BPF's "Taking the Profit" - extracting maximum value

The British Property Federation (BPF) is an organisation which represents Landlords.  Therefore it is an organisation which is important to me because it is important to my clients.  It recently launched its "Taking the Profit" campaign.  The target of that campaign is the use of administration particularly in the retail sector as a route to turning a distressed business into a more profitable one with the result that landlords either face shop closures or reduced rental income.  I made one prediction in my blog on New Year's Day and this fight was it.  Thank you to the BPF.
As frequent readers of my blog will know, I have much to say on the insolvency regimes and have blogged many times on the issues facing landlords arising out of administrations and other insolvency regimes as well as the impact of recent case law.  It is good to see the BPF seeking to tackle the issues head on and I cannot argue with the first points the BPF makes that the government has failed to act on tightening up pre-packs and making it easier to complain against Insolvency Practitioners.
However, whilst the BPF is to be praised for raising potential abuse of the insolvency regimes for the benefit of shareholders at the cost of creditors (and particularly landlord creditors) I think that in highlighting certain areas which are, perhaps, most headline grabbing some important areas for review have not received similar attention.  Some of the publicity around this campaign suggests that landlords are the unwitting, weak and undefended party in a war which is being waged against them by a united force of IPs and private investors.  Quite simply, in my experience, this is not the case.  Now it may be that my experience (which I admit is largely at the 'better' end of the retail property market (by better I mean primary and secondary) and involves dealing with the likes of KPMG, PWC, E&Y, BDO, Grant Thornton and others) largely misses out the activities at the tertiary end of the market and perhaps practices at that end are a little more shady.  However, my suspicion is that some landlord practices at that end of the market are not quite 'code compliant'.  Further by failing to identify the real reasons why the current regime unfairly prejudices landlords over and above other creditors risks losing the war.
The bad arguments
1.  It is largely pre-pack administrations where landlords are leant on to agree concessions
This is not the case. A pre-pack is when a deal is agreed and documented (but not signed) before the appointment of administrators.  Some of the administrations where landlords have been pressured to give rent concessions have been pre-packs.  However, most high profile administrations have not been pre-packs yet rent concessions have been sought by the new buyer.  Therefore, the BPF is, in fact and rightly, targeting administrations and not just pre-packs with this campaign.
2.  Administrations are effectively being used to transfer funds from pensioners who have invested in property funds and property companies to private investors buying businesses from administrators and then seeking rent concessions or threatening to close down
Using pensioners in any argument seems to be 'de rigueur' at present.  I think care needs to be exercised in utilising this argument.  Apart from anything else when it comes to unprofitable sites there are arguments that the landlord community carries some of the blame:

• in good times landlords happily agree high rents fully in the knowledge that if trading conditions deteriorate that rent may break the business
• the UK leasing model with relatively long lease lengths, upwards only reviews and full repairing and insuring provisions, whilst providing secure income in the sense of no costs, means that rising service charges add to the burden on tenants increasing the risk of insolvency
• the use of quarterly rents creates cash flow issues for tenants and also creates greater risk for landlords in the light of recent case law
• whilst some landlords have been sympathetic to struggling tenants many others have taken an aggressive route refusing to consider any concessions accusing the tenants of trying to make them pay for a bad business

3.  Landlords are being forced to agree rent reductions
No one is being forced to do anything.  Landlords may not like the threatening manner in which some agents and/or buyers act; saying that unless the rent is reduced a unit will be closed down.  But, at the end of the day, the landlord can call their bluff and refuse to agree the concession.  Landlords are not above being threatening either.  I had one case where a landlord (not institutional) unlawfully re-entered a property through the use of, what can only be described as, thugs because he did not like the possibility of a CVA.  That is far more serious than aggressive posturing in a negotiation.
Landlords are big boys and just as able to use an aggressive negotiating stance.  As advised in a recent blog landlords have quite a good negotiating position albeit limited by the commercial realities affecting each individual property.  In reality landlords are often paying for the fact that they own a property which is not in a prime location and which can no longer command rents at the level originally agreed.  If they could get a better rent then they should refuse the rent concession and get possession.  That is called risk and, without wishing to teach grandmothers how to suck eggs, that risk should have been reflected in the yield when the property was acquired.

The other side of the coin

The BPF is absolutely right to put the issue of administrations on the public agenda.  I think it is important to recognise that there are issues with the system which impact (possibly unfairly) on landlords which should be at the forefront of the campaign:

• the current legal position on payment of rents (especially in the light of the decision in the recent case of the Leisure (Norwich) II Ltd & Others -v- Luminar Lava Ignite Ltd (in administration) & others [2012] EWHC 951 (Ch) gives freedom to tenants not to pay rent and for administrators to trade rent free until the next quarter day.  The Game administration is the biggest example of this.  This flies in the face of the "pay for what you use" approach to insolvency situations and is unique to leases due to a clash between real estate law and insolvency law.
• the moratorium preventing forfeiture without consent - with all other contracts the provider can effectively terminate the contract on insolvency and there is nothing to stop them from doing it.  However termination of the lease can only occur by use of forfeiture which is a form of proceedings.  Due to the moratorium such action requires court approval (or administrator consent).  This exposes the landlord to greater potential future loss than other creditors who, whilst they might lose out on arrears, are not exposed to further losses unless they choose to contract with the administrators or the new business

In my view these are the mischiefs which the BPF should be seeking to undo.  Whilst anti-private equity and pro-pensioner arguments attract good press the reality is that they do not properly encapsulate the issues with a system which, whilst not completely broken, is not working in perfect harmony either.

Retail 2012 – a showdown between administrators and landlords?

A very experienced insolvency practitioner who has acted as administrator on some of the most high profile insolvencies of well known British retailers recently mentioned to a colleague that:

“The main problem facing retailers today is that rents are too high.  Landlords will need to accept that if they want their businesses to survive they will need to reduce significantly the rents payable.”

There is undoubtedly truth in what this IP says; if landlords reduced rents then margins would increase and/or retailers could reduce prices to make their goods more attractive to you and me.  There we go then; in one foul swoop we can fix the problems of the high street, make British retailers more profitable thus increasing tax revenues for Her Majesty and, as Gordon Brown once said “save the world” .
There is just one small problem with this hypothesis; in reality it is nothing more than window dressing.  Put another way, what is being suggested is in effect seeking to simply alter a different variable in a rather complicated equation where ultimately the same final answer always applies:

TRS = RP + BI + LP + BI;

where

TRS = Total Retail Spending;
RP = Retailer's Profit;
BI = Bank Interest; and
LP = Landlord’s Profit.

This is obviously an oversimplification of where the money spent on the high street actually goes but it is sufficient to highlight that by reducing rent what in effect happens is that LP decreases so that RP increases.
This equation also highlights another important factor; that of Bank Interest.  This affects both retailers and landlords alike and once again highlights that in reality the real issue which is damaging the High Street is debt.
In fact the one common factor affecting all three contributors to the equation (retailers, landlords and, just as importantly, the consumer) is debt.  Therefore the IP quoted above could have been more accurate if he had stated that the main problem facing retailers today is that there is too much debt in the economy.  So why not say this?
A number of answers spring to mind (in increasing accuracy):

1. IPs are generally appointed at the behest of the banks.  It would hardly be sensible for IPs to bite the hand that feeds them.
2. Banks have already taken significant hits so is it realistic to expect them to take further hits?
3. Landlords rely on tenants.  If tenants cannot pay the rent then landlords will ultimately lose out.  High rents can only be justified if there is a willing tenant.

I believe that the IP quoted was expressing the view that the average level of rents on the high street is so high that it is not reflective of the economic realities in which we live and were we to test the market then the average rent would fall significantly.
He is right but averages are misleading.  In reality there are a lot (easily the majority if not the vast majority) of retail sites where the rent is too high and should be cut.  However, there are a lot of sites where the rents could go higher as the landlord could easily re-let the property to another retailer if it became available.  Bond Street is an example but so are certain locations on Oxford Street or in major shopping centres such as Westfield London or Bluewater in Kent.
A recent review of the high street predicted a significant increase in the number of retail insolvencies in 2012.  The prediction is that those retailers with 50-500 stores will be worst hit.  What this is likely to mean is that CVAs which had been utilised a lot in 2007 and 2008 to save a number of retailers (or at least delay their demise by a year or two) is less likely to be successful.  If the IP is right in order to survive these retailers will need to do more than simply close sites; they will need to reduce the rents on a significant number of sites that are to remain open.  This is yet to be achieved through a CVA and the most well-known attempt at such a large scale CVA routed rent reduction (Stylo in 2008) was a total failure.
Therefore we are more likely to see a significant increase in administrations (as we have already in the last few weeks).  The courts to date have provided a significant amount of leeway to administrators by protecting them against claims for forfeiture by landlords even where landlords have been able to show they have alternative tenants to the administrators’ preferred assignee.  However landlords have seen some successes; most notably in the case of Goldacre (Offices) Limited v Nortel Networks (UK) Limited.  Yet even this decision is now being turned by administrators to their advantage with a refusal to pay any rent for the quarter during which they are appointed on the basis that they are appointed after the quarter day.
My prediction for 2012 is that we will see this issue and many other similar issues relating to the rights and obligations of administrators to make use of premises litigated through the courts.  So 2012 may prove bad for the high street but it is likely to provide ripe pickings for the IPs, real estate insolvency lawyers (like me I must admit) and real estate litigators.  Every cloud must have a silver lining; at least for some of us.

JJB proposed CVA: Will it succeed?

A colleague has just sent to me a copy of the announcement by JJB regarding its proposed CVAs.  Only a month ago I wrote a blog regarding the possibility of HMV proposing a CVA which contained some advice for Landlords.  Thus far it has not happened and, I have been told that my expectations may have been too high since HMV remains profitable despite its troublesome retail sites.
However, from the sidelines JJB is now proposing a CVA the mainstay of which appears to be an attempt to get rid of underperforming sites.  The announcement states the following:

"The key objectives of the CVA proposal will be to:

• enable the closure over the next 12 months of up to 45 stores which are underperforming (the "Category 1 Stores");
• enable a review to be carried out in relation to the remaining stores, with an option to close over the next 24 months up to a further 50 stores which are also underperforming (the"Category 2 Stores");
• enable the Company to continue to pay rates on closed stores in the period up to the first break date under each lease;
• vary the terms of the leases of the Category 1 Stores and Category 2 Stores such that rent will be payable on a monthly, rather than a quarterly, basis;
• reduce the amount of rent payable in respect of stores which will be closed in due course for a period of up to 12 months for the Category 1 Stores and a period of up to 24 months for the Category 2 Stores (if the stores are closed after the end of the relevant period, no further rent will be payable);
• enable landlords of the stores for closure to require the Company to vacate and determine or assign the lease of the relevant property upon at least 30 days notice; and
• vary the terms of the continuing leases such that rent will be payable on a monthly, rather than a quarterly, basis for a period of 24 months."

In November 2009, following the first successful CVA by JJB I blogged on "Tenant CVAs - what makes them successful?".  In this blog I identified a number of common themes which ran through the successful CVAs.  Let's look at those in the context of the JJB announcement:

1. No additional store closures over and above those that had already closed (i.e. landlords knew if their site was closed) - the new JJB proposal leaves 95 stores at threat of closure.  The landlords of those stores may or may not be identified at the outset creating significant uncertainty.  New JJB Proposal fails the test
2. No rent reductions on stores remaining open although movement to monthly rent payments - the new proposal is that rents will be reduced on Category 1 and Category 2 Stores and that on these stores rent will be payable monthly.  On the remaining 150 stores the rent will remain the same.  Double whammy for landlords of Cat 1 and Cat 2 stores.  New JJB Proposal largely fails the test
3. On closed stores the tenant would continue to pay the rates (landlords were protected from this oppressive liability) - this appears to be the proposal on the JJB CVA.  Test passed
4. A pot of money (normally equal to 6 months' rent) was distributed between the landlords of closed stores as compensation - there is nothing in the announcement suggesting such a pot and the implication is there will be none.  Test failed

Therefore, based on my previous views as to what makes a Tenant CVA proposal acceptable to Landlords it is doubtful that the JJB proposal passes the test.

So what should you do if you are a Landlord who has a property let to JJB?  Well, all I can do is re-iterate what I said in my blog on the possibility of an HMV CVA:

• first and foremost do not go it alone - unless you are a significant creditor your ability to block or seek changes in the proposals will be fruitless unless others share your views. Therefore find out who the other landlords are and talk to them
• take legal advice - CVAs amount to binding contracts on both the company and the creditors. Some proposals can mean that the CVA is liable to challenge for "unfair prejudice" but the law is complex
• take valuation advice - especially if your property is one which JJB seeks to dispose of as you need to understand what this would mean in terms of reletting
• act quickly - waiting until the week before the meeting to read the proposals and ask a lawyer to advise you on what it means for you is a case of too little too late. My advice to all of JJB's landlords is to take action now so that you are well prepared in the event a CVA is proposed
• beware breach of your loan covenants - if you have borrowed against the property then any action you take is likely to require the endorsement of your bank.  Also, agreeing reductions in rent could put you in breach of interest cover tests so you will need to check your loan documentation too

Of course the formal CVA proposal has not yet been published so the final form may differ from the outline proposals.  If you are a Landlord who is affected then please feel free to contact me.

HMV appoint KPMG - CVA on the way?

In my post earlier this month on VAT increases and snow - the Perfect Storm I noted how HMV had plans to close 60 stores.  What I did not mention at the time were my suspicions as to how they might seek to achieve this - through the use of a company voluntary arrangement (CVA).  The unconfirmed news today that HMV have appointed KPMG as debt advisors increases the likelihood of this significantly; in my mind KPMG are the Kings of CVA.  From a restructuring point of view I hope that is viewed as a compliment (as if not I expect to be getting some irate calls from people I know there!).
KPMG were behind the successful CVAs for well know names including JJB Sports, Blacks Leisure and the Suits You shops.  Prior to these successes the general view was that CVAs were inappropriate for retail businesses but these successful CVAs changed all that.  See my blog on what makes a retail CVA acceptable back in 2009.

So why am I so convinced that HMV will attempt a CVA?  Well the facts are all lined up perfectly:

• a business model suffering from a serious squeeze on all sides
• an internet business which is probably being dragged down by the retail units
• a significant number of unprofitable retail sites which HMV needs to close

Why will a CVA work well?

• it will allow HMV to cut a deal with all the landlords on the sites it is closing without needing to agree individual deals
• a handful of difficult landlords (especially likely where some of the landlords are in effect individuals) can be forced to accept the terms of the CVA
• trade creditors and suppliers can be left effectively untouched ensuring they will support the proposals and the business which is crucial

What should I do if I am a landlord affected by a CVA proposal?

• first and foremost do not go it alone - unless you are a significant creditor your ability to block or seek changes in the proposals will be fruitless unless others share your views.  Therefore find out who the other landlords are and talk to them
• take legal advice - CVAs amount to binding contracts on both the company and the creditors.  Some proposals can mean that the CVA is liable to challenge for "unfair prejudice" but the law is complex
• take valuation advice - especially if your property is one which HMV seeks to dispose of as you need to understand what this would mean in terms of reletting
• act quickly - waiting until the week before the meeting to read the proposals and ask a lawyer to advise you on what it means for you is a case of too little too late.  My advice to all of HMV's landlords is to take action now so that you are well prepared in the event a CVA is proposed

Whether or not a CVA is proposed it will be fascinating to see how HMV deals with its current woes - will it rock or will it bomb? 

VAT Increases and Snow: The Perfect Storm

It appears that two elements in play in the last couple of months might help create an atmosphere which will result in an increase in the number of retail failures over the next year.  One of these is man made and the other a natural phenomenen.
What George Osbourne could not have contemplated at the time of the budget when he decided to increase VAT from 17.5% to 20% was that the UK was going to be hit with the worst winter for decades with much of the country practically shut down during what should have been the busiest shopping period.  Whilst the post-Christmas sales might have recouped some of the losses there is no doubting that retailers will have been hit extremely hard and the VAT increase coming immediately after this hit is likely to cause further difficulties - at Christmas people often over extend themselves but with Christmas now over people will be less likely to buy even if they did not over extend themselves.
For retailers this is very much a double blow.  It would be wrong to say that the VAT rise will stop people spending but it will limit how much they can buy and/or affect how much of the money spent goes to the retailers' bottom lines.
So, what does this mean?
Unfortunately this must increase the risk of retailers considering or being forced into restructurings.  There is already news of HMV closing 60 stores; Clinton Cards and Mothercare have issued negative profit statements with more retailers still to report.
Historically business failures tend to peak after a recession rather than during it as businesses that have used up their reserves just to survive do not return to health quickly enough to replenish those reserves in time.  The snow and VAT rise may have created the perfect storm to ensure that history repeats itself in 2011.

JJB warns of financial breach - a threat to the CVA model?

JJB warns of financial breach Online Property Week
This was the headline which is sending shivers down the backs of Landlords across the country whether or not JJB is actually a tenant of theirs for a number of reasons.

1. JJB, whilst not a bell weather for the retail sector per se, is a large enough retailer that if it is failing to perform it is indicative of issues in the market generally.
2. JJB, utilised a Creditors Voluntary Arrangement (CVA) to much fanfare in 2009 - one in a line of large retailers to do so.  At the time I considered the reasons why one CVA is successful whereas another is not.  Now that the outcome of that CVA is not looking positive Landlords may be concerned regarding the other CVAs which they approved.

As a real estate restructuring lawyer the potential failure of JJB to turn itself around despite the CVA creates an interesting dimension.  The whole argument of a CVA is that the creditors overall will get a better deal than if the company entered administration or liquidation.  Creditors are asked to forgo a proportion of their debt and/or agree revised payment terms in order for the company to continue trading.

For landlords the deal has always been a difficult one.  In a retail CVA there are always some properties the company wishes to exit and the landlord is forced to decide between accepting a liquidated damages offer or taking its chances in an insolvency.  It seemed that JJB (and others like Focus DIY and Blacks Leisure) had managed to work out the correct level of compensation to pay landlords to get them to agree the CVA.

However, if companies that have been through CVAs begin to fail again a couple of years later landlords are going to be left asking themselves whether the problems facing the company where not really the leases but rather the management or the business itself.  Bearing in mind the cost to landlords of considering the CVA terms one wonders whether some will come to the conclusion that it is just not worth it and refuse to back CVAs in the future.

Only time will tell but for now anyway, all JJB's landlords are not sleeping quite so soundly at present.

Tenant CVAs - what makes them acceptable?

This year has seen a new phenomenon being cemented on to the toolkit of the struggling retailer which, in my opinion, was not anticipated prior to 2009 - the large retailer Creditors Voluntary Arrangement (CVA).

For those not necessarily in the know a CVA is effectively a binding agreement reached between a company and its creditors where the creditors will agree a delayed repayment and/or write-off of debts. The agreement is limited in time (a maximum of 2 years) and is monitored by an independent party. For creditors generally (and most importantly unsecured creditors) the process is preferable over administration or liquidation since in those processes the likelihood is that the unsecured creditors will get little or no p/£ of debt. The attractiveness for secured creditors is that it is cheaper than administration and thus should protect the value of the secured assets within the business whilst they retain their security over them.

The year started off very badly for the CVA when, in February, a CVA proposed by the administrators of the Stylo Group (then owner of the Barratts and Priceless shoe chains) was voted down by its creditors and most vehemently by its landlords. At that point one would have been forgiven for thinking that the view following the Powerhouse decision that CVAs were not appropriate where significant leasehold property interests were involved.

However, since the Stylo CVA proposal was defeated quite the opposite has occurred with successful CVAs being agreed on a number of large retailers including JJB Sports and Focus DIY. The latest instalment is a vote today by the creditors of Blacks Leisure on its CVA proposal. It is anticipated that it will be successful (see FT.com article).

The question is what is different about the post-Stylo CVA proposals that have made them successful where Stylo failed? Is it that the market has changed? Is it that Stylo simply broke a taboo and after venting their anger at Stylo landlords have since been more agreeable?

The answer is most likely a mixture but when you look at the detail of the proposals there is a fundamental difference between the unsuccessful Stylo proposal and the other successful proposals. That difference is money and control.

In Stylo every single landlord would have lost out as the proposal involved changing all rents to a turnover rent initially at 3% increasing to 7% (very low levels compared to normal turnover rents) and without a floor. Landlords were invited to seek to obtain better deals in the market and if successful Stylo could either match the deal or surrender their lease. The good news on the Stylo deal was that there was no landlord immediately facing a closed store with irrecoverable cost. The bad news was that the income landlords would obtain was totally dependent on the performance of the tenant. For stores with little or no likelihood of re letting in the medium to long term this was probably okay as at least void costs were avoided. But for landlords of stores that were in good areas the reduction in rent was unacceptable.

Moreover, Stylo was not guaranteeing that every store would then be safe as it sought an ability to surrender those stores it chose during the life of the CVA. There was to be no compensation to landlords for taking back their stores and no protection from void costs. It is probably this exposure that was the ultimate issue for landlords.

Compare that to the successful CVAs which have some or all of the following features:

• No additional store closures over and above those that had already closed (i.e. landlords knew if their site was closed)
• No rent reductions although movement to monthly rent payments
• On closed stores the tenant would continue to pay the rates (landlords were protected from this oppressive liability)
• A pot of money (normally equal to 6 months' rent) was distributed between the landlords of closed stores as compensation

The difference is huge. On the successful CVAs Landlords knew where they stood immediately. Closed store landlords knew that in an administration they would get nothing whereas in the CVA they would get compensation and be protected from void rates whilst the lease subsisted. Open store landlords were asked for concessions which they would probably have given without a CVA.

What the above highlights more than anything else is that timing matters. Clearly, for Stylo to have proposed a CVA along the lines of the successful proposals it would have required significantly more cash to cover the large expenses. This would have meant a CVA being proposed a lot earlier than it was. In the end the timing was wrong. To have a successful CVA you need to have sufficient funds to "buy off" the worst off creditors (i.e. landlords of closing stores). This requires the directors to be brave enough to recognise the issues and see the potential for a better result for creditors and stakeholders alike by taking early pre-emptive action when the company can afford it.

Whether the successful CVAs will actually result in successful companies in the future only time will tell but, at least for the landlords, the CVA was a less bitter pill in the short term.