The supposed abuse of CVAs has caused anger and as Focus becomes the latest to attempt one, Nicola Harrison asks if these arrangements are fair
Once again, an embattled retailer is seeking to secure its survival by means of a corporate voluntary arrangement (CVA). This time it is Focus DIY that wants to make use of the controversial procedure to offload non-trading stores and set itself on a firmer financial footing.
Focus last week told creditors that it has to rid itself of 38 non-trading stores if its banks are to renew its two-year revolving credit facility. Administration is the alternative, Focus said. Whisperings in the property world and outside suggest that Focus’s CVA proposal will be successful.
But while they are promoted by some as a way of safeguarding companies and jobs from collapse, CVAs have also provoked anger among critics who argue that the method is unfair – unfair to successful retailers that have managed their businesses well and unfair to creditors who have to take a financial hit.
Hero or villain?
Supporters of the CVA might point to the case of JJB Sports, which earlier this year looked like a lame duck. Sales had plummeted, continued support from its banks was in jeopardy and its chief executive had left, embroiled in scandal. It looked as if another retail casualty of the recession was imminent.
But the CVA, an insolvency procedure previously little used by quoted companies, gave the retailer a new lease of life, allowing it to reduce its oversized store portfolio, save many jobs and ultimately secure new funding.
Without the CVA, JJB would have collapsed and, say the people closest to it, would likely have disappeared from the high street forever.
But is the case so clear cut? CVAs are not always seen as a force for good, especially by more robust retailers that believe use of the technique amounts to an unfair subsidy for sector weaklings.
Critics might not disagree there needs to be an insolvency procedure that allows struggling businesses to survive and save jobs, rather they’d quibble over the way it is applied – which can result in shoring up companies with no future, enabling them to stumble on. Why should failing retailers be given preferential treatment?
After all, many retailers – regardless of how well they are trading – might like to get rid of a portion of their portfolios. But not all have the option of a CVA.
Ian Cheshire, chief executive of DIY giant Kingfisher, which itself has 15 to 20 unwanted stores, highlights the inequalities of CVAs. “I think CVAs and pre-packs are an example of where a good idea to help companies get sorted out has ended up getting turned into a way of being able to dump the bits of the business you don’t want, having left a bunch of creditors behind.
“The problem is, you end up with a completely uneven playing field. The strong are effectively cross-subsidising the weak.”
Landlords also have their criticisms about the fairness of the regime and do not want to see the CVA become the norm for any embattled retailer wanting to offload some stores.
Land Securities commercial director Ronan Faherty says: “The way the law is written is with the right sentiment – trying to save jobs and the economy. But the application is where the challenge is. Retailers that run their business successfully seem to be being penalised.”
Even Peter Williams, drafted in as an executive director by JJB to help revive its fortunes, concedes that critics of CVAs have a point. Williams, who no longer works with JJB but did help steer the CVA through, admits: “I can understand that view and, if I was in a more robust retailer, I would probably be saying the same thing.
“But I wasn’t. I was in a company that was desperate to survive and your duty is to the business – to try and do your upmost to make it survive.”
And survive JJB has, thanks to the successful outcome of its CVA. JJB had to rid itself of the £17.3m burden of 140 non-trading stores.
A good example
While JJB successfully pulled off a CVA, footwear retailer Stylo failed to do so just months before. Two years previously, electricals retailer PowerHouse also failed. So all eyes were on JJB.
“The non-trading stores were haemorrhaging the company to death,” recalls Williams. He says JJB looked at a pre-pack administration, but did not want to risk the business disappearing altogether, or having to lose more leases than the 140 it wanted to shed. Williams also points out that if a pre-pack route had been followed, creditors would have lost all their money, employees would be out of a job and the shareholders would have got nothing. “Pre-pack is last you thing you do,” says Williams.
So JJB went on a “roadshow” to see its top 15 landlords. The retailer explained its position, gauged opinion on a CVA and then settled on that course of action. Creditors were overwhelmingly in favour and JJB secured more than 98% of their votes on the issue.
“If we were in a normal world – which we are not – I think the property industry might have said: ‘If it’s got to die, it’s got to die.’ But there was a reason for JJB to survive,” Williams says.
JJB has been praised by landlords for its openness during this time. The retailer even set up a call centre for creditors. Faherty applauds JJB’s “open and honest approach” but adds: “Retailers negotiate deals and make the decisions to go into those properties. Then they decide that all of a sudden the terms are unacceptable.” But he concedes: “When troubled times have hit, most property companies try and be supportive.”
So why was Stylo’s attempt to strike a CVA not supported? The retailer attempted to “totally renegotiate unrealistic terms” says Faherty and, as a result, it failed. “Trying to renegotiate everything is misusing the law,” he says.
According to Faherty, what lies at the heart of a successful CVA is convincing creditors that a business has a future. And Focus must convince landlords such as Land Securities – which owns four Focus stores – over the coming weeks, before the creditors’ meeting on August 24.
If the CVA is agreed, the only creditors that will be affected are those landlords of the so-called “dark stores”.
Cheshire finds this aspect of the CVA unsettling. “It does seem odd that the majority of creditors can vote to effectively disenfranchise one subset of the creditors,” he says. “It’s a gun to people’s heads. It’s supposed to be company voluntary arrangement, but if you’re one of the landlords losing out there’s nothing much voluntary about it.”
Richard Fleming, partner at KPMG’s corporate recovery practice, worked on JJB’s CVA. He believes CVAs represent a fair option for retailers on the brink. “They provide a better deal for creditors than administration does. CVAs have particular appeal to the retail sector as they suit any business that wants to reduce its geographical footprint.”
So does Fleming sympathise with those retailers who complain of inequality? “It’s a bit like crying about social welfare, isn’t it? They are missing the point. A CVA limits the wreckage and keeps more people in jobs. This isn’t about the stronger players.”
Williams agrees. “We are not in normal circumstances. Look at the high street – you see all these boarded up shops and that’s not good for the robust retailers either.”
Focus chief executive Bill Grimsey says: “If you’re a retailer caught between a rock and a hard place you have to protect your business, creditors and customers by doing what’s appropriate. This CVA is entirely fair on all of the creditors.”
Whether the Focus terms are fair or not, not all CVAs are seen to be so, and landlords and retailers alike are calling for a more transparent process.
Time for a rethink?
Cheshire hopes for Government action. “The whole legislation needs a rethink,” he states. “It’s important that Government looks at it.”
The Insolvency Service is consulting at present, looking at the way CVAs
and pre-packs are run. The Government is specifically looking at giving moratorium powers of protection to large companies during the CVA process, without them having to apply for an administration order as they do at the moment. Only small companies have that benefit now.
Stephen Gale, partner at law firm Herbert Smith’s restructuring team, worked on JJB’s CVA and would welcome such a change, which he thinks would give companies greater protection. But those not in favour of CVAs may not be pleased. “If it happens then the number of CVAs will increase, among retailers especially,” says Gale. Fleming agrees: “There are definitely going to be more CVAs in retail.”
So the CVA is likely to be here to stay. What will dictate the extent of its successful use in future will be the conduct of retailers and the pain threshold of creditors. And both are changing rapidly in the recession.
But as Faherty says: “It’s in nobody’s interest for a retailer to go bust.”
JJB sought to address the £17.3m burden of its 140 closed stores with its CVA in March this year.
The sports retailer wanted to get out of the leases and in return offered to continue paying business rates on the stores. Landlords would also receive a payment from a £10m fund.
It also asked all landlords to move from quarterly rents to monthly rents for a 12-month period. JJB said its proposal did not seek to compromise the claims of any other creditors. Come the creditors meeting in April, 99% of creditors approved and no questions were asked at the meeting.
The first high profile CVA to be attempted this recession, Stylo was a landmark case. And, in February,
it failed. It appointed Deloitte as administrators to propose the CVA but Stylo’s terms were deemed unrealistic and creditors, led by Hammerson, rejected the proposals.
Under the terms, Stylo wanted to pay reduced rent based on turnover at all of its 384 premises for two years. From August onwards, it could also terminate any of its leases with only one month’s notice.
Landlords voted against the CVA, worrying it would set a dangerous precedent. Consequently Stylo was put into administration and its management bought back 160 stores and 165 concessions.
Focus wants to get out of the
leases on its 38 non-trading stores, which are costing the retailer £12m a year, in order to secure funding from its lenders.
If successful the CVA will save the retailer £8.6m a year. 16 of the 38 stores have sub-tenants, while 22
lie completely empty. Focus wants
to get out of paying rent, service charges and insurance on the stores. In return, the landlords will receive two lump sum dividends.
Focus will continue to pay business rates on the properties until the landlord surrenders the lease or assigns it.
The retailer is also asking all landlords to move to monthly rents for the next 18 months.
What’s a cva?
A CVA is a formal procedure under Part I of the Insolvency Act 1986, which enables a company to agree with its creditors how its debts should be paid and in what proportions
They allow retailers to effect a solvent restructuring without resorting to administration
The CVA terms are sent to creditors and must comply with the Insolvency Rules 1986. Creditors are invited to vote on the proposals at meetings held on not less than 14 days’ notice
CVAs must be approved by at least 75% of creditors present in person or by proxy at the meeting
It can be challenged in the 28-day period following the result of the meetings being reported to the court
If a challenge is successful, the court may revoke or suspend the approval of the CVA and/or press for further meetings