A CVA is a composition in satisfaction of a company's debts or scheme or arrangement of its affairs. A proposal is put to the company's creditors at a meeting and, if approved, it binds every person who was entitled to vote at the meeting or would have been so entitled if he had had notice of it (section 5(2), 1986 Act).

In February 2006, Powerhouse proposed a CVA under which it would close certain loss-making stores. Under the proposal, landlords of the closed stores were to be paid certain compensation but Powerhouse would be released of all its on-going liabilities to them and Powerhouse's New Zealand listed parent company, Pacific Retail Group Limited, would be released from guarantees it had given. All other creditors would be paid in full.

The landlords of the closed stores objected to the proposal and in particular to the release of the parent company guarantees. However, a CVA does not require unanimous approval of a company's creditors. Only a simple majority in value of the members and 75% in value of the company's creditors present and voting at the creditors' meeting is required. The Powerhouse CVA proposal was approved at the creditors' meeting on 17 February 2006.

The 1986 Act does not deal expressly with the position of guarantors and co-debtors and the existence of a CVA does not automatically release them from their obligations. Whether they are so released depends on the specific terms of the CVA, which must be construed as a consensual agreement (see Johnson v Davies [1999] Ch 117, where the Court of Appeal considered whether a co-debtor was released in an individual voluntary arrangement (IVA) based on the near identical drafting relating to IVAs in the 1986 Act).

Landlords of Powerhouse's closed stores have applied to the court to revoke the CVA on the grounds that:

A directions hearing took place on 9 May 2006 and the case is due to be heard in March 2007.

Among other things, the landlords argue that the Powerhouse CVA sets a precedent for financially unstable companies to terminate parent company guarantees that could undermine the value of such guarantees in the property sector generally. News reports in April 2006 noted that a second guarantor, Hamsard 2353 Limited, has now used a similar arrangement.

No doubt Johnson v Davies, in which the Court of Appeal considered the public policy issues arising in relation to guarantors and co-creditors in the context of IVAs, will be considered when this question comes before the court.

In that case, the court thought that, by enacting the equivalent of section 5(2) in relation to IVAs (that is, section 260(2)), the legislature appeared to have taken the view that a debtor should be able to propose a scheme under which it will obtain a complete release from its liabilities, including rights of contribution from co-debtors. Creditors bound by the scheme should not find it frustrated by action by a co-debtor (not so bound) in enforcing rights of contribution.

In practice, landlords should look closely at the terms of any tenant CVA proposal to see what arrangements are proposed in relation to guarantors and co-debtors.

They may wish to propose a modification reserving their right to pursue a guarantor or co-debtor. Or they may wish to pursue an alternative remedy: until the CVA is entered into, a landlord (like any other creditor) is free to pursue any other relevant remedies unless the tenant is a small company that has filed for a CVA moratorium (see Practice note, Tenant insolvency and its effect on the landlord for further information).

If the CVA proposal is approved at the creditors' meeting, any challenge must be made within 28 days from the day the result of the meeting is reported to the court (section 6(3), 1986 Act).

Most importantly, as a practical commercial matter, landlords should bear the experience of the Powerhouse landlords in mind when considering whether, and on what terms, they are prepared to offer a lease to a subsidiary based on comfort given in the form of a parent company guarantee.

If you have any comments on this article, or suggestions for other articles, please send them to Sara Catley.

See previous market practice analysis articles here.