Focus DIY Proposes CVA

4 August 2009

Another large retailer using CVA to kill off "dark leases" (or non performing stores to you and me).

Call Keith Steven to learn how this works, and how to do it better than the big stores! 07974 086779

...thanks to The Times of 5th August for the article below!

...thanks to Keith Steven for this CVA experts Guide! Click here

Focus DIY calls on landlords to support deal

Marcus Leroux, Retail Correspondent

Focus DIY will outline details today of a vital restructuring deal to secure its future and urge landlords to back its proposals in a vote later this month.

Focus wants to enter a company voluntary agreement (CVA) sic (its actually a company voluntary arrangement Marcus, read your law!) with landlords, under which it will dump cash-draining closed stores. Landlords of its closed stores would receive two lump-sum dividends in return for losing rent.

The company is likely to fall into administration unless it receives the backing of 75 per cent of its creditors for the CVA. If landlords — the creditors most likely to oppose the CVA — reject the deal and Focus falls into administration, the company would probably re-emerge under its present management through a pre-pack deal. That would leave the landlords of closed stores empty-handed, Bill Grimsey, Focus chief executive, said.

The 38 closed stores — 18 of which are sub-let — represent a cash outflow of £12 million a year, £8.6 million of which Focus could save through the CVA.

HBOS and GMAC, its lenders, will not renew its £50 million credit facility unless the burden of the “dark stores” is removed. Mr Grimsey said: “The CVA is absolutely essential. The key to this is revolving credit facilities, which run out at the end of this year.”

Mr Grimsey is optimistic that landlords will back the proposal at a vote on August 24. “It’s a rock and a hard place for them, but it’s also a rock and a hard place for us and our 5,500 staff. The pre-pack vehicle is over-used — it’s not a simple exercise but we have it as a contingency plan,” he said.

As part of the proposed CVA, Focus will ask the remaining landlords to accept monthly payments for the next 18 months, after which it will revert to a quarterly arrangement.

Focus is owned by Cerberus, the US private equity group that bought it for £1 in 2007. Focus said that it was trading ahead of expectations.

Back to Keith now... good use of the CVA tool. Or is it, what will the landlords think?

See this article from Macfarlanes LLP on the merits of the Stylo CVA, JJB Sports CVA and why one was accepted and the other not.

The impact of the JJB experience on pre-packs

Macfarlanes LLP

Simon Beale and Simon Hillson

United Kingdom

May 31 2009

In landlords' eyes, the February 2009 Stylo CVA proposal, considered in more detail here, was priced and structured too aggressively. The low percentage turnover rent (with no base rent) was particularly unattractive and was a significant factor in the rejection of the proposal.

JJB seem to have learnt from the Stylo experience. They structured their CVA proposal in a manner that was more attractive to landlords than the likely outcome in a pre-pack administration.

This CVA proposal may now set a precedent for the restructuring of multi-site businesses who find themselves in financial difficulty. The burst of pre-pack activity seen in the first three months of 2009 may now recede as other distressed tenants consider this seemingly workable alternative, particularly where the majority of unsecured creditors are landlords and where the business is in difficulty due to over-rented and under performing stores.

There do, however, remain some insolvency situations where a pre-pack may still be a more attractive option for tenants. If the main reason the tenant is in trouble is because it has taken on too much debt (ie there are no over-rented, under performing sites as such) a pre-pack may be the only realistic option for the tenant. Landlord creditors would not be left out of pocket because the buyer of the business will still want all of the premises for trade, but some of the more junior lenders, who may have debt that would not survive a pre-pack, might be.

How do CVAs work?

A CVA is a formal compromise between a company and some or all of its creditors. Often this will involve creditors receiving a fraction of the total owed to them. It may also involve a change in the timing of payments to creditors. In general terms, creditors are (or should be) incentivised to vote in favour of the proposal by ensuring that any reduction in their indebtedness, or other disbenefits they receive, are still likely to leave them in a better position than would be the case on another form of insolvency, such as administration or liquidation.

In a CVA, a business has a wide flexibility as to the proposals it chooses to make. Different arrangements can be reached with different creditor groups. Proposals can be made to keep some or all units open, possibly at a reduced rent and sometimes with more flexibility on break options or ability to assign. Existing management are also able to continue operating the business in accordance with the terms of the CVA, in contrast to an administration where control moves to the insolvency practitioner.

To take effect, a CVA proposal requires 75 per cent or more of creditors by value to vote in favour of it (the proposal will also fail if more than 50 per cent by value of those creditors who are 'unconnected' with the company vote against it).

In the case of landlords, the 'value' might have two components. The first component is the sum actually owing at the time of the vote. The second component is the future rent that is yet to fall due under the lease. The chairman of the meeting of creditors has a discretion as to the proper value to place on this, and chairmen have frequently valued future rent at the token sum of £1 only. If a tenant is up to date with rent payments and all other sums due under the lease at the date of the vote, the landlord may potentially only have limited voting power at the creditors' meeting.

If a CVA is approved by 75 per cent of creditors, it binds all creditors, including those voting against the proposal. In the property context, landlords cannot then pursue other remedies against the current tenant such as forfeiting a lease for unpaid rent, provided the tenant complies with the terms of the CVA. A landlord who considers that they have been unfairly prejudiced by the terms of a CVA does, however, still have the ability to challenge it within 28 days. (In a rare case, such as the 2007 Powerhouse dispute, landlords who voted against may persuade the court to overturn the CVA if they can demonstrate that it unfairly prejudices the minority who opposed it.)

Creditors, including landlords, will receive advance notice of a CVA proposal and therefore have an opportunity to consider it properly. This is one of the starkest contrasts with a pre-pack administration, where usually the first that most landlords know about the pre-pack is after it has already occurred.

Contrasting JJB with the Stylo experience

Background

The CVA proposals for Stylo, owner of the Barratts and Priceless shoe store chains, received a great deal of publicity. In February 2009, Stylo acknowledged it was in financial difficulties and proposed a novel CVA that would have involved various of its creditors, but especially its landlords, making significant sacrifices to help the chain avoid administration.

At a packed creditors' meeting on 12 February, the proposals were voted down. Many of the creditors voting against were landlords.

Why were so many landlords against the Stylo proposal?

The CVA would have involved rents on all Stylo's retail properties being reduced to 3 per cent of turnover for an initial period, rising later to 7 per cent. Putting this in context, a typical turnover rent for a chain retailer in normal economic circumstances is usually in the range of 10-12 per cent, with a base or minimum rent below which the turnover rent cannot ever fall.

We are aware of one landlord of premises whose current rent was in the region of £200,000 per annum, but for whom 3 per cent of turnover would mean the rent would fall dramatically to around £24,000 per annum.

On the other hand, the proposed CVA would have allowed landlords to market their premises and re-let to another occupier, in which case Stylo had the option either to pay an increased rent or to vacate.

Voting conduct of landlords may well have been determined by whether they perceived themselves to be a landlord of a 'good store' or a 'bad store' (landlords of 'good stores' being those who are likely to see their lease survive a pre-pack administration, and who therefore may be less willing to consider a CVA alternative involving a significant rent reduction).

Landlords of 'bad stores' in Stylo's case might have been more likely to vote in favour of the CVA proposal. They would expect to be left with nothing but an empty property if the CVA were rejected and Stylo went into administration.

On the other hand, landlords of better performing units might have considered it worthwhile making a stand against the proposals, not wanting an unappealing precedent (as they might see it) to be set for future CVAs. From their perspective, the Stylo CVA would:

• dump most of Stylo's existing liabilities; cancel existing rent arrears;

• reduce the rents to potentially very small sums;

• keep the business trading in the hands of the existing owners and managers (who landlords may feel were responsible for getting Stylo into its predicament in the first place); and

• not provide any guarantee that a specific number of jobs would actually be saved.

There were reported to be approximately 200 people at the Stylo creditors' meeting, many of them from some of the big name landlords. The Times of 14 February quoted a 'City source' who said 'the attitude of [one landlord] was incredibly fractious. They were really agitating against the deal. The tone of the meeting was set when one of the advisors [to Stylo] pointed out that this agreement would protect the employment rights of 5,450 people – and one of the landlords said "yes, but we don't care about that do we?"'

The Stylo CVA proposal was rejected, and the company promptly went into administration. One of the shareholders of the original company bought back a large chunk of the business from the administrators, saving about half the jobs in Barratts and Priceless shoes. Some 220 stores were shut, with 160 stores and 165 concessions remaining open for business.

JJB – a different type of CVA

The majority property industry perception is that the JJB CVA proposal offered a substantially better deal for landlords:-

For landlords of the 250 'good stores' that are still trading it provided for:

• full payment of the March 2009 quarter day's rent; and

• full payment of all rents going forward, but with rent being paid monthly rather than quarterly for the next twelve months. (In the current economic climate landlords appear to be relatively willing to accommodate tenant requests to switch from quarterly to monthly rent payments, so this may not have been seen as a particular concession for landlords of 'good stores'.)

For landlords of the 140 'bad stores' that had already shut, the proposal involved:

• no more rent being paid;

• a £10m ring-fenced fund being set aside to give landlords some compensation, typically about six months' rent;

• landlords being able to take premises back as soon as they wish; and

• JJB continuing to pay business rates on closed/empty stores until the lease ends.

Non-property creditors were generally to be paid in full. Indeed, the only classes of creditors who were compromised by the JJB CVA proposals were landlords of the 'bad stores', and certain contingent creditors such as former tenants who may still be liable for rents not paid by JJB.

Are the improved terms being offered because JJB are nicer than Stylo? Have JJB observed the lessons of the Stylo experience? Do JJB simply have more money left in the pot (as a result of their bank re-financing, which was conditional on the CVA being approved) to allow for a more generous offer to be made to landlords? On the other hand, would some of the bigger landlords say that the improved JJB terms simply show that the landlords made their point successfully in the Stylo case? You are invited to take your pick from some or all of these possibilities.

Recovery from former tenants and other third parties

Remember that in general terms, a landlord who is restricted from claiming against a tenant that is the subject of a CVA arrangement can usually still recover unpaid rent from other sources including (i) rent deposits, (ii) original tenants and previous assignees who have given direct covenants to the landlord (for leases granted on or before 31 December 1995), (iii) previous tenants who remain liable under authorised guarantee agreements (for leases granted after 31 December 1995), (iv) guarantors of an existing tenant and/or (v) sub-tenants.

Landlords also need to remember, though, that if they bring a lease to an end by forfeiture or surrender, this may prevent them from recovering any future rent from these sources.

From a landlord perspective, another attraction of a CVA over an administration is that with a CVA and a 'good store' there is no related lease assignment to the purchaser of the business: the current tenant remains the tenant, and any former tenants who were liable under authorised guarantee agreements (for leases granted after 31 December 1995) will continue to be liable.

Now

Keith Steven - thanks for the great article Macfarlanes

Over 98% of KSA's CVA's are accepted, so who will you call 0800 9700539.

Contact Keith Steven 07974 086779. keiths@ksagroup.co.uk