'Like CVAs on speed’: cram downs are landlords’ next headache

Virgin Active’s health club near Mansion House in the City of London would normally have been packed at lunchtime as office workers got their exercise fix.

“Normally”, of course, was before Covid. For much of the past year, the lunchtime rush has consisted of one personal trainer and a camera.

Streaming workouts to housebound members has done little to mitigate Virgin Active’s near-total drop in revenues. The financially strapped chain is now seeking to force through a debt restructuring that would have ramifications far beyond theleisure industry.

To force landlords to write off or defer rent arrears — and take ahaircut on future rents — Virgin Active is using a controversialnew tool that will allow it to push through a restructuring even if it is opposed by property owners. Landlords fear that the so-called “cram down” mechanism, permitted under Part 26a of the Companies Act, could also be used by a raft of other high streetchains in their efforts to avoid repaying the estimated £6.5billion in rent that has built up during the pandemic.

“Landlords are up in arms because this issue will be on theradar of every company sitting on a load of rent arrears,” said Zelf Hussain, restructuring partner at PwC, which is advising British Land and Land Securities in the Virgin Active case.Those landlords have also hired a top QC, Robin Dicker of SouthSquare chambers, to fight Virgin Active’s plan.

While a few companies have already implemented a Part 26a restructuring, Virgin Active’s will probably be the first attemptto cram down landlords. About a fortnight ago the gym chain,advised by the accountancy firm Deloitte, sent a letter tocreditors outlining its plan. In a court hearing last week,landlords objected to Virgin Active and Deloitte’s proposedcategorisation of creditors on the basis that the worst-affected property owners were being lumped together in the samegroup. The judge will rule on the categorisation this week.

So long as the judge is satisfied that creditors are categorised appropriately and treated equitably, and that the plan delivers abetter outcome than insolvency, it will go to a vote on April 16.

More than 75 per cent of the votes need to be in favour for it topass without a cram down. If more than a quarter of any class of creditors by value oppose it, Virgin Active will ask the judge at asecond hearing to cram them down and force the restructuringthrough. Theoretically, multiple classes of creditors can becrammed down.

Ultimately, the insolvency practitioner — Deloitte in this case —must prove that creditors as a whole will be better off throughthe restructuring than in an administration.

The cram down feature was introduced in June as part of apackage of changes to the UK’s corporate insolvency regime, designed to ease restructurings. The changes had been mootedfor years but were expedited with the aim of saving a greater number of businesses during the pandemic.

Landlords have seen the security of their income underminedin recent years by the proliferation of company voluntary arrangements (CVAs), which allow struggling tenants to shutstores and cut rents.

Under a CVA, creditors vote in a single group, their share of thevote set by the size of their claim. Landlords have objected to CVAs on the basis that the process reduces their voting powerby discounting future rent liabilities. After negotiations, thediscount applied to a landlord’s claim in CVAs was cut fromabout 75 per cent to a maximum of 25 per cent.

In the current circumstances, a landlord’s voting power in a CVA would be inflated by the outstanding rent bills, but Virgin Active’s restructuring allows the chain to nullify that advantage by lumping landlords into the same category and requestingthey be crammed down if they vote against it.

“These processes look like a CVA on speed,” said Adam Coffer, chairman of the Property Owners Forum, which says itrepresents about 350 small landlords. “They’re another backdoor mechanism for large, highly leveraged tenants to extricate themselves from legally binding contracts and striplandlords of their rights.”

Landlords are worried that in addition to having little power tothwart the new restructurings, they are given performance information pertaining only to their site or sites; lenders and bondholders, by contrast, typically have access to the fullmanagement accounts.

Will Wright, head of restructuring at KPMG, said the increasingnumber of legal challenges brought by landlords against CVAshad created uncertainty around the process. He expects cramdown restructurings to become more common.

Japanese-owned car parks giant NCP is planning a cram downof landlords in June.

Virgin Active wants landlords to contribute about £40 million ofthe £120 million in fresh liquidity the group is seeking. Some £69 million will be provided by South African group Brait, which owns 80 per cent of the company, and Virgin founder SirRichard Branson, who owns the rest. Landlords are being askedto waive or defer rent arrears and accept reduced rents for three years.

A source close to Virgin Active, which employs 2,400, said thevast majority of landlords at its 40 UK sites won’t agree to rentcuts.

Now, a judge may cram landlords down and force them to accept cuts anyway.