Landlords breathed a huge sigh of relief following the High Court’s decision that a company voluntary arrangement (CVA) which removed landlords’ rights to enforce a parent company guarantee was unfairly prejudicial to the landlords. But is this relief justified? We analyse whether any comfort can be drawn from the decision.
PRG Powerhouse Limited (Powerhouse) was the tenant under various leases. Guarantees from Powerhouse’s parent company, PRG Group Limited (PRG), had been given in relation to a number of the leases. The guarantees contained provisions confirming that the liability of PRG would not be affected by various matters, including any composition or arrangement between Powerhouse and its creditors. In all but one of the guarantees, PRG covenanted as principal debtor. Powerhouse got into financial difficulties and decided to close some of its underperforming stores. It hoped that it would then be able to continue to trade from the more profitable stores.
A CVA was proposed. The CVA distinguished between creditors in respect of the closed premises (the scheme fund creditors), which included the claimant landlords, and other creditors. Under the CVA, the rights of all creditors other than the scheme fund creditors were unaffected. In relation to the scheme fund creditors, PRG agreed to provide a fund of £1.5 million or (if less) the sum required to pay a dividend to the scheme fund creditors of 28 pence in the pound.
The landlords’ challenge was based on two grounds. The first was that the CVA was ineffective in so far as it purported to remove the landlords’ right to enforce the guarantees against PRG. The landlords did not succeed on this ground but did succeed in their second argument - that the CVA was unfairly prejudicial to their interests within the meaning of section 6 of the Insolvency Act 1986. Both arguments are worth considering.
The first issue - did the CVA operate to release the guarantees?
The CVA contained various clauses which purported to affect the guarantees given by PRG and the judge considered each in turn.
The judge concluded that a CVA is a bilateral agreement between each creditor and the company, and that it is the company, not any third party, which can enforce the provisions of the CVA. This meant that PRG, as a principal debtor under the guarantees, could not itself rely on the provision of the CVA, which stated that: “the delivery of the dividend … to any Scheme Fund Creditor will operate in full and final settlement of that Scheme Fund Creditor's debts, claims and rights to the intent and effect that it shall release all debts, liabilities and obligations whosoever and howsoever owed by the Company and/or PRG to such Scheme Fund Creditor and all claims against the Company and/or PRG under any guarantee or surety or contract or lease or licence of any kind given in respect thereof”.
However, the judge also concluded that it is legally possible for a CVA to provide that a creditor cannot take steps to enforce an obligation of a third party to the creditor which would give rise to a right of recourse by the third party against the debtor. The CVA also contained the following wording:
“any guarantee or surety of any kind given by the Company or PRG for the debts, liabilities and obligations or any one or more of them shall, insofar as it relates to any debt, liability or obligation owing to a Closed Premises Landlord … be treated as having been released”.
The judge held that this carried with it the “necessary and obvious implication” that the landlords would not sue PRG on the guarantees.
Therefore, subject to the second issue concerning unfair prejudice, Powerhouse could enforce this provision against the landlords so as to prevent them making a claim against PRG under the guarantees.
The second issue - the question of unfair prejudice
The judge thought that the issue of whether there had been unfair prejudice could be evaluated against three measures. The first involved comparing the position of the creditor under the CVA with what it would be on a winding up. The landlords were receiving 28 pence in the pound under the CVA. They would have received nothing from Powerhouse on a liquidation but (crucially) would still have retained the benefit of the guarantees given by PRG.
Secondly, the treatment of the landlords was compared with that of other creditors. The judge held that the mere fact that differential treatment exists will not necessarily be sufficient to establish unfair prejudice. For example, it may be the case that the differential treatment is necessary to secure the continuation of the company’s business which underlies the CVA. Finally, the judge considered the position under the CVA against what the position might have been under a formal scheme of arrangement pursuant to section 425 of the Companies Act 1985, although he warned that caution must be exercised in this approach:
“The fact that a particular class of creditors could and might have blocked a scheme under CA s.425, while relevant and potentially important, does not necessarily mean that they have been unfairly prejudiced within [section 6 of the Insolvency Act 1986]”.
Having regard to all those principles, the judge was in no doubt that the CVA was unfairly prejudicial to the landlords.
Two important aspects of the CVA which contributed to the finding of unfair prejudice were that the landlords (as scheme fund creditors) received fewer pence in the pound than other creditors, and that they had lost their right to enforce the guarantees against PRG.
Key to the judge’s conclusion was the fact that the guarantees had real value. Their removal deprived the landlords of any negotiating position whereby they might have persuaded PRG to pay something for the loss of the right to enforce the guarantees. This means that the case very much turns on its facts. It would not be safe to conclude, for example, that it will always be unfair to remove the benefit of guarantees via a CVA (particularly since the court held that the wording of the CVA was otherwise effective to achieve this). This same principle could apply equally to guarantees given by former tenants under authorised guarantee agreements (or the original liability of previous tenants under “old” leases), as to guarantors provided by the current tenant. If the CVA had been structured so that the landlords had received a greater payout (in terms of pence in the pound) than other creditors, this might have been deemed sufficient to compensate for the loss of the guarantees with the result that the judge may well have reached a different conclusion.
The message to landlords is that they must keep a close eye on their tenants’ financial affairs and cannot afford to take a back seat when any form of restructuring is proposed. A court challenge under section 6 of the Insolvency Act is both time consuming and costly, and should be a last resort.
Prudential Assurance Company Ltd and others v PRG Powerhouse Limited and others  EWHC 1002