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23rd August 2018

2018: Insolvencies, CVAs and Issues for Landlords

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House of Fraser. Marks & Spencer. Poundworld. Toys R Us. New Look. Reports of names eponymous with the British High Street announcing job losses, store closures or plans to enter administration seem to be an omnipresent feature on the news agenda. 2018, thus far, has been a challenging year for many companies in the retail sector and the general consensus is that the strain shows no sign of abating any time soon. Why has it been a challenging time?

Consumers want an incentive to shop in store, rather than ordering via their phone or tablet from the comfort of their own sofa. Across the board, margins are being squeezed, costs are rising and consumer spending is being vastly reduced. This vicious circle means that inevitably, landlords will feel the effects of the financial pinch on their tenants.

What is a CVA?

There are various options open to struggling high street chains, with one such option being to enter into a Company Voluntary Arrangement (“CVA”).

  • Typically, landlords whose tenants who are proposing to enter into a CVA will be asked to accept lower rents (either indefinitely, or for a certain period of time). The most pertinent recent example of this was House of Fraser: their ability to receive a fresh injection of capital was dependent on them restructuring their rent obligations for a number of stores, as well as shutting other stores across their portfolio. Without this, the business would not be in a viable position to trade going forward.
  • CVAs do not proceed unilaterally: the proposals are scrutinised by the tenant’s creditors, with the creditors deciding whether the CVA proposals are accepted.
  • Creditors will weigh up whether the proposals are robust enough to ensure that a better result would be obtained via a CVA, rather than triggering the administration or liquidation process for the flailing company.
What effect does a CVA have on the landlord?

From a landlord’s perspective, the CVA route is controversial: landlords are being asked to absorb a portion of the tenant’s financial deficit by accepting a rent lower than they otherwise would expect to receive and a sum that is the market rate currently secured in the lease. To compound the problem, secured creditors will not fall within the remit of a CVA: a CVA will only deal with the unsecured debts of the company. This usually means that the landlord is the creditor with the largest debt owed to it, and is being asked to absorb the biggest loss.

Considerations for the Landlord

Landlords who are asked to agree to CVA proposals will need to weigh up the merits of various points before responding to the proposals, including:

  • Whether they think that they can obtain better terms by voting against the current CVA proposals on the table;
  • Whether it is likely that they will be able to recoup more money in the event that the tenant enters administration or liquidation (with their views on this aspect likely to hinge on whether there are any guarantors to cover any shortfalls in the rent, amongst other things);
  • Whether it makes financial sense for them to accept a reduced rent, which is less than what they have accounted for, but where it still has the certainty that some rent will be arriving (rather than potentially none, if the tenant ‘vacates’ owing to an insolvency event); and
  • For the purposes of business rates liability, whether it is more palatable to have a tenant (albeit an insolvent one) remain in situ at the property, or whether they require an insolvent tenant to vacate the premises immediately. This decision will have an impact on whether (and for how long) the landlord will end up footing the business rates bill in the event that the tenant becomes insolvent. The question regarding business rates liability for a landlord is a particularly contentious area of tenant insolvency: landlords will bear the business rates liability from the date on which the insolvent tenant is no longer in possession of the property, rather than the date on which they become insolvent (but remain in situ at the property). From a strategic perspective, does a landlord have interest from another prospective tenant (who is in better financial health) who can take over the unit, or is it more financially ‘palatable’ to keep an insolvent tenant in place to save (potentially) a greater outlay on the business rates bill?
Rent arrears are often one of a struggling tenant’s largest unsecured debts; it is therefore of little surprise that landlords feel as though they bear the brunt of the CVA’s impact.

The Rise of the ‘CVA’ Clause?

Are there even more problems on the horizon for landlords who agree to a rent reduction as part of CVA proposals by troubled retailer clients? Next, the fashion retailer, have indicated that on upcoming lease renewals, they will seek to introduce a ‘CVA clause’. The effect of this clause will be that where neighbours to Next stores up and down the country receive a rent reduction by virtue of a CVA, Next will then be entitled to seek a similar reduction to reflect the deal struck pursuant to the CVA. Whilst this move has been criticised in some quarters, it remains to be seen whether other retailers will look to follow suit.

‘I’m a landlord – how can I protect my position?’

The situation is not all doom and gloom for landlords: there are several ways in which landlords can position themselves to ensure that they are in the best possible position to deal with any defaulting tenant.

  • Know Your Tenant: do not underestimate the importance of undertaking due diligence. When entering into new leases, ensure that you have carried out a sufficiently thorough due diligence exercise on a prospective tenant. You should be looking to assess their ability to continue to pay the rent throughout the period of the lease. Are they likely to have difficulties in meeting their rent obligations if the market turns difficult?
  • Once the outcome of the due diligence exercise is known, you can then assess whether there is any merit in requesting a guarantee from either the tenant’s parent company, or an individual connected with the tenant. The guarantee can be drafted in such a way so
  • You may require a prospective tenant to enter into a rent deposit deed: the advantage of doing so is that the prospective tenant will need to pay an upfront sum to the landlord ahead of taking the lease.
  • Should the tenant then fail to pay the rent (or any other liabilities) during the course of their tenancy, the landlord can use the deposit monies to offset any non-payment of rent.
  • Whilst this is not a fail-safe method (as the landlord’s right to draw against deposit monies is often restricted by the terms of the tenant’s CVA), it is a viable option for landlords to pursue in cases of tenant default which occur pre-CVA.
  • It is also worth considering adding a clause to new or renewal leases which permits you (as the landlord) to draw down on the rent deposit deed in the event of a missed rental payment from the tenant.
    • The clause can also place an obligation on the tenant to ‘top up’ the monies held under the rent deposit deed if they are drawn on by the landlord: if they are unable to do so promptly, it could be an early indicator of financial difficulties ahead.
    • Furthermore, should the tenant fall into an insolvency position, the incremental draw down on the tenant’s deposit by the landlord could help cushion the blow on rent arrears. By acting in this way prior to the tenant entering into a CVA, the landlord will have secured some monies to offset against the rent arrears before the moratorium period commences and ‘freezes’ the tenant’s available funds.
    • Act, rather than spectate, once it becomes clear that the tenant is seeking a CVA. There are a number of things which a landlord can do to influence the terms of the tenant’s CVA, including ensuring attendance at the creditors’ meeting and participating in the discussions. Whilst it is not compulsory to do so, the creditors’ meeting will give you a platform to try and protect yourself as a (likely) unsecured creditor. By engaging, you have the ability to shape the terms of the CVA. For example, rather than agreeing a store closure, are you content to offer the struggling tenant a reduced rent for a fixed period? The advantages are two-fold: you may retain the tenant (even for a short period) whilst they navigate through their financial difficulties, whilst at the same time it will buy you additional time to find a new tenant.
    For more information please contact Natalie Minott on 01223 447421 or click here to email Natalie.