For landlords frustrated by the lack of sway they have in determining how tenants implementing Company Voluntary Agreements allocate their funds, there is a potential solution that will see them significantly increase their voting powers.
At the moment, landlords are missing out on protecting their income and insolvency voting rights for tenants going in to administration and implementing CVAs on properties they occupy. The answer though could lie in having potential dilapidation schedules pre-determined.
CVAs have become a scarily regular fixture on the news agenda, with struggling retailer after struggling retailer turning to them as a way of restructuring their property portfolios, reducing operating costs and closing failing stores in as cost-effective way as possible. Debenhams is the latest of the large retailers to start the process, leaving lots of landlords across the UK facing the prospect of not just having rents slashed or empty units on their hands, but also potentially forfeiting vast sums in lost dilapidations claims.
Under the CVA procedure, a business has the chance to come to a binding agreement with their unsecured creditors, as a way to trying to avoid the likelihood of terminal insolvency proceedings. Within this process, the value of debt owed to each creditor is what determines the voting power that each creditor has about how funds should be allocated. Every £1 owed equates to one vote when it comes to agreeing to any deal proposed by the CVA administrator. Whereas ascertained arrears (ie. past rent owed) are allocated actual values, unascertained sums, such as a future dilapidations liability or future rents, carry a basic value of £1. Landlords often therefore have limited influence over the CVA process that will have such a huge impact on them.
The risk to landlords
When it comes to commercial leases, they tend to get put in to three categories as part of the CVA process:
- Group A – profitable stores/outlets – leases left intact, at current rents, or subject only to minor amendment;
- Group B – marginal stores/outlets – these have substantial renegotiation of the leases, including sizeable rent reductions; and
- Group C – unprofitable stores/outlets – these will be closed, and the premises returned to the landlords, albeit preferably with some agreement in terms of compensation/retention of rent by the landlords.
Once the CVA process has been started, landlords have missed the boat for starting to get their house in order and control their risk. It is therefore important for a landlord to understand its tenants’ businesses and how well the specific stores within its portfolio are performing. Like many of the big retailer collapses before them, everyone knew which direction Debenhams was heading many months before the inevitable actually happened. It was at the point that those first reports started emerging in the news that landlords should have been assessing which of the three risk groups the specific stores in their portfolio might fall in to. Then they could have started to put in place the necessary measures to help protect their interests.
Challenging the £1 dilapidations value
Whilst dilapidations is automatically allocated a value of £1 as an unascertained sum, it is possible to challenge this by demonstrating that a cost has actually already been ascertained. Common practice is for dilapidations not to rear its head until lease end, but by commissioning an interim schedule of dilapidations, a landlord is able to demonstrate a defined sum and challenge the £1 value with evidence.
Case law on this is slightly contradictory, with examples where landlords have succeeded, but also where they have failed. In the instances where the challenge has failed, it has done so due to a lack of detail. Where there has been success, it has been with detailed itemised schedules of dilapidations.
A dilapidations claim on a large department store is likely to run in to the high hundreds of thousands of pounds. Whilst an interim schedule is limited to focussing on elements that, if not addressed, could cause damage to a building, its interest to future tenants and to the asset value; the value that could be attributed to such a claim could be high enough to give a landlord significant voting rights, especially when you consider that professional fees are often recoverable as a debt.
It is also worth considering having a Section 18 Valuation carried out alongside the interim schedule of dilapidations as this will provide evidence to support the challenge by demonstrating the loss of value to the property should the work set out in the dilapidations claim not be carried out.
With a pragmatic head on, if a landlord has accepted the risk that some of the stores in its portfolio might sit in Category C, then it can also start to think ahead to the future in order to protect its post CVA income and value. Whilst having a surveyor prepare a detailed interim schedule, it can also save time and money by having a feasibility study carried out and accurate measurements taken. This will enable its advisory team to look at any need for future resizing and re-working of space to have it ready for future occupiers, a move that will minimise potential void periods.
Twelve months prior to the BHS collapse, we were called in by a client with a significant retail portfolio and the retailer as a tenant in a number of sites across the UK. The landlord was able to maximise its representation during the CVA process and protect its interests going forward thanks to its early preparation.
It is probably too late for the landlords faced with a Debenhams CVA to deal with, but the chances are high that this is not going to be the last, so when the next occasion is on the horizon, act early to avoid writing off tens of thousands – or even hundreds of thousands – of pounds worth of voting rights.
As published on EG on 30 May 2019.