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.

Carbon Reduction Commitment: Another victim of the austerity budget

The Spending Review 2010 found some innovative ways to increase the Government's revenue by using the CRC Efficiency Scheme.
One of the tools to be used was a statutory scheme whereby all participants would initially buy their annual Allowance through a bidding process. Initially the number of Allowances was to be unlimited but then it was to be capped thus encouraging participants to reduce the Allowance they require and save them money.
The second part, and what might be called the carrot, of the scheme was that the revenue generated by the auction of Allowances would be recycled to the participants so that, as you might expect, the best performers would receive the reward in the form of cash back.
In the Spending Review 2010 two major decisions were revealed:

1. The first sale of Allowances will be in 2012 rather than 2011.
2. Revenue from the sale of Allowances will be used to support public finances rather than recycled back to Participants.

The second decision is a significant change as it means that the league tables to be produced will now only have a reputational impact as opposed to a financial and reputational impact. Whilst many owners and occupiers will be concerned regarding their reputation and green credentials the cost-benefit of reducing emissions becomes much harder to justify on a reputation only basis unless one is significantly behind ones peers.

A knock on effect for Landlords is that whereas before there was some possibility of recouping some of the costs of compliance by moving up the league tables and receiving the reward of "revenue" from the sale of Allowances; now compliance is a fixed cost with no direct financial return. Depending on the terms of service charge provisions in leases it may not be possible to recover the cost of compliance from tenants. This will create an irrecoverable cost which must be deducted from the "bottom line" meaning values will suffer.

All landlords should instruct their lawyers to review the terms of their service charge drafting to ascertain whether or not the cost is recoverable. If it was before the change announced in the SR2010 then nothing will have changed. If it was not it may be now.

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.

Insolvent Companies' Directors and TUPE - a small loophole with a big cost.

Here is a bizarre scenario for you. A company exists and it is run, as all companies are, by directors. They are the mind and decision makers of the business with ultimate responsibility for the success or failure of that business.

The business fails and falls into an insolvency process. On a sale of that business the directors will automatically transfer over to the owners of the new business with the same terms and conditions unless the new owner can agree a compromise with the directors.

This is all thanks to a wonderful piece of European legislation lovingly referred to as TUPE. This legislation has a very honourable purpose - it ensures that employees of a business are protected against losing their jobs or having their terms of employment unfavourably altered just because a business changes ownership. It is widely drafted to prevent clever lawyers finding loopholes for their clients and, rightly, applies even to the sale of parts of an insolvent business to a new owner.

However, what does not appear to have been considered is that this legislation results in every employee passing across. Directors are employees (often the highest paid ones). Where a sale is one sought out by the company and it is agree that the directors will leave this is not an issue (although it does potentially create a conflict of interest for the directors concerned).

But where a company is insolvent the directors are ultimately responsible for that failure. By TUPE applying to directors even in such circumstances it has inadvertently placed directors at the front of the queue to extract payouts from any potential suitor where the money involved could have been invested in the new business providing a better chance for the future success of the phoenix entity.

So, as with the bankers and their bonuses, those with most of the responsibility for the failure of a business are given the opportunity to be compensated for their failings whilst the less responsible employee faces an uncertain financial future. An easy loophole to close if someone would just pull the right strings.

Reform the planning system . . . again!

Those of you who follow me on Twitter will already know that The British Chambers of Commerce have just released "Planning for Recovery" which is their views on the problems with and solutions for the planning system in the UK if we are to get out of the current doldrums.
The report is very well set out highlighting in separate chapters:

1. The relationship between the planning system and its effect on businesses
2. The current planning system and its shortcomings
3. Reforms to the planning system already on track
4. Recommendations for further reforms to help speed recovery

There is little doubt that the need for planning regulation will automatically result in delays and frustration. The report highlights a number of cases where the delays have been hideous, for example, Heathrow Terminal 5 where a formal planning application was lodged in 1993 but consent was only finally given in 2001.

Broadly the idea of reforming the planning system to enable applications to progress more quickly especially on large infrastructure projects where the needs of the many can often outweigh the needs of the few is one with which I agree. Further, on a street level removing the obstacles to sensible extensions and loft conversions to enable families to grow within houses rather than having to move would hopefully help keep house prices better regulated. However, I do wonder the deliverability of any such reform. It seems to me that loosening the reins in order to speed things up will only lead to minority views being totally ignored. Also, contrast the current calls for greater regulation in the financial industry as a result of the credit crunch with the calls for the loosening of regulation (not necessarily in planning) in the construction industry to help it get back on its feet - is the construction industry not partially to blame for the current situation?

On a slightly separate point, I do not feel that the current predicament of much of the construction industry is, of itself, any justification for reforming the planning system to enable them to get back on their feet. Factors in developers getting into so much trouble were taking on too much debt, being overly optimistic in their predictions and forecasts, overvaluing their assets and generally not doing a good enough due diligence and financial plan job. Should we really reward such poor judgement?

So, whilst I support reform to reduce delays it should not be at the cost of the minority voice nor merely to save those who showed poor judgement but rather to benefit those who acted with due care and attention. Now if someone can come up with such reform I will be impressed. Any ideas let me know . . .