2018: The Year of the Company Voluntary Arrangement (“CVA”)
Mark Banham, Associate in the Property Litigation team, explains the key features of a company voluntary arrangement (“CVA”) and considers the advantages and disadvantages of CVA’s and the tension that CVA’s often create between landlords and tenants.
2018 has frequently been referred to as “the year of the CVA” due to the sheer number of retailers and restaurants seeking company voluntary arrangements (“CVAs”) to restructure their estates with the aim of avoiding insolvency.
Notable examples of CVAs hitting the headlines in 2018 include House of Fraser, Jamie’s Italian, Carluccio’s, Prezzo, New Look, Byron, Mothercare and Carpetright. The reasons for the rise in the number of CVAs are multiple and complex but they include: –
- rising wages
- rising business rates
- a drop-in consumer confidence hitting sales
- traditional “bricks and mortar” retailers facing competition from online retailers; and
- uncertainty surrounding Brexit
With retailers continuing to find trading conditions tough it is likely that further CVAs will follow in 2019.
Whilst there has been much focus on the tension that CVAs cause between landlords and tenants there is little attention on what exactly a CVA is and the advantages and disadvantages (for businesses) of the CVA procedure. In this article we seek to address these points.
What is a CVA?
A CVA is a procedure which a company may use to address its financial difficulties.
It is a compromise made between a company and its unsecured creditors where the existing rights of the company’s creditors are replaced by new rights, as set out in the CVA.
Typically, a CVA will include a reduction or restructuring of the company’s debts which is part of a more complicated exercise of balancing the interests of many different parties.
A CVA does not affect the rights of secured creditors (frequently the banks) but will bind all unsecured creditors of a company, provided that the required majority of creditors vote in favour of the proposals.
A CVA requires the approval of more than 50% of the company’s shareholders and at least 75% of its creditors to be passed. Once a CVA has been passed it creates a statutory contract between the company and its creditors.
The threshold of at least 75% of creditors voting in favour of the CVA is a high one. In the Mothercare CVA, which was approved in June 2018, one of Mothercare’s subsidiaries (Childrens World) failed to achieve the required 75% whereas the other subsidiaries did. The impact of this is that the CVA for Childrens World cannot go ahead while the CVAs for the other Mothercare companies are proceeding.
Key Advantages of CVAs
When a retailer is facing dire financial circumstances the two options available to it are typically entering a CVA, or the company entering administration (like HMV and so many others in 2018).
Shareholders, management, suppliers, employees and landlords will almost always favour a CVA over administration as the advantages of a CVA are that:
- It allows the company to continue to trade with the aim of addressing its cash-flow problems to avoid entering into administration or liquidation;
- It allows a company’s creditors to have input into the process, which is not usually the case with either administration or liquidation;
- The procedure provides better prospect of a creditor receiving payment of the debt owed than either administration or liquidation, when they frequently receive nothing;
- The company’s directors are left in control of the company so that they continue to run the business with the aim of returning the company to profitability; and
- It often avoids or reduces the job losses that tend to accompany an administration or liquidation;
Shareholders prefer CVA’s as survival of the company is promoted, management and employees prefer it as they are more likely to retain their jobs, suppliers prefer CVAs as they have a better chance of recovering the debt that the company owes and landlords may prefer a CVA as a reduced rent can be preferable to receiving no rent, having a vacant unit and taking on the liability to pay business rates (see further below).
Disadvantages of a CVA
The disadvantages of a CVA are that:
- Not all CVA’s are successful and it is not uncommon for CVAs to fail (as in the case of BHS, JJB Sports and Austin Reed) leading to the company entering into administration or liquidation. If this happens then some creditors are left in a worse position than they would otherwise have been;
- When CVA’s are drawn up they often do not go far enough in terms of streamlining a company and cutting its costs, which ultimately makes the chance of a turn around less likely;
- Talented members of staff often leave a company when warning signs of its financial difficulties appear. A strong management team with knowledge of the business is one of the most important factors in restricting a business and recruiting is very difficult when a company is going through an insolvency process;
- Creditors that disagree to the CVA proposal will be bound if the required majority of creditors and shareholders vote in favour of the CVA; and
- Creditors are left with only a claim to a share of the fund that is put together at some point in the future. This can lead to cash-flow implications for the creditor.
Impact of CVA’s on Landlords
Landlords are often in the worst position of all creditors under CVA’s as the proposals often allow tenants to try and save their business whilst paying a reduced or even a nil rent. Under a CVA a retailer can “opt out” of lease agreements with landlords in respect of under-performing stores and can vacate them whilst also agreeing large rent reductions across the rest of their portfolio.
This process is seen as very unfair on landlords in that it forces a landlord to take the pain for the failure of the company whilst giving them very little say in whether the CVA goes ahead.
The House of Fraser CVA was one of 2018’s most contentious CVA’s, as evidence of landlords’ discontent and of landlords seeking to fight back. In that case a number of property company landlords (including Legal & General and Westfield) grouped together and sought to block the proposed CVA. The landlords sought legal advice and were advised that they had a strong case for opposing the CVA on the basis that they were being treated unequally to other creditors e.g. shareholders, banks and bond holders.
Despite a huge backlash from those landlords the House of Fraser CVA was approved, which one may argue is be evidence that the current legislation is skewed in favour of retailers and non-landlord creditors and is in real need of reform. The other point of view is that very few CVA’s this year have failed to achieve the 75% threshold and that CVA’s are and will continue to be approved as they represent the lesser of two evils.
There have, however, been recent reports that landlords are considering re-letting stores where retailers are in occupation under CVAs pursuant to which they are paying reduced rent to companies in better financial positions. Under the terms of a CVA landlords can choose to break leases if 60 days’ notice is given. This can be tempting for landlords with properties in prime locations.
What are we likely to see with CVAs in 2019?
Whilst the difficult trading conditions and Brexit uncertainty continue, it is likely that 2019 will see more household names entering into CVA’s.
Some alternative solutions are, however, being discussed, with Colliers International having recently proposed a five-point model to change the dynamic between landlords and tenants, aiming to avoid the need for CVAs at all. Under that five-point model five-year leases would become standard, in place of historic, longer-term leases, and rents may be based solely on the turnover of the store in question to avoid retailers facing bills that they cannot pay. Such short-term leases give flexibility to both landlords and tenants, but they make investment in high quality fitting-out less attractive. You can read our 19 December 2018 article by Partner, Richard Higgs, on turnover rent for more information.
It remains to be seen whether the CVA procedure will be reformed or whether alternatives, such as that mentioned above, will be adopted. For now, however, it looks like the CVA is here to stay.
Get in Contact
If you are a landlord concerned about the financial position of one or more of your tenants, if you are a tenant struggling to pay rent and/or other debts or if would like any further information on CVAs within a landlord and tenant context then please contact Mark Banham: [email protected].