Company voluntary arrangements enable companies to restructure debt and continue trading for the benefit of their creditors as a whole. But landlords have become increasingly hostile to what they regard as the aggressive use of CVAs against them. So they will be bitterly disappointed by the outcome of the litigation in Lazari Properties 2 Ltd v New Look Retailers Ltd [2021] EWHC 1209 (Ch).
The case concerned the CVA approved by New Look’s creditors following projections that the company would run out of cash by October 2020 as a result of the coronavirus pandemic. The creditors had been divided into different categories and a number of landlords considered that the arrangement was “unfairly prejudicial” under section 6(1) of the Insolvency Act 1986 because it wrote off rental and service charge liabilities, turned annual rents into turnover rents, released “keep open” covenants, despite the move to turnover rents, and created new termination rights in favour of both parties, as well as making other changes to the leases.
The landlords argued that it is unfairly prejudicial to compromise the claims of a sub-group of creditors where the requisite majority at the creditors’ meeting is achieved by the votes of creditors unimpaired by the CVA, or who receive substantially different treatment. But the judge rejected the notion that basic principles of good faith and equality mean that differentiation is inherently unfair. The authorities had established that differential treatment is a cause for enquiry, but not inherently unfairly prejudicial. And the inclusion of the cross-class cram-down power in the Corporate Governance and Insolvency Act 2020 supported that view.
In considering whether an arrangement is unfairly prejudicial, the courts have developed two tests: the “vertical” and “horizontal” comparators. The former compares the position that a creditor would occupy in a liquidation with its position under the CVA. And the latter involves a comparison between creditors to decide whether any imbalance is disproportionate and whether differential treatment can be justified, for example by the need to secure business continuity by paying essential suppliers.
Discovery (Northampton) Ltd v Debenhams Retail Ltd [2019] EWHC 2441 (Ch); [2019] PLSCS 186 had established that reductions in rent are not necessarily unfair. And, although the judge saw considerable force in the argument that a permanent or long-term reduction in rent imposed on landlords without an option to terminate would be inherently unfairly prejudicial – if achieved by votes from creditors who did not suffer the same treatment – that was not the case here. The landlords had been offered the choice between terminating their leases or continuing on reduced rent and modified terms.
The answer to objections that, in certain respects, some reduced rents under the CVA were below market rates also lay in the landlords’ rights to terminate. Furthermore, the judge disagreed with, or rejected, the notion (supposedly established in Debenhams) that modifications cannot reduce rent below market rates – certainly insofar as the period after a lease could have been terminated is concerned.
The rights of both the landlords and the secured creditors had been substantially impaired by the CVA. But a formal insolvency process would have resulted in a significantly worse recovery for the secured creditors and virtually no recovery for the landlords. And, finally, although the ordinary unsecured creditors and a very restricted number of landlords were substantially unaffected, the payments to them were necessary for business continuity. Furthermore, the CVA would still have been approved, even if their votes were discounted.
Allyson Colby is a property law consultant
