With so much negativity around CVAs, are they the only answer? 

Increased footfall, falling unemployment and rising wages meant that the stars should have aligned for the UK’s high street retailers in the first quarter of 2019. Yet sales remained extremely poor and any positive movement failed to offset last year’s dismal performance, when the ‘beast from the East’ left the UK’s high streets like ghost towns. According to BDO’s high street sales tracker, a mere +4.8% rise in in-store sales proved dire for retailers trying to rebound from a brutal base of -10.1% for March last year – resulting in the worst month for the high street since November 2008. 

A number of factors contribute to this decline: notably, increased competition from online retail together with over expansion and expensive estate and fit outs. In addition, all UK businesses have had to absorb several increases in employment costs and property taxes. Unforeseen external events, including Brexit and the effect on consumer confidence, have also been sighted as reasons for the decline in this sector. Retailers trying to boost sales are giving bigger discounts, yet the resulting squeeze in margins has left many of them burdened with loss-making stores. This has all contributed to the rise of Company Voluntary Arrangements (CVAs).

A CVA is a process under the Insolvency Act 1986 which enables a company to make proposals to its unsecured creditors to compromise their claims – provided 75% of those creditors, by value, vote to approve it. A company does not have to be insolvent or unable to pay its debts to propose a CVA.

The use of the procedure is popular with businesses with large leasehold estate portfolios, such as in the retail sector, as it allows the retailer to opt out of lease agreements with landlords on underperforming stores and vacate them entirely, while negotiating rent reductions of huge percentages on the rest of their estate.

The number of large retailers that launched CVAs in the UK in 2018 increased seven-fold compared to the previous year, with 13 multi-store retailers using CVAs as a restructuring method in 2018, compared to two in 2017. Household name retailers to have launched CVAs in the past year include New Look, Mothercare and Carpetright, with Philip Green’s firm, Arcadia, the latest looking to restructure in the form of a CVA.

Landlords are the group of creditors often cited as being the ones to lose out in a CVA in a business with a leasehold estate. Some landlords have expressed concern that not only do they seem to be forced to pay out for the failure of another company, with no other stakeholders sharing the pain, but they have a very limited say in whether or not it goes ahead. They are left in an unenviable position. Do they agree to reduce rents to retain their tenants, or do they run the risk that their portfolio of stores will sit empty? One group of landlords is hoping that a legal challenge they have brought, in relation to the CVA of the hair salon chain Regis UK, will, if successful, set a precedent for future retail restructurings.

With so much negativity around CVAs, are they the only answer? How successful CVAs really are has become the topic of debate over more recent months, where analysis has shown that many companies have subsequently fallen into administration. CVAs are attractive for a number of reasons, the primary one being that the control of the company remains with the directors. A CVA is also generally less expensive and disruptive to a business than an administration and has less impact on value and liquidity.

For a CVA to be successful the ingredients are simple: an underlying viable business, a committed management team and a deliverable, robust, funded business plan. A number of CVAs have failed because of overly optimistic business plans and not being able to raise funding following approval. The plan should not all be about cutting cost. It should demonstrate how operational efficiencies will be delivered and how this will have a positive impact on the business. In addition, having the right team with the appropriate skills and who are properly incentivised is key to delivering a successful CVA.

For many years, the most popular alternative to the CVA has been an administration with a sale of the business, with assets being negotiated in advance of the company going into administration and completed immediately thereafter. Classed as a pre-pack sale, there are a number of benefits to this approach. They generally protect value, and therefore the returns to the creditors of an insolvent company, and they help to rescue the underlying business and to save jobs. The purchaser acquires only the parts of the business that they require going forward and the least profitable units are left behind for the administrator to deal with. The purchaser will occupy under a licence granted by the administrator and will seek an assignment of the lease with the landlord. They may take this as an opportunity to negotiate more favourable terms than the company in administration was bound by. The landlord will be under no obligation to renegotiate, but may determine that continuity of occupation is more favourable than an unoccupied premises and the cost of holding onto an empty property. The number of retail administrations is increasing, with over 20 in the first few months of 2019; the most high-profile being the administration of Debenhams, where the business was sold via a pre-pack sale.

So, what next for the UK’s high streets? Looking forward, we expect more of the same in the second half of 2019, with a known pipeline of teetering high street retailers under close scrutiny by analysts and suppliers alike. Vacancy rates will increase. The re-purposing of the high street will continue to be a subject debated both at local and national government level. Repurposing will require changes to local planning and the more flexible attitudes of landlords both of the high street outlets and shopping centres.

Both CVAs and pre-pack sales have their place in the restructuring landscape, but each case needs to be assessed on the prevailing circumstances. Administration can be used in most cases, whereas a CVA will only be suitable in certain circumstances. However, with landlords making more noise around CVAs and proposed changes to restructuring and insolvency, which include the adaption of insolvency procedures to enable companies in financial difficulties to restructure early, we believe that there will be a higher level of engagement with landlords who will provide more flexibility of retail lease terms.

It will be interesting to see if any new proposals are developed further and, if so, the impact this has on the UK’s high streets.