The High Court decision in Prudential Assurance Co Ltd v PRG Powerhouse Ltd; Lactor Ltd v PRG Powerhouse Ltd [2007] EWHC 1002 (Ch); [2007] PLSCS 91 is important and has attracted huge interest. It represents a victory for landlords faced with the improper use of company voluntary arrangements (CVA).
It involved a practice that became known as “guarantee stripping”. The terms of a CVA were designed to enable Powerhouse to close its loss-making stores. Under the CVA, landlords of loss-making stores were to be partially compensated for their losses, but the company and its guarantor were to be released from all liabilities under the leases of those stores. Landlords of stores that were to remain open were to be paid in full.
Votes for or against a CVA are calculated by reference to the value of the creditors’ debts at the date of the creditors’ meeting. Although the landlords of the loss-making stores objected to the proposals, the requisite majority of creditors approved the CVA. The landlords of the loss-making stores applied to the court to have the CVA revoked, under section 6 of the Insolvency Act 1986. They argued that the arrangement unfairly prejudiced their interests because the creditors that were to be paid in full swung the vote in favour of the CVA. The landlords also argued that, as a matter of law, a CVA cannot unilaterally release guarantees given by third parties.
The court agreed with the landlords that the Insolvency Act 2006 did not operate directly to release the company’s guarantor from liability under its guarantees. However, the judge decided that Powerhouse could include a provision in the CVA that required the landlords of the loss-making stores not to enforce the guarantees in their favour, because if they were to pursue the guarantor, the guarantor would then be entitled to claim against Powerhouse, which would defeat the purpose of the CVA.
However, a comparison of the treatment of the different groups of creditors showed that the present, future and contingent claims of the landlords of the loss-making stores were to be discharged at a fraction of their value, so that other creditors could be paid in full. No account had been taken of the value of the parent company guarantees and the votes of creditors, which had nothing to lose and everything to gain from the CVA, swamped the votes of the landlords of the loss-making stores, which were significantly disadvantaged by the CVA.
The decision that the CVA unfairly prejudiced the landlords is not an unqualified victory for all landlords. Insolvency legislation is designed to foster a “rescue culture” and a balanced, well-crafted CVA, which recognises the value of third party guarantees, may enjoy a different reception. The case highlights the tensions that inevitably arise between different interest groups when a company is failing, and may trigger demands by landlords for additional forms of security from prospective tenants whose covenant strength is in doubt.
Allyson Colby is a property law consultant
