In this three-part series looking at the state of the UK retail sector, we have seen that retailers are facing a number of significant challenges and considered how these might shape trends in the sector, in both the short and medium term. Unfortunately, all of this has pointed to the fact that there are likely to be a number of retailers needing to restructure operationally and financially in order to continue trading profitably.
Often the source of some of these problems will be excessive or unplanned expansion in the past, leaving a strong core business held back by stores that are unprofitable due to high rent or poor footfall, as a result of fierce competition or expansion into areas without the requisite demand.
However, with challenge comes opportunity and companies are able to restructure themselves, or look for investors to acquire a restructured business at reduced values free from the legacy of the old capital structure. Company Voluntary Arrangements (CVAs) and pre-pack administrations offer two contrasting routes to achieving a restructuring, while preserving the core of the business.
What is a pre-pack administration?
A pre-pack administration is a sale negotiated before the appointment of administrators and implemented immediately upon appointment. Where the sale is of business and assets rather than of shares, this will allow the business to be sold free from any legacy liabilities of the old company, save for those the purchaser elects to assume, or is required to assume, to ensure continuity of business.
What is a CVA?
A CVA restructures liabilities within the existing company. It is a general compromise with creditors which is binding on all creditors, provided it receives the requisite level of support, and that it is not challenged as ‘unfairly prejudicial’ to certain creditors within 28 days of being approved. The requirement to avoid unfair prejudice does not mean that all creditors must be treated equally. Case law has shown that there may be different deals for different classes of creditors, provided that all classes have a better position than they would in the alternative situation of insolvency.
How do they compare?
To compare the two processes, a pre-pack allows for more specific tailoring of the business being taken forward. This is because there is only a requirement to purchase the assets and assume the liabilities that are required. It also means that a more specific approach can be taken on a creditor by creditor basis. It allows for liabilities to simply be left behind in the old entity, whereas a CVA would require some level of compromise payment. An administration can be used to leave behind other liabilities which might be difficult to deal with in a CVA, such as employment claims relating to employees of closing stores who will not TUPE across.
A CVA has a broader brush approach, as it needs to deal with all categories of liabilities. Theoretically the same level of differentiation could be achieved but this would make the CVA complicated and hence more open to challenge. As an example, lease liabilities in a CVA would be put into general groups with the same adjustment being made, say a switch to monthly rent from quarterly for performing stores, compared with termination of leases for non-performing stores.
It’s all about timing
The timing of the two processes also differs. A pre-pack is notionally quicker to implement and delivers certainty up front, compared to the need with a CVA to convene meetings and obtain shareholder and creditor approval, followed by a 28-day creditor challenge period. This, however, is only half the picture. If the pre-pack involves a sale back to existing management it may be appropriate, and prudent, to make an application to the pre-pack pool prior to execution of the transaction. Also, because a pre-pack requires a transfer of assets and leases individually where third party consents are required, this can be a lengthy post-closing process to implement.
There is also a risk on a pre-pack that if a store is under rented, the need to assign will give the landlord the opportunity to exert leverage to increase rent, to the extent the lease terms enable this. Indeed, there is a risk that landlords or other vital suppliers or customers may refuse to deal with the new business. Another advantage of the pre-pack is that, as a restructuring tool, it lends itself to the delivery of the business to a third party through a distressed M&A process.
One final area where both processes have had their challenges is in relation to perception. In the past CVAs have been subject to criticism and challenge, particularly from landlords. Now terms offered to landlords are carefully drafted and have been tested, and they are reluctantly accepted and seen as a necessary evil.
Greater scrutiny is being given to pre-packs, particularly to related parties, where the pre-pack pool has been established as a partial mitigant of perceived unfairness.
One area of negative perception that may take longer to dispel is that, whatever process is used, it is rarely seen as a complete rehabilitation of the business. There is often a perception that a pre-pack or CVA is merely delaying the inevitable failure of the business. This can be the case where the proposed restructuring deals with superficial issues but does not take the opportunity to resolve deeper-seated problems in the business, and if a restructuring is not fully worked through to establish a robust business, able to withstand further shocks, then the fault is with the implementation, not the tool used to deliver the restructuring.