Insolvency — Company voluntary arrangement (CVA) – Unfair prejudice – Applicants letting retail units – Tenant’s obligations guaranteed by parent company – Tenant becoming insolvent and entering into CVA – Administrators structuring CVA so as to deprive applicants of benefit of guarantees on payment of compensation – Application to set aside CVA under section 6(1) of Insolvency Act 1986 – Whether CVA unfairly prejudicial to applicants – Application allowed
The first respondent operated a retail fashion chain, including two units in a shopping centre in Liverpool let by the applicants under two leases for terms of 10 years from October 2006. The first respondent’s obligations under the leases were guaranteed by its parent company, which also covenanted to take new leases of the premises for the residue of the contractual term if the first respondent went into liquidation and the liquidator disclaimed the lease. Its premises included two units in a shopping centre in Liverpool let by the applicants for a term of 10 years from October 2006. The first respondent fell into financial difficulties and, in September 2008, the second and third respondents were appointed as administrators. Following an initial creditors’ meeting in December 2008, they proposed a company voluntary arrangement (CVA), which was issued in March 2009 and approved, subject to certain modifications, at a creditors’ meeting in April 2009. The second and third respondents were also the supervisors under the CVA.
Under the terms of the CVA, most creditors would continue to be paid in full; the necessary majority voted in favour. The applicants, the only creditors who voted against the proposal, were to release the first respondent’s parent company from all liabilities under the guarantees in return for compensation of £300,000; that figure purported to represent 100% of the first respondent’s liability to the applicants on a surrender of the leases, calculated on the basis of advice and specified assumptions.
The applicants applied to the court to overturn the CVA on the grounds contained in section 6(1) of the Insolvency Act 1986, namely that: (a) the CVA unfairly prejudiced them as creditors; and (b) there had been a material irregularity at or in respect of the creditors’ meetings. They argued that the CVA left them in a substantially worse position than they would have been in on a liquidation and that £300,000 represented less than one-third of the first respondent’s liabilities and therefore amounted to unfair treatment by comparison with the rest of the creditors who were to be paid in full. They contended that there was no justification for requiring them to relinquish the benefit of the guarantees since the first respondent’s parent company was solvent and could meet its obligations; they alleged that the parent company had dictated the terms of the CVA.
Held: The application was allowed.
(1) It was legally possible for a CVA made between a tenant and its creditors, including landlords with the benefit of third-party guarantees, to impose on the landlords a binding release of their rights under such guarantees, even though the guarantor was neither the company that was proposing the arrangement nor a party to it. Furthermore, a CVA could have that effect even though the relevant guarantees contained provisions designed to prevent the release of the principal debtor from affecting the creditor’s rights under the guarantee. However, when considering whether such an arrangement unfairly prejudiced the applicants, it was relevant that the applicants would have retained the benefit of the guarantees on a liquidation and there was no reason to doubt the parent company’s ability to honour them, including the obligation to step into the first respondent’s shoes and take equivalent leases in its own name. Those contractual rights were of obvious commercial value to the applicants. Moreover, the applicants, as guaranteed landlords, would have formed a separate class of creditors for the purposes of a formal scheme of arrangement under section 899 of the Companies Act 2006, and would have been able to veto a scheme that deprived them of their guarantees, whereas the CVA had been passed by a majority of unsecured creditors, who stood to lose nothing by the CVA and whose votes had inevitably swamped those of the guaranteed landlords: Prudential Assurance Co Ltd v PRG Powerhouse Ltd [2007] EWHC 1002 (Ch); [2007] 3 EGLR 131 applied. The applicants had been unfairly prejudiced for all those reasons.
The only possible factor militating the other way was that the applicants had been offered the full amount of the value placed on their rights. However, in times of commercial and financial turmoil, the ability to enforce the terms of the existing leases against the guarantor for a further seven-and-a half years was a valuable right, and it was not justified in such circumstances to require a guaranteed landlord to accept a sum of money in lieu. At a time of market uncertainty, it would be difficult, if not impossible, to determine what sum would fairly compensate the landlord for the loss of such rights, and, in the absence of a compelling justification, a landlord should not be forced to accept a sum that was based on numerous assumptions that might not prove to be well founded. To adopt such a procedure where the solvency of the guarantor was not in issue, would undermine the basic commercial function of the guarantee and force the landlord to accept a commercially inferior substitute. Accordingly, it had been unreasonable and unfair in principle, in the context of the instant case, to require the applicants to relinquish their guarantees. Moreover, the evidence showed that the £300,000 assigned to the applicants claim was not a genuine estimate of that claim but was dictated to the administrators by the first respondent’s parent company, which stood to benefit from the release of the guarantees. A figure in the region of £1m could fairly be regarded as appropriate. The difference between the treatment of the applicants and the other unsecured creditors could not be justified.
(2) The second and third respondents, as administrators, had abdicated their responsibilities as office holders and allowed the first respondent’s parent company to dictate the terms of the CVA. They had lost a proper sense of objectivity and sided with the parent company against the interests of the guaranteed landlords. That led them to put forward a proposal for the CVA that they must have known was not objective, and that was based on a cynical calculation by the first respondent’s parent company of what it hoped to away with. They had compounded their dereliction of duty by falsely representing in the proposal that the figure of £300,000 was based on advice that they had received. Administrators were under a duty to retain an independent stance, act in good faith and to propose a CVA only if they were satisfied that it would not unfairly prejudice the interests of any creditor. The need for a responsible and professional attitude was even more pronounced where the CVA was structured in such a way that it was bound to be passed by the votes of creditors whose position was either unaffected or improved, despite the fact that it would deprive another smaller class of creditors of valuable contractual rights. Where it was proposed to deprive a creditor of the benefit of a guarantee, greater care was required to ensure fairness in the substance of what was proposed and in the procedure to be adopted. There was a prima facie case of misconduct by the second and third respondents, which should be referred to the relevant professional bodies to which they were answerable.
Peter Arden QC and Edward Francis (instructed by Davies Arnold Cooper LLP) appeared for the applicants; the respondents did not appear and were not represented.
Sally Dobson, barrister
