The High Court has released an important decision for landlords and Insolvency Practitioners in the wake of the failure of the company voluntary arrangement (CVA) entered into by BHS Limited (BHS).
In Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd, the court upheld a clause in BHS' CVA which stated that, if the CVA were to fail, the rent concessions made by certain landlords would be treated as never having been agreed and the full rent entitlements would be reinstated retrospectively. As a result, the landlords were able to claim the full amount of the rent as an administration expense.
BHS entered into a CVA in March 2016. One of the main purposes of the CVA was to reduce BHS' rental outgoings. The affected landlords agreed to the rent concessions in the CVA but insisted on a provision bringing the rent back up to its full level with retrospective effect in the event that the CVA failed.
The CVA did fail, with BHS going into administration followed by a creditors' voluntary liquidation. Seeking to rely on the rent reinstatement clause, the landlords claimed the full rent for the period of the administration as an expense of the administration. The liquidators challenged the application of the clause, arguing that it was an unenforceable penalty clause because the detriment on BHS was wholly out of proportion to the legitimate interests of the landlords. The liquidators also argued that upholding the clause would breach the fundamental principle of equal distribution among unsecured creditors.
The court rejected the liquidators' arguments. The clause reinstating the full rent was not a penalty clause because the agreement to reinstate the rent on failure of the CVA was part of the commercial proposal agreed with the landlords and was not considered exorbitant.
In any event, the court held that, although CVAs are deemed by insolvency legislation to have contractual effect, not all principles of contract law apply to them. The law on penalty clauses did not apply to CVAs because it required an assessment of the respective bargaining strength of the parties and whether one of them had been oppressed during negotiations. This assessment was not appropriate in the case of a CVA which has been voted on by creditors. There was nothing in insolvency legislation which envisaged the possibility of challenging a CVA based on general contract law; one of the designated statutory challenge mechanisms must be used.
Neither was there any breach of the principle of equal distribution among unsecured creditors. The rent reductions were clearly not intended to be permanent as the leases had not been formally varied. This meant that the administration was always subject to the full rent as an expense, if only as a contingent liability which only crystallised later. Therefore, the full rent was not the imposition of a new liability and the normal principle of administration expenses being paid before unsecured creditors should apply.
This decision will clearly be welcomed by landlords where a CVA has failed and will embolden landlords to push for a full rent reinstatement clause in any CVA which is put to them. The rent reinstatement would not apply if there had been a permanent variation of the lease terms by way of a separate deed of variation. The result of the case would almost certainly have been different had the rent reductions been permanent.
The court's reasoning that the full rent was always a contingent liability could be applied to other situations. For example, if there was an outstanding rent review under the lease, it seems likely that a landlord could successfully argue that the full rent following the review should count as an expense of any administration to the extent that the property was used for the purposes of the administration. Indeed, without definitively deciding the point (as it was not applicable to the facts of this case), the court indicated that such an argument would succeed.
Insolvency Practitioners, on the other hand, need to be aware that the expenses of the administration will not necessarily be limited to the actual rents payable under the terms of the CVA, but may include the full rent before any reduction. IPs should bear this in mind when considering the likely expenses of trading during concurrent or subsequent administrations.
TLT has a full service team of insolvency specialists who are well placed to advise on a wide range of insolvency situations.
Contributor: Matt Battensby
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at May 2018. Specific advice should be sought for specific cases. For more information see our terms & conditions.