High Court ruling
Published: 01 May, 2007
A key High Court judgement has successfully upheld landlords' rights to enforce rental guarantees underwritten by their tenants' parent companies.
The electrical retailer Powerhouse had been attempting to walk away from its lease obligations on 35 UK stores but the judgement means it will now be forced to pay rent on the stores, and other retailers will be blocked from exploiting an apparent loophole.
During 2005, when Powerhouse found itself in financial difficulties, it entered a Company Voluntary Arrangement to pay its creditors at 28p in the pound. Controversially, it included its landlords in this arrangement even though they held rental guarantees from its parent company PRG Group.
The CVA procedure enables a company to reach an agreement with its creditors about how debt is to be repaid, while allowing it to continue to trade. The law states that a company can only propose a CVA if it is insolvent or contingently insolvent and the CVA may provide for full or partial repayment, depending on the amount that company can reasonably afford to pay.
Before it can come into effect, the CVA requires the approval of 75 per cent of the voting creditors, measured by the value of their debts. If the required majority of creditors vote in favour, the CVA binds all creditors irrespective of how they voted and allows the directors to retain control of their company.
According to Simon Beale, solicitor with City law firm Macfarlanes: "The CVA, which was put forward on the basis that it would enable Powerhouse to continue trading generally, offered each landlord six months' rent. However, crucially, it also released the parent company guarantor from any liability to meet further rent. For this reason the landlords opposed the CVA, but were out-voted by trade creditors."
Two groups of leading landlords, made up of property companies and institutional investors, challenged the decision in the High Court this March on two grounds: first that a CVA had no powers to void rental guarantees and second that the landlords' interests were unreasonably prejudiced by forcing them to be bound by a vote dominated by unsecured creditors.
The British Property Federation (BPF) made it clear how much was at stake. It estimated the total value of commercial property investment in the UK to be £573bn, of which £380bn is held by UK institutions and listed property companies. Assuming, rather conservatively, that 10 per cent of the UK's commercial property has a parent company guarantor, £38bn of property assets could have been at risk if Powerhouse's actions were upheld by the courts.
Donaldsons investor services partner Charles Woollam explained: "In a cooling market, attention turns to investing in prime property let to quality tenants with strong covenant values. If landlords can no longer rely on parent companies to bail out struggling subsidiaries, it will undermine covenant strength and investor confidence in some properties will be seriously dented."
The BPF warned that commercial property valuation yields could move by up to 150 basis points if the Powerhouse strategy was upheld.
However, to the relief of the property industry, the court decided in the landlords' favour on both grounds and Addleshaw Goddard partner Louise Verrill, who advised British Land, Scottish Widows and Standard Life, said: "In our view, it would have set a dangerous precedent for financially unstable companies to terminate parent company guarantees at will. Any other result than victory for our clients would have undermined the value of such guarantees in the property sector and had a significant impact on the value of the commercial property."
So what are the prospects of Powerhouse causing further uncertainty by lodging an appeal? Legal experts think it unlikely. "The general consensus in the legal profession is that the decision is fundamentally right for the right reasons," said Matthew Lonergan, property partner at solicitors DLA Piper. "So far there's no sign that there's going to be an appeal."