The Rise of Retail Insolvency and the CVA

2018 has been one tough year on the High Street…

Retail, as a sector, has long been under pressure from increased competition from online retailers, which has resulted in reduced footfall on the High Street, affecting many companies, including many well-known names.

One of the main issues for retail companies is that many are tied into long and expensive premises leases. Retailers have therefore been forced to consider how they can operate in those circumstances, which has led to the resurgence of an insolvency process that had previously seemed unpopular for several years – the Company Voluntary Arrangement (CVA), which only last week creditors of House of Fraser voted to approve.

What is a CVA?

A CVA is a process under the Insolvency Act 1986 which enables a company to make proposals to its unsecured creditors to compromise their claims, provided 75% of those creditors, by value, vote to approve it.

If there are “connected creditors” comprising that 75% who wish to approve the CVA, there is then a second round of voting and the CVA will only be approved if 50% of the unconnected creditors vote in favour of it.

Within the CVA proposal, the company will set out the consequences of the CVA not being approved. This is normally that the company will enter into Administration or be wound up, with the result that there would be a much worse outcome for creditors than if the CVA were to be approved.

A company will need to instruct a licenced insolvency practitioner (IP) to oversee the CVA process. The IP will act as the “Nominee” when the CVA is proposed to creditors. If it then is approved, they will become the “Supervisor” of the CVA. Quite often, if the CVA will permit the company to continue to trade intact and will allow, the existing directors will remain in control of the business, unlike in an Administration where control passes to the IP that is appointed over the company.

Why are CVAs used in retail?

A CVA does not bind a secured creditor unless they consent to it. As most restructurings are dependent on the assistance of financial institutions who are likely to hold a charge over the company’s assets, a CVA is not normally an option.

However, in the retail sector, the main creditor of the business is likely to be the landlord of its retail premises. This means that landlords are likely to be unsecured creditors of the company (ignoring any security taken in the form of a rent deposit deed).

A company proposing a CVA may be subject to an unprofitable lengthy lease containing upwards-only rent reviews. Therefore, the CVA will likely propose that either the company remain in occupation of the premises albeit on a reduced rent, or alternatively, state that if the CVA is rejected, the company will vacate the premises (leaving the landlord with an empty property that it may then struggle to let).

Unless there are already significant rent arrears, landlords lack the power to oppose a CVA as they can only vote on the proposal for future losses based upon one year’s loss of future rent and one month’s rent in respect of dilapidations. This is despite the fact there may be several years remaining on the lease term, meaning their future losses will potentially be significantly more. CVAs can also be used to amend the terms of the leases, such as the frequency when rent is paid, its covenants and any guarantor obligations.

Steps for landlords

Landlords need to act quickly if they receive a CVA proposal from one of its tenants, given there is normally only 14 days before the meeting of creditors will be held to consider it.

Landlords should seek advice at an early stage regarding what effect the proposed CVA will have on them and, in particular, their rental income. Normally they will be faced with a commercial decision as to whether to support the proposal but retain a tenant paying reduced rent or to oppose the proposal with the possibility of having to find a new occupier for their premises.

Fight back?

The British Property Federation stated that it considered companies were abusing CVAs and thereby leaving landlords with a “raw deal”. As a result, there is a growing backlash by some landlords, who are now seeking to persuade other creditors who make up at least 25% of the company’s debts to seek variations to seek improvements to the CVA proposals and a share in the company’s future profits.

Landlords are also calling on the Government to review the use of CVAs by retailers.

Furthermore, it has been reported that Next, which is unhappy in seeing its competitors achieve reductions in rent, is now seeking to now incorporate a “CVA clause” into its own leases with its landlords, so that if a competitor’s rent is reduced following the approval of a CVA, it also gets a rent reduction. It is yet to be seen how landlords will react to that.

Summary

There are clearly going to be further retail casualties on the High Street as the sector continues to suffer financially, and this is likely to involve the further proposal of CVAs by those in the retail sector.

At the same time, there is increasing landlord dissatisfaction regarding the use of CVAs. However, it can only be a matter of time before landlord’s challenge in the courts the use of CVAs as an abuse of process.

In the meantime, any landlord who receives a CVA proposal from one of its tenants should seek specialist advice at the earliest opportunity.