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27th September 2019

Challenging times for retail landlords

By Lindsey Whittle

The High Court have handed down judgment in the case of (1) Discovery (Northampton) Limited, (2) Discovery (Nuneaton) Limited, (3) Southampton Real Estates Limited, (4) Discovery (Torquay) Limited, (5) Discovery (Folkestone) Limited and (6) Discovery (Harrogate) Limited v (1) Debenhams Retail Limited, (2) James Robert Tucker, (3) Edward Boyle and (4) Glas Trust Corporation Limited [2019] EWHC 2441 (ch), being the application to challenge the Creditor’s Voluntary Arrangement (“CVA”) of Debenhams Retail Limited.

The applicants are all landlords of Debenhams Retail Limited (“the Company”), whose leases with the company have been compromised by virtue of the CVA. There is some commercial background to the challenge acknowledged by the Court, insofar as Sports Direct Limited was previously a co-applicant and continues to fund the litigation.

The challenge was brought under section 6(1) of the Insolvency Act 1986 (“the Act”) on five distinct grounds:

 

Ground 1: landlords are not “creditors” as future rent is not a debt at the date of the CVA, therefore the CVA goes beyond the jurisdiction of Section 1 of the Act

The Applicants said that because future rent has not been incurred as at the date of the CVA, landlords cannot have a ‘present pecuniary debt’. The logical argument, said the Applicants, was that, for the purposes of the Act, landlords cannot therefore be classed as creditors.

The Court examined the authorities including cases relating specifically to CVAs and found a creditor in a CVA must have a ‘debt’, but said the term ‘debt’ in this context goes beyond a debt strictly so-called and includes pecuniary liabilities. The Court considered that future rent is a pecuniary liability to which the tenant company may become subject to in the future, due to the existing obligations in a lease to pay rent. The Court made clear that a landlord has the power to refuse to accept a surrender or to choose not to exercise a right of re-entry and therefore a tenant can remain subject to a covenant to pay rent for the term of the lease. This amounts to a contingent claim within the meaning of the Act and so, the landlord is a creditor for the purposes of the CVA.

The applicants therefore failed in relation to Ground 1.


Ground 2:
reducing rent is unfairly prejudicial or the CVA goes beyond the jurisdiction of the Act by changing the terms of leases thereby creating new obligations

The Applicants argument in relation to unfair prejudice was described as the ‘basic fairness’ argument, i.e. the landlord and tenant signed up to a lease by which the landlord expected, on the basis of the agreement between the parties, to receive a certain amount of rent. It is therefore the Court’s job to ensure that the landlord receives the full value of that agreement, given the tenant remains in occupation and continues to obtain the benefit of the property and to fail to do so would result in unfairness to the landlord.

The Court was not in agreement that there was any unfairness caused by the reduced rent, and of particular relevance was the fact that none of the landlords claimed that the discounted rent would mean that they would be receiving less than the current market rent.

Whilst this meant the Applicants were unsuccessful on this point, it poses an interesting question for the future of CVAs; it leaves open the question of whether the Court would consider there to be an unfairness if a CVA were entered into in a more buoyant market, thus the discounted rents would then come below market rent, suggesting a retailer is using the CVA process simply to seek to lower its overheads. Perhaps this will be of some comfort to landlords whose concern is the rise of the use of CVAs in situations where the intention of the retailers is somewhat grey.

In relation to the argument that the CVA created new obligations, the Court held this not to be the case, on the basis that the entire purpose of the CVA within the meaning of the Act is to vary obligations and this does not mean new obligations are entered into.

The Applicants therefore failed in relation to Ground 2.


Ground 3:
landlord’s proprietary rights are abrogated by a CVA which removes a landlord’s right to forfeit a lease

It was common ground that the CVA prohibited the landlords from forfeiting the leases for an insolvency event, i.e. for the very reason that the tenant has entered a CVA. The Applicants argued that the right of re-entry is not a right as between creditor and debtor but between landlord and tenant, and therefore the right is a proprietary right which cannot be altered by a CVA.

The Court noted that a right of re-entry is indeed a right which enjoys the usual attributes of a property right and is, importantly, annexed to the reversion rather than the term of years. It is therefore a proprietary right and, on the Court’s analogy of the relevant authorities, a CVA cannot alter such a right.

The Applicants were therefore successful in relation to Ground 3.

Essentially, the Court has made clear that a landlord ought to retain ultimate control of his own property This will be a relief to landlords, particularly those who have granted leases of retail stores in areas or of a size which are capable of being re-let or redeveloped.


Ground 4:
landlords are treated less favourably than other unsecured creditors, without justification

This ground relates to the “horizontal comparator”, i.e. whether landlords are treated unfairly in comparison to other creditors of the Company. It was said by the Applicants that the unfairness arose where other creditors would be paid in full, notwithstanding they were not necessarily ‘critical’ suppliers, whilst landlords are subject to reduced rents to the benefit of those suppliers.

The Company argued this approach covered a “contagion risk”, i.e. that compromising trade creditors would lead to other suppliers becoming concerned about the company, which would have a knock-on effect on the Company’s cash flow, trading performance and prospects of survival.

The Court found in favour of the company on this point and said the differential treatment of landlords was justified for ensuring business continuity, therefore there was no unfairness.

The Applicants therefore failed in relation to Ground 4.

However, the Court again referred to the fact that rents were not being discounted to below market value, and stated that if that were the case, unfairness would have been found; a point, once again, for landlords to consider in the future.


Ground 5:
the CVA fails to comply with the requirements of IR2.3(1)

The final ground of challenge related to specific requirements of the Act and whether the CVA fell foul of them.

The Applicants sought to suggest that the CVA ought to have set out that, in the event of insolvency or administration, there would be potential claims under section 239 of the Act – preference claims – or under section 245 of the Act – floating charges created over the company’s assets within 12 months prior to the appointment of an administrator would be invalid – and the failure to do so means the CVA is invalid.

The Court, however, held this not to be the case. They considered a necessary number of landlords and local authorities would still have voted in favour of the proposal and therefore even if such potential claims had been detailed within the CVA, they would have been immaterial to the outcome.

The Applicants therefore failed in relation to Ground 5.


The takeaway?

It is fair to say that this decision was not a resounding success for landlords and the high street will continue to feel the impact of the CVA. However, the Court’s acknowledgement that landlords do, in fact, still have some proprietary rights and its unwillingness to allow companies to interfere with them is promising, as is the Court’s clear message that if companies seek to limit rents to below market value a dim view will be taken, and a different result may arise. The concern that the Courts will allow CVAs in any scenario, on the assumption that saving the retail market at landlords’ expense is worth it, or that years of over-renting premises creates an inherent unfairness to tenants such that the tenant will be regarded as always in the right, has been cautiously tempered.

Although, Judge’s parting words should be noted “I am anxious to hand down judgment in a form in which it can be appealed…” so watch this space!

Have a question? Contact Lindsey

Have a question? Contact Lindsey

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