Leases: corporate rescue at landlords’ peril

Julie Gattegno reviews the landscape following three High Court rulings on CVAs and restructurings involving New Look, Regis and Virgin Active. Like buses, three major court decisions on corporate tenant restructuring of lease liabilities were handed down within seven days of each other in May in the ad hoc landlord group challenges to the Regis UK Ltd and New Look Retailers Ltd company voluntary arrangements and the restructuring plan proposed under the new Part 26A (Companies Act 2006) by three Virgin Active group companies. With the level of Covid-rent debt expected to be more than £5bn and the cliff edge, from the end of the moratorium on forfeiture and other restrictions, in sight, corporate restructuring is going to come to the fore, so these decisions will have important consequences. Despite the landlords’ success in the Regis challenge on the specific facts of that CVA, these decisions have left landlords reeling from what is largely perceived as a field day for tenants to disregard landlords’ rights when restructuring. The objection from landlords No one would deny that a corporate rescue culture is required, particularly in these unprecedented times. But the issue for landlords is the use of CVAs and, now, restructuring plans, where it is believed landlords take an unfair share of the pain to assist the company’s survival by tenants stripping landlords of their contractual rights beyond what is considered necessary, while leaving other creditors unaffected. So, certain tenants that overextended, were mismanaged or that had paid significant returns to members in good times can escape future liabilities and start afresh with impunity. And while secured lenders (and shareholders) may be subject to some compromise, they are also entitled to the upside if the value of the company increases post-restructuring. Landlords, on the other hand, are expected to accept the compromises on the basis that this provides a better outcome than their position as unsecured creditor if the tenant is insolvent – or take their properties back. While the legislation allows this approach, it is this form of restructuring of lease liabilities, often coupled with the tenant’s refusal to engage and/or share vital information relating to the restructuring, that has prompted landlords to challenge recent CVAs and plans. The recent judgments given by Mr Justice Zacaroli in Lazari Properties 2 Ltd and others v New Look Retailers Ltd and others [2021] EWHC 1209 (Ch); [2021] PLSCS 96 and Carraway Guildford (Nominee A) Ltd and others v Regis UK Ltd and others [2021] EWHC 1294 (Ch) show that landlords have an uphill battle successfully challenging a CVA, though the revocation of the Regis CVA shows that it can be done. Although many of the arguments raised in these cases were unsuccessful (see the table below for a summary of key points), what is clear is that, if corporate tenants give members or subordinated creditors preferential treatment without proper justification, the CVA is likely to be unfairly prejudicial. Likewise, if the value of unaffected creditors’ claims swamps the votes of compromised creditors, there may be, in Zacaroli J’s words, “strong grounds” to argue that the CVA is unfairly prejudicial. This should at least require more careful thought by the company and the nominees appointed on the CVA (who equally want to avoid a personal claim against them as happened in Regis) about the terms of the CVA proposal, any wider restructuring and the treatment of unimpaired creditors and members. With landlords still smarting from the judgment in New Look, the decision of Mr Justice Snowden in Re Virgin Active Holdings Ltd and others [2021] EWHC 1246 (Ch) (see below for details) came hot on its heels and did nothing to quell landlords’ concerns. Key findings in Virgin Active Determining the “relevant alternative” (ie the most likely outcome if the plan is not approved) and what distribution would be available for unsecured creditors in the relevant alternative is key to establishing whether landlords are “in the money” and to considering the position under the plan. The court will determine that question solely by looking at what the relevant alternative is “now”. Market testing is not necessary to establish the “relevant alternative”. If no assets are available for unsecured creditors, so landlords are “out of the money”, the condition for cross-class cram-down that no creditor is worse off in the relevant alternative than under the plan is very likely to be satisfied. If landlords are “out of the money”, any objections to the plan carry little to no weight on exercise of the court’s discretion to sanction. It is for the creditors “in the money” to decide how to distribute the benefits of the restructuring, though circumstances could arise where sanction is refused where differential treatment of creditors was done “arbitrarily or capriciously” between different classes all “out of the money”. A battle between assenting and dissenting creditors in different classes all “in the money” would need to be closely looked at on sanction. Restructuring plans Restructuring plans provide for a “holistic” restructuring of a company – ie, a much broader restructuring which includes secured lenders and members, as well as unsecured creditors. A plan is far more powerful than a CVA because: a) it includes the cross-class cram-down (see “Cross-class cram-down”, below); and b) for a class of creditors, like compromised landlords, who are “out of the money” in the relevant alternative (ie the value breaks with creditors who rank in priority to the unsecured creditors), it provides limited scope for challenge following the judge’s findings in Virgin Active. This means that restructuring plans may be far more attractive to some corporate tenants despite increased expense at the outset, as the ability to use the cross-class cram-down and the greater certainty a plan affords may warrant that outlay. The court’s decision on costs (if not agreed by the parties) in Virgin Active will also be highly relevant. Virgin Active was the first time a plan was used to restructure lease liabilities since the legislation came into force last year. It adopted the same approach taken in landlord-only CVAs by rewriting lease terms, releasing liability for certain properties and guarantees, and included write-off of Covid arrears, which is now a feature of current CVAs. Landlords were motivated to challenge various aspects of the plan, including whether the conditions for cross-class cram-down were satisfied and whether the plan was fair and should be sanctioned by the court. As a result, the case garnered immense interest, as landlords looked to see how the court would determine the issues raised. Ultimately, the court sanctioned the plan. One of the key issues facing landlords is that, where they are “out of the money”, there will be limited scope to challenge given the judge’s findings that, in these circumstances, landlords’ objections should carry little to no weight. Of course, it will always be fact-specific, but this does create a big hurdle. Cross-class cram-down Where one or more classes of creditors (or members) vote against the plan, the court can still sanction the plan if two conditions are met: Condition A – The court is satisfied that, if the plan was sanctioned, none of the dissenting class would be any worse off than they would be in the event of the “relevant alternative” – which is whatever the court considers would be most likely to occur to the company if the plan is not sanctioned, ie administration, liquidation or continuing as a going concern. ondition B – The plan has been agreed by 75% in value of a class of creditors (or members) voting who would “receive a payment” or have a “genuine economic interest” in the company in the event of the “relevant alternative”, ie the approving class is “in the money”. What’s in store? It might be thought that these judgments will embolden tenants to continue pushing the envelope on the terms of CVAs and plans, particularly in light of the court’s findings that lease modifications are largely acceptable providing landlords are given a right to terminate. But tenants will have to weigh up a number of factors when deciding how far to push landlords when restructuring: Given the level of Covid arrears, will the company be able to get a CVA approved without offering terms that will be acceptable to the vast majority or will it pursue a plan so it can use cross-class cram-down? If the company does have the necessary votes from unaffected/preferentially treated creditors then, depending on the facts, this may pose a risk of a vote swamping argument and greater risk of challenge. The risk of any challenge, whether or not successful, is still a major concern for tenants, not least the impact on the release of future funding if a challenge is launched. Restructuring plans may offer tenants an alternative option with greater certainty, but the potential cost for small and medium-sized enterprises will be a major concern. Nevertheless, if a CVA is not viable, or a wider restructuring is required, companies may well choose this route, particularly given the court’s approach to cross-class cram-down and sanction in Virgin Active, which may give tenants comfort. Whether tenants choose a CVA or plan, there’s a limit to how far they can push lease modifications for those leases that are not paying a full contractual rent in the future. Otherwise, more landlords will exercise their termination rights, leaving the tenant unable to achieve future forecasts, at least not without the additional expense of finding new properties where it will have to negotiate new leases on no doubt very different terms. The future of new leases Pre-pandemic, structural changes were gradually taking place in the retail/leisure sectors, with the move to shorter-term leases and turnover rents and other rent structures, which the pandemic has accelerated. If turnover leases become the norm in these sectors, this may well alter the look of future restructuring. The need to compromise lease liabilities where rent is pegged to the property’s turnover, so there’s no question of being overrented, arguably falls away. Whatever the lease structure agreed with tenants for new leases, landlords will need to carefully consider what security can and should be required for providing their property in return for the tenant fulfilling its contractual obligations (not just rent), to try to ensure, in the words of the landlord group’s counsel in Virgin Active, a seat at the table as opposed to “being lunch”. CVAs cannot compromise secured creditors and, as the court decisions show, it is creditors “in the money” who call the shots. That will inevitably be the secured creditors, although where value breaks in the relevant alternative will still depend on the value of the company and the priority of the relevant secured creditors. The question is how lease liabilities can be adequately secured. While rent deposits and bank/third-party guarantees are options frequently used, and the right to forfeit for non-payment is a form of security, now is the time to consider new forms of security for lease liabilities so landlords can claw back some control. Landlords’ performance breaks are another potential option, enabling landlords to terminate if the tenant fails to achieve certain financial metrics, married with suitable contractual provisions for key financial information to be given. Imposing a contractual obligation on the tenant to provide key financial information should also be considered whatever the lease structure, possibly with express provisions around the information to be provided if the tenant proposes a CVA or plan. Short-term contracted-out leases and/or mutual break options provide greater flexibility for both parties and, while this may impact values, should give landlords greater control over their properties compared with a restrictive CVA/plan termination right if the worst happens. Collaboration and compromise Good relationships, engagement and early requests for information from tenants will no doubt work to both parties’ advantage, as well as creating a paper trail for landlords whose attempts to engage are blocked, meaning that legal action cannot be avoided. Likewise, collaboration with other landlords means that, jointly, landlords may have greater weight to get engagement and information early on. With compressed timescales in both CVAs and plans, this can be crucial to assist with timing and costs. Ultimately, what landlords want to see is a fair compromise of all creditors; for all creditors to share the pain and any future gain. In the meantime, the outcome of an appeal in New Look and the other CVA challenges in train will be keenly awaited. Julie Gattegno is a partner at CMS Photo © Shutterstock