Landlords have lost their legal challenge against fashion retailer New Look’s use of a company voluntary arrangement (CVA) it put in place to help it restructure its business.
The CVA was approved by creditors of the fashion chain last September but a number of landlords launched a legal challenge against it.
The business, which has almost 500 stores and employs over 12,000, asked landlords to agree to rents based on a percentage of sales for 402 of its stores, an arrangement relatively new to CVAs termed “turnover rent”. In return, it offered them enhanced rights to take back stores to re-let to other tenants.
The landlords argued several points of challenge, most importantly from a legal and commercial perspective that CVA jurisdiction does not extend to complex, differential arrangements.
The case was heard by Mr Justice Zacaroli, who stated in his judgment:
“I do not accept that “arrangement” in section 1(1) IA 1986 is to be construed…. so as to limit a CVA to an arrangement in which the rights of all creditors are such that they can consult together with a view to their common interest.”
The judge indicates, however, that unfair prejudice might be found where the votes of a largely uncompromised class are instrumental in reaching the statutory majority.
Doug Robertson, Restructuring & Insolvency partner at law firm Irwin Mitchell, said:
“Had the jurisdiction challenge been successful, it would have placed limits on the aggressive use of CVAs and shifted such compromises into the restructuring plan market. This decision retains the use of a CVA as a tool in complex, differential compromises and arrangements and is in line with increased emphasis on providing a debtor protection to enable it to restructure its affairs with a view to financial recovery.
The further guidance on the parameters of unfair prejudice is helpful, particularly concerning vote swamping. We look with interest across to restructuring plan sanction discretion to see to what extent the law in these two processes develops in parallel.”
Give and take
Mr Justice Zacaroli considered there was sufficient give and take in an arrangement which “takes” from the creditors their contractual rights and “gives” them a return which is at least as good as that which the company could give in the relevant comparator (274).
Interference with proprietary rights
The Applicants contended that the release of all liability to pay rent and other sums due under a Category C Lease operates in substance as a surrender binding on the parties, with the proprietary consequences that follow from that. Zacaroli J did not agree, noting that it is not an essential requirement of a lease that the tenant is obliged to pay rent and that the Proposal does not require Category C landlords to surrender the lease but merely the opportunity to do so.
Mr Justice Zacaroli determined that the court is necessarily required to consider whether a different allocation of assets would have been possible, stating (at 196) that the principle adopted in scheme cases, against considering whether an alternative arrangement would have been fairer, needed to be modified. The point would benefit from being more fully articulated in subsequent application and the practical implications of the comments are not apparent. In particular, it is not clear how the application will differ from considering whether there is a fair allocation of the assets available (articulated at 193).
The judge stated that a finding of unfair prejudice ought not to be precluded merely because the same result might have been achieved in a Part 26A restructuring Plan (199).
Some of the further principles applied are discussed in the final section of this analysis.
Permanent rent reduction (where termination rights available)
Mr Arden QC for the Applicants had invited Mr Zacaroli to depart from the determination of Norris J in Debenhams (Discovery (Northampton) Ltd & Ors v Debenhams Retail Ltd & Ors  EWHC 2441 (Ch) (19 September 2019) the only prior CVA challenge to be heard by the courts) that a CVA cannot operate to reduce further rent while permitting the tenant company to remain in possession, because it is inherently unfair on the landlords.
In both cases, the compromised landlords had the option to terminate their leases. It was accepted that the right to terminate the leases would in principle eliminate any unfairness. The argument therefore related only to the termination notice period.
Mr Justice Zacaroli declined to accept that interference with the landlords’ rights during the notice period must be to the minimum extent necessary to achieve the objectives of the CVA, noting that the landlords had the option to get out of them by virtue of their termination rights.
Zacaroli J noted (at 222):
“As a practical matter, any company proposing [a CVA such as the present] will need to ensure that the reduction in rent and other modifications to the leases are as fair to landlords as possible, because it will need a sufficient number of landlords to opt to continue the leases if it is to have premises from which to trade….The fairness of the modifications, per se, is not something which falls to be evaluated by the court as part of the unfair prejudice challenge.”
The court declined to rule that the absence of a rolling termination right was unfairly prejudicial: it was simply an aspect of the modification to the lease that the creditor had opted to continue (277).
Rent reductions (turnover) during continued occupation
The court considered alleged unfairness by reason of the fact that New Look was entitled to remain in occupation of the relevant premises during the notice period if a landlord had exercised its right to serve a termination notice. This was not an issue dealt with in Debenhams. The issue related to Category B Landlords, who were entitled to receive only turnover rent during the relevant period.
Zacaroli J considered that the answer lay in considering the circumstances of a pre-pack administration as the vertical comparator (234). The right to forfeit (relevant to the consideration of that comparator), at the time of the CVA, was complicated by the Coronavirus Act 2020, which would have precluded the Category B Landlords from exercising a right of forfeiture based on the non-payment of rent, although it would have permitted them to forfeit because of the promotion of the CVA. On analysis of the comparator, the rent reductions were not deemed unfair.
i. Participation in upside
The court did not consider that a lack of mitigating factors, such as a profit share fund, rendered the CVA unfair. Similar arguments have been run in the Virgin Active sanction application and is a common theme aired in debate. Zacaoli J considered this was not a case where creditors’ rights were being compromised in order to benefit existing equity holders (229), leaving open the possibility for a contrary finding on different facts. See also discussion in ii bullet four.
ii. Differential treatment of the SSN Holders (secured creditors)
Zacaroli J was satisfied on the facts that it was appropriate for the compromise of the SSN Holders to be found in a parallel scheme.
The court did not consider that it was unfairly prejudicial that the compromises imposed on the Compromised Landlords were achieved by virtue of the votes of the SSN holders. The decision was based on the following reasons:
- The benefits the SSN Holders received were referable to their security interest.
- The SSN Holders agreement not to enforce their security allowed assets to be made available for the other creditors so as to permit New Look to continue trading
- The treatment of the SSN Holders’ unsecured claim was materially worse than the treatment of the Compromised Landlords.
- Looked at in the round, it could not be said that the SSN holders were offered a better deal than the Compromised Landlords. Zacaroli J characterised their post restructuring equity interest as speculative and noted it featured at the bottom of the priority waterfall in contrast to the top ranking of the original secured interests.
- Regard was also had to the voting majorities, albeit that the statutory majority would not have been achieved without the votes of the SSN Holders.
Finally it was confirmed that the fact that a large majority of SSN Holders had voted under the LUA to vote for the Scheme (under which they would have become holders of equity in the restructured group) should not lead to their characterisation as equity in the CVA.
De minimus compromise of Ordinary Unsecured Creditors and Category A Landlords
Mr Justice Zacaroli characterised the modification of the Ordinary Unsecured Creditor and Category A Landlord claims as de minimus, featuring only the waiver of termination rights based on a CVA related event and (in the case of Category A Landlords) a move to monthly rather than quarterly rents.
For the following reasons, the court considered that neither the differential treatment afforded to them nor the fact that they were permitted to vote notwithstanding they were not materially impaired by the CVA constituted unfair prejudice:
- It was accepted that payment in full was justified and necessary for reasons of business continuity.
- Their vote would not have had a material effect on the outcome of the meeting.
Zacaroli J indicated i that unfair prejudice might be found where the requisite majority is reached by reason of the votes of a notional class that is treated more favourably (known as “vote swamping”), even where there is an objective justification for their payment in full. The test is articulated as a sliding scale, the impact of which will depend on the extent to which the numbers of unimpaired ‘tip the scales’ at the meeting (see e.g. 197).
Mr Arden QC accepted during the hearing that the use of the votes of unimpaired classes to achieve the statutory majority was better dealt with under an unfair prejudice challenge.
The principal remaining contention was that the 25% discount applied to the claim of all landlords for voting purposes was not justified. The Applicants also contended that the approach to the valuation of dilapidations claims and to break premiums was a material irregularity.
The methodology included (in the Applicants submissions):
- A fetter on the chair’s duty to put an estimated minimum value on the claims for voting purposes.
- Duplication of deductions.
- The creation of a “one-way bet” by failing to allow for the possibility that the estimate would result in an under-estimate of the claim.
- An arbitrary justification based on the practice in other CVAs.
- Particular unfairness on the basis no similar discount was applied to SSN Holders who were also contingent creditors.
The court found no irregularity on the facts and considered that if there had been one, it would not be material. Duplication of discount was not found as the estimate for the initial value did not represent a low point. The chair’s duty was to place an estimated minimum value on the claim, requiring inherently a one way adjustment.
The SSN Holders’ claim was contingent only on non-payment by the Issuer. There was no doubt that the Issuer was not in a position to pay and accordingly there was no reason to discount the claim at all. In respect of the unsecured portion of the SSN Holders’ claims, the same regime under Rule 15.31(3) requiring the placement of a minimum value is not engaged. In any event, the lower end of a range of possible values had been placed on the valuation of the unsecured portion of the SSN Holders’ claim.
The “broad brush” treatment of dilapidations claims was considered proportionate. Additionally, there was no evidence a separate calculation for each lease should have made a material impact on the outcome of the meetings.
Material irregularity was not found in relation to New Look’s failure to take break premiums into account in valuing the landlord claims because it would have had no impact on the outcome of the meeting. The court rejected however New Look’s contention that the treatment was justified on the basis of consistency.
Disclosure inadequacies were asserted in relation to:
- Inadequate disclosure of the wider restructuring
- Failure to disclose the existence and terms of a management incentive plan.
The threshold for materiality was not found on the facts.
CVAs vs restructuring plans
Mr Justice Zacoroli considers some important points regarding the contrast between CVAs and plans (at 199) including that in a plan:
- There is significant court oversight before the plan becomes effective, particularly regarding class constitution
- Creditors know at the outset with whom they are able to consult and negotiate and have clarity on the strength of their position
- Creditors are likely to have significantly more time to consider the plan and consult
- The timetable is less compressed
These differences will continue to be important as the judgment leaves CVAs available in complex cases. They feature in many aspects of the law in this area, including in relation to disclosure and fairness. Further discussion and clarification in Regis (Regis UK Ltd 8276 of 2018 & CR-2019-BHM-000782) and Virgin Active sanction (In the matter of Virgin Active Limited CR-2021-000549) is awaited (Virgin Active due 12 May at 10.30am) and we will provide analysis when the judgments are handed down.
Some commentators are looking to the application of fairness in New Look as a proxy for how Mr Justice Snowden might exercise his sanction discretion in Virgin Active (and in schemes and restructuring plans more generally). In particular the considerations of:
- Whether there is a fair application of the assets available within the process between compromised creditors and other sub-groups of creditors (including considering the source of the assets and whether they would or could have been made available to all creditors in the relevant alternative (193).
- The nature and extent of the different treatment, the justification for that treatment, and its impact on the outcome of the meeting (197).
- The extent to which others in the same position as the objecting creditors approved the CVA (scheme and restructuring plan case law cited at 198).
Additionally, we will see what is made in the restructuring plan and scheme context of Zacaroli J’s comments (196) that alternative arrangements might need to be considered in a fairness determination.
“Had the jurisdiction challenge been successful, it would have placed limits on the aggressive use of CVAs and shifted such compromises into the restructuring plan market. This decision retains the use of a CVA as a tool in complex, differential compromises and arrangements and is in line with increased emphasis on providing a debtor protection to enable it to restructure its affairs with a view to financial recovery. The further guidance on the parameters of unfair prejudice is helpful, particularly concerning vote swamping. We look with interest across to restructuring plan sanction discretion to see to what extent the law in these two processes develops in parallel.” Doug Robertson, Restructuring & Insolvency partner at law firm Irwin Mitchell