In an important decision for commercial property landlords, the High Court in Prudential Assurance Co Ltd and Others v PRG Powerhouse Limited and Others has ruled that a CVA (defined below) cannot operate so as to prevent landlords from enforcing a parent company guarantee. The Court's decision however was reached on the basis that to determine otherwise would have been "unfairly prejudicial" to the landlords.
The Court has ruled that in principle, a CVA can legitimately prohibit creditors from enforcing the terms of parent company guarantees where there is a right of recourse by the parent against the company in debt.
The case concerned Powerhouse's use of a Company Voluntary Arrangement (CVA). This is an agreement between a company and its creditors under Part 1 of the Insolvency Act 1986 which details how the company's debts and liabilities will be repaid in such a way so as to allow the company to continue trading and avoid insolvency. Approval of a CVA proposed by the directors of a company requires the consent of 75% of the company's creditors present and voting at a creditors' meeting. The Act allows a CVA to be challenged where a creditor considers that his interests are unfairly prejudiced.
How the Company Voluntary Arrangement was used
- Powerhouse was a retailer operating from 88 stores across the UK. Powerhouse elected to close 35 of its loss-making stores and settle the company's debts through the use of a CVA. The intention was to secure the future of the company by trading from its most profitable stores.
- The CVA provided that:
- The creditors of the closed stores (which included the claimant landlords) would be paid the equivalent of 28p in the pound. The remaining creditors would be unaffected by the CVA, being entitled to repayment of any debt from the trading of a reduced Powerhouse portfolio.
- The payment would relieve Powerhouse of any claims by any of the creditors paid in terms of the above.
- The CVA was also said to release the obligations of Powerhouse's parent company guarantee in relation to the closed stores. In exchange for this, the parent company would guarantee the payment of 20p in the pound.
- A creditors' meeting was held to seek approval of the CVA. Votes were weighted according to the amount each creditor was owed, albeit the CVA had placed a limit of £1 on the value of future rental payments due to the landlords.
- As a result, the votes of the creditors who expected full repayment outweighed the votes of the landlords whose guarantees were rendered useless, and therefore the outcome was approval of the CVA.
- The landlords of the closed stores raised legal proceedings to challenge the effects of the CVA. This was both in relation to their rights (under guarantees) against a third party (PRG Group Limited the parent company) ("PRG") and on the basis that the terms of the CVA were unfairly prejudicial to their interests.
Landlords not to be unfairly prejudiced
Mr Justice Etherton of the High Court held that a CVA is for the benefit of the company in relation to its creditors and does not extend to any parent company or other third party. Consequently, the condition in the CVA that purported to release PRG from the guarantees was not enforceable. However, the Court did accept that the terms of a CVA could be drawn up so that a creditor would not be entitled to enforce guarantees. An example is where a guarantor is entitled to recover sums from the company, the guarantor having met liability on behalf of the company under a guarantee. This scenario existed in this case and as such, the CVA had the effect of extinguishing the guarantees.
The next consideration for the Court was whether or not in the circumstances, this was "unfairly prejudicial" to the creditors claiming so. It was accepted that the CVA was prejudicial to the landlords as it placed them in a less advantageous position than they had been before the CVA. The question of unfairness was then determined.
The Court used a two-pronged test to determine this. The first element was comparing the position of the landlords under a CVA to the position they would have been in the case of liquidation. The second part of the test was a comparison of the position of the landlords of the closed stores and the position of the company's other creditors. In terms of the first part of the test, it was again clear that the landlords of the closed stores would have been in a better position in the case of a liquidation, being able to enforce the terms of the guarantee. As regards the comparison to other creditors, it was restated however that it is not always the case that differing treatment for different creditors is regarded as unfair. It was the fact that the value of the guarantees had been unfairly determined and in the losing of the benefit of enforcing these, that led to the decision that the outcome was unfair.
A mixed message for landlords
It is highly likely that if the guarantees had been given a monetary value that accurately reflected the future loss of rent, the weighting of votes would have been very different and may have led to a different outcome in relation to the approval of the CVA. The case highlights the benefit and advantage of attending creditors' meetings even as landlords with parent company guarantees as it is clearly the case that a CVA can operate to extinguish the rights of a landlord under a guarantee. There is no certainty that in challenging this, the landlord will be regarded as having been unfairly prejudiced.
Although the case is regarded as good news for landlords, it also presents further problems for landlords and tenants. Landlords can no longer simply rely on the existence of parent company guarantees. They will need to provide for the potential changes in tenant covenant strength which may result in differing solutions including Bank guarantees and/or rent deposits. From a tenants' perspective, the case is likely to present practical difficulties at the negotiation stage of leases and although it appears that the CVA is one way to restrict the company's liabilities and the liabilities of those companies related to it, there is likely to be more resistance from creditors in the future which may begin to render CVA's less useful, leaving financial difficulties to be resolved by Court intervention.
The full text of the decision in Prudential Assurance Company Ltd & Ors v PRG Powerhouse Ltd. & Ors [2007] EWHC 1002 (Ch) is available from:
this link