Insolvency update

One of the key questions in administrations of leasehold property
on which practitioners have been
awaiting clarity is whether rent should be payable
as an administration expense (as opposed to a
provable debt).

Focusing on company voluntary arrangements (CVAs), there has been growing unease among the landlord community and their advisers about the use of this process to compromise landlords’ claims while other creditors are paid in full.

Game on

Practitioners will be aware of the uneasy and unhappy stalemate that had arisen following the two first instance cases of Goldacre Office Limited v Nortel Networks UK Limited [2009] EWHC 3389 (Ch) and Leisure (Norwich) II Limited v Luminar Lava Ignite Limited [2012] EWHC 951 (Ch).

The arguably arbitrary outcome of these cases was that provided administrators were appointed after the quarter day, they could occupy any premises tenanted by the company for the quarter with rent constituting only a provable debt.
In contrast, if administrators were appointed before the quarter day, they would have to pay rent in full as an administration expense.

Following the precedent set out in Goldacre and Luminar, Game Group was placed into administration on 26 March 2012, the day after
the March quarter day, when rent was due for three months in advance on multiple sites from which
the group companies traded. On 1 April 2012, the administrators transferred the business of the
Game Group to a third party, Game Retail Limited (Game Retail) and granted that company a licence
to occupy certain premises.

Game Group’s landlords were understandably unhappy as the administrators and Game Retail reaped the benefits of the Luminar decision.
And so at the instigation of Game Group’s landlords, the administrators brought proceedings relating to five sample leases (under four of which Game Retail had been granted a licence to occupy), asking the court to determine whether or not rent should be payable as an administration expense.

As practitioners will recall, at first instance,
the High Court was of course bound by previous precedent. Recognising the importance of the issues at stake, however, leave to appeal to the
Court of Appeal was granted.

In February 2014, the Court of Appeal handed down its judgment (Pillar Denton Limited and others v Jervis and others [2014] EWCA Civ 180), overturning Goldacre and Luminar and holding:

• n the so-called ‘salvage principle’ (otherwise known as the Lundy Granite principle, after the case of the same name) applies to rent which is payable in advance;
• such rent should be treated as accruing from day to day;
• however, where such rent is payable in advance, it will be payable as an administration expense only for the actual period of beneficial ownership of the premises – to be determined by fact, rather than by quarter days.

The Court of Appeal’s Game Station decision puts the position back to what it was before the Goldacre decision in 2009. It seems to be a victory for common sense – meaning that administrators will pay rent as an administration expense for leasehold properties while they occupy them for the benefit
of the administration, but will not be bound by arbitrary quarter days. Arguably this does not sit easily with the rescue culture as, where funding is not available to pay landlords and a pre-packaged sale cannot be put in place, continuing to trade companies while seeking a buyer will typically present a huge challenge.

As at the end of July, an application for permission to appeal has been made to the Supreme Court,
but no decision has been made – we understand from the Supreme Court listing office that landlords and insolvency practitioners (and those advising them) will now have to remain on tenterhooks until after the summer recess.

Retail CVAs

A CVA (a ‘composition in satisfaction of its debts or scheme of arrangement of its affairs’ – essentially,
a contract between a company and its creditors which has statutory effect) will come into force if
it is approved by the requisite majority of the company’s creditors (for the CVA to be approved,
75 per cent of the creditors present in value must vote in favour (this must include 50 per cent in value of creditors unconnected to the company). Following approval, it can still be challenged by disgruntled creditors within 28 days of the date of the meeting on two grounds:

1. unfair prejudice; or

2. material irregularity at or in relation to the creditors’ and members’ meetings.

It will not necessarily be unfairly prejudicial if the different groups of unsecured creditors are being treated in a different manner – a factor that has significantly disadvantaged landlords in recent years. While there is no defined test for unfair prejudice, in the case of Re Prudential Assurance Co Limited v PRG Powerhouse Limited [2007] EWHC 1002 (Ch), Etherton J proposed two tests: a vertical test (comparing the creditors’ position under the CVA with the position on a winding up) and a horizontal test (comparing the compromised creditors’ position to that of other creditors).

Over the past ten years, CVAs have become popular among retailers as a way of dealing with underperforming stores. Typically, the CVA proposal will assess landlords between those whose premises house underperforming stores, who will receive
a payoff for a surrender of the lease, and those from whose premises the company wishes to continue trading. For this latter category, the picture is often rosier, although they are typically asked to accept alterations to lease terms (especially rent being paid on a monthly, rather than quarterly, basis).

CVAs of large retailers seeking to modify their property portfolio have been met with varying success. In 2007, the PRG Powerhouse CVA was successfully challenged on the grounds of unfair prejudice because the CVA sought to strip away guarantees granted by the parent company of the debtor’s obligations through the CVA of the debtor.

Pre-packaged administration

While the court in Powerhouse held that a CVA
could in principle compromise the liabilities of a third party guarantor (by obliging landlords to
treat the obligations of the guarantor as having been released), in this case doing so was held to
be unfairly prejudicial because it would deprive
the landlords of guarantees which would have provided a significant return. A similar challenge was successful in respect of the owner of the
Miss Sixty fashion retailer in 2010 (Mourant & Co Trustees Ltd v Sixty UK Limited and others [2010] EWHC 1890 (Ch)).

Following Powerhouse, CVAs for companies
within the Stylo Barratt group proposed in February 2009 did not even make it past the first hurdle,
and were voted down by creditors. The terms of these CVAs were prejudicial to landlords, reducing rent to a proportion of turnover for two years.

In terms of getting CVAs past creditors, JJB Sports arguably fared better, with two separate CVAs being approved in 2009 and 2011 which closed 140 and
89 stores respectively. Nevertheless, the business and assets were soon sold to JJB’s rival, Sports Direct, in a pre-packaged administration sale in 2012.

Likewise, Focus DIY used the CVA route to close
38 stores in 2009, but entered administration within two years and the creditors of Blacks Leisure approved a CVA in 2009, only for the business and assets to be sold in a pre-packaged administration
in 2012. In multiple cases therefore, it seems that landlords who have approved CVAs and accepted less favourable lease terms for a defined period
have ultimately still seen their tenants fail.

Most recently, in June 2014, the landlords of restaurants in the Bella Italia and Café Rouge
stables were asked to consider CVAs proposed
by companies within the Tragus Holdings
Limited group.

The CVA terms split properties into different categories, with landlords for the majority of properties continuing to be paid rent at the same rate, but on a monthly rather than quarterly basis. Smaller groups of landlords were asked to take a rent reduction down to 60 per cent and 50 per cent of current rents for defined periods (also paid monthly rather than quarterly).

Guarantees from other group companies would be treated as being released or reduced – however, it was stressed that the companies offering guarantees did not have significant assets to meet claims in any event. Other unsecured creditors
were unaffected.

The Tragus CVAs were approved by the creditors on 20 June 2014. We are, however, aware of rumblings of discontent among the landlord community, who are again outraged that they should compromise their contractual terms while other trade creditors are unaffected by the CVA,
and yet with no certainty, if the examples of JJB, Focus and Blacks are anything to go by, that doing so will ultimately avoid an administration.

The 28-day challenge window for the Tragus
CVAs was still open at the end of July and we wait with interest to see if any challenge is made by the landlord community on technical or general unfairness grounds. SJ

Brett Israel, pictured, is a partner and Pippa Hill is a senior associate at Wragge Lawrence Graham & Co 

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