Can a CVA bind a landlord in respect of future rents? Is the landlord a creditor in respect of future rent? What about the right to forfeit; can a CVA modify that right? Is compromising rent under a CVA automatically unfair to landlords when other trade creditors are paid in full?
These were some of the points considered by the Court in determining whether the Debenhams’ CVA (which had been challenged by landlords) should fail.
One point of particular interest is whether reducing rents below market value in a CVA is automatically unfair to landlords?
We consider the answer to these questions and the implication for (i) landlords; (ii) corporates considering a CVA and (iii) practitioners following the ruling in the Debenhams case last week.
Debenhams Retail Limited proposed a CVA that was approved by 94.71% of Debenhams’ unsecured creditors on 9 May 2019. A number of landlords (funded by billionaire retailer Mike Ashley) challenged the CVA on the grounds of unfair prejudice and material irregularity. The effect of the CVA on those landlords challenging the CVA was to:
- reduce the rents payable for a period of time by between 35% to 50%;
- prevent the landlord from exercising any forfeiture rights triggered by the CVA;
- release the Company from any liability under dilapidations claims and
- shorten the terms of some leases to January 2020.
Landlords were given a one off right to terminate the lease and in some cases the landlord and the company had a mutual right to terminate on specified dates upon giving notice.
Those terms are typical of retail CVAs.
The right to terminate the lease at specified points is often included to be fair to landlords. They can choose to terminate the lease and accept the property back or accept a reduced rent under the CVA. If they choose the latter, the landlords right to forfeit the lease is then modified, preventing a landlord from exercising the right to forfeit contained in the lease.
This term gives certainty to the corporate that the property is available to support ongoing trade, but the landlord cannot rely on the insolvency forfeiture provisions to seek a return of the leased property.
The Court confirmed that landlords are creditors in respect of future rent and are therefore bound by the CVA in respect of that rent. It also confirmed that rent can be compromised as part of a CVA but held that a CVA cannot modify a landlord’s right to forfeit the lease.
What is the impact of the finding that the right to forfeit cannot be modified by a CVA?
Probably very little.
Quite often, the terms of a CVA give landlords the right to determine the lease at pre-determined times. This was in fact the case in the Debenhams CVA, where some landlords had a one off right to determine and others has a recurring right to determine at specified times in the future.
However, the right to terminate the lease did not arise under the terms of the lease itself. It was a right granted under the terms of the CVA. The right to forfeit under the lease was modified to prevent landlords from forfeiting as a consequence of Debenhams entering a CVA.
In practical terms, this means that the landlords can only forfeit the lease at the times and in the manner set out in the CVA, not the lease.
Most commercial leases allow a landlord to forfeit if an insolvency event occurs, this is more than likely to capture a CVA. The decision in the Debenhams case, that this right cannot be modified, means that should a landlord wish to forfeit the lease relying on the insolvency event trigger in the lease, it can do so, assuming that the landlord has not waived that right to forfeit.
However often landlords choose not to determine the lease and instead accept the lower CVA rent because determining the lease could leave them with an empty property, liable to pay business rates and no income stream.
Notably, the aggrieved Debenhams landlords had not exercised the right of re-entry permitted under the CVA. If the landlords were not inclined to exercise that right, does the fact that they retain the right to forfeit therefore change things?
The Judge commented that the disinclination to exercise that right “may indicate a view of the current market for vacant department stores”. If market conditions are challenging, then a landlord is likely to opt for the reduced rent payments under the CVA rather than an empty property.
In reality, the decision is therefore unlikely to make much difference to how landlords view CVAs. Where it might make a difference is if the rent under the CVA is unpaid or a landlord finds a new tenant and wishes to recover possession of the property. In that case, the landlord’s rights to rely on the forfeiture provisions in the lease are not restricted, assuming the right to forfeit has arisen and has not been waived.
Does this mean a landlord can forfeit for non-payment of rent?
Yes, if the tenant fails to pay the CVA rent on the terms set out in the CVA. However, landlords cannot exercise the right to forfeit on the basis of the unpaid rent due under the lease if that amount has been reduced by the CVA.
It is only non-payment of the reduced rent payable under the CVA that will give landlords the right to forfeit for non-payment provided the landlord has not waived that right.
What does this mean for corporates considering a CVA and practitioners involved in drafting CVA proposals?
Any term which modifies or affects a proprietary right should be avoided.
The Debenhams CVA was able to continue because the severance provisions in the CVA allowed the judge to remove the offending provisions in the CVA which modified the landlord’s right to forfeit. Had it been unable to do that, the CVA may have failed on the basis that the modified forfeiture provisions were unfair.
What is a fair rent for landlords?
Landlords often find that a CVA reduces rent whilst other trade creditors are paid in full. That can seem unfair.
The Debenhams leases were well above current market rate, none of the landlords said that the rent they would receive under the CVA would be less than the current market rent for the premises and the valuation evidence was not challenged.
The leases were long leases, with upward only rent reviews.
However, the rent reductions proposed in the Debenhams CVA seemingly brought the rent payments back in line with current market rent.
The judge, when considering whether the rent reduction imposed during the termination notice period were automatically unfair commented that:
“the landlord should receive at least the market value of the property he is providing. He should not subsidise other creditors but nor should they be compelled to overcompensate him
He further indicated when considering the differential treatment of landlords and suppliers, that:
“There would have been unfairness if landlords were expected to take reductions in rent to below the market value of the premises concerned”
The judge also made the below comment about contractual rent saying that it:
“should be interfered with to the minimum extent necessary in the circumstances, the modification being limited to what is necessary to achieve the purpose of the CVA”
If the rent reductions proposed in the Debenhams’ CVA were below market rent, would that have therefore led to a finding that the CVA was unfair to landlords?
How do you determine market rent? The valuation evidence in the Debenhams’ CVA was not challenged. Had that been in dispute the position might have been different.
What if the rents were already turnover rents? Can a CVA compromise those? The judgment confirms that monetary obligations under a lease can be varied so in theory, yes. However, how would the observations that the landlord should receive at least market rent then apply.
The landlords had a right to terminate the lease and therefore a choice as to whether to accept the CVA rent or take the property back and re-let it. Therefore, even if the CVA had proposed a below market rent, that may not have made the Debenhams’ CVA unfair. Certainty not automatically unfair.
The judgment makes it clear that the question of fairness has to be considered in the round.
Having heard evidence that rumours and fear of non-payment leads to immediate actions such as cancelled deliveries, changes of credit terms and suppliers refusing to accept orders. The judge found that the need for business continuity justified the differential treatment between landlords and suppliers in the Debenhams’ CVA . However what might be fair in one case, may not be fair in another.
For practitioners and those companies contemplating a CVA the judgment provides some comfort that the flexibility which a CVA offers over other insolvency regimes, remains.
For landlords, their position remains largely unchanged. Whilst they have a right to forfeit the lease, the judgment confirmed that a CVA can compromise future rent. The question remains a commercial one, do landlords accept the lower CVA rent or terminate the lease (as provided for in the CVA) or forfeit the lease under the terms of the lease and take possession of the property if market conditions are difficult.
Had the landlords succeeded with their claims then the future of retail CVAs in their current form may have been in doubt However, this may not be the end of the story. We do not know yet whether the judgment will be appealed, so watch this space.