The UK CVA
What makes CVAs so popular? Readers will be familiar now with how they work. A company makes a proposal to creditors. If 75% of creditors vote for it, including a majority of unconnected creditors, 100% of creditors are bound into it. Unlike administration, where a business is handed over to an insolvency practitioner (IP) and sold to new owners, the directors stay in charge, albeit under the supervision of the IP, and the shareholders remain in control. If the CVA is successful the main beneficiaries, at least in contrast to an administration, are the shareholders.
Secondly, a high street CVA is always selective. Not all creditors are treated equally, as would be the case in any other insolvency process. The CVA can be used to reduce rent, end leases early and avoid dilapidations whilst at the same time paying all other creditors on time in full. This principle goes against the very heart of UK insolvency law, which requires all creditors to be treated equally.
The arguments for and against are well rehearsed. Retailers and restaurant groups (and their shareholders) point out that the structural shifts in retailing mean that high street space is overvalued. A CVA is a fair way to rebalance this because it recognises value in different categories of leases. A Category 1 landlord will be unaffected by the CVA; a fortunate Category 5 landlord might receive the keys back and a quarter's rent.
Suppliers are broadly supportive. They get continuity of supply with a more stable customer without the risks of proving retention of title to an administrator.
Landlords are publicly furious that they have been singled out to bear the brunt of a failing business model, and that their own business model is put at risk. Why should profits be diverted to developing online stores when rent needs to be paid? This is compounded because shareholders will receive the benefit of a turnaround whilst the best the landlord can hope for is continued reduced rent. Privately some landlords might admit that some high streets are over-rented and a rebalance is required. They might also acknowledge that shareholders often make substantial equity investments if the CVA is approved as they will again see a business worth investing in.
In this context we look at how a selection of different countries address these issues and whether any more workable solutions have been found.
The Australian retail sector in many ways mirrors that of the UK, as many traditional high street businesses struggle with the rising competition, both in terms of price and convenience, from online competitors. Consequently, there have been some similarly high profile insolvencies, with Maggie T being the first such example earlier this year.
Voluntary Administrations in Australia are a form of insolvency appointment under the Corporations Act 2001, with the aim of allowing an orderly restructure of a company for the benefit of creditors as a whole. A Voluntary Administration is easy to initiate by a resolution of a majority of directors to appoint an independent insolvency practitioner to assess all available options which will include the viability for a proposal for a deed of company arrangement.
Recent amendments to the Corporations Act 2001 in Australia operate to prevent a party from terminating contracts entered into after 1 July 2018 on the basis that the company is in voluntary administration (i.e. an ‘ipso facto’ clause – being contractual provisions that allow one party to suspend the performance of a contractual obligation or terminate a contract upon the happening of an insolvency event). The purpose of these amendments is to preserve value in the company and avoid having contracts terminated, giving the company its best chance of successfully restructuring.
These changes will impact landlords of retail tenants. Upon the appointment of a Voluntary Administrator to the tenant, the landlord cannot enforce the right to terminate the lease (if entered into after 1 July 2018). There is now an automatic stay or ‘pause’ on that right. The stay or ‘pause’ operates whilst a restructure is undertaken and automatically ceases when the tenant company is wound up. As a result of the amendments, so long as the tenant company complies with its obligations under the lease, the landlord will no longer be able to terminate the lease due to the appointment of the administrators. As a result, the commercial options available to landlords have been reduced, although they will still be able to terminate for ‘non insolvency event’ breaches.
In moving forward, we are seeing landlords including clauses in new leases that require tenants to provide financial information and other similar requirements on a regular basis to monitor a tenant’s capacity to meet its obligations under the lease. The purpose of these clauses is to provide a mechanism for a landlord to terminate a lease if it is not satisfied with the tenant's capacity to carry on the business, and thereby overcome the restriction of not being able to terminate because of an ‘insolvency event’.
Caution must be exercised in drafting such clauses however because the Corporations Act has provisions designed to ensure the Act is not circumvented.
The EU position
In November 2016, the EU Commission presented a “Proposal for a Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU". The directive is envisaged to be adopted before the European Parliament election of May 2019 and the member states would then be left to implement the directive in national law within approximately 2 years.
The currently available draft of the framework would inter alia contain a moratorium on enforcement measures to allow debtors - if appropriate with the involvement of a restructuring administrator - to present a restructuring plan which could under certain conditions bind dissenting creditors and shareholders. After the negotiators of the European Parliament and the member states agreed on the procedure on 19.12.2018, the final text is currently eagerly awaited. It still has to be formally adopted.
It remains to be seen which provisions the final European directive will contain and how the individual EU jurisdictions will shape the regulatory leeway granted to them by the directive. And it remains to be hoped that the measures will be sufficient so the pre-insolvency restructuring plan will become attractive as a genuine restructuring tool – also in the case of cross-border restructurings.
Under French law, a collective procedure places the operation of a company in difficulty under judicial control. It brings together all the creditors and deprives them of the right to act individually. The purpose of the procedure is first to allow the company to maintain its activities (in order to preserve employment and avoid a cascade of bankruptcies, especially those of the suppliers), by staggering or even erasing all or part of the debts. When the continuation of the activities is no longer possible (the situation is irreparably compromised), the company is liquidated: sale of all assets and repayment of debts, according to an order of preference.
A company facing financial difficulties can be subject to collective proceedings. When the procedure is opened, the Court appoints an administrator (administrateur judiciaire) to implement a plan which consists either in the assistance, the monitoring or the complete management of the distressed company. In the first two instances the company remains under the control of the directors, and the ownership of the shareholders. In the last instance complete management is transferred to the administrator.
If the tenant has not yet stopped paying rent, but is facing financial difficulties that cannot be overcome, the tenant can request the initiation of Safeguard proceedings or Accelerated (Financial) Safeguard proceedings.
The initiation of collective proceedings does not necessarily lead to lease termination. This falls under the responsibility of the administrator (receiver or liquidator) appointed by the Court to oversee and assist with the process. The administrator should request the lease termination if the tenant cannot pay the rents accruing. The landlord can also request the lease termination if the tenant cannot pay the rent and expenses, provided three months have passed.
Both Safeguarding proceedings allow the company to negotiate and agree a plan with the majority of creditors which is then enforced against all creditors. The plan is negotiated with the assistance of the Court appointed administrator and is approved by the Court. The Court must look at whether the interests of other creditors are protected in deciding whether or not to approve the plan.
The Commercial Court does not automatically order the opening of collective insolvency proceedings. Between January and October 2018, out of the 35,350 applications for opening of collective insolvency proceedings, 31,470 were approved and external administrators appointed. This lack of automaticity in France means that the protection of the company in difficulty is subject to the control of the court, excluding those who only wish to invoke the benefit of the protection to avoid facing their debts.
The larger retail restructurings in France (Vivarte, Camaieu) have tended to be completed consensually as financial restructurings, though Camaieu has recently entered Safeguarding proceedings.
Italian Law provides for several insolvency procedures where the debtors are not automatically wiped out: the Renovation Plan ("Piano attestato di risanamento"), the Debt Restructuring Agreement ("Accordo di ristrutturazione dei debiti"), and the Composition with creditors ("Concordato preventivo").
According to these procedures the company may, under specific circumstances, continue to manage its assets and carry on its business.
Under certain conditions a company may also enter into an agreement with one or more secured creditors, setting forth partial payments by virtue of a Composition with creditors.
A Debt Restructuring Agreement must obtain the consent of the creditors representing at least the 60% of the overall creditors.
A Composition with creditors should provide the obligation to pay the unsecured creditors for at least the 20% of their credits. Once approved by the court, the Composition plan binds all the creditors.
The debtor applying for a Composition with creditors may ask the competent court to terminate or suspend the pending contracts, though this cannot apply to lease agreements (in case of submission of the said petition by the landlord).
Note that on January 10 2019, the Italian government approved a legislative decree, providing the reform of the Italian law on insolvency.
Under German law, it is not yet possible to reach an agreement with individual creditors outside of court insolvency proceedings which have an effect on the legal positions of other creditors without them also having agreed. This possibility currently only exists after the opening of court insolvency proceedings within the framework of an insolvency plan. Here creditor groups can be formed and, under certain conditions, creditor consents are deemed to have been given. Under certain conditions, measures under foreign law (e.g. the Scheme of Arrangement) can support restructuring in Germany.
Ireland has seen some notable retail failures over the last few years such as B&Q (Ireland), Pamela Scott, Elverys Sports and Debenhams (Ireland).
The restructuring structure normally adopted is an Examinership. Provided a company is or is likely to be insolvent it can apply to the Court for the appointment of an Examiner. If appointed a maximum of 100 days moratorium will commence and the Examiner has 70 days to prepare a compromise or 'scheme of arrangement' to help ensure the survival of the company. This may involve one or more elements but typically includes:
- A requirement (as is almost always the case) that a portion of the company's debt is written off;
- A requirement that the company is permitted to repay its debts over a longer period of time;
- The forced termination of onerous contracts;
- An injection of capital into the company by a third party in exchange for a shareholding; and/or
- The investment of further money into the company by an existing shareholder.
In drawing up the compromise, the Examiner classifies the different creditors – preferential/secured/unsecured – and each class may be treated differently under the compromise agreement. There would not normally be subdivisions so as to single out landlords within the class of unsecured creditors. Only one class of creditors has to agree to the compromise agreement to allow the examiner to present his compromise to the Court for ruling. Shareholder consent to the compromise is not required.
The court will hear members and creditors in relation to the compromise who may object to the proposal. The Court confirms, modifies or rejects the proposal. If confirmed, it is binding on all parties.
In practice whilst this process may be capable in theory of forcing losses on landlords, in practice landlords have agreed rent reductions to allow the company to survive, rather than having this forced on them.
The United Arab Emirates
The United Arab Emirates (the UAE) has recognised that an effective insolvency regime is critical to the stability of its financial system. In 2016, the UAE issued Federal Bankruptcy Law No. 9 of 2016 (the UAE Bankruptcy Law). A key feature of the UAE Bankruptcy Law is that it allows a company capable of being rescued through restructuring to apply to the UAE courts for formal restructuring. The UAE Bankruptcy Law also establishes a formal committee that will help manage the restructuring and facilitate a dialogue between the company and its creditors. With these changes, the UAE insolvency regime now allows struggling businesses to stay afloat, which in turn creates a more stable economic environment.
The UAE Bankruptcy Law applies to all companies established under the UAE's Commercial Companies Law No. 2 of 2015 and state owned entities. Unlike its predecessor law, the UAE Bankruptcy provides a variety of options to companies in financial distress to consider before filing
For bankruptcy for example, it places more focus on restructuring proceedings and makes specific provision for a consensual restructuring process, whereby a financial restructuring committee (the Financial Restructuring Committee) is appointed to oversee the management of the restructuring process. If a company is capable of being rescued via restructuring, the company may apply to the UAE courts for formal restructuring of its financial affairs after it has filed an application for insolvency.
However, unlike in a stakeholders restructuring of a company, members of the Financial Restructuring Committee are not stakeholders in the distressed company. The key role of the Financial Restructuring Committee is to supervise and manage the restructuring process and to facilitate discussions between the company and its creditors in order for the parties to agree to a restructuring arrangement. The Financial Restructuring Committee also has the power to appoint experts, if the need arises.
Nevertheless, it is important to note that despite the enactment of the UAE Bankruptcy Law, creditors and debtors both prefer to engage in restructuring arrangements without the involvement of the UAE courts.
In the event of a court managed preventive composition, all creditors of the relevant debtor whose debt has been accepted by the court vote on the restructuring plan that has been negotiated. In order for the plan to be approved, a majority of the creditors must approve the arrangement, on the condition that this majority represents at least two-thirds of the value of the debtor's total debt. Once approved, all creditors must abide by the restructuring plan, including creditors who did not vote.
Most of the jurisdictions we've explored have the ability to complete a restructuring and allow the directors to remain in control and shareholders to potentially benefit from a successful process.
Most of the jurisdictions also have the ability for majorities of creditors to agree to accept losses and then impose the same outcomes on any dissenting minority.
However these tools tend to apply to financial creditors in leveraged situations such as banks, bondholders and other debt investors. In practice, they will almost always be used to impose losses on shareholders (or participation in the equity by investors) as a condition to agreement. Ordinary unsecured creditors including landlords will continue to be paid.
Of all the jurisdictions surveyed, it is only here in the UK that these tools are being used to focus on unsecured and non-financial creditors. And it is only in the UK that the directors are able to persuade a majority of unsecured creditors (including many landlords) to accept losses and thereby impose unequal outcomes on the few dissenting landlords.
It remains to be seen whether other jurisdictions will move toward this structure; or UK High Street CVAs will be seen as a high water mark.
This article was first published in Estates Gazette in February 2019.
Contributions by Matthew Brown (DWF UK), Kirsten Farmer (DWF Australia), Charles Koskas (DWF France), Danilo Cicero (DWF Italy), Christiane Huismans (DWF Germany), Susan Connolly (DWF Ireland) and Umeera Ali (DWF Dubai).