Fairness, Lease Guarantees and CVAs

Fairness, Lease Guarantees and CVAs

Kieran McGarrigle looks at a recent judgment which offers some guidance for the treatment of lease guarantees in a Company Voluntary Arrangement.

Fairness, Lease Guarantees and CVAs

Lease guarantees and the terms of a Company Voluntary Arrangement (CVA) came under the judicial spotlight recently in the case of Prudential Assurance Co Ltd & Others v PRG Powerhouse Limited.

A CVA is a compromise or an arrangement with creditors where part or all of the company's debts are repaid on terms agreed with 75% or more of the company's unsecured creditors by value. Where a creditor believes that the terms of a CVA are unfairly prejudicial to its interests or there was a material irregularity at the meeting of creditors, that creditor may apply to Court for an order revoking or suspending the CVA.

PRG Powerhouse Limited ("Powerhouse") carried on business as an electrical retailer from 88 leased stores. Its obligations under these leases had been guaranteed by its parent company, PRG Group Limited ("PRG"). In February 2006, Powerhouse closed 35 of its 88 stores and proceeded to put a proposal to its creditors for a CVA. The relevant terms of the proposal put forward were as follows:

• the rights of all creditors (save for those who were creditors in respect of the closed stores) were to be unaffected by the CVA;
• the creditors of the closed stores were to be offered 28p in every £1 owed and all of those claims against Powerhouse were to be released; and
• the guarantees given by PRG to the landlords of the closed stores (the "Landlords") were also to be released.

The proposal was approved by the requisite majority of creditors, including those creditors not affected by the terms of the voluntary arrangement. The votes of those creditors who stood to lose nothing from the CVA, and had everything to gain from it, inevitably swamped the votes from the Landlords. The validity of the CVA was subsequently challenged by the Landlords on the basis that terms of the CVA unfairly prejudiced their interests.

The Court agreed with the Landlords that their interests had been unfairly prejudiced by the terms of the CVA. Whilst the CVA was not binding on or enforceable against PRG (or indeed any third party), the Court considered that the effect of the CVA was to release the guarantees provided by PRG. The CVA was a contract between Powerhouse and its creditors and Powerhouse could enforce an obligation on the Landlords not to claim under the lease guarantees. The CVA therefore effectively released PRG from its obligations to the Landlords under the lease guarantees. The Court also considered that the interests of the Landlords had been unfairly prejudiced by the terms of the CVA because the Landlords had been put in a worse position as a consequence of the CVA's terms. The Landlords had been unilaterally disenfranchised of their rights under lease guarantee which could have provided the Landlords with 100p rather than 28p for every pound they were owed. As a consequence, the effect of the CVA on the Landlords was illogical as well as unfair.

Implications

The Powerhouse case is hugely important for the commercial property market. Prior to the Court's decision, there had been some concern that lease guarantees negotiated at arm's length could be undermined if the tenant entered into a CVA. However, the Court's decision that the Powerhouse CVA was unfairly prejudicial to the Landlords should be a considerable relief to landlords throughout the UK. In practice, all landlords should now look very closely at the terms of a tenant's proposal for a CVA to see if their lease guarantee is in anyway affected. If it is, the proposal should be challenged at the meeting of creditors and subsequently in Court, if necessary. Insolvency practitioners who are instructed by companies to put together proposals for a CVA should also ensure that such proposals do not affect the rights creditors may have freely negotiated with third parties.

Kieran McGarrigle is a Partner and head of the firm's Corporate Recovery and Insolvency team.

Kieran can be contacted at: kieran.mcgarrigle@lestrangeandbrett.com

Quote: Landlords ..... unfairly prejudiced