Re Powerhouse Limited: Prudential Assurance Company Limited v PRG Powerhouse Limited  EWHC 1002 Ch Guarantees are widely used in commercial transactions to provide assurance to creditors that debts or other obligations owed to them are discharged fully in the event the principal debtor fails to perform. This assurance was shaken by the steps taken in early 2006 by PRG Powerhouse Limited (Powerhouse) to enter into a company voluntary arrangement (CVA) that contained proposals to release certain parent company guarantees given to landlords of premises being vacated by Powerhouse.
Powerhouse, an electrical retailer, was experiencing financial difficulties and decided to enter into a CVA with a view to preserving the future viability of the business. The CVA proposals included closure of a number of loss making stores, payment to the landlords of the abandoned premises amounting to a fraction of the rents that would have been payable if the leases were continued and the release from its obligations of Powerhouse’s parent company which had guaranteed payment of the rent to the landlords. The CVA further proposed to pay other creditors in full. The proposals were approved by the required majority of creditors and were immediately challenged by the landlords.
A CVA is a compromise agreement between a company and its unsecured creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs. It is not possible to use a CVA to modify any rights of a secured creditor to enforce its security without consent or to alter the priority of payment of any preferential creditor, however Part 1 Insolvency Act 1986 which governs CVA’s does not contain any other provisions for the treatment of other creditors. There is no obligation to treat unsecured creditors equally, nor is there any provision for the treatment of guarantees. Guarantees do not create security interests against the debtor, but are merely contractual obligations of a third party to the creditor. If approved by 75% of the creditors by value present or represented at the creditors’ meeting and a simple majority of the members, the terms of the CVA will bind every person entitled to be at the meeting, whether or not present or in receipt of notice of the meeting, as if the creditor were a party to the CVA.
There are two grounds on which a creditor may challenge a CVA and seek its revocation, suspension or revision: that it is unlawful (ie there has been a material irregularity at a meeting) or that it is unfairly prejudicial to the interests of one of the creditors, a member or the company.
The landlords’ challenge in Powerhouse was that: firstly, the CVA was invalid or ineffective insofar as it purported to affect the rights of the landlords against the guarantor or constitute a release of the guarantees; secondly, it was unfairly prejudicial to the landlords’ interests having been voted for by creditors who would be paid in full whereas the landlords would only receive a partial payment and no compensation for the loss of the guarantees.
The long-awaited High Court decision was to have a significant impact not only in the commercial property market but also for all creditors holding guarantees. The judge confirmed that as a CVA is a contract between a company and its creditors it could not affect any arrangement, such as guarantees, involving third parties; consequently the provisions in the Powerhouse CVA purporting to release the parent company guarantees to the landlords were not binding. However, the court did find that was possible for a CVA to impose on a creditor a requirement that it does not take any steps to enforce any rights against a third party (such as a guarantor) which if exercised would give the third party a right of recourse against the company (such as a right of subrogation against the principal debtor upon payment under a guarantee) as this would fall within the scope of the company’s arrangement of its affairs.
Therefore Powerhouse could enforce a provision in the CVA against the landlords not to claim under the guarantees. On the question of whether the Powerhouse CVA was unfairly prejudicial to the landlords, the court confirmed that there was no statutory requirement for a CVA to treat all creditors equally, there would be many situations where different treatment between creditors would be totally justifiable. The question of whether there is unfair prejudice between creditors in any case will depend on the facts: the court considered that in making a determination it would be necessary to compare both the position of the claimant creditor under the CVA with that under a liquidation or scheme of arrangement and the treatment of that particular creditor with that of the other creditors under the terms of the CVA.
In the Powerhouse case, the court found that the CVA was unfairly prejudicial to the landlords of the closed stores for a number of reasons, including: the landlords were put in a worse position by the release of the guarantees with no opportunity of negotiating with the guarantors and no compensation for the loss of value, the argued opportunity to re-let the properties was not accepted as valuable to the landlords; if there had been a liquidation of Powerhouse, the landlords would have been in a better position than under the CVA , not only would they have been able to claim under the guarantees but given the extent of the debts there would not have been any distribution for other creditors; the landlords were only to receive a fraction of their debt in order that the other creditors could be paid in full.
Whilst this decision provides some immediate comfort to the landlords in this case, other creditors of financially distressed companies holding guarantees in respect of the company’s debts and obligations should remain aware that Powerhouse leaves a loophole by which a creditor can be prevented by the terms of a CVA from making claims against a third party that could trigger rights of subrogation against the company where, on all the facts, the other terms of the CVA are not unfairly prejudicial to that creditor in contrast to the treatment of any of the other creditors.