'Back To The Future' DeLoreans And A Developer That Threatened The British Banking System: How The Wild Birth Of CVAs Is Shaping Today’s Property Market
As Britain’s major landlords this week digest the implications of creditors to New Look approving a company voluntary arrangement that will slash the retailer’s rents, did any of them sit there and ask: Who invented the CVA, why and how did it come to this?
Perhaps they should have done. Because the origin story of how CVAs became part of the British business and property landscape gives an insight into what the process was meant to do and how it is reshaping towns and cities today. It is a story that takes in a property developer whose eventual bankruptcy broke records and was seen as posing a threat to the stability of the financial system, and the DeLorean cars made famous in the Back to the Future film series. Its echoes reverberate down the years to be heard today.
New Look’s CVA is the 16th undertaken by a retailer or food and beverage brand so far this year, British Property Federation data shows, and perhaps the most important so far, raising the possibility of dramatic changes to the way shops, restaurants and bars are leased. More are almost certainly coming. Landlords are by no means blameless in the current fractious negotiations with retailers over how rents are paid, and how much. But the way CVAs are becoming commonplace has the potential to undermine the vital redevelopment of Britain’s struggling town centres. And the property industry would argue that the system is not being used in the way it was originally intended.
To understand the current situation you have to delve into the history of one family, and one member of that family in particular. The Cork dynasty dominated the British insolvency world for almost 75 years, and Sir Kenneth Cork has shaped the way insolvency works in Britain today.
Cork’s life does not fit any stereotype you might have of an insolvency practitioner. As well as running the largest insolvency business in the UK, Cork Gully, from 1935 until it became part of PwC in 1980, he was Lord Mayor of London and played a huge role in shaping the development of the arts in Britain as chairman of the Royal Shakespeare Company, vice chairman of the Arts Council and a significant figure in bodies such as the National Theatre and the development of the Barbican.
His 1988 autobiography, Cork on Cork, is a strange mix of stories recounting the liquidation of long-forgotten meat suppliers and washing machine companies, alongside ceremonial dinners with the Queen and drafting in Diana Rigg to consult on the future of the arts. It opens with the famous quote from As You Like It: “One man in his time plays many parts.”
“He was the doyen of the insolvency industry,” Lipton Rogers founder Sir Stuart Lipton, who knew him, told Bisnow. “He was very smart, took no nonsense, and he knew property very well.”
Cork authored the Cork Report, a 1982 defining report on UK insolvency law. It was commissioned by the Labour government in 1976, and the Conservative government of 1986 took on board many of its recommendations when they passed that year’s Insolvency Act, which radically shook up insolvency laws and practice in Britain.
Before 1986, if a company became insolvent, receivers or liquidators were appointed and the company’s assets were pretty much sold straight away and the company broken up. The 1986 act brought in administrations as mechanisms to try and mirror the U.S. Chapter 11 bankruptcy system, where companies could be kept running by insolvency experts to try and keep them alive and sell them as going concerns, to protect jobs and ultimately get a better result for creditors.
It introduced company voluntary arrangements as a way of doing this outside of the court system, providing a way for a company and its creditors to efficiently agree on a way to restructure its debts.
Cork had been a long-term exponent of this way of doing things, and his views were moulded by myriad cases where the way the law worked meant that potentially viable companies were broken up when they hit financial difficulties. But two cases had a particular influence.
The first is that of Willi Stern, a Belsen concentration camp survivor and property investor and developer who had assets with personal guarantees of £200M in the 1970s (£2.1B in today’s money), but who in 1974 saw his empire collapse when a market slowdown meant he was unable to repay a group of more 30 banks the £170M he owed them.
Cork was appointed to handle the liquidation of the business, and some banks pushed for a quick sale of assets to get their money back. But Cork insisted this would cause a fire sale that would bring down the value of assets across the sector by more than 50%, which in his autobiography he said could have posed a threat to the stability of several banks and pension funds. Instead, he got the Bank of England to agree to what today we would see as a CVA, managed the company on the lenders’ behalf and minimised the losses taken.
The second case was that of the DeLorean car company, which Cork was appointed receiver of in 1982. DeLorean was the eponymous passion project of John DeLorean, an American automobile executive. He manufactured the car, famously used as a time machine in Back to the Future, in Northern Ireland with backing from the British government. When the company got into financial trouble due to poor sales, Cork was brought in to keep the company running as best as possible to maximise returns. While the company eventually shut down, Cork points out in his book that thousands of jobs were protected for up to a year because the company was continued as a going concern rather than simply being broken up.
(In a strange coda to the DeLorean tale, Cork followed a paper trail via Panama to Switzerland to uncover that the equivalent of £60M had been illicitly siphoned from the company. DeLorean, who died in 2005, was arrested during the insolvency by the FBI for cocaine trafficking, but was found not guilty after he proved he was targeted because the FBI knew he was financially vulnerable and entrapped him in a sting operation.)
While Cork knew the property sector well, in his book he doesn’t seem to like it much. He puts the mid-1970s property crash down to the “greed” of developers, and wrote the following of investors like Stern who bought land, gained planning permission and then sold it on: “Civil servants giving a hole in the ground planning permission is what adds to its value of course, and gives the developer his easy profit. For me this taking money out of the community to no good purpose and swapping it for sewing machines, television sets and motor cars made in Germany and Japan is stealing. You have eaten away community assets and put nothing back in return.”
That aside, the original purpose of CVAs was to create a mechanism so struggling companies could come to an agreement with the creditors to reduce liabilities in an orderly way while keeping the business operating and thus protect jobs. A company puts forward a rescue plan, and if 75% of its creditors approve it, it is put into action.
“We have no issue with this business rescue culture, if it is used to help a business successfully turn itself around,” Revo chief executive Vivienne King told Bisnow. “But CVAs have been pounced on by some operators and used against the spirit in which they were intended.”
Search the archives of the Estates Gazette, which date back to the mid 19th century, and you find very few mentions of CVAs from the time of the Stern collapse until 2005, when electrical retailer Powerhouse used the mechanism to exit leases on a number of its stores, in what proved to be a test case for the property industry. Landlords argued that what Powerhouse was doing was illegal, and while the court found in their favour, there were enough loopholes and caveats for the retailers to be able to use the strategy in future. That was the moment the dam broke, and from then on a steady stream of retailers have used the technique to exit leases and reduce rents.
The financial crisis saw their use increase.
“That was when things started to get ugly,” Knight Frank partner Steven Springham said.
As retailers have continued to struggle due to changing consumer habits, their use has become more common and more controversial. There is still money to be made from retail and leisure, but less from physical stores, and so CVAs have become a regular tool for businesses to reduce their property costs. For that reason, today CVAs epitomises the tension and mistrust between property owners and retailers and leisure businesses, an animosity that has only been exacerbated by the impact of the coronavirus. This year has already seen more CVAs than the whole of 2019.
Property owners argue that they are unfairly prejudiced in the CVA process. Tenants are almost always asking for rent cuts, a switch to turnover rents or to exit leases as part of their CVA plan, meaning landlords take a big hit in the process. But they don’t get much voice on the plan.
“CVA proposals are supposed to be a temporary remedy to stabilise a business, but the changes that are increasingly being proposed are permanent,” BPF chief executive Melanie Leech said. “If a viable plan is put forward, landlords will support it. But landlords take a big share of the pain, company owners often don’t, and landlords don’t get a huge part of the vote.”
The way the voting system works doesn’t take into account the fact that under a lease contract, a tenant might owe a landlord millions of pounds in rent over a number of years. Each creditor gets a vote for every pound they are owed, but only the rent due to landlords in the current quarter is counted in the voting process, reducing the number of votes landlords have in a CVA process. Tenants will usually launch a CVA just before rental quarter day to minimise the proportion of the vote given to landlords, tenant rep specialist Tony Lorenz said. Leech pointed out that in situations where the votes of landlords are the difference between winning and losing a CVA vote, landlords are usually offered better terms.
The situation has been escalating in recent years, in both frequency and animosity. The BPF has openly criticised CVAs launched by retailers including New Look and Select in recent years, citing a lack of transparency and unfair terms of landlords. The potential implications of New Look’s CVA are huge and could spur many more large retailers to use CVAs to force landlords to accept turnover rents on huge numbers of stores.
“It was a watershed moment and could set a powerful precedent,” Reed Smith Head of Real Estate Disputes Katherine Campbell told The Times. “You could almost hear the collective groan of landlords across the country. It will be interesting to see if it will be possible to put this genie back in the bottle.”
“Property owners are asking, is a CVA necessary, or is it a lifestyle choice,” Springham said. “People are abusing the system.”
He outlines a common complaint from the property industry: Many retailers and leisure businesses that have launched CVAs have been owned by financial investors like private equity firms or hedge funds, which have taken equity out of the companies in the form of dividend and replaced it with high levels of debt. When times are tough, these companies are less able to weather the storm and rather than recapitalise companies, they seek rent cuts or to exit leases as a way of reducing costs. New Look is a case in point; it is owned by a group of financial investors that have a net worth in the billions of pounds, and the company was loaded with more than £1B of debt following its buyout at the beginning of the last decade.
“The issue with CVAs is that they often compromise only one class of creditor, rather than dealing with the underlying operational issues a company might have,” Blandford Capital Partner and former Deloitte insolvency practitioner Neville Kahn said. “It won’t address the issue of a company losing its customer base.”
From the point of view of retailer and leisure operators, landlords have had it coming.
“The relationship between landlords and tenants has been fractious for so long that the disharmony is almost institutionalised,” British Retail Consortium Property Policy Adviser Dominic Curran said. “Especially given COVID, a lot of retailers think it’s time for landlords to take their share of the pain. CVAs have become the only options where landlords aren’t willing to negotiate in a meaningful way.”
For decades landlords have been protected by upward only rent reviews, and Curran said CVAs have been seen as a way of rebasing rents to true market levels, now that there is more supply of retail space than there is demand to fill it. He added that the coronavirus has hit trading for many operators badly, but some landlords have remained unwilling to cut realistic deals on rents.
In many ways it comes down to an argument about risk. Revo’s King points out that retailers signed long leases willingly, and knew the inherent risk.
“A contract is a contract,” she said. “They will have done their due diligence.”
Tenant rep Lorenz argued that landlords know the risk they are taking when they buy and lease a property — that is why property yields more than government bonds, because it is not a risk-free asset.
Many might agree with the BRC point of view, and feel little sympathy if all of a sudden Cork’s “greedy developers” see their income drop. But the way CVAs are being used have unintended negative consequences that go beyond the balance sheet of property owners — the system may be stymieing the necessary reimagining of dying town centres.
“It has an effect on the risk profile of property investment, and is putting pension funds and institutions off investing in the retail sector in particular,” Leech said. “Every pound that is lost by those institutions is a pound not available to reinvest in the repurposing of town centres.”
“It is a messy system and it creates confusion,” Springham added. “Investors might look at a retail scheme and they don’t know whether a tenant is staying or going, and so they don’t know what the potential is for redevelopment.”
There is clearly an oversupply of physical retail space right now, but rather than a way of addressing the imbalance between supply and demand, the CVA system might be hindering the process of taking that excess space and turning it into much-needed new uses like town-centre residential and community space.
Are there any prospects for the system to change? The BRC’s Curran said the system could be more transparent, with tighter rules in place requiring retailers to disclose how stores are performing so that landlords can take a view on the pros and cons of a CVA plan. King said the rules on how votes are calculated could be made fairer.
But there is likely to be little appetite for the government to address this right now. The government’s moratorium on commercial evictions has just been extended, a move that Leech argued would give tenants who are abusing the system, choosing not to pay rent when they can afford to do so, even more leeway. Lorenz predicted more retailers will rush to undertake CVAs while they have the protection from eviction the moratorium provides.
“The CVA does seem to unfairly penalise landlords, but it is legal,” St Bride’s Managers senior partner Robert Houston said. “So is it a classic, but uncomfortable, instance of the boot this time being on the other foot? After all, over the years, the property industry has made an art of finding loopholes in plannIng and tax law. The Government has then either blocked the holes or learned to tolerate the consequences.
“The Government is clearly aware of how CVAs are now being utilised but, thus far anyway, has chosen not to get involved.”
Cork’s biography contains a quote from Tennyson: “The old order changeth, yielding place to the new/And God fulfils himself in many ways/Lest one good custom should corrupt the world.”
For property owners thinking about how the original intentions of the CVA system are being applied today, it might seem an apt sentiment.
