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? 

Real Estate investors and the VAT increase: a non event?

The great thing about value added tax (VAT) is that, unlike other taxes, for many involved in business the tax represents a cash flow issue as opposed to a hard cost.  The ability to offset input tax against output tax and recover your VAT means that for those providing B-2-B services the impact of the VAT rise on them and their customers is significantly more limited.
On the face of it the commercial real estate market should be similarly protected.  After all, once a property has been opted to tax the owner can charge VAT to its tenants and recover its VAT that it incurs from its suppliers.
But, as always with tax, the position is not quite so simple.
First of all it is not always possible to opt to tax and, in some cases, an option to tax can be disapplied.  Where this happens the owner of the property may not be able to recover its VAT costs relating to the building and where it has claimed it may be forced to pay the monies back to HMRC.
Secondly, there are certain classes of business that cannot recover VAT.  From the city perspective the one encountered most often is financial institutions.  This is a significant issue since for these class of tenants any VAT on the rent is a hard cost and not a mere cash flow issue.  Therefore before deciding whether to opt to tax a property (if the choice exists) it is important to consider what sort of tenant you are targeting.  In a mixed use scenario this can be quite complicated and you need to balance all the drivers before making a decision.
Another reason the VAT position will affect property is because stamp duty land tax is calculated on the VAT inclusive consideration.  So where a property is being acquired and it is not a transfer of a going concern (TOGC) SDLT will be calculated on the price plus VAT.  In that scenario the effect of the 2.5% increase in VAT is an additional SDLT liability.  In the lease context the effect is larger since you are considering the NPV of all future rental payments including the VAT element.  In both cases it does not matter that the buyer/tenant can recover the VAT.
So whilst the increase in the VAT rate on the face of it might not seem that important in the real estate context when you look at it in a bit more detail you realise that getting your VAT decisions right at the outset could have a significant effect on the financial performance of your real estate assets over the long term.

McGoldacre: A Scottish lilt on rent and admin expenses

In January 2010 I posted a blog on the decision in Goldacre (Offices) Limited -v- Nortel Networks UK Limited (in administration) in which the High Court ruled that where an administrator uses a leasehold property for the benefit of the administration on a rent payment day then the whole quarter's rent is payable as an expense of the administration.
Now a court in Scotland has produced a carbon copy in slightly different circumstances. In its decision in Cheshire West and Chester Borough Council -v- Springfield Retail Limited (in administration) the in the Outer House of the Court of Session Lord Menzies held that the fact that the person in actual occupation was neither the administrator nor the company in administration but rather a licensee of the company in administration, was not relevant and that since the licensee had been let into occupation by the administrator as part of a sale of the business then the rent was due as an expense.
Frankly the decision does not come as a surprise. It would be strange if the court had held that administrators could allow a third party into occupation of a leasehold property and that in doing so they would not be liable for the rent as an expense. To do so would create a significant arbitrage opportunity whereby third party licensees could run businesses out of leasehold property of companies in administration where the landlord had no contractual right to rent from the licensee and only an unsecured claim against an insolvent company.
Therefore, in reality the case tells us nothing new and does not answer a number of fundamental questions which the decision in Goldacre raise including:

1. If the administrator goes into occupation the day after a rent payment day will none of that period's rent be payable as an expense?
2. Are dilapidations arising during the period of administration an expense of the administration?
3. If there is a sub-tenant in occupation who carries the credit risk of that sub-tenant defaulting? Does it affect the analysis if the company in administration does not continue to use the remainder of the premises?

Rent is an administration expense - but at what cost?

A recent decision in the High Court (Goldacre (Offices) Limited -v- Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch.)) has confirmed that where an administrator makes use of a leasehold property the rent reserved by that lease will be an administration expense. This is in accordance with most practitioners' prior views.

However, the case did decide some other related points which are, in some ways, surprising as follows:

1. the amount of rent which becomes an expense of the administration does not relate to the area occupied. Use of a small part of the premises demised will make the whole rent reserved an expense of the administration;


2. if the administrator is using the premises on the rent payment date then the whole period's (e.g. quarter's) rent will be payable as an administration expense even if the administrators' use ceases during the relevant period.

These two points could have interesting implications. The corollary of (1) might be that where the premises are part sub-let and the administrators continue to use the other part then it may be that the administrators are exposed to the credit risk of the sub-tenant default. The corollary of (b) might be that where the administrator is not using the premises on the rent payment date then there is no liability for the rent as an expense even if the premises are used for the remainder of the relevant period.

Neither of the above points were directly addressed in the judgment.

It should be noted that the fact that it is now confirmed that rent will be an expense of the administration if the administrators are using the premises does not mean that the administrators have to pay it on the due date and in full. This is still dependent on there being sufficient realisable assets out of which the rent can be paid. This was expressly confirmed in the judgement.

So whilst the case confirms a generally held belief it has muddied the waters for both landlords and administrators in some regards and altered the balance of power slightly but with the administrators arguably still holding the upperhand through the benefit of the moratorium.