Contributed by Tom Bannister (Akin Gump)
Landlords and Leasehold Restructurings in the UK: What does 2022 hold?
The COVID-19 pandemic has impacted a number of businesses in a number of ways. In the UK, the retail sector has been particularly hard-hit. Even before the pandemic, companies had been struggling due to (among other things) increased competition from online retailers. Faced with decreasing profits, in the years preceding the pandemic, many well-known retailers proposed company voluntary arrangements (CVAs) in an attempt to rationalise their leasehold portfolios and restructure high fixed rental costs. The pandemic only exacerbated the issues in the retail industry, as the digital revolution collided with a (further) decline in footfall. We consider below how, in the early part of 2022, commercial landlords and tenants may seek to address the implications of the pandemic and what the future might hold for operational restructurings in the UK.
CVAs: a reminder
A CVA is a legally-binding, flexible, rescue procedure enshrined under Part 1 of the Insolvency Act 1986 that allows a company to come to a bespoke compromise or other arrangement with its creditors in respect of payment of its unsecured debts. Once approved by the requisite majority, a CVA will be binding on all of the company’s unsecured creditors. Used in the right context, CVAs can be an effective and quick tool for companies seeking to avoid potentially terminal insolvency proceedings by agreeing a reduction or rescheduling of unsecured debts over a specified period, while continuing to trade as a going concern under the control of its directors who may also restructure the operations of the business.
While the directors remain in control of the management of the company throughout the CVA process, a CVA is administered and implemented under the supervision of a qualified insolvency practitioner (who is referred to as “the nominee” before the CVA proposal is approved and is responsible for assisting the directors with preparation of the CVA proposal and as “the supervisor” once the CVA is approved, tasked with overseeing the implementation of the CVA).
The CVA process
Technically, there is no statutory requirement that the company proposing a CVA be insolvent or unable to pay its debts but, in practice, CVAs are used where there is at least a risk of insolvency. CVAs can therefore be used by companies showing early signs of distress.
Once the nominee has made a statement to court that in his/her view, the CVA has a reasonable prospect of being accepted and implemented successfully, notice of the proposed CVA must be sent to all known creditors of the company (including secured creditors) at least 14 days before the proposed decision date. The CVA proposal must include all “matters that the company considers appropriate to enable creditors to reach an informed decision”, including an explanation as to why, in the company’s view, the CVA is desirable, details of the company’s assets and liabilities, an explanation of how the business of the company will be conducted, the proposed duration of the CVA and the proposed dates for creditor distributions and estimates of the amount of any such distributions.
To be effective, a CVA requires the approval of:
- at least 75% (by value) of the creditors who vote on it. The proposal will not be treated as approved if more than 50% (by value) of the total value of unconnected creditors vote against the proposal; and
- more than 50% (by value) of the company’s shareholders.
If there is a difference of decision between the creditors and the shareholders, the decision of the creditors will prevail, subject to any order of the court.
Once approved, the CVA binds all unsecured creditors of a company who were entitled to vote on the CVA proposal (including creditors who voted against the CVA, creditors who received notice of the CVA proposal but who did not vote and any unknown creditors).
Critically, a CVA cannot affect the rights of secured creditors or preferential creditors unless they agree to the proposals, meaning that debts owed to secured and preferential creditors must be dealt with outside of the CVA or repaid in full. Relatedly, a secured creditor is entitled to vote on a CVA but only in respect of the unsecured part of its claim.
Any person entitled to vote on the CVA proposal can, by application to court, challenge the implementation of the CVA within 28 days of the date the result of the CVA vote is filed in court.
In order to be successful and obtain a court order revoking the CVA, a challenge applicant must evidence that either:
- there was a material irregularity in the conduct of the procedure used for consideration of the CVA proposal; and/or
- the CVA is unfairly prejudicial to the interests of a creditor, member or contributory of the company.
A “material irregularity” challenge is not concerned with the substantive content of the CVA but with the circumstances and processes by which the CVA was approved. An “unfair prejudice” challenge, on the other hand, focuses on the effect of the CVA on the substantive rights of creditors. Whether a finding of unfair prejudice and/or material irregularity will be made by the court is ultimately a question of fact, determined on a case-by-case basis.
Commercial landlords: current constraints
At the beginning of the pandemic, measures were introduced which restricted the actions landlords could take against tenants for non-payment of rent. Certain of those measures will continue through the first quarter of 2022, including:
- until 25 March 2022, landlords cannot forfeit their commercial leases if rent is unpaid for any reason, meaning that no landlord will be able to re-enter the leased premises for non-payment of rent; and
- until 31 March 2022, a landlord cannot present a petition to wind-up a tenant company if rent under a commercial lease is unpaid and that rent is unpaid because of the impact of the pandemic.
Landlords can still take certain other steps to recover unpaid rent (including seeking summary judgment or drawing funds from any deposit paid in connection with a lease). However, the right to forfeit is a key remedy for landlords in the UK and the constraint on that remedy when rent is unpaid has significant practical consequences for landlords.
Commercial landlords: what comes next?
The UK government has been clear that the restrictions on landlord actions have been retained until the end of March 2022 in the hope that, during that period, landlords and tenants will be able to find mutually agreeable solutions to pandemic-related rent arrears. At the end of March 2022, a new regime should come into force, which will allow certain landlords and tenants to make a reference to arbitration and for the arbitrator to determine how unresolved COVID-19 rent arrears should be addressed. While the relevant legislation is still being finalised, it would appear that the regime will be limited in scope: it will only be available for leases relating to premises which were mandatorily closed during the pandemic (such as restaurants and gyms) and, importantly, the regime will not apply to pre-pandemic rent arrears or arrears that have accrued after a sector re-opened. Landlords and tenants will also only be able to refer their dispute to arbitration for six months after the regime comes into force. On the assumption that the current constraints are lifted when the new arbitration regime is introduced, landlords owed arrears which do not fall within the scope of the regime may breathe a sigh of relief: forfeiture and winding-up petitions are, after a two-year hiatus, back.
Leasehold restructurings in the UK: what comes next?
During the pandemic, the CVA remained available to tenant companies to compromise rent arrears and – where necessary to ensure the sustainability of a leasehold estate – future rents. In June 2020, a new restructuring procedure was introduced into UK law: the restructuring plan. In a restructuring plan, creditors vote in separate classes by reference to their rights, and it is possible for assenting classes to cram down dissenting classes, subject to the satisfaction of certain conditions. In May 2021, the UK court sanctioned the Virgin Active restructuring plan, which was the first to compromise leasehold liabilities and, in the process, cram down disgruntled landlords. While CVAs and restructuring plans will continue to be available to tenants, during the period until the end of March 2022, landlords will be constrained in the actions that they are able to take.
From the end of March 2022, for tenants with rent arrears outside the scope of the arbitration regime and/or broader concerns with their ability to meet on-going rental costs, the CVA and restructuring plan will continue to be fundamentals of the restructuring toolkit. Even if arrears are within the scope of the arbitration regime, a CVA or restructuring plan can still be proposed. However, if a reference to arbitration is made, the arrears which are protected by the arbitration regime cannot be included in a CVA or restructuring plan from the day on which an arbitrator is appointed to the day which is 12 months after the date of any award.
CVAs and restructuring plans which seek to compromise leasehold liabilities have not, as might be expected, been welcomed with open arms by landlords. In the last few years, a number of CVAs have been challenged. These challenges have, perhaps unsurprisingly, been accompanied by calls for reform to the existing CVA regime, focused on increased transparency and oversight and greater clarity for creditors. Traditionally, the strength of CVAs has been their flexibility and lower cost when compared with other formal rescue measures. This has often made them the restructuring tool of choice for small to medium-sized businesses seeking to address operational liabilities. However, as the calls for legislative reform grow and if more CVAs are challenged by landlords, CVAs may become as protracted and costly as other formal restructuring and insolvency procedures.
Still, where viable CVA challenges are not anticipated, the comparatively lower costs and shorter timelines of an uncontested CVA will likely mean that CVAs remain a feature of the restructuring landscape for the foreseeable future. Forfeiture and winding-up petitions may be back, but that is certainly not the end of the story for landlords in the UK.