CVAs can compromise landlords’ claims for future rent (Discovery (Northampton) Ltd and others v Debenhams Retail Ltd and others)

CVAs can compromise landlords’ claims for future rent (Discovery (Northampton) Ltd and others v Debenhams Retail Ltd and others)

Kate Stephenson, partner at Kirkland & Ellis International LLP, predicts that Debenhams’ High Court victory will become the leading case on company voluntary arrangements (CVAs).

Discovery (Northampton) Ltd and others v Debenhams Retail Ltd and others [2019] EWHC 2441 (Ch)

What are the practical implications of this decision?

In a resounding victory, and what will no doubt become the leading case on CVAs, this seminal judgment confirms that a CVA can compromise landlords’ claims for future rent, upholding the CVA as valid and enforceable—subject to the removal of provisions waiving landlords’ right to forfeiture. It offers welcome recognition that companies have legitimate reasons for the differential treatment of landlords and other unsecured creditors, such as suppliers. 
 
The first test case in the current wave of CVAs, this judgment provides major comfort to companies in financial distress with burdensome leasehold estates that a CVA remains a potential route to restructure and compromise their rent obligations.
 

The market will adjust to reflect the court’s ruling that a CVA cannot vary a right of forfeiture (because it is a proprietary right). There may, however, be grounds to say that landlords have waived their right to forfeit, including where they voted in favour of the CVA or treat the lease as continuing post-CVA (including by accepting rent). 

What was the background?

Debenhams, one of the largest UK retailers, was acquired by a creditor-owned SPV via pre-pack administration in April 2019. Shortly thereafter, it proposed a CVA, which was approved by creditors in May 2019, by approximately 95% by value of creditors voting. Debenhams’ CVA compromises rent payable to landlords—across six different categories—and business rates. The CVA was challenged by a group of six related landlords—the challenge was funded by Sports Direct, a former major shareholder of Debenhams. The challenge was brought on five grounds.
 
For those less familiar—a CVA may be challenged on the grounds that it unfairly prejudices the interests of a creditor (among others) or that there has been a material irregularity. The authorities identify two useful ways of assessing whether a CVA is ‘unfairly prejudicial’:

  • the ‘vertical comparator’, which compares the projected outcome of the CVA with the projected outcome of a realistically available alternative process (usually liquidation). This sets a ‘lower bound’ below which a CVA cannot go
  • the ‘horizontal comparator’, which compares the treatment of creditors under the CVA as between each other. While there is no prohibition on differential treatment, any differential treatment must be justified

Recent years have seen a notable increase in UK retail and casual dining companies using CVAs to deal with burdensome leases and other liabilities.

What did the court decide?

The court’s judgment on each of the applicants’ grounds of challenge was as follows.

Ground one

A landlord is not a ‘creditor’ for future rent (within the scope of the Insolvency Act 1986 (IA 1986))—therefore, its claims cannot be compromised in a CVA.
 
Decision—future rent is ‘a pecuniary liability (although not a presently provable debt) to which the company may become subject’. While the term of the lease endures, the company is ‘liable’ for the rent, and the fact that in the future the landlord may bring the term to an end by forfeiture does not mean that there is no present ‘liability’. Accordingly, as a matter of jurisdiction, ‘future rent’ can be included in a CVA.
  

Ground two 

A CVA cannot operate to reduce rent payable under leases, because it is automatically unfairly prejudicial to do so, or because there is no jurisdiction to do so (because the CVA imposes ‘new obligations’ (including to make the premises available on new terms), outside the scope of what a CVA can impose, as a matter of jurisdiction).
 

Decision—as a matter of principle, it was not ‘unfair’ that a landlord might receive less than its contracted for rent in certain circumstances. The court noted unchallenged evidence that valuation advice was that all stores were ‘over- rented’. A CVA that reduces rent under an existing lease is not automatically ‘unfair’—‘if the creditor/landlord does not like the variation [under the CVA] he can bring the obligation to an end’. A CVA varies existing obligations, it does not create new ones.

Ground three 

The right of forfeiture is a proprietary right that cannot be altered by a CVA. The right of forfeiture is a landlord’s unilateral right to terminate a lease in the event of a breach by the tenant. Debenhams’ CVA includes provisions to waive landlords’ right of forfeiture, which might otherwise have been triggered by the CVA.
 
Decision—a CVA cannot vary a right of re-entry. The right of re-entry is property belonging to the landlord. On this ground alone, the court agreed with the applicant landlords—varying the right of forfeiture would exceed the power granted by IA 1986. Accordingly, the court ordered that the relevant provisions which waive landlords’ right to forfeit be deleted from the CVA under the severance provisions of the CVA—however, Debenhams’ CVA otherwise remains valid and enforceable.
 

Ground four

The applicants are treated less favourably than other unsecured creditors without any proper justification (Debenhams’ CVA varies rents and business rates but does not compromise claims of other unsecured creditors like suppliers).
 
Decision—differential treatment of landlords from suppliers is justified by the need for business continuity (and itself embodies a principle of ‘fairness’). The landlords were providing long-term accommodation at above-market rates, while suppliers were providing goods and services on an order-by-order basis which, given competitive pressures, were likely to be at market rates. There would have been ‘unfairness’ if landlords were expected to take reductions in rent to below the market value of the premises concerned, but none of the applicants suggested that was the case.
 

Ground five 

The CVA fails to comply with the content requirement of rule 2.3(1) of the Insolvency Rules 2016 by not referring to potential antecedent transaction claims in the CVA proposal (Debenhams had granted security in connection with new money in March 2019, a condition of which was the granting of security in respect of its existing revolving credit facility and notes). The applicant landlords argued that the CVA should have set out that, if the company were to enter administration or liquidation, circumstances existed which might give rise to potential claims under IA 1986, s 239 or s 245.
 
Decision—evidence for Debenhams had shown why it had granted security in respect of the revolving credit facility and the notes—it was a non-negotiable condition of the grant of new money. The case that the directors might (in granting security for existing indebtedness in order to obtain new money) have been influenced by a desire to prefer the financial creditors ‘did not have legs’. The account in the CVA was fair, alerting the creditors as a whole to the existence of the issue and enabling any creditor to ask further questions before or at the meeting. There was no evidence to conclude that the prospect of a modest ‘claw-back’ would have influenced compromised creditors to view the CVA differently.
 
All of this remains subject to appeal, if any.
 
Kate Stephenson has extensive restructuring and insolvency experience, including advising strategic investors, debtors and creditors in all forms of national and international financial restructurings and insolvencies. 
 
Kirkland advise a committee of Debenhams’ bondholders who are now lead shareholders following a debt-for-equity swap via pre-pack administration in April 2019. Kirkland also advised on a majority of other recent high-street CVAs, including House of Fraser (creditor-side) and advising Toys ‘R’ Us, Prezzo, Homebase, Paperchase, A.S.Adventure (comprising Snow+Rock, Runners Need and other brands), Travelodge, LA Fitness and Fitness First on their respective CVAs. 
 
Interviewed by Kate Beaumont. 
 
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor. 
 

Related Articles:
Covid-19 image
DHSC publishes findings from coronavirus (COVID-19) REACT study
Covid-19 |
1 min read
Covid-19 image
DHSC publishes JCVI statement on the AstraZeneca vaccine for coronavirus (COVID-19)
Covid-19 |
1 min read
Covid-19 image
Visas extended for frontline health and care workers amid coronavirus (COVID-19)
Covid-19 |
1 min read
Corporate Law image
Market Tracker weekly deal round-up—8 April 2021
Corporate Law |
2 min read
Latest Articles:
INSOL Europe/Lexis®PSL launch Joint Project on ‘How EU Member States recognise insolvency and restructuring proceedings of a third country’
Restructuring and Insolvency |
3 min read
sun
Sailing into the sunset—cruise port operator given go-head for scheme of arrangement (Re Port Finance Investment Ltd)
Restructuring and Insolvency |
9 min read
New criminal liability for deficient defined benefit pension schemes—the impact on restructurings and corporate transactions
Restructuring and Insolvency |
10 min read
Lexis®PSL announces variations to R3 standard form COVID-19 CVA proposal (Northern Ireland) for administration exits and debt waivers
Restructuring and Insolvency |
7 min read
About the author:
Zahra Ali

Zahra started working as a paralegal at Lexis Nexis in Banking and Insolvency teams in April 2019. Zahra graduated with a 2.1 honours in a BA French and Spanish, completed the GDL at BPP University and is seeking some experience before commencing the LPC. She has undertaken voluntary work for law firms in London, Argentina and Colombia.