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Case law: Landlords benefit from clarification of when tenant’s company voluntary arrangement is unfairly prejudicial

Landlords faced with a looming company voluntary arrangement (CVA) should review the proposed terms for potential unfair prejudice by comparing the expected outcome with that of available alternatives, and assessing whether they are being treated unfairly and unjustifiably compared to other classes of creditor.

November 2019

This update was published in Legal Alert - November 2019

Legal Alert is a monthly checklist from Atom Content Marketing highlighting new and pending laws, regulations, codes of practice and rulings that could have an impact on your business.

CVAs allow insolvent companies to restructure their debts and liabilities so they can carry on trading, giving them breathing space to try to sort matters out.

The aim of a CVA is to benefit the creditors as a whole but there can be winners and losers. If the company is a tenant, their landlords can end up with a reduced rent – which means a drop in both rental income and the value of their investment - while other creditors fare better.

In a recent case, the landlords argued that the tenant’s CVA was ‘unfairly prejudicial’ to them compared to other creditors. The CVA, which had been approved by more than 90%of the tenant’s creditors (although not the landlords), provided for store closures, reduced rents, a block on the landlords’ right to forfeit leases, reduced rights to terminate, and releases of the tenant from liability for dilapidations.

The High Court made helpful comments on when a landlord is unfairly prejudiced, by reference to the ‘vertical comparators’ test and the ‘horizontal comparators’ test.

  • The vertical comparator test involves comparing the anticipated result of the CVA with that of a realistically available alternative, such as a liquidation. If the creditors as a whole would do worse under a CVA than the alternative(s), then there may (but not necessarily) be grounds to challenge the CVA. However, if the creditors as a whole will do better under the CVA, it passes the test.
  • The horizontal comparator test involves comparing the treatment of different creditor groups, and asking if the differences are fair. Differences are not automatically evidence of unfair prejudice – for example, it may be that treating landlords and other creditors differently is necessary because the company would otherwise have insufficient funds to meet short-term liabilities and could not continue trading - but the differences must be justified in the particular circumstances.

The landlords in this case argued that the reductions in their rents were not justifiable – they were automatically unfairly prejudicial to them as a class of creditor because the rents had been contractually agreed with the tenant in return for its right to occupy the various premises - and the tenant was still occupying them. It was not fair that the CVA allowed the tenant to carry on trading for the benefit of past creditors at the expense – both current and future - of its landlords. The CVA therefore failed the horizontal comparator test.

The High Court disagreed. It accepted that a CVA could be unfair if the reduction in rents took them to below current market value, but this was not the case here.

Instead, it noted that the landlords might have benefited from rents that had been agreed with their tenant at times when the market was in their favour, so had been charging rents over market value during the tenancy. Or they may have been able to increase rents during the tenancies, under rent review clauses, so that they remained above market value.

The court also found the rent reductions were ‘limited to what is necessary to achieve the purpose of the CVA’ and that the landlords could still end the lease if they wished.

Therefore, it was not automatically unfair for contractual rents to be reduced during the CVA in the circumstances – although it would have been different if they had been reduced to below market rental values.

However, the landlords won on one point. The court agreed with their argument that blocking their rights to forfeit their leases (even though they were given limited rights to break the lease) was unlawful because a right to forfeit was a property right which could not be altered by a CVA.

The court upheld the CVA, subject to striking out the provisions blocking the landlords’ rights to forfeit the tenant’s leases.

Operative date

  • Now

Recommendation

  • Landlords faced with a looming CVA should review the proposed terms for potential unfair prejudice by comparing the expected outcome with that of available alternatives, assessing whether they are being treated unfairly and unjustifiably compared to other classes of creditor. Particularly, they should consider whether reductions in rent reduce them to below market rental values, and whether the CVA purports to block their rights to forfeit.

Case ref: Discover (Northampton) Limited and others v Debenhams Retail Limited and others [2019] EWHC 2441

Disclaimer: This article from Atom Content Marketing is for general guidance only, for businesses in the United Kingdom governed by the laws of England. Atom Content Marketing, expert contributors and ICAEW (as distributor) disclaim all liability for any errors or omissions.

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