Dealing with tenant CVAs

Restrictions introduced as a result of the COVID-19 pandemic have brought into sharp focus the problems already faced by struggling commercial landlords in retail and other sectors.

Many might consider that this has created a charter for tenants to avoid their contractual obligations. However, where struggling businesses are building up significant rent arrears, their landlords have some important recovery options still available to them. Landlords can also still bring proceedings in county courts or the High Court to recover arrears, as debt claims brought by landlords are not prohibited by the government restrictions.

While there is understandable sympathy for struggling companies in these unprecedented times, the British Property Federation has made clear that landlords are businesses too and the pension funds of millions of individuals are invested in the commercial property sector.

It is therefore important to balance the interests of both; mutual engagement and ongoing dialogue remains essential. See the Code of practice for the commercial property sector for government guidance in which RICS played a significant role. The RICS COVID-19 commercial rental independent evaluation service is also available to aid compliance with this code.

These options might include the moratorium procedure introduced by the Corporate Insolvency and Governance Act 2020, which provides viable businesses with a window to reorganise their operations or seek reinvestment, protected from court or other enforcement action.

The new moratorium is a short-term option where existing management stays in place, overseen by a qualified insolvency practitioner who acts as monitor. It remains to be seen whether this is an effective solution for struggling businesses, many of whom are at present supported by financial relief from the chancellor in the form of business interruption and bounce-back loans as well as furlough payments.

A landlord’s rights of action are only suspended for a limited time by the moratorium, and it will not affect the general obligations of the tenant under a lease. These obligations may be varied by other restructuring options available, including perhaps the most well-known, the company voluntary arrangement (CVA).  

It is a feature of certain CVAs involving substantial property portfolios that the only creditors adversely affected by the scheme of arrangement are landlords and local authorities, with all others paid in full. This ensures that the CVA receives the necessary majority of 75% of creditors voting for approval. 

The compromise imposed on landlords by a CVA may include a reduction in the contractual rent payable under leases and closures of unprofitable stores. The only recourse available to the landlord is to assert in the courts that the CVA contains a material irregularity or unfairly prejudices their interests as a creditor.  

In the widely reported case Discovery (Northampton) Ltd & Ors v Debenhams Retail Ltd & Ors [2019] EWHC 2441, the court decided that treating landlords differently to trade suppliers does not amount to unfair prejudice, and may be justified by carrying out a balancing exercise to determine the overall fairness of the CVA proposal. However, the judgment did reassure landlords that a CVA cannot by its terms restrict the right of a landlord to forfeit a lease.  

The judge  in Debenhams applied the facts of the case to reach his conclusions on the issue of unfair prejudice, which emphasises the importance of constructive interaction between the parties when negotiating over the terms of any proposed CVA.

In certain circumstances, a landlord may want to consider a turnover-based rent agreement rather than facing the prospect of a vacant property. This model takes into account the uncertain nature of future trading, and may give the retailer or business the flexibility it needs to survive.

If dialogue has broken down and there is a risk of administration or liquidation, it is preferable to have been proactive by issuing letters before taking legal action and/or court proceedings for the debt. An aggressive and proactive debt recovery strategy such as this may work to a landlord’s advantage, particularly if its tenant is keen to avoid judgments that may breach its banking covenants or other commercial arrangements.  

If a business is forced into administration or liquidation, a landlord’s claim will now most likely rank with other unsecured creditors behind HMRC, after having regained its preferential status in relation to certain tax liabilities with effect from 1 December 2020.

However, if the tenant enters a formal insolvency process and remains in occupation of the premises, ongoing rent can be demanded as an expense of the administration or liquidation.

As we emerge from the pandemic and more commercial properties are at risk of closure and lying vacant, landlords may choose to consider more open dialogue and perhaps sharing risk and reward with their tenant in new turnover-based rent agreements, rather than taking the more traditional option of enforcement action.

Related competencies include: Corporate recovery and insolvency, Landlord and tenant, Leasing and letting