Discovery (Northampton) Ltd & others v Debenhams Retail Ltd & others [2019] EWHC 2441(Ch)

Company Voluntary Arrangements (“CVAs”) are seen as most unfair by landlords who are often forced to continue to make a supply of premises at an imposed reduced rent.

A group of landlords known as the Combined Property Control Group (“CPC”) unsuccessfully challenged the CVA proposed by Debenhams Retail Limited (“Debenhams”). CPC argued that, pursuant to section 6 (1) (b) the Insolvency Act 1986 (the “Act”), the CVA was unfairly prejudicial because it treated landlords less favourably than other unsecured creditors.

Background

A CVA is a legally binding arrangement entered into by a financially distressed company and its creditors. A CVA serves to allow a company to continue trading whilst its liabilities and debts are restructured. CVAs have become increasingly popular as a method of reducing the rental costs that commercial tenants (often retailers) perceive to be onerous. Debenhams’ prepack administration was announced 9 April 2019. The company proposed a CVA soon after with the aim of restructuring the company’s balance sheet and store portfolio. The CVA was approved at a meeting of creditors on 9 May 2019. On 10 June 2019 CPC launched its legal challenge against the CVA. 

Grounds of Challenge & Decision

The challenge was brought on five grounds (detailed below) all of which failed, with the exception of Ground 3. 

Ground 1 – under the Act landlords do not constitute ‘creditors’ in respect of future rent; therefore, they cannot be compromised under a CVA.

This challenge failed. It was held that the Act did provide jurisdiction for landlords to be deemed creditors in respect of future rent. Mr Justice Norris stated that ‘”future rent is a pecuniary liability (although not a presently provable debt)… whilst the term endures the company is “liable” for the rent, and the fact that in the future the landlord may bring the term to an end by forfeiture does not mean that there is no present “liability”’. 

Ground 2 – in reducing the rent payable under a lease the CVA was ‘unfairly prejudicial’ to landlords.

CPC argued this on two grounds:

i. as a matter of law and basic fairness; and

ii. it is beyond the scope of a CVA to do so.

These challenges also failed. It was held that the CVA was fair because it retained the landlords’ freedom to bring an end to the lease if they so wished to. The Court was also of the opinion that because the CVA did not impose any new obligations, but only altered existing ones, it did not act beyond its scope. 

Ground 3 – a landlord’s right to forfeiture is a proprietary right beyond the scope of the Act and cannot be altered by a CVA

This challenge was successful. Justice Norris held that pursuant to section 1(2) of The Law of Property Act 1925 a landlord’s right to re-enter premises is a proprietary right between a landlord and tenant, not debtor and creditor relationship, and, therefore, cannot be altered by a CVA. 

Ground 4 – under CVAs landlords are treated less favourably than other unsecured creditors, without any proper justification. This challenge failed. The court held that there was justification to treat landlords less favourably under CVAs. Justice Norris stated that payment to suppliers in full was justified on the grounds of business continuity, as in this case, a reduction in rent that maintained rent above market value was fair insofar as it allowed other creditors’ claims to be paid in full.

Ground 5 – Debenhams’ directors gave such inadequate disclosure that the CVA failed to comply with the content requirement of the Insolvency Rules (“IR”) .

The landlords argued that the CVA failed to comply with rule 2.3 IR because it did not set out the circumstances that could give rise to claw-back claims in the event that Debenhams did go into administration/liquidation. Mr Justice Norris dismissed this challenge on the grounds that it was an irregularity that did not make a material difference to the way in which creditors considered the CVA overall. Goods and services were traded daily on an order-by-order basis. The landlords in question, on the other hand, had been providing accommodation over long terms at above market prices. It was noted that it would be unfair to force landlords to accept rent reductions that took rents below market value. Mr Justice Norris explained that fairness would be judged in the round and not in respect of each individual creditor.  

Implications

For Debenhams

Had the challenge been successful Debenhams would most likely have entered administration. Debenhams will now progress its CVA and close a further 22 stores by January 2020. The CVA also allows rent reductions at a further 105 stores. In total, 50 of 166 stores will close. 

For landlords

Although the landlords did not achieve their desired outcome overall, the judgment grants them a certain amount of power insofar as it preserves their right to forfeit notwithstanding CVAs purporting to effect the contrary. Provided the clause in the lease is robust, a landlord could use a CVA as justification to exercise a forfeiture clause and take back their property. Equally, landlords will now be on notice that efforts to reduce their rental income below market value will likely be deemed unfair.

For retail tenants

Retailers will be comforted by the ruling as it provides further justification for the contemporary use of CVAs as a means of reducing rental costs. Going forward retailers should note that the court will not allow for re-entry rights to be varied and should not seek to obtain a rent reduction that would take rent to below market rates.