Company voluntary arrangements: secured creditors' (almost) impenetrable rights

Background

High-profile use of company voluntary arrangements or CVAs, has led to widespread media coverage and controversies. Household names such as Jamie's Italian, Prezzo, Toys R Us, Mothercare, Gourmet Burger Kitchen and more recently Debenhams are amongst the growing list of companies who have followed this well-trodden path, with varying degrees of success. Those companies unable to turn their fortunes around face administration or liquidation.

CVA, enshrined in statute under the Insolvency Act 1986, was introduced as a rescue mechanism to aid companies which are experiencing financial difficulties. A CVA enables the company and its creditors to reach an agreement or compromise as to how its debts will be repaid. This is with the aim of helping the company to avoid insolvency proceedings. More importantly, a CVA allows the company in question to continue trading and provides an opportunity for the company to restructure and formulate a business strategy.

This article will briefly cover the CVA process, analyse the recent Debenhams High Court appeal, and discuss the impact of CVAs on lenders.

The Company Voluntary Arrangements process

As CVAs are intended to be a rescue mechanism, statute has provided for the directors of the company to propose a CVA to the company's shareholders and creditors, if they wish to do so in the light of the company's financial difficulties. There are two principles which underpin a CVA:

• the proposal must not unfairly prejudice the interests of any creditor, and
• the proposal must not affect the rights of secured creditors to enforce on their security without their consent. Accordingly, any debt owed to a secured creditor will have to be paid in full unless an agreement can be negotiated otherwise.

While CVAs are enshrined in statute, a statutory procedure has not been prescribed and CVAs do not require approval from the courts.

Generally speaking, a typical CVA follows these steps:

• The directors of the company will put together a proposal with the assistance of the nominee (an insolvency practitioner who has been nominated by the directors to supervise the implementation of the proposal). It is very likely that the company's lenders will also be consulted at this stage.
• In addition to the CVA proposal, the directors will have to provide a statement of the company's affairs. The nominee will then consider the proposal and provide any comments to the directors before a finalised version of the proposal is produced.
• Once satisfied, the nominee will file its recommendation, the CVA proposal and a statement of the company's affairs with the court. The nominee will then have to obtain the creditors' approval by giving notice to every creditor of the company that the nominee is aware of.
• The nominee will also have to obtain shareholders' approval on the proposal. Such decision must be made after the creditors' decision but not later than five business days after the creditors' decision.
• In order for a CVA to be implemented, at least 75% (by value) of the company's creditors will have to approve the proposal. While approval is sought from the shareholders, as long as there is creditors' approval, the shareholders' approval is not material.
• Once the CVA is approved, the nominee will then become the supervisor and will implement the proposal. It is important to note, however, that the CVA is an arrangement between the company and its unsecured creditors.

Case study: Debenhams

In the recent High Court case, a group of disgruntled Debenhams' landlords brought a challenge to the CVA on the grounds of unfair prejudice and material irregularity. This is despite the fact that the CVA obtained an approval of approximately 82% from voting landlords.

In essence, the CVA proposal sought to alter the conditions of the shop leases depending on which category they fell into (eg reduction in rent, break rights, reduced business rates, early termination rights).

Unsurprisingly, the group of challenging landlords failed on both grounds.

Unfair prejudice

The Court held that the landlords were not treated less favourably compared to other unsecured creditors.

The fact that the level of rent was being reduced did not render such treatment unfair prejudice because this was balanced by the fact that the landlords have the ability to terminate the lease within a certain timeframe.

While the landlords were treated differently compared to the other unsecured creditors, this was for business continuity reasons. Further, the Court noted that the CVA proposal did not bring the level of rent below market rate (which would have been viewed as unfair had that been suggested).

Material irregularity

The landlords argued that the CVA failed to comply with the content requirements of the Insolvency Rules, which constituted a material irregularity. Again, the Court did not rule in favour of the landlords. An irregularity will only be deemed 'material' if, had the irregularity not occurred, "it would have made a material difference to the way in which the creditors would have considered and assessed the terms of the CVA".

It was held that the omission of details in relation to potential clawback claims that might crystallise, should the company go into administration, was not material. This was because the landlords potentially compromised by this would only amount to 0.5% of votes (by value), "a wholly immaterial amount".

Landlords' right of forfeiture

The landlords, however, succeeded in their argument against the proposed waiver of the landlord's right of forfeiture. The right of forfeiture was deemed to be a proprietary right, which belonged to the landlord and not a 'security'. Therefore, the CVA was unable to modify the right of forfeiture in and of itself.

What do CVAs mean for lenders?

If triggered, a moratorium will prevent a secured creditor from enforcing its security for the duration of the moratorium without the consent of the Court. However, only SMEs that satisfy two or more of the following conditions are able to trigger a CVA moratorium:

• turnover no greater than £10.2 million
• balance sheet assets no greater than £5.1 million, and
• no more than 50 employees.

Furthermore, companies which have incurred a liability under an agreement of £10 million or more will be ineligible for a CVA moratorium. The possibility of a moratorium in connection with a larger enterprise with secured loan arrangements in place is therefore rather remote.

While the company is not required to consult its lender before proposing a CVA, in reality, it is likely to do. This is because the onset of a CVA is likely to be caught within the definition of an event of default in a loan agreement. It is important that such consultation takes place as soon as possible because any prudent lender will want to evaluate the workability of the CVA proposal and its potential impact on the lender.

It is highly unlikely that a secured creditor will be affected by a CVA but as the ever persistent calls for CVA reform grow, it is anyone's guess as to whether any reform proposal will adversely affect the almost impenetrable secured creditor's rights.

Discovery (Northampton) Ltd & Ors v DGabrebenhams Retail Ltd & Ors [2019] EWHC 2441 (Ch)