Published on 11 November 2010 by Tony Groom

In April 2009 the retailer JJB successfully proposed a CVA designed to save 250 stores and 12,000 jobs. It has become the model for subsequent CVAs in the retail sector.

The proposal included closing 140 unprofitable stores but made available a fund of £10m for the landlord creditors of these premises, equating to a payment of approximately six months rent.

JJB also made a significant compromise in bearing the substantial costs of the business rates of the unprofitable stores. The landlords of the open stores were offered the passing rent on a monthly basis for a period, after which the standard contractual quarterly payments would be reinstated.

No leases were ‘torn up’ by the CVA and it was left to individual landlords to decide whether they wished to accept a surrender, consent to an assignment or forfeit the lease.

The landlords as a group recognised that there was a substantial risk that JJB would go into administration, which would have meant that they received no payments of rent or business rates for the closed stores. They appreciated being consulted in a transparent process and being offered a genuine compromise.

It often happens that the core of a struggling business is viable and it need not go into administration if it can be restructured to focus on the parts that are profitable.

That can be beneficial to the creditors too, because they will then see some return on what they are owed, as the above example illustrates. In many cases the creditors will include landlords who own the property or properties from which the business is trading.

While the landlords’ rights for dealing with arrears are included in the lease they usually include both the right to seize assets from premises to cover arrears or the right to forfeit the lease and claim loss due to breach of contract.

The forced termination of a lease can only be done by a liquidator following a company’s liquidation. If a company goes into administration and is sold the Administrator can also force termination of those leases no longer required.

However, in the JJB illustration above, negotiation with the landlords to terminate some leases was made possible by proving to them how much they would receive in the event of a liquidation and showing that the alternative offer set up using a Company Voluntary Arrangement (CVA) was better than liquidation.

Another way of using a CVA to deal with lease liabilities is to crystallise them and include the landlord(s) as creditors although this only really works with vacant premises.

Forcing a change in the terms of a lease is extremely difficult and the courts will want to test whether or not a landlord has been treated fairly as a creditor in a CVA, regarded as vertical and horizontal tests.

The vertical test considers whether or not a landlord’s outcome is better or worse that would have been achieved in liquidation and may require expert opinion.

The horizontal test compares the landlord as a creditor with other creditors and where contingent creditors may vote but are excluded if a CVA is approved then the Court considers creditors by class as would be applied in a Scheme of Arrangement under Part 26 of the Companies Act 2006 (formerly s425 of the Companies Act 1985).

While terminating leases might logically be handled by a lawyer, assistance from business rescue advisers or insolvency practitioners can help by carrying out a business review and producing a comparison of outcomes to show the outcome for landlords in the event of liquidation to help justify them accepting an offer that avoids liquidation.