High Court decision in Debenhams CVA case offers little comfort to landlords

Company Voluntary Arrangements (CVAs) have become a popular way for struggling retailers to reduce their costs, in particular, liabilities under their leases. In this blog, Adam King looks at the recent High Court decision to reject a claim by a group of Debenhams’ landlords who challenged the legality of the retailer’s recent CVA. The decision has important and, for the most part, negative implications for landlords of retail property.

This begs an interesting question about what would happen if a landlord challenges a CVA where the reduced rent is below market value

Earlier this summer, creditors of high street retailer Debenhams overwhelmingly approved a CVA that it hopes will enable it to turn around its struggling business. The terms of the CVA allow it to close 50 stores and obtain rent reductions in several others.

Not all Debenhams' creditors were in favour of the arrangement and a group of six landlords brought a High Court action (funded by Sports Direct's Mike Ashley) challenging the CVA on five grounds. The challenge was unsuccessful on four of the five grounds, and the CVA (as slightly amended, see below) was held by Mr Justice Norris to be valid and enforceable.

The grounds of the challenge were:

Ground 1: That the CVA went beyond the jurisdiction of the Insolvency Act 1986 as landlords are not "creditors". This, the applicants argued, is because future rent cannot be classed as a debt and instead is an unearned future payment.

Mr Justice Norris disagreed. He said that while a creditor in a CVA must have a debt, the term "debt" includes "pecuniary liabilities" arising out of an existing legal arrangement (such as a lease). As future rent is a pecuniary liability, landlords are creditors for the purposes of the CVA.

Ground 2: Reducing a landlord's rent transgresses the requirements of common justice and is unfairly prejudicial. In short, the landlords argued, they entered into a lease under which they expected to receive a certain rent. It is not fair if the tenant is entitled to remain in occupation and receive the benefit of the property, but they don't receive the full rent they agreed.

Mr Justice Norris disagreed, saying a CVA that reduces rent under an existing lease is not automatically unfair; the fairness of the CVA must be considered in the round. It was relevant that none of the landlords claimed the reduced rent would mean that they receive less than the current market rent for the property.

This begs an interesting question about what would happen if a landlord challenges a CVA where the reduced rent is below market value

Ground 3: By removing the landlord's right to forfeit the lease, the CVA abrogates the landlord's proprietary rights. The applicants argued that a right of re-entry under a lease is a right between a landlord and tenant and not a creditor and debtor and so cannot be altered by the CVA.

On this point, the judge agreed with the applicants and approved a modified CVA removing the provisions that would prevent a landlord from forfeiting the lease.

This offers a crumb of comfort to landlords who may wish to forfeit a lease because, for example, they can let the store in question to another tenant or redevelop the premises (assuming the lease states that a CVA is an event entitling forfeiture).

Ground 4: The CVA treated the applicants less favourably than other unsecured creditors, without justification. In essence, the applicants argued that the CVA "is designed to create a situation in which the company's general body of unsecured creditors is paid in full at the expense of certain landlords and local authorities".

The judge rejected this argument stating that the different treatment of landlords and suppliers was justified by the need for business continuity and was, therefore, fair. However, it would not have been fair if landlords were expected to take reductions in rent below the market value of the premises.

Ground 5: The CVA failed to comply with the requirements of a specific section of the Insolvency Act to do with preference claims. The judge rejected this ground of the claim.

Conclusion

The decision highlights the fact that CVAs can be unfair on a group of creditors (and quite often this group is landlords) but that doesn't mean the CVA as a whole is unfair and likely to be overturned.

The courts seem keen to allow CVAs if it means the survival of a retailer at the expense of landlords (who are often perceived to have benefitted from years of over-rented premises). The judgment indicates though that this won't necessarily be the case if the reduced rent is less that the market rent.

It is worth noting that 94.71% of Debenhams' creditors by value approved the CVA and, of the landlords voting, 82.1% by value approved the CVA.

The decision is undoubtedly a blow to retail landlords at a time when high street conditions couldn't be tougher. At the time of writing, John Lewis is threatening to withhold 20% of service charges to some shopping centre landlords as a protest against "unacceptable" increases in recent years. John Lewis is in a strong position given that few, if any, landlords would want to threaten John Lewis with repossession for failure to pay.

An interesting post-script is Mr Justice Norris's words at the end of the judgment: "I am anxious to hand down judgment in a form in which it can be appealed." Whether Mike Ashley (or anyone else) is willing to finance an appeal remains to be seen.

If you would like to discuss any property litigation matter, please contact Adam King at [email protected].