Landlord wins as CVA term not a penalty

Following the liquidation of BHS Ltd, the High Court was asked to consider whether a landlord could claim full rent as an administration expense following termination of the CVA.

Background

Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd concerned three principal insolvency processes applicable to companies under the Insolvency Act 1986:

• A company voluntary arrangement or CVA: this is an arrangement between a company and its creditors where creditors are asked to accept less than the full debt owed to them in order to enable the company to avoid administration and/or liquidation.
• Administration: where a company is managed by administrators in place of its directors to achieve certain statutory aims, including, if possible, the rescue of the company as a going concern.
• Liquidation: the company's assets are realised and its liabilities settled (insofar as possible) before the company is dissolved.

Facts of the case

In March 2016, after several years of losses, the retailer BHS negotiated a CVA with its creditors and members. A key feature of the CVA was to reduce the amount of rent payable for BHS's leasehold premises. Its landlords were divided into various categories according to how viable the leasehold premises were for continued trading. Prudential fell into a category which entitled it to 75% of the rent payable whilst the CVA was in place.

A month after the CVA was agreed, BHS went into administration. During the administration, the terms of the CVA continued and the company name was changed to SHB Realisations Limited. The company moved into liquidation in November 2016.

The CVA was terminated a month later in December 2016. On termination, the following provision (clause 25) took effect:

"Upon a termination under this clause 25.the compromises and releases effected under the terms of the CVA shall be deemed never to have happened such that all landlord and other compromised CVA creditors shall have the claims against [the company] that they would have had if the CVA Proposals had never been approved (less any payments during the course of the CVA)".

On the basis of this clause Prudential argued that:

• It was now owed the full amount of rent payable under the leases as if the rent reduction had never been agreed (minus any sums actually paid); and critically,
• Any rent arising from the period during which the administrators traded from the leasehold premises was payable as an 'expense of the administration' (meaning it would be payable in priority to all claims except those of fixed charge creditors).

The issues

BHS's liquidators applied to court to determine whether:

• clause 25 was a penalty clause - in which case it would be unenforceable
• the effect of clause 25 in increasing BHS's liabilities to Prudential in the liquidation contravened the pari passu principle (that all unsecured creditors must share an insolvent company's assets equally)
• Prudential could claim the additional sums as an administrative expense given that the administration had already ended

Arguments and Decision

Penalty Issue: Penalty clauses only exist in relation to contracts. They operate on breach and must be so out of proportion to the legitimate interests of the innocent party so as to be considered oppressive and/or unconscionable (Cavendish Square Holdings BV Makdessi [2016] AC 1172 - see our previous article Penalty clauses -not so fashionable after all).

The liquidators argued that the CVA was a contract that varied the leases to provide for the reduced rent being payable. The termination provisions only came into operation on breach of the CVA's terms and they created a liability that did not otherwise exist for BHS to pay additional sums on breach. This, they said, engaged the law against penalties, meaning the requirement to pay further rent was unenforceable.

The judge disagreed with the liquidators:

• Although a CVA could have effect like a contract, it was not actually a contract. This meant the law of penalties did not apply.
• It was difficult to see how a proposal put forward as being in the interests of BHS could later be said to be oppressive to BHS. Also, clause 25 could not be a penalty if its effect was simply to entitle the landlords to the full rent they would have been paid if the CVA had never been agreed.
• The liquidators could not rely on the full and final settlement wording in clauses 9, 10 and 17 and simply ignore clause 25. This would be to rewrite the terms of the CVA.

Pari Passu issue: The liquidators argued that clause 25 provided for a substantial increase in BHS's liabilities to landlords in the event of the CVA being terminated following a breach of its terms. They said this increase was a new liability that had not existed before.

The court disagreed. The termination of the CVA did not increase the landlord's claims. Rather, the rent reduction was brought to an end and the original rent became payable once again. The pari passu principle was therefore not contravened.

The administration expense issue: During the period of rent reduction under the CVA the administrators traded from the leased premises for the benefit of the administration. The case of Jervis v Pillar Denton Ltd [2015] Ch 87 held that in these circumstances, the rent should be paid as an expense of the administration. Clause 25 restored the original rent with retrospective effect, meaning the full amount was payable as an administration expense for the period during which the premises were used for trading.

Comment

Although this case turned upon the specific wording of the CVA termination provisions, it illustrates that:

• CVAs are not contracts but are agreements enforceable under specific insolvency law. It may be possible for future CVAs to include provisions whereby any rent reductions continue should the CVA fail and the company subsequently proceeds into administration and/or liquidation.
• If a rent reduction under a CVA is to be permanent, the tenant's interests might best be served by the completion of a deed of variation to the lease.

It also serves as a prompt to landlords to ensure they fully read and understand the terms of any CVA proposal made to them and in particular, understand the effect that the CVA has on them should a company subsequently proceed into administration and/or liquidation

Wright and another (Liquidators of SHB Realisations Ltd) v The Prudential Assurance Company Ltd [2018] EWCH 402 (Ch)