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Lawbite: A New Look for CVA’s?

  • United Kingdom
  • Litigation and dispute management
  • Real estate
  • Real estate litigation - LawBite

14-05-2021

 

Lazari Properties 2 Limited and Others – v – New Look Retailers Limited [2021] EWHC 1209 (Ch)

Landlords had been hoping that the eagerly awaited decision on the challenge to New Look’s CVA would help to curtail the erosion of their rights by successive ‘retail’ CVAs. They will now be left disappointed, following the dismissal of the challenge on all grounds.

Overall, whilst it is clear the landlords were unsuccessful in their challenge on all grounds, many will take some comfort from the detailed guidance set out by Zacaroli J as to what factors may be of particular relevance in considering unfair prejudice.

The CVA was challenged by a consortium of landlords on three broad grounds:

1.    that the applicant landlords were unfairly prejudiced, both because the requisite 75% majority voting in favour of the CVA was achieved with the votes of creditors who were not impacted by the CVA and because of the specific modifications to the lease terms made by the CVA (most notably a switch to turnover rents);

2.    there were material irregularities, particularly in relation to the calculation of landlords voting rights; and

3.    the CVA did not constitute a “composition or arrangement” as required by the legislation, because it involved separate arrangements with different groups of creditors,  there was insufficient “give and take” and because the CVA improperly sought to interfere with landlords’ property rights.

In considering whether a CVA is unfairly prejudicial, the courts have developed a two stage test;

the “vertical comparator” test - a comparison with the creditor’s position in the event that the CVA is not approved. Typically this involves asking whether the creditor would be better off if the company entered into administration; and

the “horizontal comparator” test – a consideration of the relative treatment of different creditors.  Unjustified differential treatment between creditors potentially leading to a conclusion of unfair prejudice. 

Unfair prejudice - voting

A CVA will be approved if 75% or more (in value) of voting creditors vote in favour of it, unless more than 50% of the total value of unconnected creditors vote against it.

As is commonplace, the CVA grouped landlords into different categories depending on the performance of each store and applied differential lease variations to each category.  Almost 100% of secured creditors (in respect of their unsecured shortfall), ordinary unsecured creditors and Category A landlords (who were not materially impacted by the CVA) voted in favour, but only 58% of Category B landlords and 70% of Category C landlords voted in favour. 

The Category B and C landlords contended that it was inherently unfairly prejudicial for a CVA to compromise claims of a sub-group of creditors where the requisite 75% statutory majority is achieved using the votes of other creditors who are unimpaired by the CVA, or who receive substantially different treatment. The court concluded that was not necessarily unfairly prejudicial, and it was not on the specific facts. 

However, the court did accept that such a situation would be a “highly relevant factor in determining whether there is unfair prejudice”, and that there would be “strong grounds to conclude” that a CVA is unfairly prejudicial where it is passed “only because of the votes of a large swathe of creditors who are unaffected by the CVA”. Important considerations will be:

  • whether there is a fair allocation of assets available within the CVA between compromised creditors and other sub-groups of creditors;
  • the nature and extent of the different treatment, the justification for that treatment, and its impact on the outcome of the meeting;
  • the extent to which others in the same position as the objecting creditors approved the CVA; and
  • if a Part 26A restructuring plan would have been able to impose the same outcome on creditors, that does not preclude a finding of unfair prejudice.

Unfair prejudice – lease terms

The applicant landlords’ fundamental objection was to the switch to turnover rents, which they said was unfair in principle because it involved a fundamental reallocation of commercial risk and would result in substantial rent reductions.  They also objected to, amongst other things, the rent reductions continuing during the period between the service of a landlord termination notice and the relevant lease coming to an end. 

Mr Justice Zacaroli held that the inclusion of a right for landlords to terminate the compromised leases if they were not happy with the varied terms would, in principle, eliminate any unfairness.  The fact that landlords were “stuck” with the turnover rent during the notice period was not unfair, because on the facts that outcome was likely better than what would have been achieved if the company had entered administration, with a pre-packaged administration sale. 

The court also concluded that there was no rigid test that a CVA could only escape a finding of unfair prejudice if (a) the rent paid during the landlord notice period was at least the market rent and (b) the interference with rent was the minimum necessary to achieve the CVA’s purpose, as was contended by the landlords. The Judge was clear that reference must be had to all of the circumstances and that could, as was the case, result in landlords being stuck with below market rents until the expiry of a landlord termination notice.

It was also noteworthy that the court determined that:

  • it is relevant to have regard to the extent to which others in the same position as the objecting creditors approved the CVA;
  • an important consideration is whether there is a fair allocation of the assets available within the CVA between the compromised creditors and other sub-groups of creditors. That will include considering the source of the assets from which the treatment of the different sub-groups derives, and whether they would or could have been made available to all creditors in the relevant alternative;
  • the fact that exercise of landlord termination rights triggered a full and final settlement of all compromised landlord claims was not unfairly prejudicial as, on the facts, it satisfied the vertical comparator test; and
  • the lack of any profit sharing with landlords to share the “upside” of any future turnaround was not unfairly prejudicial on the facts, although the court implied that a profit share may be relevant where the existing equity holders in the company would benefit from its turnaround.

Material irregularities

A challenge based on material irregularity requires a material irregularity at the creditors’ meeting or in relation to the relevant decision procedure.

Failure to give adequate disclosure of the value of equity interests, the exit process for equity holders and a management incentive plan were not material, even if they were irregularities, and would not have impacted the voting.

Further, a 25% discount applied to the claims of all landlords for voting purposes did not constitute a procedural irregularity, but rather was consistent with the duty to place an estimated minimum value on each claim.

The court also concluded that a broad brush calculation of ‘dilapidations allowances’ based on a fixed amount per square foot did not constitute a material irregularity – the cost of a detailed exercise would have been disproportionate and unlikely to have a material impact on voting.

Key points

  • the decision, assuming that it is not appealed, highlights that a CVA can reduce future rents or make other adjustments to lease terms and providing that landlords have an option to terminate the lease, in most cases that would eliminate any unfairness.
  • the basic principles of “good faith and equal treatment” continue to apply in shaping the meanings of any challenges to a CVA framed on the grounds of unfair prejudice or material irregularity.
  • if landlords are not content with the varied lease terms, they will have the option to terminate the relevant lease, but they must act quickly as the deadlines for service of termination notices are strict and often arise soon after the CVA is passed.
  • since there will be “strong grounds to conclude” that a CVA is unfairly prejudicial where it is passed only because of the votes of a large number of creditors unaffected by the CVA, landlords will need to consider the voting composition swiftly after a CVA is approved, particularly given that the challenge period is just 28 days.