Sweet Dreams for trade creditors but nightmares for Landlords

The news (Private equity firm pays Dreams' creditors) that Sun European has paid 75p in the £1 to trade creditors of Dreams, which it acquired from the hands of administrators in March is great news for those creditors.  But unfortunately the story for landlords is not so good - no such pay out for them. 

The commercial logic is obvious - in order to continue trading Dreams needs its suppliers to continue to supply.  Whilst there was no legal basis for those debts owed by old Dreams to be paid by new Dreams the ability of those suppliers simply to stop supplying puts them in a strong negotiating position and in this case they have achieved a result which is not bad.  Landlords, on the other hand, don't generally have the ability to stop supplying in a way that can impact the whole of the business.  At best a landlord may have a few sites and thus be able to negotiate a position on lesser performing sites by leveraging the better sites.  But in most cases the negotiating position is pretty much a one way street. 

It is this unlevel playing field that means landlrods consistently feel they are getting a raw deal on administrations.  Unfortunately it is the very nature of Real Estate that creates this unlevel playing field.  I wish I had an easy solution which could level it out but I have to admit I struggle to see a path at this point.  So for now I predict whilst trade creditors may get some sweet dreams most landlords will continue to suffer nightmares!

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.

Blacks and La Senza: Aggression vs Seduction?

Yesterday saw the first of what will most likely be a wave of pre-pack administrations of high street names when both Blacks Leisure and La Senza went into administration and immediately thereafter their businesses (or at least the profitable parts of it) were sold to willing buyers.  Pre-pack administrations have come in for a lot of criticism on the basis that they often, if not always, return no value to unsecured creditors or shareholders.  However, they have their merits and, in a lot of cases, genuinely achieve the best result possible overall for stakeholders.  Therefore, much to the dismay of some readers, I am not about to launch into vitriolic criticism of the use of pre-packs to save jobs and businesses with unsecureds being left high and dry.
There is, however, one common thread of both the La Senza and Blacks pre-packs which are worth highlighting and, as a landlord, preparing for: lease renegotiations.  In the case of Blacks, the official press release from JD Sports Fashions stated:

"Following the elimination of any underperforming stores and other cost reduction initiatives we believe the business can be run successfully as independent fascias within the Group."

With La Senza, less than half the retail sites leased by the group were bought out of administration with the majority of sites closing down so, it is likely, only the performing stores were part of the original deal.  However bearing in mind the official press release which stated:

"Today’s announcement represents a first step in a long-term commitment to developing the La Senza UK business, which we believe has great potential."

it seems likely that 'new' sites are on the cards.
My prediction is that in both cases landlords will be approached by the new owners to renegotiate lease terms.  What we have is a difference in approach from the new owners; one is seeking to pressure landlords whilst the other is seeking to seduce them.
In the case of Blacks the new owners have probably taken a licence to occupy all the sites and will now meet with the landlords of "underperforming sites" to seek to renegotiate the leases.  This will be the stick or 'Aggression' based approach; if the landlord does not agree the terms the site will be closed and the landlord left with the void costs, which would include empty rates liability, service charge irrecoverability and an unoccupied site which quickly becomes unattractive.
In the case of La Senza whilst landlords of transferring sites might be approached, bearing in mind the number of up front closures, I anticipate that the new owners will approach landlords of some of the closed sites and propose new terms under which they would be willing to re-open.  This is more of a 'carrot' or 'Seduction' based approach offering to relieve landlords of the void exposure.
As a landlord it is important that you are aware of what your negotiating position is in respect of any approaches.  It is worth keeping the following in mind (and get detailed legal advice in respect of them where relevant):

• an administrator has no right to disclaim or unilaterally surrender a lease or otherwise bring a lease to an end earlier than a solvent tenant (only a liquidator has that power).  Therefore rates liability in particular should not fall on a landlord simply because of the tenant going into administration although ultimately liquidation is likely).
• if the property is still being used (and this is particularly important in the case of Blacks) then the lease liabilities arising are likely to be an expense of the administration.
• due to the decision in Goldacre expect there to be significant pressure to get deals done before rent payment dates as administrators in particular will wish to ensure that they can avoid any risk of the next period's rent being payable as an expense in whole.  My view is that a challenge to Goldacre or an attempt to extend it is very likely this year.
• pre-conditions or requirements set out in the lease as things which the landlord can rely on in terms of refusing consent to an assignment apply to an assignment by a company in administration just as much as they do in non-insolvency positions.  Obviously a balance is to be achieved but if you really do not want to consent to an assignment or the proposed terms don't think you will have no choice in the matter.
• the courts will not be quick to grant consent to forfeiture.  In our experience to date courts have given administrators quite a long time to try and assign a lease so even where the proposed assignee cannot meet lease pre-conditions do not assume the courts will be on your side.

La Senza and Blacks might be the first major retailers of 2012 to go to the wall but, if the reports are to be believed, they certainly will not be the last.  Whether buyers of such portfolios use might or seduction methods to seek new lease terms we can only speculate but what La Senza and Blacks show is both approaches are being considered and pursued.  Either way, make sure you use protection!

Changes to Competition Law: An end to "good estate management"?

Many thanks to Adrian Magnus, a partner in BLP's EU and Competition Law practice for his input in this blog.

From 6 April 2011, the Chapter I Prohibition under the Competition Act 1998 will apply to land agreements.  This might come as a surprise to a lot of people.  What on earth does competition law have to do with the ownership of land and why have land agreements hitherto been exempt?


Another legal tightrope for Landlords?
Photo by Donald Judge



I do not want to carry out a detailed analysis of the history of competition law and land agreements.  In summary competition law should apply to any agreement the effect (whether intended or not) of which is to be anti-competitive.  This can, for example, be by creating barriers to entry by preventing competition or by two competitors carving up markets between themselves.  Up until 6 April 2011 land agreements were exempt from the legislation.  However, the Government, in its wisdom no longer sees any justification for such differentiation and so now all land agreements will be caught.

Be warned, this change is not forward looking only and does not have any grandfathering provisions.  Even an agreement entered into 100 years ago could be in breach.

One area of particular interest for the real estate industry is the management of large retail estates especially shopping centres and retail parks.  It is not uncommon in these estates to have leases which contain different restrictions including:

• very specific user covenants limiting the use to, say, a shoe shop or a coffee shop

• allowing the landlord a right to refuse changes of use in the interests of "good estate management"
• exclusivity arrangements whereby the landlord agrees not to let other units for a specific use or to specific identified entities

Are these restrictions in breach of the law? 
Can tenants seek changes of use and threaten the landlord with reporting them to the OFT if they rely on "good estate management" as a reason for refusing the change?

Thankfully, the revised guidelines published by the OFT is an improvement on and much clearer than the first draft.  It recognises the fact that there are many legitimate reasons why a land owner might seek to impose or agree restrictions on the use of land and that only a minority of such restrictions will infringe competition law.

The OFT Guideline specifically recognises the need for user restrictions in leases in order to ensure a good mix of tenants and notes that such provisions are unlikely to be in breach of competition law.  Therefore limiting use to or prohibiting use as, for example, a shoe shop or allowing the landlord to refuse consent to a change of use in the interests of "good estate management" should not cause concern.  There are exceptions to this especially where the owner of the land is also a retailer.  For example, if Boots owned a shopping centre and in all leases for that shopping centre had an absolute restriction preventing the sale of pharmaceuticals, perfumes or personal grooming items this is much more likely to be considered an infringement.

Furthermore, exclusivity arrangements which place restrictions on the landlord's ability to let other parts of the same centre or park to a competitor carry with them bigger risks.  These can take a number of forms.  Let's take the Boots example again (nothing personal I promise).  If in a lease to Boots the landlord covenanted that it would not grant any leases within the same centre to other chemists and/or would include in all other leases of the centre a restriction on the sale of pharmaceuticals, perfumes or personal grooming items then there is a real possibility of an infringement of competition law.  The reasoning is that if no one else can sell these items in the centre this will result in reduced choose, potential for higher prices and worse service; there is no competition to encourage best practice.

Whether or not such provisions do in fact infringe competition law is not a black and white call.  This will depend on a number of things including:

• the geographical area (market) affected - for example a shopping centre such as Bluewater or the Trafford Centre may well be considered differently to the shopping arcade at Bond Street Station
• the market power of the parties concerned - for example Boots as opposed to a 5 shop franchise

There are also exemptions which may be able to be relied upon which are relevant for the shopping centre/retail park scenario.  These are applied on a case-by-case basis if the criteria is met rather than being blanket exemptions for certain types of agreement.  For example, exclusivity being granted to an anchor tenant could be justified since without the anchor tenant the proposed centre/park would not be economically viable.  Of course, this does not give a blanket exemption and the specific provisions relating to the exclusivity being granted need to be carefully considered in context to ensure that they do not go further than necessary to achieve the desired results.

In summary, the removal of the exemption from land agreements of the effects of competition law have wide ranging implications for land owners.  Shopping centre and retail park owners should carefully review and consider their agreements and developers need to consider how to operate within the rules when setting up new developments.  The good news is that "good estate management" can continue but the ability to restrict uses for the benefit of certain occupiers or the landlord is severely restricted and has become another legal tightrope for landlords to walk if they are to avoid expensive and image-damaging litigation and negative publicity.

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.