Pre-pack administrations and company voluntary arrangements
Landlords face a competitive lettings market and the tough trading conditions experienced by tenants in recent years (particularly in the retail and hospitality sectors) have seen an increased risk of tenant insolvency. Pre-pack administrations and company voluntary arrangements (CVAs) have made headlines in the last few years and have been on the rise.
The impact of the Covid-19 pandemic will likely bring an increase in these types of insolvency processes in the short to medium term, despite the extensive UK Government assistance packages announced to help businesses.
Insolvency process can be fast moving, presenting a trap for unprepared landlords. In this article we consider recent developments in these somewhat controversial procedures and how landlords should remain vigilant and take proactive steps to preserve their position.
What is a pre-pack?
A pre-pack administration is a sale of the whole or part of a business negotiated prior to administration and then completed by the administrators relatively quickly after appointment. Whereas secured creditors (such as funders) will often be consulted in advance; unsecured creditors, (such as landlords) often complain of the opaque nature of pre-packs (particularly with sales to former directors) and that they are the last to know about the deal. Insolvency Practice Statement 16 sets out best practice including publicising the availability of the business to the widest group of potential purchasers as possible and explaining the marketing strategy to creditors. However with speed often of the essence and a need for confidentiality, advance disclosure may be limited. If there is neither a pre-pack nor a rescue, then the company may move quickly into insolvency.
Implications for landlords
Once a company is in administration there is a moratorium on action against the insolvent party. This means that a landlord cannot distrain, forfeit the lease or sue for arrears without administrator's consent or leave of the court.
It is not uncommon for a pre-pack of a retail tenant's profitable stores to be agreed, with the tenant later entering into liquidation so that the liquidator can disclaim leases of the unprofitable stores.
If administrators continue trading from premises, rent is payable by them on a daily basis as an expense of the administration ahead of claims from most other unsecured creditors. It does not matter whether rent fell due before or after the administration or was payable in arrears or advance.
Tactics: before a pre-pack
- Look ahead - When considering a new tenant's covenant package, 'cash is king'. Landlords should try to negotiate a rent deposit owned outright by them which should prevent claims by creditors in the event of tenant insolvency. It may also be appropriate to request a guarantee from a stronger parent or group company, as the guarantor's liability would not be affected by the tenant's administration unless the guarantor itself becomes insolvent.
- If a landlord believes tenant insolvency is impending it should take advice and consider what steps might be taken to recover the rent arrears, before administration and the moratorium takes effect. However, the UK Government has recently put in place emergency measures to protect tenants impacted by the Covid-19 crisis which severely limit the action that landlords can take against their tenants in respect of rent arrears.
- Before agreeing to concessionary rents or payment programmes, landlords should ask whether they are throwing good money after bad. A retail tenant with strong performing prime stores may be worth assisting, whereas a tenant with unprofitable stores and no assets may have less chance of recovery.
Tactics: after a pre-pack
Much depends on the landlord's objectives and the relevant premises. Where premises are important to a successful pre-pack (such as a flagship retail store) or enable administrators to recover unpaid debt (such as a credit control centre), they are less likely to be jettisoned as part of the process. A fortunate landlord of sought after premises may be in a strong negotiating position to preserve the status quo on assignment of the lease to the pre-pack buyer.
If a store is excluded from the pre-pack and administrators do not want to trade from it, and the landlord wants to recover possession, administrators may agree to early surrender or lease forfeiture to reduce rents accruing as a claim in the administration. However, as liquidation and lease disclaimer approaches, the administrators' incentive is reduced. Some administrators may agree to a conditional surrender, triggered once a new tenant is found, and whether this is acceptable depends on how confident the landlord is this will happen.
An aggrieved landlord or other creditor can complain to the Insolvency Service if it considers that the pre-pack process has been abused, although this could be difficult to prove.
What is a CVA?
CVAs can be proposed by directors (but not shareholders or creditors) and are designed to avoid administration and liquidation; commonly through rent reductions and variations in payment periods.
Once a CVA is approved by a vote of both its shareholders (50% threshold) and unsecured creditors such as landlords (75% threshold by debt value) a binding agreement is created between the company and those creditors; including those entitled to vote, but who failed to do so, lasting for as long as is required to achieve the CVA's objectives. Secured creditors are not bound. Unlike administration, there is no automatic moratorium, apart from 'small' companies (less than 50 employees) or where an administrator proposes a CVA.
The advantage of CVAs is that they are flexible and, unlike with a pre-pack, the directors remain in day to day control giving a second chance at re-structuring. The insolvency practitioner supervising the CVA acts in a monitoring role to ensure compliance with the CVA. But CVAs have been criticised by landlords as being opaque and often presented as a fait accompli. Although CVAs offer a chance for restructuring, they may not work where the tenant has systemic problems and many CVAs fail within the first few months. The current crisis will only make the success of any CVA more challenging.
Aggrieved landlords have a remedy of arguing unfair prejudice and in the 2010 case of Mourant and Co. Trustees Ltd-v-Sixty UK Ltd (in administration) the High Court upheld a complaint that two landlords had been prejudiced by a release of guarantors under the CVA.
Warning signs for both a pre-pack and a CVA can include:
- missed rent payments;
- requests for concessionary rent payments or instalments;
- failure to comply with those concessionary arrangements;
- requests for relaxation of alienation covenants;
- rent or other payments by third parties who are unconnected to the lease;
- failure to 'top up' a rent deposit when drawn upon;
- inability to locate a guarantor;
- profit warnings and/or poor trading figures;
- regular changes of key personnel;
- becoming aware or receiving notification of a CVA. As only 28 days' notice need be given landlord need to move quickly and may want to make common cause with other unsecured creditors to avoid being 'picked off'; and
- negative press reports.
Without reform of the pre-pack and CVA procedures, landlords need to make the best of the current environment and, when faced with tenant insolvency, proactively assess their position to minimise exposure. For some landlords a CVA may appear the lesser of two evils given creditor landlords can vote on the CVA process. Conversely, a landlord of a flagship store may prefer a pre-pack, if confident that a stronger buyer will be found without significant rent or other concessions.
Being left with vacant premises has both security and financial implications for landowners. Whilst short term arrangements such as 'pop up' lettings or rates mitigation arrangements may assist; in the longer term more radical thinking may be required, including re-configuring premises designed for sole occupiers (such as department stores) so as to provide more modern and energy efficient units and increase the pool of potential tenants. In recent years growth areas have included food markets and start-up and tech businesses often operating from a non-traditional work environment. It is difficult to predict what the market will require following the COVID-19 crisis but a requirement for flexible space and letting agreements is likely to prevail and this presents further challenges to landowners.