The ready availability of credit over the first seven years of the past decade fuelled a massive, property-led consumer boom. Although perhaps a long time coming, the restriction in the continuing availability of such credit since mid 2007 has resulted in a serious recession. The scale of the problems will take time to unwind but given the continuing restrictions on credit, consumers are spending less, especially on high-value discretionary items.
Retail is a very important sector of the UK economy, employing over three million people, equal to one in ten of the workforce (more than the whole of the manufacturing sector). However, many retailers are struggling with a triple hit of falling sales, crushed margins and rising costs. Consumers have become very adversely affected by the collapse in property values, the weak state of the labour market, the lack of job security and the prospect of future tax rises.
Retail collapses soared in the first quarter of 2009 as companies fell victim to falling consumer confidence and the deteriorating financing environment. On average, more than seven retailers became insolvent a day in the three months to March 2009 and, according to PwC research, the number of insolvencies jumped 24 per cent on the previous quarter. In total, 705 retailers entered insolvency in the period – a 60 per cent rise from 440 in the same period last year. The roll call of the fallen includes many familiar names (such as Woolworths, Zavvi and MFI) with some forecasters predicting that 10 per cent of all retail stores may close in 2009.
In more recent months, retail sales have started to stabilise although they fell by 0.6 per cent in May, their first decline in three months. The rout that many predicted would follow the March quarter date also did not happen and many commentators have started to predict the “green shoots of recovery”. We should not get carried away – it is too early to comment on the fall out from the rent demands of the June quarter day. It is also incredibly difficult to gauge the likely pace of the retail sector recovery and caution should be exercised when drawing too many parallels with the last recession. For instance, since the downturn in the 1990’s, private equity has established itself as a dominant force in UK retail. The result of highly leveraged transactions (with steep financing costs) means some private equity backed businesses could find it difficult to invest for growth, dampening the pace of the sector upturn.
High rent obligations remain problematic for the retail sector, despite a large number of landlords agreeing to reduced rents and/or accepting monthly rent payments. Retail insolvencies in the Spring were given a reprieve because many retailers had made it clear to their landlords well in advance that three months’ rent just was not feasible. Fortunately, many landlords agreed. One thing for certain is that retail businesses will continue to struggle in the current environment. For those for whom the strain becomes too much, they will seek survival through a formal insolvency procedure or a consensual out-of-court restructuring.
There are a number of ways in which a distressed retailer might be restructured. These are:
Company Voluntary Arrangement
If a company and its creditors can reach agreement on a plan to deal with the company’s debts, an appropriate means of implementing such agreement may be a company voluntary arrangement (or CVA). Under this process, a debtor makes a proposal to its creditors (e.g. “I will pay you back 100, 50 or 20 per cent (or whatever) of what I owe you over a specified period of time”). If at least 75 per cent in value of the debtor’s creditors taking part in the creditors’ meeting to consider the proposal vote in favour then, subject to certain safeguards, the proposal becomes binding on all creditors including those who voted against the proposal (although secured creditors need to consent specifically to a CVA in order for it to be binding on them). As we shall see, CVAs are becoming more acceptable in the retail sector probably because landlords would rather have their claim against their tenants reduced than their tenant entering into administration or liquidation with the consequent risk of the premises falling empty and generating no income at all.
In the retail sector there have been a number of high profile pre-packaged insolvencies such as Whittards of Chelsea, USC and The Officers Club. “Pre-packs” have been lauded as providing a lifeline to companies whose businesses would not survive a formal insolvency. They enable customerfacing businesses, where administration would devalue the brand, to continue to trade seamlessly, transferring staff (whose jobs and rights are protected by law) and salvageable assets to a new corporate vehicle.
Criticism is often levelled at pre-packs, as the impression given is of a company failing one day and then operating the next; with collapsed companies being sold on as new corporate entities, stripped of their liabilities and leaving creditors – such as landlords and suppliers – to suffer financial losses. In many cases, the same management and owners who presided over the failing company have bought the new businesses which has led to anger and widespread criticism of the pre-pack procedure. A report by the Business and Enterprise Committee found that unsecured creditors fare worse during a pre-pack, recovering 1 per cent of their debts on average, compared with 3 per cent on a standard business sale. However, independent research by Dr Sandra Frisby of Nottingham University has established that in over 90 per cent of pre-packs all the jobs in the business are saved, compared to only about 60 per cent in other insolvency business sales. Pre-packs can also reduce the risk of value destruction as a result of the insolvency process, they often realise more than simple liquidation and they almost invariably cost less than a period of trading followed by a business sale.
If time and financial resources permit, the decision may be taken to appoint administrators over a failing retail company and then allowing the business to continue to trade. This allows the administrators time to identify and negotiate with prospective buyers and arrange an orderly disposal of the business or its assets. Trading administrations may allow an easier reduction in the workforce before the sale of the business. Pre-packs do not have this advantage.
Acquisition of under-performing businesses or division
If stakeholders or lenders to a failing business are able to spot an under performing subsidiary or part of the business, one option is to sell that part of the business and keep the core business going. Doing so will lead to improved financial performance of the overall retail business by cutting out the loss making part. A clean exit from the under-performing part may also avoid insolvency if the buyer has the will and resources to turn the distressed business around.
Purchase of distressed debt positions
When a business is distressed, the lender or stakeholder may wish to crystallise its exposure by selling its debt and any associated security. A secured debt sale will occur when the bank believes that it will realise more value by the sale of its debt to a third party than through a formal insolvency procedure.
Set out below are three recent examples illustrating how CVAs, pre-packs and trading administrations have been used recently to try and protect the core business of retailers.
Stylo was an AIM listed footwear retailer based in Bradford which acted as the holding company to a number of subsidiaries which sold high street branded footwear such as Barratts, Dolcis and Priceless. The company had a high cost base, in particular, high rent obligations. Following losses of £12.5 million in 2008, in February 2009, the company appointed administrators over each of its operating subsidiaries and proposed a CVA to its creditors and landlords. The CVA proposed that, in compromise of their claims for rent arrears, the landlords would receive 3 per cent of shop turnover for three months beginning in June 2009, increasing to 7 per cent for the remaining 11 month period of the CVA.
The proposed CVAs were eventually voted down by the landlords since the proposal would have put them in the unenviable position of subsidising the rest of Stylo’s creditors, who would be paid with the money the landlords would concede. They also believed that it was likely, even if the CVA had proceeded, that under continuing pressure they would lose their tenants in the following few months anyway. However, commentators believe that the most important reason for the rejection was that the landlords were concerned about setting a precedent which other struggling retailers might follow. The property industry intended to send a clear message to the retail sector – that CVAs were not going to be an easy way out. Following the rejection of the CVA proposal, administrators were appointed over the listed parent company, Stylo, and the core profitable elements of the business were “prepacked” to an entity owned by the chairman of the Stylo group, with the non-profitable stores closing.
JJB Sports plc
JJB Sports, the sports equipment retailer, was struggling with a combination of a high cost base and low sales. In contrast to the rejected CVA proposed by Stylo, JJB proposed a CVA to its creditors on terms that the landlords of closed stores would be able to claim from a fixed pot of £10 million on two payment dates in September and December 2009 and that the terms of the leases for the open stores would be varied to permit monthly, as opposed to quarterly, rental payments. The CVA was approved by 99 per cent in value of creditors, saving the retailer from administration. Early engagement with the landlords, and other creditors, is said to have been the determining factor for the success of the JJB CVA. The success of the CVA also showed that most landlords are coming to the view that CVAs will not be rejected out of hand.
Birthdays owned over 330 stores nationwide selling greeting cards and associated products. A combination of high rentals and reduced trading made its business uneconomical although many individual stores were profitable and viable. Birthdays had to rationalise its store base but the cost of doing so outside insolvency was prohibitive and so it entered into administration. The administrators traded the business for a month and sold a significant proportion of the stores as a going concern.
Whilst economists’ predictions for the retail sector remain uncertain, there will undoubtedly be further insolvencies and more high street retailers struggling to meet their overhead and rental obligations. It is likely that the formal insolvency procedures and out of court restructurings described above will be utilised, but, in particular we expect the use of CVAs to become more widespread as they become more acceptable to stakeholders and creditors.