It’s been referred to as Armageddon. A score of landlords have lost out on rent owed to them by a retailer who used a form of insolvency to abandon unprofitable stores and leave its landlords out of pocket. And hundreds of landlords could be left in the lurch in this way as retailers seek to escape their financial woes.
In February, electrical goods retailer PowerHouse sent shockwaves through the property industry when it used a method of extricating itself from financial difficulties called a company voluntary arrangement to close 31 of its underperforming stores. Last Tuesday, a dozen landlords, including Prudential, Hammerson, Slough Estates and Land Securities, were given leave to take the retailer’s parent company, Pacific Retail Group, to court in an attempt to get the CVA revoked.
“This is an issue of fairness for us. This CVA discriminates against a group of creditors,” says Peter Best, head of investment operations at PruPIM. “There were other alternatives, such as liquidation.”
In 2003, PowerHouse was the UK’s third-largest electricals chain, with 200 stores and a turnover of £266m. But after poor sales and spiralling costs, it collapsed and was sold by its liquidators to Pacific Retail Group. PRG, a New Zealand-based company owned by business tycoon Eric Watson, then steadily downsized PowerHouse to 81 stores by February.
But it was the closure of the a further 31 stores via a CVA that put the cat among the pigeons. A CVA allows a company to avoid going into administration or liquidation so long as its creditors agree. Under PowerHouse’s CVA, the company has to pay back only 28p for every £1 of debt it owes to creditors.
At the creditors meeting in February, the CVA was agreed with the backing of PRG’s trade suppliers. Several landlords, however, objected, saying that, as well as avoiding paying them the rent owed, the CVA allowed PowerHouse and PRG to discard the parental guarantees given by PRG on rental payments for the closed stores. The landlords were given just £2m — “a fraction of what we are owed,” according to one landlord.
PRG chairman Bruce Gordon says it was the only way for PowerHouse to survive. “The CVA was chosen after extensive advice as the most effective remedy available for PowerHouse to have a core business which could carry on trading.”
PRG’s novel use of a CVA appears to have caught the industry by surprise. “It’s the first time to my knowledge that a company has used it as a means of closing down only the non-profit making stores of its business,” says Charles Woollam, corporate partner at retail agent Donaldsons. “It’s a surprise that CVAs can be used to hand back the keys on underperforming stores — it is usually all or nothing. But it is also a shock that it ringfences the parent company from picking up the historic debt.”
And the PowerHouse case could set a precedent. “Other retailers may only use CVAs if they are in financial difficulties, but the underlying concern for landlords is that they will try to use them,” says PruPIM’s Best.
It may not quite be Armageddon — a term Woollam has used to describe the dispute — but it has widespread repercussions, since if such CVA get-outs are permitted, guarantees by parent companies to support rental covenants could be meaningless. Donaldsons estimates that 10% of the £380bn of leased UK property held by institutions and property companies has a parent company guarantor. “So up to £38bn might now be subject to revaluation,” says Woollam. “Values could be hit by 150 basis points and that could seriously dent investor confidence.”
But, if more retailers use CVAs in this way, the greatest shock is likely to be felt in the relationship between landlord and tenant: the relationship enshrined by the covenant would be undermined.
“It’s serious,” says John Bywater, UK managing director of Hammerson, one of the country’s largest retail landlords. “If we find retailers are looking for loopholes to escape their rent obligations then that is going to cause concern for us. The relationship will begin to break down.”
But PRG’s Gordon suggests this is overreaction. “Some think that a CVA simply allows retailers to sever leases or release lease liabilities. That is very misleading. You do not enter a CVA lightly. It is a complex and demanding process that is not without risk.”
The problem, says Donaldsons’ Woollam, is that in the PowerHouse case landlords appear to have been left with a disproportionately large slice of that risk.
Landlords cannot help fearing the worst, considering today’s difficult trading conditions. According to the Insolvency Service, in the first quarter of 2006, retail liquidations are up by 17% against the same period last year, to 3,56. The use of CVAs has also increased by almost 30% since 1998, from 470 a year to 604.
“We’ve had 18 months of very low sales growth with enormous downward pressure on prices,” says Kevin Hawkins, director general of the British Retail Consortium.
And while, according to a release last week from the BRC, the sales figures for April were up by 9.8% against the same period last year, the house sales slowdown last year was felt acutely by home accessory retailers, such as PowerHouse.
“Inevitably when some are struggling there are going to be more insolvencies, and landlords are at an increased risk of default,” says Woollam. “The danger is that using a CVA will become a standard part of an insolvency practitioner’s armoury.”
PRG’s Gordon denies that the CVA was used purely for selfish reasons. “We were genuinely trying to ensure that everybody got something,” he says. Landlords were offered six months’ rent on the affected stores — or roughly 28p in every £1 owed. “The CVA allows us to continue trading with the core business. It enables landlords to have some money in their pockets and gives them some time to relet properties.”
According to Gordon, a number of PowerHouse landlords have accepted surrenders and are “moving forward”. Those that aren’t will have their day in court, but not before November.
The implications are enormous. According to some landlords, if PowerHouse is allowed to set a precedent, every facet of the property industry could be put in jeopardy. “We invest millions and millions of our shareholders’ funds into things such as the Bullring,” says Hammerson’s Bywater. “Unless we have a fairly consistent cash flow from things like rent, then we will not be able to build these shopping centres.”
Landlords could try to ensure tenants always pay up by demanding rent deposits that could be drawn down in the event of default. If a parent company guarantee is not accepted as sufficiently secure then a bank guarantee could also be sought.
“But these won’t be very popular with occupiers,” says Woollam. “Rent deposits can tie up significant sums of working capital.”
And they are certain to be fought by retailers, which are currently fighting to pay rent by the month instead of in advance for each quarter. The ensuing dent in cash reserves would of course be bad for struggling retailers desperate to continue trading.
Retailers like PowerHouse, for example.
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The company voluntary arrangement was introduced by the Insolvency Act 1986. It allows a struggling company that would otherwise go into insolvency to continue trading if it can come to some arrangement with its creditors. It is based on preserving the viable parts of a business, rebuilding sales and profits and eventually paying something — but not necessarily all debts — back to creditors. In many cases, it allows a struggling company to wipe away its historic debt and start again. |
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At a directions hearing last week in the companies court, the landlords asked for full disclosure of the records to show that PRG is “much healthier” as a result of the CVA, and that the parent used the arrangement to turn PowerHouse “from an insolvent to a solvent company” at their expense. On Tuesday, the companies court ordered PRG to disclose its records by 2 June. The group must also provide documentation showing why it decided that both liquidation and administration were “not viable options”. The landlords, which include Land Securities, Prudential, Hammerson, Slough Estates and Morley Fund Management, claim the CVA sets a precedent for financially unstable companies to terminate parent company guarantees without compensation, and results in other creditors being paid to the detriment of landlords. The landlords claim they were inadequately involved in the CVA decision and that liquidation may have been a “fairer” option. But PRG argues that the so-called “fairer” option would have resulted in no money for shareholders and no payments for creditors. Faced with that, 83% of the creditors voted for the CVA — far more than the 75% needed to pursue the procedure. |
