Insolvency: the impact of a CVA and how to handle it

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Yesterday, a majority of the landlords of the struggling high street retailer, BHS, voted in favour of a creditors' voluntary arrangement (CVA).

Following the creditors meeting on 23 March, 95 per cent of the creditors of BHS voted in favour of the CVA.

The CVA will significantly reduce BHS’s obligation to pay rent across its portfolio of 164 stores.

Although the majority of the landlords in the BHS case approved the CVA, landlords who are opposed to the approval of a CVA can find themselves bound by its terms anyway, and with few options available to take back possession of their premises. If a landlord is faced with the prospect of one of its tenants entering into a CVA, it is vital to act quickly.

What is a CVA?

In simple terms, a CVA is an informal, but legally binding, arrangement or compromise between a company in financial difficulty and its creditors. Typically, a CVA will reduce the amount of the company's debts so that only a proportion of the debt is owed.

If approved by the company's creditors, a CVA can prevent the company from being placed into liquidation or other formal insolvency procedure. Importantly, if approved, a CVA will bind all unsecured creditors of a company, but it will not affect secured or preferential creditors, whose rights will remain unaffected (unless they agree otherwise).

A CVA may be proposed by the directors of a company, but it must be implemented by a qualified insolvency practitioner. Before the CVA is approved, this insolvency practitioner is known as the "nominee", and afterwards as the "supervisor". In order to be approved, the proposed CVA must be approved by 75 per cent in value of the company's creditors.

How a CVA can affect landlords

As unsecured creditors, landlords will be bound by the terms of a CVA if it is approved by the requisite number of the company's creditors, even if those landlords voted against the CVA's approval.

Voting rights

The value of the debt owed to a creditor determines that creditor's vote on whether to approve the CVA. A landlord's claim will constitute two elements:

1. A claim for any arrears of rent that exist at the time.
2. A claim for future rent, which has not yet fallen due, and dilapidations.

The second element of the landlord's claim is unascertainable at the time of voting, but will probably constitute the significant majority of the value of its claim, particularly if dilapidations will be substantial and/or if there is long term left to run on the company’s lease. The Insolvency Rules provide for the chairman of the meeting to approve the CVA to value unascertainable claims at £1, unless the chairman agrees to put a higher value on it, which can result in the consequential devaluation in the substantial part of the landlord's claim.

The terms of a CVA

In many circumstances, the terms of a CVA will rewrite the covenants in a lease. This will change the contractual relationship previously agreed between the landlord and the company (as its tenant) to the benefit of the company and often to the significant detriment of the landlord. For example, a CVA could:

• reduce the amount of rent payable by the company;
• provide for the lease to be surrendered; and/or
• remove the landlord's right to forfeit the lease.

In Thomas v Ken Thomas Ltd [2006], the Court of Appeal held that it is unlawful to forfeit a lease subject to the terms of a CVA for any arrears of rent that fell due before the CVA was approved, as these arrears crystallise as a debt in the CVA for which the landlord is entitled to submit a claim.

A CVA may vary a lease to reduce the future rent payable to the landlord to a nominal amount and, at the same time, remove the landlord's right to forfeit the lease. Given the principle set out in Thomas, a landlord in this scenario will find himself lumbered with a tenant who is in substantial arrears, paying little rent, and with no proprietary rights to end the lease and take back possession of the premises.

Of course it is open for the landlord in this scenario to negotiate with the company to accept a surrender of the lease. However, such a surrender may not be forthcoming, particularly if the reduction in rent means that the company starts to become profitable again. Ultimately, the landlord is left in a state of limbo.

Challenging a CVA

A CVA can be challenged by a creditor in court on two grounds:

1. that the CVA unfairly prejudices the challenger; or
2. there has been a material irregularity.

Unfair prejudice

In order to prove unfair prejudice, it may not be enough to demonstrate that the CVA treats some creditors differently to others. What is crucial is demonstrating that, in the context of the overall effect of the CVA, whether the CVA is unfairly prejudicial to the creditor.

Material irregularity

In order to prove a material irregularity, for example, a creditor would have to prove as a matter of fact that the conduct of a meeting held to approve the CVA resulted in the value of that creditor's claim being devalued (see above). Such a claim may be difficult to prove, however, unless the creditor is able to substantiate that the unascertainable element of its claim should be valued at more than £1.

Challenges made by a creditor under each of these grounds must be made within 28 days of the approval of the CVA being reported.

Action points for landlords

Here are some points to note for a landlord faced with the prospect of one of its tenants entering into a CVA:

• Act quickly. The period between the CVA being proposed and its approval is key.
• Review the terms of the CVA immediately.
• If you are happy to approve the CVA, take measures to gather evidence during this period to substantiate the unascertainable element of your claim (e.g. by preparing a schedule of dilapidations).
• If you do not want to approve the CVA, consider taking action against the tenant during this period to recover possession of the premises, before the CVA is approved.