New Look CVA challenge dismissed by High court
The restructuring market has been eagerly anticipating the judgments in the New Look and Regis CVA challenges. The New Look judgment was handed down on 10 May 2021 and the Regis Judgment followed on 17 May 2021. This article briefly sets out the issues in the New Look CVA challenge, the decision of Mr Justice Zacaroli and what this means for the future of CVAs.
Overview of the New Look CVA Challenge
The claim brought by the Applicants (a consortium of compromised landlords) can be summarised briefly under three heads of claim:
- The “Jurisdiction Challenge” - that the CVA did not amount to a composition or arrangement within the meaning of section 1(1) of the Insolvency Act 1986 (IA86) because (a) it constituted separate arrangements with different groups of creditors, (b) there was insufficient “give and take” for it to be a compromise and (c) it improperly sought to interfere with landlords' proprietary rights.
- The “Unfair Prejudice Challenge” - there was unfair prejudice as a result of (a) unimpaired creditors (including secured creditors) being allowed to vote on the CVA proposal and thus effectively enable the CVA company to impose an impairment on other creditors who voted against the proposal, (b) the differential treatment of compromised creditors, and (c) the CVA making unfair modifications to the leases.
- The “Material Irregularity Challenge” - there was a material irregularity due to (a) omissions and inaccuracies in the CVA proposal, and (b) the calculation of the landlords' voting rights, namely the application of a 25% discount to landlords' claims for voting purposes.
The Applicants lost on each of the three heads of claim. Whilst this article will not summarise the full reasoning in Zacaroli J's lengthy judgment, set out below are some of the key takeaways for each of the three heads of claim.
The basis of the Applicants’ case in the Jurisdiction Challenge is that a CVA cannot be used to effect two or more deals on substantively different terms with different groups of creditors, because there is no jurisdiction to do so.
Zacaroli J rejected the Jurisdiction Challenge, finding that:
- The fact that a CVA provides for different treatment of different sub-groups of creditors does not mean that it falls outside the jurisdiction of section 1(1) IA86.
- An “arrangement” for the purposes of section 1(1) IA86 should not be construed in the same way as in section 895(1) of the Companies Act 2006 for a scheme of arrangement, so as to limit a CVA to an arrangement in which the rights of all creditors are such that they can consult together with a view to their common interest.
- Whilst “give and take” is a necessary element for a CVA, there was sufficient “give and take” in New Look on the basis that (a) the compromised landlords received a return for giving up their contractual rights which is at least as good as the return available with the relevant comparator insolvency process (in this case a pre-pack administration), and (b) whilst the landlords already had termination rights, the additional termination rights in the CVA were part of a package of new rights. Furthermore, any “give and take” should be looked at in the context of a wider restructuring, where appropriate.
- There was no interference with the landlords’ proprietary rights as the release of New Look from having to pay rent and others sums did not operate as a surrender of those leases as the obligation to pay rent is not an essential requirement of a lease. Although the CVA proposal offered certain landlords the opportunity to agree to a surrender of the lease it did not require them to do so.
Unfair Prejudice Challenge
The Applicants contended that the CVA comprises at least three substantially different deals with three categories of creditors, who were (a) the senior secured noteholders who are unimpaired by the CVA but who are party to a wider restructuring via a scheme of arrangement; (b) the compromised landlords; and (c) the ordinary unsecured creditors and the category A landlords who are entitled to receive payment in full. The Applicants argued that the CVA was effectively imposed upon them by these unimpaired creditors.
In relation to the Unfair Prejudice Challenge, Zacaroli J held:
- Where a statutory majority is achieved by the votes of unimpaired or differently treated creditors this will be an important consideration in determining whether unfair prejudice exists but it will not necessarily lead to a finding that a CVA which is approved in those circumstances is unfairly prejudicial.
- Where a CVA reduces the rent payable to landlords to below market rent, this does not necessarily lead to a finding of unfair prejudice. Nor is there a rigid test which requires the rent reductions to be to the minimum extent possible, particularly in circumstances where, under the CVA terms, the landlord is given the ability to terminate the lease.
- The vertical comparator test (which compares the projected outcome of the CVA with the projected outcome of a realistically available alternative process, in this case pre-pack administration) was met, it was not unfairly prejudicial to offer the landlords the choice between terminating their lease and accepting the financial return, or continuing the lease on reduced rent and with additional termination rights.
- An important consideration is the fair allocation of assets available within the CVA between compromised creditors and other sub-groups of creditors and whether those assets would, or could, have been made available to all creditors in the alternative insolvency scenario.
- The CVA could be viewed in the context of the wider restructuring, in which the senior secured noteholder's rights were significantly impaired by the scheme of arrangement even though they were not impaired in the CVA.
- In light of the cross-class cram down provisions contained in the new restructuring plan introduced by the Corporate Insolvency and Governance Act 2020, it cannot now be said that creditors should not have their debts compromised by a statutory majority unless the majority and minority share sufficiently similar rights to enable them to consult together on the proposal with a common interest.
Material Irregularity Challenge
The application of a discount of between 25% to 75% to landlords' claims for voting purposes has been widely adopted in the market to reflect the fact that landlords claims for future rent are unliquidated and unascertained.
In New Look the Applicants argued that there was a material irregularity because, among other reasons, the CVA proposal fettered the chair's duty to place an estimated minimum value on the claims for voting purposes and the 25% discount was effectively double discounting to the prejudice of the landlords as there had already been a deduction to their claim to reflect their ability to re-let the premises.
Zacaroli J dismissed the Applicants' claims of material irregularity, finding:
- Schedule 2 of the CVA proposal setting out the formula for calculating the value of landlord claims for voting purposes ensured transparency to all landlords on how their claims were calculated and did not fetter the chair's discretion.
- The chair agreed with the formula for calculating the claims and no landlords put forward evidence to the chair in support of an alternative valuation.
- The range of potential outcomes in respect of future rent liabilities is such that identifying an appropriate discount is not an exact science.
- As the discount was applied equally to all landlords and the aggregate claims of those voting in favour was greater than the aggregate of claims of those voting against, the 25% discount had no impact on the outcome of the CVA meeting and therefore there was no material irregularity.
Lessons learnt and what’s next?
This judgment provides helpful certainty that CVAs can continue to be used in instances where different categories of creditors are required to be treated differently in order to deliver a successful and sustainable outcome for the CVA company.
The outcome will therefore be welcomed by companies seeking to compromise lease liabilities accrued during the pandemic. With the various restrictions introduced at the start of the Covid-19 pandemic to prevent commercial landlords from taking action for non-payment of rent due to end on 30 June 2021 and landlords looking to recover these unpaid sums, tenants might look to CVAs (and the new Restructuring Plan procedure) as providing the solution. However, Zacaroli J did sound some notes of caution. First, that it is “emphatically not enough”, when considering the question of unfair prejudice, to simply satisfy the “vertical” test, which requires the CVA to deliver a better outcome for creditors than would be the case in the relevant alternative. Secondly, the “horizontal” test is not necessarily satisfied even if it can be demonstrated that differential treatment between creditors (eg those which are considered “critical” and those which are not) is objectively justifiable. Whether there is unfair prejudice will depend on all the circumstances.
The High Court granted the applicant landlords permission to appeal on 14 May 2021 and it is possible that challenges will continue to be made to CVAs going forward, at least until that appeal is determined. It therefore remains to be seen whether companies will increasingly turn to the more powerful Restructuring Plan both to drive a more favourable outcome and to deliver certainty on a shorter overall timeline, given the development of court guidance through the case of Deep Ocean and, most recently, Virgin Active. Our commentary on those cases is here (A series of firsts for UK Restructuring Plans) and here (UK Restructuring Plan Update: One further sanctioned case, one giant step forward).