Landlord and tenant restructurings - New Look CVA

An important judgment handed down by Zacaroli J yesterday in the New Look CVA challenge. The New Look CVA proposal involved treating landlords of different leases in various different ways, including (i) resetting rent to a turnover percentage (ii) keeping rent intact and (iii) reducing rent to nil. Landlords are given the flexibility to terminate leases within a prescribed period where they identify a tenant prepared to pay better rent (important to ensure the landlord's proprietary right is not interfered with). In a CVA, all unsecured creditors are invited to vote. Therefore, other unsecured creditors, including trade creditors and senior secured noteholders whose claims were dealt with by a prior albeit inter-conditional scheme of arrangement, were eligible to vote on the CVA in accordance with the statutory provisions (even though their claims were effectively unimpaired by the CVA as their claims and ability to participate in the equity of the company was dealt with pursuant to the scheme, albeit that scheme required the CVA to become effective).

In rejecting a challenge by certain landlords, Zacaroli J concluded that a CVA:

• that treats different sub-groups of creditors differently is not, for that reason, outside the jurisdictional scope of a CVA or necessarily unfairly prejudicial;
• is not necessarily unfairly prejudicial to a comprised sub-group where the statutory majority is achieved by the votes of unimpaired creditors or those who are treated substantially differently. These will, however, be relevant factors, in each case, in determining whether there is unfair prejudice.

The judgment contains a detailed consideration of the law relating to CVAs and addresses various arguments put forward by the landlords. The judgment makes clear that while CVAs may have been intended for "simpler" cases, that did not preclude it from being used in more complex situations.

However, Zacaroli J did not accept the company's position that a CVA would not be unfairly prejudicial where (1) any differential treatment was objectively justified (2) the vertical comparator was satisfied and (3) a reasonable and honest person in the position of the applicant could have approved the CVA. Zacaroli J held that this analysis did not pay sufficient regard to the basic principle of equality and, in particular, the importance (as demonstrated by pre-1986 cases) of ensuring that a statutory majority shares sufficiently similar rights with the minority it seeks to bind. Zacaroli J stated that where a sub-group of creditors is compromised by a CVA and their vote was swamped at the creditors’ meeting by the votes of those who were unimpaired by the CVA, he did not think that it is necessarily enough to avoid a finding of unfair prejudice that the differential treatment of others was objectively justified (e.g. because they were critical creditors) and the compromised creditors are treated more favourably than they would be in the relevant vertical comparator (eg a liquidation). 

Without attempting to define what all the circumstances in any case might be, Zacaroli J gave the following guidance  - and in doing so, pointed out some fundamental differences to schemes and plans:

1. An important consideration is whether there is fair allocation of the assets available within the CVA between the compromised and other sub-groups of creditors (including considering the source of assets from which the treatment of the different sub-group derives and whether they would or could have been made available to all creditors in the relevant alternative). So if secured creditors receive favourable treatment solely by reference to their security so that they are treated insofar as their unsecured claim is concerned no better than other unsecured creditors, then the fact that their vote was decisive is unlikely to be unfair. In contrast, if the assets in the relevant alternative available to unsecured creditors are allocated in a greater proportion to other creditors (eg where critical creditors are paid in full) then the fact that the CVA was carried by reason of those votes may point towards unfair prejudice even if there was an objective justification for their payment in full. The principle adopted in scheme cases, against considering whether an alternative arrangement would have been fairer, needs to be modified.
2. The nature and extent of the different treatment, its justification and its impact on the outcome of the meeting will be important. There would be strong grounds to conclude it was unfairly prejudicial where a CVA, which compromises the claims of a sub-group of creditors, is achieved only because of the votes of a large swathe of creditors who are unaffected by the CVA, even if there was an objective justification for those creditors being unaffected by the CVA. As was pointed out in Powerhouse, that could not have been achieved in a scheme, not because the unaffected creditors would have formed a separate class, but because they would not have been included in the scheme at all. On the other hand, if CVA creditors are impaired, but in different ways, or where the creditors who were (justifiably) unimpaired, though sufficient on the numbers to tip the scales at the meeting, were small in number and value, then that is less likely to constitute unfair prejudice.
3. It is also relevant to have regard to the extent to which others in the same position as the objecting creditors approved the CVA. This is similar to the position on schemes (see Lehman) and plans (see Deep Ocean).
4. A finding of unfair prejudice ought not to be precluded merely because the same result might have been achieved in a Part 26A plan - the process under a plan contains important safeguards that are absent from a CVA process - including court oversight before the scheme becomes effective and the identification of classes. There is also likely to be more time for creditors to consider in light of the practice statement letter procedure and in light of court directions at the convening hearing.

The judgment on the Regis CVA challenge, which covers similar issues, is expected shortly. The ability to compromise landlord and tenant liabilities (and to use cram down) will also be decided shortly in the Virgin Active Part 26A plan case. Watch this space for further commentary!