What can we learn from the BHS CVA?

By any measure, 2018 is shaping up to be the year of the CVA. Already, we have seen the collapse of Toys R Us’s CVA and proposals put forward by Byron Hamburgers, Jamie’s Italian, New Look, Prezzo, Select and Carpetright, to name just a few. Rumours abound of many other companies with draft CVA proposals waiting in the wings. At the same time, few CVAs come before the courts for consideration. That makes the recent case of Wright and another (as joint liquidators of SHB Realisations Ltd (formerly BHS Ltd) (in liquidation)) v The Prudential Assurance Company Ltd [2018] EWHC 402 (Ch) regarding BHS’s CVA and the rule against penalties all the more worthy of note. What is a CVA? A CVA is an insolvency process that allows a company to settle its debts by paying a proportion of the amount due to its creditors, or come to some other arrangement with them over their affairs. They have proved popular with struggling retailers facing poor consumer confidence and changes in shopping habits, as well as restaurant chains suffering from rapid over-expansion and the inevitable correction. In either case, tenant companies may find that they have built up a leasehold property portfolio they can no longer afford. Proposing a CVA provides those companies with an opportunity to improve their balance sheet by imposing rent reductions on landlords of poorly performing units, and closing others down altogether. If a proposal is approved by three-quarters (by value) of the company’s creditors voting on the CVA, it binds all creditors regardless of how or whether they voted. What happened to BHS? In March 2016, BHS put forward a CVA in an attempt to rescue its business. It proposed closing 40 of its 164 stores and reducing rent by 25% or 50% for many others. The CVA was approved at a meeting of the company’s creditors. Unfortunately, this was not enough to turn around BHS’s fortunes, and it was put into administration only a month later. The company’s CVA did not terminate automatically   on administration, and its administrators carried on trading from its stores for a number of months paying the reduced level of rent, before the business was folded and stores closed. BHS subsequently went into liquidation. The CVA did, however, entitle landlords to terminate the CVA for non-payment of sums due under it, which is precisely what one of the company’s landlords then did. The CVA provided that if the CVA terminated, the “compromises and releases effected under the terms of the CVA shall be deemed never to have happened, such that all Landlords… shall have the claims against BHS Limited that they would have had if the CVA proposal had never been approved”. It was the effect of this clause that came before the court for consideration. What did the court have to decide? The defendant landlord in the case claimed that, following termination of the CVA, it was entitled to be paid the difference between the full contractual rent due under its leases and the discounted rents that it had received under the CVA, and this payment ranked as an expense of the administration. This meant that it would be payable in full in priority to other creditors. The liquidators sought a direction that the rent was not payable, despite what the CVA said, arguing that it was an unenforceable contractual penalty. They also said that the CVA contravened the pari passu principle that all unsecured creditors are entitled to share equally in any available assets of an insolvent company, in proportion to the debts due to each of them. Even if the rent was due, the liquidators argued that it was not payable as an expense as the liability crystallised after the administrators had stopped using the premises. The court’s decision The liquidators relied on the Supreme Court decision of Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67; [2016] EGLR 15. Lord Neuberger, in that case, said about penalties: “The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.” The liquidators’ case was that the CVA had varied the leases so BHS’s primary obligation was to pay the discounted rents. The obligation to pay full rent dating back to approval on termination of the CVA for breach was therefore a secondary obligation. This, they said, was out of all proportion to any legitimate interest of the landlord in the performance of the CVA. The court disagreed. First, the rule against penalties did not apply to CVAs. A CVA is not a typical contract. It is a hypothetical contract imposed by statute and can only be challenged on limited statutory grounds within a 28-day period. There was, the court said, no room for additional avenues of challenge outside that process. The court also referred to the public policy grounds behind the penalty doctrine and said that it was “impossible to see how a proposal put forward by or on behalf of the company… can somehow be said subsequently to have oppressed the company in some respect”. The liquidators’ argument relied on the CVA having varied the leases at law, which the court said it did not, as a matter of construction and because it was not executed by deed. Without a variation, the primary obligation under the leases remained to pay the full contractual rents. Termination of the CVA simply brought the temporary rent concession to an end. The court distinguished Vivienne Westwood Ltd v Conduit Street Development Ltd [2017] EWHC 350 (Ch); [2017] EGLR 11 concerning a rent concession letter, because the discounted rent in that case was the primary obligation agreed from the outset. For similar reasons, the court found that there was no breach of the pari passu principle: termination of the CVA and the unwinding of rental discounts did not have the effect of increasing the landlords’ claims against BHS on insolvency. The true position in the court’s view was that the temporary rent concession was “brought to an end and the original rent… continued to have effect”. Finally, the court made clear that, for any period during which administrators use or retain leasehold premises, they were liable to pay as an expense “all sums payable for the premises in respect of that period, even if they are only contingent or yet to be ascertained at that time”. Therefore, it did not matter that the liability to pay the full rent for the period was not triggered until after they had vacated. This might include things like backdated rent review uplifts, balancing service charge payments and even covenants to yield up in repair, which are all liabilities that administrators like to avoid. The importance of the decision This is a significant decision for all BHS’s former landlords, who stand to see some of their losses clawed back following the retailer’s collapse. It also has a wider impact on the credibility of CVAs, which is important in the current market. By their very nature, CVAs depend on creditor support. That, in turn, requires some give and take where creditors are given something in return for the rights they are losing. Creditors’ trust in the process, fragile at the best of times, would be further eroded if companies could on the one hand get the benefit of a CVA, but on the other refuse to honour their own obligations under it, should that suit them at a later date. Mathew Ditchburn is a partner and Ben Willis is an associate in Hogan Lovells’ real estate disputes team. They acted for the successful landlord in the case.