A shop window of opportunity: Act now to recover
Challenges in bricks-and-mortar retail are not new. However, the impact of the COVID-19 pandemic has accelerated many key consumer trends away from the high street, forcing acute (and potentially permanent) reductions in footfall as well as widespread store closures. To date in 2021, the number of stores in the UK is reported to have fallen by almost 10,000.
The availability of government-backed loans and restrictions on creditor action have given UK retailers the liquidity and space to reflect on their recovery strategy. Many of these support mechanisms have been extended restrictions on winding-up petitions have been pushed out to September 2021 and the moratorium on forfeiture for non-payment of rent to March 2022.
Legislative changes in 2020 introduced powerful new restructuring tools, and in recent weeks we have seen the courts upholding attempts by two high-profile consumer-facing businesses to deliver their turnaround strategies in the wake of creditor resistance. These cases are briefly reviewed below.
In short, there has arguably never been (and may never again be) a better opportunity for retailers to transform their operational and capital structures and reposition their business for long term sustainable recovery.
High-profile fashion retailer New Look proposed a Company Voluntary Arrangement (CVA) in the wake of the COVID-19 pandemic. The CVA was approved by creditors but subsequently challenged by a consortium of landlords. They raised objections on a number of grounds, including that
(a) a CVA should be struck down if it is passed because of votes cast by creditors who are not compromised;
(b) differential treatment of creditors is unfair; and
(c) certain modifications to existing leases (e.g., in relation to rent and termination rights) are unfair.
In a significant and wide-ranging decision, the court found against the landlords on all grounds. Among other findings, the court decided that even if a CVA reduces the future rent payable by a company to its landlord to below market rent, this will not necessarily enable a successful challenge, provided the landlord is given the option to terminate the lease and re-let the premises. This gives businesses the flexibility to offer landlords terms that are affordable (accepting that landlords may choose to terminate if they can achieve a better rent elsewhere).
This judgment will enable retailers to propose CVAs with greater confidence that they can defend a potential challenge, provided they deliver a fair and justifiable outcome for creditors, which is better than would be achieved if the company was to fail. The outcome will be of particular interest to retailers with a leasehold store portfolio, with liabilities which have accrued as a result of the trading impact of the pandemic. Our detailed commentary on this case is here.
Well-known gym operator Virgin Active was one of the first companies to make use of the new Restructuring Plan, which was introduced into legislation in 2020. Indeed, this company became the first to use it to target the reduction of lease liabilities. The Restructuring Plan is available to any company which “has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern”.
The Restructuring Plan is starting to gather traction as it is tested by the courts (with DLA Piper’s Restructuring team having acted on a number of the key developments). It enables a company to deliver more fundamental transformation due to lower approval thresholds and the ability of the court to override the wishes of dissenting classes of creditors if the relevant conditions are satisfied, namely that
(a) 75 percent (in value) of a creditor class which has a genuine economic interest in the company votes for the plan; and
(b) dissenting creditors will not be any worse off than they would be in the relevant alternative (i.e., the likely outcome if the plan was not approved, which will often be insolvency). This is known as “cross class cramdown.”
Virgin Active’s creditors were divided into numerous classes, including secured creditors and five classes of landlords. The landlord classes ranged from those whose leases would not be impaired to those whose sites would be closed (with a range of outcomes in between, mostly involving switching to turnover-based rents). Of the landlords, only the unimpaired class voted for the plans. As a result, Virgin Active saw the first contested use of cross class cramdown and the court had to decide whether to sanction the plans.
The landlords organized a formidable challenge. However, the court was satisfied that the relevant conditions were satisfied.
The Virgin Active case is a significant step forward for companies seeking to deliver a turnaround strategy. It demonstrates that the Restructuring Plan, as a single process, can address all of a company’s balance sheet considerations and preserve an existing corporate group, without the need for a formal insolvency process.
Our detailed commentary on this case is here. Looking forward – act now The courts have shown that they will not let a solvent restructuring be blocked by creditors with a limited economic interest, including landlords. With the benefit of ongoing protection from creditor action, which will not be here for much longer, now is the time for retailers to plan for (and deliver) their long-term recovery.