UK: BHS CVA: Landlords Win On Penalties

Background

BHS agreed a CVA with its creditors in March 2016. As with so many large, high-profile CVAs the key issues for BHS were the rental burdens arising out of their store network- they are known as "landlord CVAs".

The CVA followed a now common format where landlords were placed into different categories according to the viability (or otherwise) of the specific premises , the top category benefitting from the least interference with lower categories taking increasingly substantial reductions in rent. There was a provision (clause 25) which stated that on termination under that clause "the compromises and releases effected under the terms of the CVA shall be deemed never to have happened". Furthermore, a landlord creditor was entitled to send a notice demanding payment within 14 days of sums due and if payment were not made, a further notice could bring about the termination of the CVA on receipt by BHS. One of BHS' landlords served the relevant notices on BHS and the CVA accordingly terminated with effect from 16 December 2016. It should also be noted that BHS has gone into administration in April 2016, and liquidators were appointed in October 2016. The formal procedures had run concurrently with the CVA until it was terminated.

Prudential was a landlord in respect of two leases. It contended that it should be paid certain additional sums following the termination of the CVA, provable in BHS' liquidation and that, in so far as its claims related to periods in which the BHS administrators were using its properties for the purposes of its administration, they were payable in full as expenses of the administration. In SHB Realisations Limited in liquidation [2018] EWHC 402 (Ch) the liquidators sought directions from the court:

1. Were the additional sums payable at all? The penalty issue

The court was required to consider whether the termination provisions of the CVA fell foul of the law on penalties. The submission was that the CVA operated as a contract; that the contract varied the terms of the leases so that the amended rent was paid, that the termination provisions come into operation on breach of the terms of the CVA, and that that they created a liability which did not otherwise exist.

The court did not accept that there was a penalty. The judge stated that the fact that the CVA had contractual effect did not mean that it had every attribute of a contract. The Insolvency Act 1986 ("Act") creates a deeming provision or "statutory hypothesis" which compels the court to apply a contractual analysis to issues such as the true construction of the CVA or the effect on co-debtors and sureties. However, the Act makes it unnecessary and inappropriate to consider any of the usual principles of contract formation and the statutory hypothesis works instead to bind all those affected by the arrangement, including BHS itself. The judge considered that the law on penalties was not intended to deal with hypothetical contracts. It is intended to provide relief against oppression which would normally take into account the parties' respective bargaining power. There was no negotiation and no actual contract between the parties in this instance. The arrangement had been brought about by a statutory procedure and was binding on BHS itself and its members and creditors by reason of a statutory hypothesis. The law on penalties was therefore not appropriate here. The judge also considered it impossible to see how a proposal put forward by BHS in the interests of itself, its members and creditors, approved by a statutory procedure and having effect by the statutory hypothesis, then be said to have oppressed BHS.

The CVA provided for a rent concession period to enable BHS' finances to be re-structured; that objective was not achieved and BHS defaulted; the consequences of which were that the concession be unwound entitling Prudential to claim for the full amounts under the leases.

Having established landlord entitlement to the additional sums there were two other elements to consider.

2. Did the liabilities offend the pari passu principle?

The liquidators queried whether the effect of clause 25.9 would be to create a new liability and increase substantially the claims which the "Category 2 and 3" landlords would have in the liquidation. This, it is said, infringed the "pari passu principle" in that "statutory provisions for pro rata distribution may not be excluded by a contract which gives one creditor more than its proper share": Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2011].

The judge did not accept that the CVA effected a variation of BHS' liabilities to its landlords so that a new liability was created where none existed before. In his judgment, the CVA created a rent concession period during which reduced sums were payable to Category 2 landlords like Prudential, in full and final satisfaction of any liability under the relevant leases. However the terms of that concession included the unwinding of those provisions in the event that the CVA were terminated. The termination of the CVA did not increase the landlords' claims in the liquidation; the true position was that the rent concession was brought to an end and the original rent (and other sums) continued to have effect.

3. Were the liabilities an administration expense?

Given the findings above, it followed that the additional sums falling due to Prudential upon the termination of the CVA were payable as an administration expense for the period during which the (original) administrators were in possession of the premises for the purposes of the administration.

Conclusion

The case provides useful clarity and more certainty for landlords and their advisors when dealing with a "landlord CVA" from the perspective of how the judge treated the contractual provisions of the CVA in the face of a formal insolvency procedure such as liquidation. The decision was positive for the affected landlords in the BHS CVA, and it gives comfort to other landlords who are already bound by CVAs containing similar provisions. It should also help and inform how companies seek to structure their proposal and the decisions that landlords make when a future CVA is proposed.

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