment right entitling Regis Corp to receive a percentage of the net profits received by IBL or Regis of certain events. Backing that was a debenture executed by Regis in favour of Regis Corp where Regis undertook as primary obligor to pay the amount due to Regis Corp and also granted a fixed and floating charge over all its assets and undertaking as security. Unlike in New Look, there was no challenge on the basis that there was no jurisdiction, or that there was unfair prejudice because certain creditors’ claims were unimpaired and they were material in carrying the votes. But also unlike in New Look, the CVA was held to be unfairly prejudicial to the landlord applicants because of the treatment of IBL as a critical creditor. The justification offered for leaving the IBL debt unimpaired was that IBL was obliged to account to Regis Corp for payment of the debt and if IBL did not account for it there was a risk that Regis Corp would terminate the franchises and other agreements which would prevent Regis from operating under the existing trading names. Zacaroli J was satisfied on the evidence that there was no justification for such differential treatment. It had been simply assumed that if the Regis did not pay IBL, then IBL would not pay Regis Corp and there was no evidence that any consideration had been given to whether it was appropriate to consider IBL as a critical creditor in the circumstances. He held that those promoting the CVA had failed to consider that IBL was the entity that was legally obligated to Regis Corp, IBL was wholly owned by Regent and therefore likely to have sufficient assets to meet those obligations, and, to the extent that the company’s debt burden was reduced, Regent, as equity holder, stood to benefit. Treating IBL as a critical creditor had an immediate and significant impact on the other creditors because nearly £600,000 was due to IBL and would be paid in full from Regis’ assets whereas the amount funded from the company’s assets to pay allowed-CVA claims was only £330,000 (that is, the sole shareholder of the company got paid twice as much as the company would pay to fund all the impaired creditors). And, but for the CVA, IBL would have received nothing. Zacaroli J also considered the discount applied to the landlord’s claims. In Regis, a 75% discount had been applied in order to achieve the minimum value. Zacaroli J held there were two distinctions with New Look in the application of the discount:

• The unform formula: all landlords’ claims were treated identically. But there were large variations in the likelihood of premises being re-let (largely, reflecting the categorisation of the leases). Thus, those premises which the company hoped to retain, and where the CVA provided for a higher percentage of rent, were more likely to be re-let (and at a better rent) than those which the company wished to vacate and where the CVA provided for no rent to be paid. The justification offered was that some discount was appropriate but, the problem was that the discount was likely to be an overestimate for the category 2 leases and an underestimate for the category 5 leases, such that the blanket percentage could not be justified.
• The size of the discount: there had to be an adequate justification for a discount of such a size and there was none. Zacaroli J rejected the argument that it is not permissible for the Court to consider the amount of the discount.

Although he did not need to decide whether the modifications were unfairly prejudicial because of the determination relating to differential treatment, Zacaroli J did express the view that a term in the CVA which provided that a landlord of multiple leases could only exercise a right of termination in respect of one lease if it exercised it in respect of all could have led to the landlords being unfairly prejudiced by being forced to accept a reduction in rent in a particular lease without an unqualified option to terminate the lease. Further, he held that the benefit provided by the profit share fund was illusory and that the absence of a real prospect of sharing in the profits was significant because the current equity holder stood to gain and exacerbated its treatment as a critical creditor. While the CVA was revoked, the decision was in many ways academic given the CVA had terminated. The real significance of it lay in the potential prospect of the nominees having to repay their fees as a result of breaching their duties. While Zacaroli J did hold that Mr Williams’ conduct as nominee fell below the standard of a reasonable nominee in accepting without question that the shareholder was to be treated as a critical creditor, he declined to make an order requiring the nominee to repay the fees given he would not have been obliged to do so in a professional negligence action and suggesting that such an order should be limited to cases of particularly egregious conduct. Landlord and Tenant Act 1954 An issue which has vexed landlord and tenant lawyers, and which remains unresolved by the decisions, is how new rights to terminate granted by a CVA interplay with the provisions of the Landlord and Tenant Act 1954 (LTA 1954). Section 24(1) of the LTA 1954 provides that a tenancy to which Part II of the LTA 1954 applies shall not come to an end unless terminated in accordance with the provision of that Part of the LTA 1954. Subsection (2) provides that section 24(1) does not prevent a tenancy coming to an end by notice to quit given by a tenant, by surrender or forfeiture or by the forfeiture of a superior lease, unless, in the case of a notice to quit, the notice was given before the tenant had been in occupation in right of the tenancy for one month. So, how does that affect a right given by a CVA for a landlord to terminate a lease which has the protection of the LTA 1954? It will all depend on constructing the specific CVA in question as to what the nature of the right being granted is. If the right being granted is properly construed as an option to determine the lease before expiry of the fixed term, the lease will be continued under section 24(1) of the LTA 1954 and exercise of that right to terminate cannot be effective to terminate the lease under the LTA 1954. Query, therefore, how the rights to terminate would be effective to terminate the leases in the case of New Look given they appear to have been described as being exercisable on "the Initial Break Date" and "Final Break Date" (although the exact terms of the CVA proposal do not appear to be publicly available and are not recited in Zacaroli J’s judgment). It may be that, properly analysed, the specific right granted is, in fact, a right to re-enter or to forfeit the lease, in which case the landlord could exercise it and it would be valid to terminate the lease due to section 24(2) of the LTA 1954. But the landlord would need to comply with section 146 of the Landlord and Tenant Act 1925, given the right is not exercised in the case of non-payment of rent. And, as a matter of principle, can such a construction be correct? While exercise of the right operates to bring the lease to an end earlier than it would "naturally" terminate, can it be said that it is exercisable in the event of some default of the tenant (see the definition adopted by the Court of Appeal in Clays Lane Housing Co-operative Limited v Patrick (1985) 17 HLR 188 at 193)? It all depends on the drafting of the CVA but, that definition does not naturally apply to the usual termination provisions, exercisable by a landlord giving notice on or before a certain date. Or, properly analysed, might the right constitute an agreement that the tenant surrender if the landlord gives a certain period of notice after or before a certain a date? Again, however, this does not naturally work with the drafting of the usual CVA termination provisions. Even leaving that aside, while a surrender could be effective to terminate a lease protected by the LTA 1954 because of section 24(2) of the LTA 1954, the agreement to surrender analysis opens another Pandora’s box. Under section 38A(2) of the LTA 1954, the landlord and the tenant may agree that the tenancy shall be surrendered on such a date or in such circumstances as may be specified in the agreement and on such terms (if any) as may be so specified. However, as a result of section 38A(4) of the LTA 1954, such an agreement will be void unless (a) the landlord has served on the tenant notice in the form, or substantially the form, set out in Schedule 3 to the Regulatory Reform (Business Tenancies) (England and Wales) Order 2003; and (b) the requirements in Schedule 4 to that order are met, namely that:

• The notice has been served on the tenant not less than 14 days before the tenant enters into the agreement to surrender or (if earlier) becomes contractually bound to do so
• .If the requirement in first bullet point above is met, the tenant or a person authorised by them must, before the tenant enters into the agreement, make a declaration in the form of paragraph 6 of Schedule 4.
• If the requirement in the first bullet point above is not met, the notice must be served before the time that the tenant enters into the agreement or becomes contractually bound to do so and the tenant must before that time make a statutory declaration in the form of paragraph 7.

Even if practically possible for a landlord to comply with these steps prior to the CVA being approved by members and creditors (and query this in light of the timing requirements in rule 2.27 of the Insolvency (England and Wales) Rules 2016 and the consequences of any possible adjournment of the decision procedure or calling of a physical meeting), the instances of landlords doing so are rare, if it ever occurs: it may well not be in the landlord’s interest to do so due to it possibly constituting a waiver of any rights for the landlord to forfeit for arrears of rent and/or other defaults giving rise to a right to forfeit (such as a proposal of a CVA), especially if the CVA is not approved at the meeting. What, then, is the position if no notice under section 38A(4) of the LTA 1954 has been served prior to the CVA coming into force? Is the agreement to surrender void? One answer to this might be found in the, confused and confusing, authorities on whether CVAs are, in fact, contracts. In short: there is no clear answer. However, in light of the claims in Re Rhino Enterprises Properties Ltd [2020] EWHC 2370 (Ch), the High Court will soon have to consider the question again, in the context of the Contracts (Rights of Third Parties) Act 1999. There are signs of an answer from the decision in the applicants’ application for permission to claim against the joint administrators of a company for breach of duty and/or misfeasance in Re Rhino Enterprises Properties Ltd. HHJ Simon Barker QC held that it was realistically arguable that a CVA is not a contract, on the basis that the IA 1986 does not refer to CVAs as contracts, (critically) agreements, enforceable promises or bargains but as arrangements. Following Debenhams, HHJ Barker QC held that CVAs bring about compromises or variations of contracts and the validity of a CVA is not based on actual agreement, but upon compliance with the procedure in the statute. The CVA operates "as if" it were a contract. But, it is not that. Accordingly, the best analysis might be that the landlord and the tenant do not "agree" for the purposes of section 38A(2) of the LTA 1954 that the tenancy will be surrendered on a date or in circumstances that may be specified in the "agreement": the voluntary arrangement binds the landlords and the tenant by virtue of the proposal being carried into effect, following the procedure in the IA 1986, and, when it comes into effect, it is deemed to operate as if it were a contract. And, in those circumstances, the agreement is not one that has to comply with section 38A(4) of the LTA 1954. But, is the only way of having an enforceable agreement to surrender a lease that is protected by Part II of the LTA 1954 one which complies with sections 38A(2) and (4) such that the consequence of that analysis is that the "arrangement" to surrender is not enforceable in any event? Or, does the approval of the CVA operate as an agreement for the purposes of section 38A(2)? Conclusions So, landlords’ principled objections to the drafting of retail CVAs have been rejected as not being inherently unfairly prejudicial. However, there are clear indications from the decisions that the Court will scrutinise carefully cases where certain creditors are unimpaired by the CVA and carry the vote. Factors such as the source of assets and their allocation will be critical as well as what the nature and extent of differences in treatment are and, critically, how they are justified contemporaneously. Cases where there are connected creditors, or the shareholder stands to benefit, will draw particular attention. Further, neither New Look nor Regis (nor, indeed, Debenhams) grapple with the issues relating to the LTA 1954. Indeed, in New Look and Regis, it was assumed by Zacaroli J that those termination rights were capable of being exercised by the landlords. These ambiguities are generally unhelpful for landlords and most routes to rationalising present problems with a landlord’s exercise of CVA termination rights. For a hungry landlord with an appetite for a bite of the CVA-challenge cherry, however, these arguments might provide a route in on the basis that any modification of its existing rights which is premised on its ability to terminate is unfairly prejudicial if the new CVA termination rights are rendered unenforceable as a consequence of the anti-avoidance and termination provisions of the LTA 1954 (even if, in practice, this point is never taken by CVA supervisors). Given in New Look and Regis the termination rights were held to be the quid pro quo for the modifications (as Peter Arden QC said, they provided the landlords with the chance to "get off the bus"), and the edifice of the retail CVA rests on the efficacy of the termination rights, one can imagine the Courts will strain against finding that the LTA 1954 renders CVA termination rights void where leases are protected by the LTA 1954. And, will the next frontier be the conduct of directors in how proposals are put together and voted on? In Regis, no decision was made on whether there had been a breach of the directors’ duties in respect of the transaction giving rise to the liability to IBL given the directors were not parties or present at the hearing and the CVA had terminated. Allegations regarding directors’ conduct are central to the challenge against the Café Nero CVA, where it is alleged that the decision-making procedure did not allow proper consideration by the creditors in circumstances where there were material developments affecting the proposal (being an offer of funding by a third party, which the applicant says should have resulted in the decision making procedure being postponed). And what about the treatment of guarantors? No case has yet considered whether the modification of the terms of leases offends the rule in Holme v Brunskill such as to release guarantors. While express guarantee stripping is a thing of the past following Prudential Assurance Co Ltd v PRG Powerhouse Ltd [2007] EWHC 1002 (Ch) and Sixty UK Ltd (In Administration) v Mourant & Co [2010] EWHC 1890 (Ch), are some CVAs stripping landlords of their rights of recourse against guarantors by operation of law?