CVAs: Volunteering to be fleeced

The so-called “year of the CVA” is now well into its second year, fuelled by the use of this insolvency process to compromise the rights of landlords while leaving other creditors intact. In this first of a two-part article summarising their recent Blundell lecture, Stephen Jourdan QC and Mathew Ditchburn examine the legal backdrop. The company voluntary arrangement (CVA) was introduced by the Insolvency Act 1986 (the 1986 Act), following recommendations made by the Cork Committee in 1982. Interestingly, the committee thought that CVAs would only be used for simple arrangements by small companies. The reality has proved quite different. Part 2: CVAs: Unwilling to be fleeced The central features of a CVA regime are set out in section 1(1) of the 1986 Act: “The directors of a company (other than one which is in administration or being wound up) may make a proposal under this Part to the company and to its creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs…”. The proposal may also be made by a liquidator or administrator, but it must in any case provide for an insolvency practitioner to act as “nominee” in relation to the arrangement for the purpose of overseeing its implementation. There is no definition of “scheme of arrangement of its affairs”. It has been interpreted very widely, although it does require an element of give and take between creditors: Commissioners of Inland Revenue v Adam & Partners Ltd [2002] BCC 247. That inbuilt flexibility has enabled retail tenants to use CVAs to compromise their future leasehold liabilities by closing stores and cutting rents – sometimes called a “landlord CVA”. What a CVA cannot do Neither the company nor its creditors may approve any proposal or modification which affects the rights of a secured creditor to enforce its security, except with their agreement. It has been held that a scheme of arrangement cannot impose new obligations, as opposed to revoking or altering existing obligations: Re Apcoa Parking Holdings GmbH [2015] 4 All ER 572. This is important in the context of landlord CVAs. A lease is a relatively long-term contract, so a CVA can alter the landlord’s rights without imposing a new contract. Conversely, it would not be possible for a CVA to require a supplier under a short-term arrangement to continue making supplies after the current contract ends. The effect is that landlords are treated differently to other creditors, whose rights are rarely affected over the long term (if at all). It has been said that a CVA cannot affect proprietary rights. In Khan v Permayer (unreported, Court of Appeal, 22 June 2000) the judge commented in relation to individual voluntary arrangements (IVAs): “Decided cases have also made it plain that an individual voluntary arrangement does not affect the proprietary rights of the creditor”. If that is right and it applies to CVAs, then arguably a CVA cannot provide for the determination of a lease, only the release of the tenant’s contractual obligations. (A similar point is currently being considered by the High Court in Discovery (Northampton) Ltd and others v Debenhams Retail Ltd and others.) The process The nominee must submit a report to the court within 28 days of a CVA being proposed, giving their opinion on various matters. The court does not review the document but it has been held that nominees owe a duty to ensure that the proposals are “fair to all the creditors of the company and to the company itself” and “to try to structure an arrangement that will be capable of achieving the necessary statutory majorities and will not be unfairly prejudicial to any creditor”: SISU Capital Fund Ltd v Tucker [2006] BCC 463 and Mourant & Co Trustees Ltd v Sixty UK Ltd (in administration) and others [2010] EWHC 1890 (Ch); [2010] 2 EGLR 125. The proposal is then sent to creditors and the nominee summons a meeting not less than 14 days later for the creditors to decide whether it is approved. Under rule 15.34 of the Insolvency (England and Wales) Rules 2016 (the 2016 Rules), a CVA proposal can be approved by 75% by value of the creditors (including 50% of the unconnected creditors) who vote. After the decision, the chair of the meeting (usually the nominee) must report the result to the court and give notice to those affected. If the CVA is approved, then it binds everyone who was entitled to vote, or would have been entitled had they been given notice of it. An approved CVA is analogous to a contract and is interpreted applying principles of contractual interpretation. However, because a CVA is not actually a contract, not all the rules applicable to contracts apply. In Re SHB Realisations Ltd [2018] BCC 712, for example, the court held that the law relating to unenforceable contractual penalties “was not designed to apply to hypothetical contracts of this kind”. Guarantors In Johnson v Davies [1998] 3 EGLR 72, the Court of Appeal expressed the view that it was legally permissible for an IVA to release someone liable for the same debt as the debtor entering into the arrangement. This was followed in Prudential Assurance Co Ltd v PRG Powerhouse Ltd [2007] EWHC 1002 (Ch); [2007] 3 EGLR 131, in which the court held that a CVA may impose an obligation on a landlord, enforceable by the tenant company, not to enforce rights against a guarantor. However, the release of the solvent guarantor in that case was held to have unfairly prejudiced the landlord. The issue must probably be regarded as settled up to the level of the Court of Appeal in the light of Johnson. If the point reached the Supreme Court, it could be argued in line with the older authority of RA Securities Ltd v Mercantile Credit Co Ltd [1994] 2 EGLR 70 that if a guarantor wants to be released then it should propose its own CVA, not ride on the back of the tenant’s CVA. Challenging a CVA An application to the court may be made by a creditor challenging a CVA on the grounds that (1) the arrangement unfairly prejudices the interests of a creditor; and/or (2) there has been some material irregularity at a meeting or in relation to the voting procedure. These grounds are the subject of the second part of this article.  An application asserting unfair prejudice or material irregularity cannot be made more than 28 days after the chair reports to the court (or, if later, 28 days after the date on which the creditor became aware that the procedure had taken place). Where the court is satisfied as to either of the grounds, it has wide powers to revoke or suspend any decision, or to give a direction leading to further meetings or further decisions. Reduction in future rent Almost all landlord CVAs compromise the tenant’s liability to pay future rent, ie they allow the company to trade from leasehold premises at less than the contractual amount provided for in the lease. As explained above, the directors of a company may make a CVA proposal for “a composition in satisfaction of its debts” or for “a scheme of arrangement of its affairs” and, once approved, a CVA binds everyone who was entitled to vote at the meeting. Rule 15.28(5) of the 2016 Rules says that every “creditor… who has notice of the decision procedure is entitled to vote”. Do the company’s “affairs” include future rent, and do the “creditors” include landlords who are entitled to receive it? In Doorbar v Alltime Securities Ltd [1996] 2 EGLR 33, the judge said in relation to an IVA that “a scheme of arrangement of affairs” was wide enough to encompass a liability to make future payments of rent under a lease. The same point was put to the same judge in relation to CVAs a year later and unsurprisingly he came to the same view: Cazaly Irving Holdings Ltd v Cancol Ltd [1995] EGCS 146 (commonly known as Re Cancol. The court held that the meaning of “creditor” was wide enough to include someone entitled to receive future rent (a point also being determined in the Debenhams case), and that the purpose of CVAs was to provide a cheaper and more commercially attractive alternative to liquidation. Claims to future rent were susceptible to being compromised in liquidation and so they ought to be under a CVA.  Lease segmentation It is another common feature of landlord CVAs that the treatment of each lease depends on the category in which it is placed, eg category 1 (profitable) stores are unimpaired, category 2 (middling) stores trade at reduced rents and category 3 (loss making) stores are closed altogether. Such differential treatment has been considered by the courts, and while it may be a factor, it is not something which on its own has been said to make a CVA unfair. (It is, however, to be considered in the Debenhams case whether landlords can be treated less favourably than other types of creditor.) The judge in Doorbar found that unfairness could arise from an uneven spread of prejudice between one creditor and another. In Re Cancol, one landlord was entitled to have its rent paid in full, whereas another only received rent until the date that the company vacated. The court said that this was not unfair; it was acceptable to close stores that were no longer used and pay rent for valuable properties needed to earn the profits envisaged by the CVA. In PRG Powerhouse, the court said that in some cases differential treatment may actually be necessary to ensure fairness, eg where one creditor has greater rights so it would be unfair to treat them the same as others. It may also be necessary to favour some creditors in order to secure the continuation of the company’s business. This is often used by companies as a justification for paying suppliers in full whilst compromising the rights of landlords.  In relation to dilapidations, the landlords’ concern is often not so much that they are being treated differently, but that they are being treated the same as each other, regardless of the size of their claims. Typically, there is a full release in return for an additional percentage of the rent. Landlords’ termination rights Where a CVA imposes rent reductions on landlords, a right for those landlords to determine the lease is usually given in return. The reason for that can be derived from the judgment of Lord Neuberger in the Court of Appeal decision of Thomas v Ken Thomas Ltd [2007] EWCA Civ 1504; [2007] 1 EGLR 31: “It strikes me that, at least normally, it would seem wrong in principle that a tenant should be able to trade under a CVA for the benefit of its past creditors, at the present and future expense of the landlord. If the tenant is to continue occupying the landlord’s property for the purposes of trading under the CVA (and hopefully trading out of the CVA) he should normally, as it currently appears to me, expect to pay the full rent to which the landlord is contractually entitled”. The approach of giving landlords rights to terminate leases gets around this issue (so it is said; this is another point to be considered in Debenhams) by making it a matter for their election whether the tenant can trade at a reduced rent or must return the premises. Even if that is correct, the landlord’s termination right is usually limited to a short period and so may be difficult to operate in practice. Exercising the right also invariably results in a full and final release of the tenant’s liabilities, whether past, present or future. Termination is stated to take effect either pursuant to an agreement to surrender (without there being any validation procedure under the Landlord and Tenant Act 1954) or as a forfeiture in relation to which the tenant agrees not to seek relief. Property lawyers may be curious as to how these work in practice. Tenant’s termination rights Termination rights are often given to the tenant as well, although, as indicated above, it might be queried given Khan whether a CVA can be used to destroy an estate in land.  Two other points arise. First, the tenant invariably gets a full and final release under the CVA of all liabilities, past, present or future, when exercising its termination right. Secondly, the likely possible effect of such provisions is that business rates liability will fall to the landlord. Moratoria and full and final releases Unlike in administration or liquidation, there is no moratorium against enforcement action in the case of a CVA, unless it is a small company. However, a landlord CVA will typically include a contractual moratorium preventing landlords from enforcing their rights, including by forfeiting on the ground of the CVA proposal itself. Interestingly, in Thomas, Lord Neuberger said that a CVA “is concerned with obligations, not remedies”. Perhaps for that reason, most landlord CVAs also provide for a full and final settlement of all the company’s liabilities to landlords, not just rent.  Voting Landlords’ claims are usually for future rents and so treated as unliquidated or unascertained debts. Landlord CVAs include a complex formula for calculating each landlord’s claim for voting purposes based on their ability to mitigate loss by reletting the premises. The common practice is then to apply a further discount of 75%. The justification given for this is the wide discretion in rule 15.31(3) of the 2016 Rules: “…a debt of an unliquidated or unascertained amount is to be valued at £1 for the purposes of voting unless the… chair… decides to put a higher value on it”.  The result is that the votes of compromised landlords are usually swamped by others and they are incapable of achieving the 25% required to vote down the CVA. In Chittenden v Pepper [2006] EWHC 1511 (Ch); [2006] 2 EGLR 7, the landlord argued that the chair of the creditors’ meeting had a duty to estimate a minimum value for their dilapidations claim for voting purposes, rather than valuing it at £1. The court held that: “The chairman should not speculate. Nor is he obliged to investigate the creditor’s claim. But he must examine such evidence, and I do not use the word in any technical sense, as the creditor puts forward and any relevant evidence provided by any other creditor or the debtor. If the totality of that evidence leads him to the conclusion that he can safely attribute to the claim a minimum value higher than £1 then he should do so”. Accordingly, the chair must consider whatever evidence is available and attribute a minimum value of more than £1 to the landlord’s claim if it is safe to do so. If that process is followed then query whether the further 75% discount is arbitrary and unnecessary. It might also be said that rent is different to the dilapidations claim in Chittenden as at least some loss might be assumed. Stephen Jourdan QC is joint head of Falcon Chambers and Mathew Ditchburn is head of real estate disputes at Hogan Lovells