Readers will not need to be reminded that these are challenging times for retailers and their landlords. In the last week, Paperchase has announced a CVA which will involve the landlord accepting a cut in rent (Times 23rd March 2019). They are said to have struck a deal whereby they negotiated turnover based rents in relation to half of their shops. Debenhams is teetering on the brink of administration or corporate restructuring which could wipe out the value of their shares and Mike Ashley has continued his march on the high street, usually at the expense of existing shareholders and the landlords of those companies.
The threat of departure from the EU and the perceived risk of a recession can only add to the general atmosphere of gloom prevailing in the retail sector, but in reality the difficulties facing this sector run much deeper – internet shopping, changing shopping habits and disparity between online retailers and their more traditional relations in the high street, who pay high business rates and face an onslaught of other burdens, are also important factors.
Research has shown a long-term decline in capital values of retail property as well as fixed or declining rental yields. This is a very challenging environment for commercial property landlords, especially those specialising in the retail sector. Unfortunately, however, the impact is much wider than the retail sector.
Having conducted a series of short seminars on the topic recently, I thought it helpful to identify some of the points that came out of those seminars especially the points made by delegates.
The CVA conundrum
Three quarters of the creditors must vote for a CVA (see IRs 2016 r 15.34) but unlike other insolvency procedures it leaves the management team in place and often disadvantages landlords, who have a wider interest in the value of their security in addition to the need to maintain their rental stream. They might put this above the short term need to get a tenant over a cash flow problem. The CVA is binding if the creditor would have been entitled to object had the creditor had notice of it (see section 5(2) IA 1986). Often, the only alternative to “going along” with the CVA is to forfeit, on grounds of non-payment of rent where there are rent arrears of rent, or in other cases, on grounds of the tenant’s insolvency which normally gives rise to a right to forfeit . Alternatively, the landlord can push the tenant into insolvency, e.g. administration or liquidation. At least liquidation has the value of certainty in the sense that it crystallises the loss and enables the landlord to re-market the premises. This is usually following a disclaimer of the lease.
The CVA is often an unattractive outcome for the landlord who is often in conflict with other suppliers who have an interest in keeping the trading relationship going. Shareholders are also likely to be in favour as it preserves some shareholder value whereas every other form of the insolvency procedure wipes that out. All creditors are treated equally but in practice, a CVA will be used to reduce the rent. There is no doubt that in practice the CVA has been abused to gain commercial advantage. The increase in the use of these insolvency procedures in recent months is very marked. Some names have already been mentioned but one could add BHS, Comet, Homebase and Blacks Leisure – all well-known high street names who utilised CVA’s for various reasons. Jamie’s Italian and Byron Burgers are big players in the branded restaurant business but both of them, as well as Carluccio’s, are in CVA’s at present.
Wider impacts
Landlords are not the only ones affected by the widespread use of CVA’s.
What does it mean for banks and other lenders who depend on the stated value of the asset on which they are advancing a loan?
Banks which lend money to landlords are also going to be concerned in the reduction of freehold values as well as potentially being saddled with a lease with a reduced or stagnant rent. So far, they have not been particularly active at placing landlords into insolvency procedures but in a recession, this could all change and many think a recession is close.
What does that mean for mixed- use developments which typically contain a retail element together with a leisure element and possibly some residential use?
Many developments that will lose one “linchpin” tenant will simply not be able to carry out a project they might otherwise have planned. The development may simply not take place, and this has an impact on the construction sector as well as commercial landlords who are dependent on an increasing range of properties on their books.
Where does it leave the traditional commercial lease?
A typical traditional commercial lease will have:
- A lengthy term;
- An upwards only rent review clause;
- A cast-iron guarantee;
- A highly restrictive break clause;
- Widespread spread restrictions on user, alienation and so forth.
Without those strong foundations in place the commercial property market looks much riskier and possibly the whole property market falls into a downward trajectory.
Going legal
Assuming the landlord does not go along with the CVA but 75% of the creditors do, he is generally stuck with it. His only means of challenge is within twenty-eight days on grounds of unfairly prejudicial treatment or a material irregularity. The challenge is on the basis that the CVA has been unduly prejudicial is on the basis that it does not represent a favourable outcome to the creditor over other insolvency procedures, for example liquidation. Otherwise, the manager oversees the CVA and the landlord hopes for better times.
There are signs that things are “hotting up” in the courts. Guarantee stripping was successfully halted by a series of challenges approximately ten years ago (see for example: Pan Assurance v PRG Powerhouse [2007] EWHC 1002). The High Court in those decisions, including Pan Assurance, found such practices to be highly prejudicial to commercial landlords and set aside CVA’s entered for the purpose of reducing the real value of the guarantees given by parent companies.
The current practice of utilising CVA’s as a commercially savvy move to reduce liabilities and keep an otherwise insolvent company trading have not been subject to such widespread challenge. But this may be about to change as there has been more landlord disquiet in recent times. Particularly since the House of Fraser CVA, which ultimately ended in that company going into administration, there has been a greater appetite for challenge by the landlords. At least one recent case (RegisSupercuts) may well result in a reported case. The claim was issued in the High Court last November and it will be interesting to see how far it gets. It is understood the basis for the challenge is that the CVA has been unduly prejudicial.
There is also more guidance from landlord groups, for example, the British Property Foundation has issued guidance on good practice in CVA use.
Good news or bad for lawyers?
Feedback from recent seminars suggest that landlords are doing anything to keep tenants trading as the prospect of a vacant unit with business rates liability as it is commercial suicide. Not only is the landlord left without any rent and with a massive business rates liability, but word tends to spread quickly amongst other tenants and the general public, which can have a corrosive effect on the viability of a shopping centre, for example.
Clearly there are drafting challenges for those commercial conveyancing solicitors have to advise their landlord clients to settle for less onerous alienation and user provisions. Rent reviews are often put on hold. However, often a landlord will often wish to preserve his position in case better times come.
Where is the government right now?
As I write ( on 29 March 2019 – surely it a historic day will be etched on our memories for years to come) the government has other things to occupy itself! However, the government’s only answer so far, the collapse of the high street has really been to free up the planning regime to allow more residential user within commercial and office buildings. The wider challenge of reducing dependence on high levels of business rates has effectively been put “on- hold”. At present business rates are linked to rental values and ultimately these may be heading downward, which may reduce business rates. However, the experience so far has been that multipliers have increased.
The wider challenge is to wean governments off taxes on bricks and mortar, but I don’t see a government prepared to accept the turnover-based tax any time soon! Would a sales tax be a fairer way of doing things?
These are all issues to be considered when normal times return.