It seems hard to believe that when the property industry named 2018 the year of the CVA we would now be looking back to those times as the good old days. Fast forward to January 2021 with the UK in a second lockdown, the COVID 19 pandemic is having wide ranging economic repercussions. We haven't seen a major surge in tenant insolvencies to date (except in High Street retail) but that is in part due to the measures taken by the government (such as VAT deferment, the furlough scheme and restrictions on creditors taking action) being reasonably effective.
Also, many landlords have responded to the financial difficulties that their tenants have found themselves in during lockdown and there has been a lot of constructive engagement in the form of rent holidays and lease regears. However, as government support reduces and gradually draws to an end, rent holidays come to an end and landlords find themselves having to ensure that there is a flow of rental income to keep their own creditors at bay, it is expected that a marked increase in insolvencies will hit later this year.
Unlike in 2018, there is also new legislation to contend with when dealing with a distressed tenant. The Coronavirus (Scotland) Act 2020 brought in temporary protections from irritancy for non-payment of rent and other sums by extending the usual pre-irritancy notice period from 14 days to 14 weeks. That protection is in place until 30 September 2021. The Corporate Insolvency and Governance Act 2020 has introduced permanent changes to UK insolvency law. This note looks at how the recent changes in the insolvency legislation will affect tenant insolvencies in the context of leases as well as looking at some recent trends.
Two New Insolvency Regimes
In addition to administrations, liquidations and CVAs (which all benefit from varying levels of statutory moratorium on action being taken against tenant companies by creditors such as landlords) the Corporate Insolvency and Governance Act 2020 has introduced two new insolvency type arrangements.
Firstly, the Act introduces a new Restructuring Plan similar to CVA type schemes of arrangement but with important additional features. The Restructuring Plan is, in essence, a compromise agreement between a tenant company and its creditors which requires to be voted for by 75% (in value) of each class of creditors and court sanction but with the major change that it is within the discretion of the court to approve the plan and impose a "cross class cram down" even if there are classes of creditors who have not voted in favour of the agreement.
For a court to be able to sanction such a plan, certain conditions must be satisfied. These are that the members of the dissenting class would be no worse off under the plan than they would be in the event of the relevant alternative and that at least one class who would receive a payment or would have a genuine economic interest in the company in the event of the relevant alternative voted in favour of the plan. Relevant alternative is whatever the court considers would be most likely to occur in relation to the company if the plan were not sanctioned.
The Virgin Active case decided last month was the first time that the new "cross class cram down" was used to effectively reduce and restructure a struggling tenant's lease liabilities. The plan was strongly opposed by a number of affected landlords who now face write off or deferral of substantial rent arrears accrued since March 2020 with further measures being imposed on them by way of temporary rent reductions and in some cases a switch to turnover based rents.
Secondly, a new standalone moratorium was also introduced by the 2020 Act aimed at providing companies with breathing space to explore options for survival. This process allows a company in financial distress to file documents at court to obtain a moratorium against creditor action which is similar to the moratorium currently available in administration. A key document which must be filed is a statement from an insolvency practitioner known as the monitor that the moratorium is likely to result in the rescue of the company as a going concern. It remains to be seen how popular this new process will be as insolvency practitioners may be reluctant to make that statement for fear of exposing themselves to potential liability if that statement turns out not to be the case.
The moratorium initially lasts for 20 business days but can be extended for a further 20 business days and then for a period up to a year with consent of creditors or approval from the court. It is broadly similar to the administration moratorium, and includes restrictions (among others) on insolvency proceedings, enforcement of security, and irritancy of leases. During the moratorium, the company must continue to pay certain debts including rent in respect of the moratorium period. If those debts are not paid, the moratorium will end.
There hasn't been a lot of take up for standalone moratoriums so far but it is assumed that there will be greater use of these once the temporary restrictions on landlord's recovery remedies (the restriction on irritancy brought in by the Coronavirus (Scotland) Act 2020 being just one of them) are lifted later this year.
New Trends with CVAs and Administrations
The first COVID 19 lockdown triggered an initial wave of retailer CVAs and administrations. One significant difference from 2018 is the fact that a lot of these COVID-19 related CVAs and administrations involve much larger retailers (such as New Look and the Arcadia Group) with more stores across the UK being affected.
For example, New Look's CVA moves more than 400 stores in their portfolio to turnover rent based agreements. The New Look CVA was challenged by landlords in court last month on numerous grounds but was upheld as valid. The case was high profile because it makes clear the courts’ reluctance to interfere with restructuring measures taken by retailers who are struggling with the way that the COVID-19 pandemic has affected their businesses, even where these measures impinge disproportionately on landlords.
The approach of the court in that case reflects what we have been seeing generally in the current market. We are seeing purchasers in administrations/CVAs taking a tough negotiating stance refusing to pay any pre-insolvency arrears and looking for major changes in the lease terms (rent reductions, turnover provisions making a comeback, introducing break options, COVID clauses etc) and being willing to walk away from properties if they don't get what they are looking for. Another big change from 2018 is that then the focus of CVAs and administrations were on retailer tenants struggling to compete with online retailers.
The COVID-19 lockdown has affected tenants in sectors that had been buoyant in 2018 such as the hospitality and leisure industry, travel and tourism and offices serving business sectors hard hit by the lockdown (eg travel and recruitment). These are the sectors where tenant insolvencies may increase when government support and temporary restrictions on landlord's recovery remedies are withdrawn later in the year.
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It is clear that, as lockdown unwinds, there are challenging times ahead for tenants and landlords alike. Whatever the future brings, we are here to help.