Time to pay the piper now that lockdown is lifting? Considerations for landlords and tenants facing a mounting pile of rent bills
The Government is consulting on how to best manage the accumulation of debt between commercial landlords and tenants once the current rent moratorium comes to an end on 30 June 2021. Our article discusses the proposals and records some of the recent responses from industry to the tabled options. We also discuss the restructuring process and how various restructuring tools might be used by distressed tenants as they navigate the lifting of the temporary protective measures.
Exit from moratorium on forfeiture
Since March 2020, in response to the impact of Covid-19 on the economy, the Government has introduced various temporary measures designed to protect tenants from eviction, insolvency and debt recovery. These measures have assisted in preserving tenant businesses and jobs during periods of reduced trading primarily as a result of Government mandated lockdowns. These temporary measures have included:
- a moratorium on a commercial landlord’s right to forfeit a business tenancy for non-payment of rent during the relevant period (26 March 2020 to 30 June 2021);
- restricting the use of CRAR against tenants who defaulted during the Covid-19 pandemic by increasing the minimum amount of net unpaid rent which has to be outstanding before it can be exercised; and
- restricting a creditor from presenting a winding-up petition on the grounds of a company's inability to pay its debts unless the creditor has reasonable grounds for believing that Covid-19 has not had a financial effect on the company or that the debt issues would have arisen anyway.
The Government’s current position is to support commercial landlords and tenants in agreeing their own arrangements for payment (or otherwise) of accumulated rent debts by 30 June 2021 and in conducting discussions about their ongoing relationship and lease terms. The Government has stated that it will consider both regulatory and legislative options to protect viable businesses and jobs. See our blog post on Covid 19 tenant protections: as the moratorium on forfeiture nears its end date – what happens next?
Code of Practice
On 15 June 2020 the Government published a voluntary Code of Practice designed to set out principles of behaviour and responses to difficulties experienced by commercial landlords and tenants as a result of the Covid-19 pandemic. See our article on the Code of Practice. Despite being voluntary there has been reported evidence of landlords and tenants actively engaging with the Code. Generally speaking, it is a helpful best practice document which may have increasing relevance and importance as we approach 30 June 2021 and beyond.
The Code of Practice is due to expire on 24 June 2021, however, the recent addition of an Annex to the Code of Practice, including the template for landlords and tenants to use in negotiating arrears, is a helpful step in providing parties with additional tools to facilitate discussions as the 30 June 2021 deadline approaches.
Call for Evidence
On 6 April 2021 the Government launched a Call for Evidence. The consultation explored challenges to successful rent negotiations and the potential impacts of failure to agree a way forward. It also set out six possible methods of exiting from the temporary protective measures. The consultation closed to responses on 5 May 2021.
The six exit methods under consideration are outlined below.
- Option 1 – allow these measures to expire on 30 June 2021 (the "return to normal" option)
This option will not take into account the variable impact that Covid-19 has had on tenants across different sectors. Landlords would benefit from being able to exercise a broad range of rights and, in particular, this would assist landlords who have been unable to secure rental payments from tenants who have been able to pay but have elected not to do so. However, struggling tenants may find that this option will expose them to greater risk of recovery measures being taken in circumstances where they are seeking to recover their position such that they can continue their letting.
- Option 2 – allow the moratorium on commercial lease forfeiture to lapse on 30 June 2021 but retain the insolvency measures and additional rent arrears amendments to CRAR for a period of time.
The moratorium has the effect of preventing petitions being made in respect of business which would only "fail" as a result of the effects of the Covid-19 pandemic. Restricting the use of CRAR for a further period of time may be more acceptable to landlords if other methods of recourse remain available and forfeiture becomes an available remedy. Tenants would benefit from extended restrictions on the use of CRAR since it will protect their stock and tangible assets as they rebuild and restabilise their businesses. The extension of CRAR would also likely have the effect of continuing protection for subtenants.
- Option 3 – target existing measures to businesses based on the impact that Covid-19 restrictions have had on their businesses for a limited period of time.
The targeted approach might be helpful insofar as it provides additional assistance for those industries which it is widely acknowledged (including in the Budget) have been most affected by the lockdowns. However, this does not mean that other tenants in other sectors have not been similarly impacted. By adopting a targeted approach there is a risk that tenants falling outside of those identified "protected businesses", but who are in similar commercial positions to those falling within those classes of business, are unable to access the additional support that this targeted approach seeks to provide to prevent viable businesses from failing. The definition of affected sectors would need to be clear yet sensitive to those at the "margins". It is unclear from the proposal how the affected sectors would be defined and a method of categorisation would be required. There are also a broad range of tenants and tenant businesses within classifications and the protections should be nuanced enough to respond to these differing needs.
- Option 4 – encourage increased formal mediation between landlords and tenants
Mediation can assist where it has the effect of preserving the relationship between landlord and tenant. This is a key consideration in the current economic climate given that many landlord and tenant relationships have modulated over the course of the Covid-19 pandemic. The non-binding nature of mediation would also allow the landlord and tenant to retain control over and to be actively involved in the process.
- Option 5 and Option 6 – non-binding adjudication/binding-adjudication
Options 5 and 6 propose a method of non-binding adjudication/binding-adjudication (respectively) between landlords and tenants. The adjudicator would have the power to alter the commercial deal between landlords and tenants. This is an uncommon position in real estate with parties freely entering into commercial negotiations and agreed letting documents (albeit within a statutory framework). There are examples in case law of Courts being reluctant to interfere with or reset commercial bargains and mutually agreed contracts. Lease terms are often bespoke and will have been agreed following careful commercial analysis by both parties and detailed legal negotiation. Selecting either or the adjudication options would demonstrate that the binding nature of the commercial agreement between parties is capable of being undone and, in turn, would create doubt as to the robustness of real estate documents (leases in particular).
A number of further potential issues flow from these options, for example:
- without consistency of adjudication decisions there will be uncertainty for landlords and tenants and the potential for conflicting outcomes or unsatisfactory results;
- these options would only be viable if there are enough adjudicators with the necessary expertise and training available; and
- if rent under a lease is reset by an adjudicator and there is a third-party lender there is likely to be a need for ancillary or parallel adjudication between the landlord and lender.
The call for evidence also suggests a range of remedies that might be available to adjudicators to determine how disputes should be resolved. These include waiving a proportion of rent arrears or service charge arrears, extending or shortening the term of a lease, resetting the rent under a lease and waiving the right to a top up of a rent deposit. Each of these proposals have commercial and legal ramifications.
Industry Response to Call for Evidence
There have been a number of reported and publicised responses from industry, including:
- The British Property Federation has expressed support for option 1. This would reinstate a "normal" position in respect of future rent payments and would ensure that industry retains control over the appropriate commercial solution rather than submitting to a Government imposed solution. It is the BPF’s opinion that “the market will deliver a fair outcome for the minority of tenants that have not already reached an agreement with their property owner and that rational owners will wish to keep viable tenants in place.”.
- British Land and Landsec favour an alternative industry proposal which is targeted at retail, food and beverage, hospitality and leisure premises and which supports proportionate rental debt settlements in way that takes into account both relative business strength and ability to trade during the Covid-19 pandemic. The proposal favours lifting of the moratorium and an immediate return to normal market operation after 30 June 2021. This solution is subject to an exception for historic rent arrears (incurred between March 2020 and May 2021). It is suggested that the moratorium should continue in relation to such arrears until December 2021 to allow space for landlords and tenants to agree concessions where appropriate. This carve-out will not apply to arrears in respect of which parties have already reached commercially binding agreements. Following expiry of the extended moratorium binding arbitration is recommended as a last resort where parties fail to reach a deal.
In their proposal, British Land and Landsec recommend enhancement of the Code of Practice “to give more specific guidelines for negotiation between landlords and occupiers to speed up negotiation and resolution.”
- It has been reported that the British Retail Consortium has suggested to Government that arrears accrued between March 2020 and June 2021 should be protected from legal action for an additional six-month period. The intention would be for parties to seek to reach agreement during this time and that the matter should be referred to binding arbitration in the event that they fail to do so. Media reports have stated that UK Hospitality has recommended that the moratorium should be extended to the end of 2021 and adjudication used to address arrears (with a 50 per cent write-off being the starting position). This is proposed on the basis that it would allow for a period of bounce-back following the lifting of lockdown and a sharing of losses between landlord and tenant.
Two summary judgments have recently been handed down in cases where landlords have sought to recover rent arrears from tenants which have accrued during the Covid-19 pandemic. Both judgments have found in the landlord’s favour which is at least indicative of the current view that the courts are adopting regarding treatment of arrears. It is possible that both judgments will be appealed, if so, the outcome will be of great interest to landlords and tenants since the results of such cases will likely inform the outcome of other arrears cases before and after 30 June 2021.
- In the case of Commerz Real Investmentgesellschaft v TFS Stores Limited the High Court issued summary judgment that The Fragrance Shop must pay rent and service charge arrears accrued during the Covid-19 pandemic to the owners of Westfield London. The Court found that a term could not be implied into the rent cesser provisions within the lease which would allow for rent to be withheld if the premises had to close as a legal requirement (i.e. due to Government lockdown during a pandemic). The rent cesser provisions provided only for suspension in event of damage to or destruction of the premises.
- In the case of New York Mellon v Sports Direct (and others) the tenants (Cine-UK Ltd, Mecca Bingo Ltd, SportsDirect Ltd, and Deltic) were unable to trade to varying extents as a result of the lockdown periods. The High Court rejected an argument that the leases were frustrated finding that there was no basis for the lease being suspended temporarily under the doctrine of frustration. The Court also found that, although the landlord had pandemic insurance which insured against loss of rent (and that the tenants paid for that insurance) it had been open to tenants to take out business interruption insurance. The Court noted that the terms of the leases were largely standard form and there was no precedent for the rent cesser clauses in the leases, which referred to “damage or destruction,” to be construed to include inability to trade (or a term implied into such clause to that effect).
In the judgments handed down in both cases it was found that the Code of Practice does not assist tenants in defending landlord debt claims since ultimately it is the tenant’s liability to pay its arrears. Master Marsh, in Commerz Real Investmentgesellschaft stated that “the Code is not a charter for tenants declining to pay any rent” and in handing down judgment in New York Mellon Master Dagnall commented that the Code of Practice exists outside of the litigation process and is not applicable to tenants who are able to pay their arrears. The findings and obiter in these cases may have the effect of discouraging engagement with the Code of Practice.
Residential tenants (of certain residential tenancies) have been protected from eviction by the temporary statutory extension of notice periods in relation to possession proceedings under the Coronavirus Act 2020. The protections will remain effective until 31 May 2021 in England. The notice periods for service of section 8 notices (subject to certain exceptions) and section 21 notices under the Housing Act 1988 in relation to properties in England has been increased to six months with effect from 29 August 2020. Possession claims have also been stayed with a "reactivation" process set out in Practice Direction 55C.
Under the recent Debt Respite Scheme (Breathing Space Moratorium and Mental Health Crisis Moratorium) (England and Wales) Regulations 2020 an individual residential tenant with rent debt can apply for a "breathing space" moratorium from an approved debt advice provider. If successful the debt will be frozen, creditors will be prohibited from contacting the debtor for 60 days and certain enforcement action will be prevented.
CVAs and Restructuring Plans
Historically, where tenants have sought to use a statutory restructuring procedure to compromise their leases they have used company voluntary arrangements (CVAs). Schemes of arrangements have not been used as they are typically more expensive than CVAs as they involve two court hearings. In addition, in a scheme of arrangement creditors are divided into classes where their “rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest.” Each class of creditor must approve the scheme or else the whole scheme would fail. Landlords would likely be in a class of their own and so, as a class, would have an effective veto on a scheme of arrangement.
The Corporate Insolvency and Governance Act 2020 introduced restructuring plans as a new statutory process. Procedurally restructuring plans are similar to schemes of arrangement. However, a restructuring plan can be implemented (in certain conditions) even if an entire class of creditors has failed to approve the plan by the requisite majority (a so called "cross-class cram down"). The possibility of a cross-class cram down mitigates the execution risk of a class of creditors vetoing the restructuring. Accordingly, restructuring plans are now seen as a viable option for a tenant seeking to restructure a leasehold portfolio. Virgin Active has recently implemented a restructuring plan to compromise its leases despite heavy opposition from its landlords and NCP are in the process of launching a restructuring plan primarily aimed at restructuring its leases.
A summary of the differences between CVAs and restructuring plans can found in this table.
Both CVAs and restructuring plans are flexible regarding the terms of the arrangements that can be proposed to creditors. We expect restructuring plans aimed at compromising leases to include many features which have become common in CVAs in the retail and leisure sector over the past few years, including:
- grouping of landlords for different compromises according to the performance of the underlying premises;
- changing quarterly rents to be paid monthly;
- rent concession periods during which a reduced rent is paid and/or fixed rents are converted to turnover rents;
- resetting of rent at the end of rent concession periods to market rent (ignoring any upward only rent review restrictions);
- discharge of arrears; and
- additional break rights.
Tenant’s perspective on restructuring plans
A restructuring plan is expected to be more expensive than a CVA as it will involve two court hearings. However, a tenant may nonetheless seek to use a restructuring plan instead of a CVA because:
- the tenant has secured or preferential debts (which now include VAT liabilities) that it wishes to restructure at the same time. These cannot be restructured by a CVA without the consent of all of the secured or preferential creditors who are affected;
- the tenant may consider that the possibility of using a restructuring plan’s cross-class cram down allows a more extensive and deeper compromise to be imposed on landlords than may be the case under a CVA where a tenant may have to propose a less aggressive compromise to ensure a sufficient number of landlords approve the CVA. Virgin Active’s restructuring plan was sanctioned by the court even though a majority of the classes of landlords voted against the restructuring plan (the opposition was unanimous in the case of some heavily compromised classes of landlords). The Virgin Active judgment acknowledges that Virgin Active chose a restructuring plan instead of a CVA in part because Virgin Active considered that landlords would have more negotiating leverage if a CVA was used. The court noted that Virgin Active was entitled to choose between using a restructuring plan or a CVA for this reason; and
- the tenant may wish to have certainty that the restructuring will not be challenged. With CVAs there is a 28 day period after a CVA has been approved by creditors during which a creditor may challenge a CVA on the grounds of either material irregularity or unfair prejudice. Although, it is possible to appeal the court’s order sanctioning a restructuring plan we expect such appeals to be rare1 and so the court’s sanction order will in almost all cases end the risk of the restructuring being challenged. However, New Look’s recent successful defence of its CVA against a challenge by its landlords may give tenants renewed confidence in the robustness of CVAs against challenge. At the time of writing this note the judgment in the challenge by landlords to CVA of Regis UK Limited (the former owners of Supercuts) is still awaited.
Landlord’s perspective on restructuring plans
As noted above a restructuring plan’s ability to impose a compromise on a dissenting class of creditors may cause landlords concern that tenants may be emboldened to propose more aggressive compromises of their leases. However, restructuring plans do have certain procedural protections for creditors that are not found in the CVAs. In particular:
- all restructuring plans (whether or not a cross-class cram down is used) are subject to the review of the court. The court will consider if it is fair and just to sanction the restructuring plan. The court is keen to stress that this is not a ‘rubber stamp’ process;
- a cross-class cram down can only be imposed if: (i) the dissenting class of creditors would be no worse off than in the relevant alternative (being the scenario if the restructuring plan was not implemented, typically administration or liquidation); and (ii) at least one class of creditors with a genuine economic interest in the plan company. The court will, in addition, also consider the fairness of approving a cross-class cram down;
- it may be cheaper for a landlord to challenge a restructuring plan. Challenging a CVA requires a landlord to initiate a claim whereas a restructuring plan already requires two court hearings at which creditors may make representations. The court may order that the plan company (i.e. the tenant) pay a landlord’s legal costs even if the restructuring plan is approved and sanctioned where the court has nonetheless found the landlords’ representations at the hearings to be a constructive contribution. However, the court’s approach to recovery of costs is expected to be reconsidered when the Virgin Active restructuring plan has a separate court hearing to consider costs; and
- landlords will be able to vote as a class. Although, this is subject to a potential cross-class cram down (as was the case in the Virgin Active restructuring plan), unlike a CVA, a restructuring plan does not lump landlords in with other creditors who are treated differently by the proposed restructuring.
Following the sanctioning of the Virgin Active restructuring plan, landlords may be forgiven for considering that these protections for creditors are of little worth. Where the value of the tenant company breaks in the secured debt (as was the case with Virgin Active) it will be predominately the secured creditors who can decide how the benefit of the restructuring is divided up. This can include the secured creditors allowing the shareholders of a tenant to retain some value in their equity even though the shareholders would otherwise rank behind unsecured creditors in an insolvency of the tenant. However, if all secured debts would be satisfied in full and the value of the tenant company broke in its unsecured liabilities, then we expect the court to place greater weight on the views of unsecured creditors, including landlords, in deciding whether to sanction a restructuring plan.
Neither a CVA nor a restructuring plan automatically impose a moratorium on creditors. The Corporate Insolvency and Governance Act 2020 did introduce a free-standing statutory moratorium that could be used in conjunction with a CVA or restructuring plan. The new moratorium provides a payment holiday for pre-moratorium debts (including rent arrears) for an initial period of 20 business days. The moratorium period can be extended by the debtor company for a further 20 business days. The moratorium could potentially be extended for up to one year with creditors’ approval or even longer with the court’s approval.
So far, the statutory moratorium has been little used, largely because there is a requirement that the debtor must keep current with certain expenses that fall due during the moratorium period, including rent. Tenants have also generally sought to instead rely on the temporary tenant protections from forfeiture, winding-up petitions and CRAR. However, as the temporary tenant protections are removed and tenants are able to trade (and so pay ongoing rent) we may see increased use of the statutory moratorium to allow tenants time to restructure their accumulated rent arrears.
The eligibility requirements for a moratorium have been temporarily relaxed until 30 September 2021. These relaxations allow a moratorium to be used by companies that have already been through an insolvency procedure in the last 12 months and allow a company subject to a winding-up petition to access a moratorium without a court hearing. There may be an increase in use of the moratorium as the withdrawal of these temporary relaxations approaches.
In addition, as a restructuring plan is a court process the court has an inherent power to stay other proceedings that may interfere with the process of approving a restructuring plan. This is at the court’s discretion, but there is a recent example of the court staying a debt claim of a landlord of Virgin Active for seven weeks so that the sanctions hearing for Virgin Active’s restructuring plan can be held first.
New regulations concerning pre-packaged administration sales took effect from 30 April 2021. The regulations apply to a disposal of all or a substantial part of the assets of a company in administration to a connected party within the first eight weeks of the administration. An administrator cannot make such a disposal unless: (i) the connected person buying the assets has obtained a qualifying report by an independent evaluator; or (ii) the approval of the creditors has been obtained.
We expect that the majority of pre-pack administration sales will involve an independent evaluator rather than seek the approval of the creditors due to the speed with which a pre-packaged administration sale typically needs to conclude. We also expect the use of pre-packaged administration sales to continue to be used as a restructuring tool by distressed tenants, notwithstanding the additional complications of having to comply with the new regulations.
As the consent of the landlord will typically be needed for the transfer of a lease to the purchaser the landlord may, depending on the importance of the premises to the purchaser, have leverage in negotiations. A landlord in this position may be able to demand that the purchaser pay off any rent arrears as the price for its consent to avoid taking a haircut as a result of the pre-pack.
- The Government consultation into exiting from the moratorium on forfeiture for non-payment of rent (commercial tenancies) has closed and a report is anticipated. The proposed options 1-6 have been received to varying effect within industry with bodies such as the BPF resisting any suggestion other than a comprehensive lifting of the temporary restrictions. There are also legal and commercial issues which arise in respect of each of the proposed options which require further consideration by Government.
- Temporary residential protections currently remain in place and have been supplemented by "breathing space" provisions to protect some tenants from enforcement action.
- Restructuring plans are expected to compromise leases to include a number of hallmarks which have become commonplace in CVAs in the retail and leisure sector.
- Restructuring plans do contain certain protections for creditors such as landlords that are not found in CVAs. However, despite increased costs, restructuring plans can also be appealing to tenants in preference to a CVA since they may be able to impose a more aggressive compromise on landlords and secured debts can be restructured alongside.
- The Corporate Insolvency and Governance Act 2020 has introduced a standalone statutory moratorium which can be used in parallel with a CVA or restructuring plan however there has, to date, been limited take-up of the new moratorium.
- New regulations are not expected to impact the use of pre-pack administration by tenants.
1 This was historically the case with schemes of arrangement. There may be a greater risk that while restructuring plans are still a relative novelty the sanctioning of a restructuring plans is appealed due to points of law resulting from the differences between restructuring plans and schemes of arrangement.