Increasing pressures placed on those operating in the retail and hospitality sectors as a result of COVID-19, means there is likely to be an increasing use of CVAs in these sectors. The intention would be to help support and restructure businesses in distress, but could retailers use a CVA as a mechanism to re-write the terms of its leases?

In the second of our series of blogs regarding CVA challenges in Ireland, we consider the recent decision of New Look Retailers (Ireland) Ltd v Companies Act 2014 (Approved) [2020] IEHC 514, which should be noted as a cautionary warning to UK companies not to (mis)use the CVA process to force landlords to accept changes to lease terms.

The New Look case considered whether New Look Retailers (Ireland) Ltd (the “Company”) could enter examinership under Irish law and seek rent cuts from its landlords despite not being insolvent. The High Court refused to appoint an examiner on the basis that to do so, would be ‘entirely premature’. Indeed, the Company was been criticised for trying to use an insolvency procedure in order to obtain rent reductions without negotiating with landlords.

The upshot of this case is that:

• companies should take proactive steps to resolve differences with landlords before seeking court protection; and
• CVAs should not be utilised simply as a mechanism to negotiate lower rent.

For a look at the impact of the recent Monsoon case on UK retailers, please see our earlier blog.

Background to the case

The Company was incorporated in 2003 and is a subsidiary of UK-based New Look Retail Holdings Ltd. It operates 27 stores in Ireland all held under long leases. The Company relied on its parent, whose creditors approved a CVA in March 2018 and August 2020, for the provision of significant services.

Despite making a profit in recent years, the Company suffered losses following store closures during the Covid-19 pandemic. The Company’s petition for examinership argued that, with projected turnover down almost 60%, a reduction in its rental costs across its 27 stores was essential to its survival. The Company sought to enter examinership but the petition was opposed by several of its landlords.

Two issues were debated at the hearing:

• Whether the Company could satisfy the statutory test in s.509 of the Irish Companies Act 2014 (the “2014 Act”) in respect of its inability to pay debts; and
• The extent of the Court’s discretion to dismiss the case even if the Company met the statutory test for inability to pay debts.

The Company’s case for appointing an examiner

The Company sought an order for the court to appoint an examiner under the 2014 Act in order to deal with the losses suffered between March and June 2020 when its Irish stores were closed.

On the basis that it expected to be cash flow insolvent by October 2020, the Company sought a reduction in rent and repudiation of those leases with ‘upwards-only’ rent review clauses.

The Company stated that the restructuring it needed would have the best chance of success if action was taken before reaching actual cash flow insolvency.

The controversy

Under s.509(1)(a) of the 2014 Act, the Court’s power to appoint an examiner is triggered both where a company cannot currently pay its debts and where it is unlikely to be able to pay its debts at some (unspecified) point in future. At the time the petition was presented in August 2020, the Company had cash reserves of €15.6 million so it was argued that the first trigger was not met. It was said to be unusual to request court protection be given to the Company because of some future, potential insolvency.

The Court dubbed independent expert’s finding that the Company would be cash flow insolvent by October 2020 as ‘erroneous’. The projected time was subsequently changed to March 2021. An opposing report prepared for the landlords by Grant Thornton showed the Company would have the funds to pay its debts. Neither report made it easy for the Court to determine who was correct.

Each landlord who opposed the petition complained about the conduct of the Company and the parent in (i) withholding rent payments without engaging with them and (ii) the delay in obtaining information on the Company’s financial position. They expressed the view that the Court should use its discretion to refuse the petition.

In response, the Company claimed there had been ‘limited constructive engagement from landlords’. However, the Court was presented with very little evidence of the steps taken on behalf of the Company to negotiate with landlords.

For these reasons, the Company’s decision to seek court protection was widely criticised as a scheme to rewrite tenancy agreements in its favour.

The decision

Although the statutory test for inability to pay debts was met, the Court used its discretion to refuse the petition to appoint an examiner.

Unless an unexpectedly early Covid-19 vaccine became available, the Court accepted that the Company was likely to be unable to pay its debts ‘at some stage in the first half of next year’. The statutory test under s.509(1)(a) of the 2014 Act was therefore met.

However, the Judge ruled that it would be premature to appoint an examiner of the Company when the simple alternative of negotiating with landlords had not been explored. The Court accepted that examinership may be necessary in the future if negotiations were unsuccessful but criticised the Company for issuing the petition without first attempting to negotiate at all:

‘in circumstances where no real attempt has been made to date to enter into negotiations, it would be wrong, as a matter of principle, to allow this factor to influence the outcome of the present application or to presuppose that the parties will not act commercially and sensibly.’ [110]

The judge did not think it necessary to consider whether it was appropriate for a company to use the examinership process to achieve a compromise with its landlords. The focus was on the fact that the petition had been issued prematurely in any event.

The implication for use of CVAs in England

CVAs are a tool for creditors and distressed companies to reach a genuine, negotiated compromise and should not be used opportunistically by tenants to rewrite tenancy agreements.

In this case, the failure of the tenants to engage properly with their landlords at the outset was enough to prevent the success of their application to appoint an examiner. In the wake of renewed tiered and lockdown restrictions and the temporary closure of non-essential businesses in England, this should be borne in mind by high street retailers on both sides of the Irish Sea.

This article features contributions from Francesca Puttock.