Rent arbitration and the UK restructuring toolkit

• Commercial tenants have benefitted from a number of government protections over the past two years. The government is now pursuing a return to normal commercial relations between tenants and landlords as part of a move towards "living with Covid".
• The message from government is that tenants that can pay rent should do so. Tenants and landlords should consensually resolve unpaid rent arrears accrued during the pandemic.
• On 24 March, the government introduced a new ringfencing and arbitration regime of last resort for tenants and landlords who cannot resolve unpaid rent arrears. For our snapshot alert on this new regime under the Commercial Rent (Coronavirus) Act 2022 (the Act), see here.
• Doubt has been cast over whether large commercial tenants and their landlords will need to resort to the new arbitration regime as many have already reached agreement. However, in the face of continued domestic and global economic uncertainty, large tenants and landlords should be mindful of other restructuring tools available to financially distressed tenants. 

Why has the government introduced a ringfencing and arbitration regime?

The Covid-19 pandemic and mandated lockdowns hit businesses that trade from physical premises hard. The government introduced a number of temporary measures in an attempt to protect commercial tenants. As a consequence, landlords saw their ability to take action against commercial tenants for non-payment of rent restricted for two years. From most landlords' perspectives, the temporary measures disproportionately placed a burden on them to support commercial tenants through the pandemic (particularly given landlords did not receive corresponding protections for their obligations to their lenders).

The government now wants a return to normal commercial relations as part of a move towards "living with Covid". Many of the temporary measures have expired. The government has encouraged landlords and commercial tenants to consensually resolve unpaid rents that accrued during the pandemic. As a safety net of last resort, the government has introduced a temporary ringfencing and arbitration regime for tenants and landlords that have not been able to resolve unpaid rent debts.

This article outlines that new regime, and considers why tried and tested procedures in the UK restructuring toolkit will remain relevant for large corporate tenants and their stakeholders.

The temporary ringfencing and arbitration regime

The new regime relates to "protected rent debts". These are a narrowly defined pool of rent liabilities (and certain other amounts) that have accrued under a business tenancy ^[1] adversely affected by coronavirus. To qualify as protected rent debts, the unpaid amounts must be attributable to periods:

• of occupation by the tenant between 2pm on 21 March 2020 and 18 July 2021 (in England); ^[2] and
• where coronavirus regulations mandated that the tenant's business close.

Where a commercial tenant has protected rent debts, the Act provides for two temporary regimes.

• Ringfencing - the Act provides for a moratorium on landlord action for non-payment of protected rent debts. During the moratorium, landlords cannot:

• pursue a judgement debt (this prohibition looks back to 10 November 2021);
• exercise a right of forfeiture for non-payment;
• seize tenant assets under the Commercial Rent Arrears Recovery procedure;
• drawdown on rent deposits; or
• present a winding up petition against a commercial tenant, in respect of unpaid protected rent debts.

The restrictions apply for a period of six months ^[3] (or the conclusion of an arbitration, see below).

• Binding arbitration - where landlords and tenants are unable to agree on how to resolve protected rent debts, they may instigate the new binding arbitration procedure. A landlord or tenant may refer a protected rent debt to arbitration within a six month referral period. ^[4] Both parties may make a proposal to the arbitrator. In coming to a decision, the arbitrator is required to consider the viability of the tenant's business, what is affordable for the tenant, and the solvency of the landlord.

In the event an arbitrator is appointed or an arbitration award made, the Act restricts a tenant's ability to use other restructuring tools ^[5] to compromise protected rent debts. Stakeholders involved in restructuring negotiations may need to consider whether the new regime presents any potential tactical advantages in those negotiations.

The outlook for larger tenants and their landlords

Many stakeholders have commented on the potential difficulties with the arbitration regime. The regime is untested, and how an arbitrator might assess concepts of viability, affordability and solvency is unclear. Consequently, both tenants and landlords would face significant uncertainty if they were to refer a protected rent debt to arbitration. That uncertainty alone may have encouraged large tenants and landlords into resolving any protected rent debts. Reports suggest that many large tenants and landlords have resolved their protected rent debts prior to the Act coming into force.

Despite the government's desire to return to normal commercial activity, large tenants may face challenges beyond historic protected rent debts. The re-opening of society has allowed tenants to resume trading, but economic health remains fragile. Pressures arising from the fallout of the conflict in Ukraine, rising inflation, soaring energy prices and delays in global supply chains present challenges for large tenants and their stakeholders going forward. 

The new ringfencing and arbitration regime is not of wider application

The government designed the arbitration regime to resolve rents accrued during periods of mandated Covid-19 lockdown. In that way, the ringfencing and arbitration regime is narrow in its scope. The regime does not protect tenants from landlord action for unpaid rent debts accrued outside of periods of lockdown. Further, tenants cannot use the arbitration regime to restructure future rent liabilities.

In light of these limitations, large tenants with the benefit of sophisticated restructuring advice may look to other tools to restructure their liabilities. Large tenant groups have successfully used the company voluntary arrangement (CVA) and, more recently, the restructuring plan. As landlords cannot opt-out of these restructuring tools, landlords and their stakeholders will need to be alive to the potential consequences should a tenant pursue a formal restructuring. At least for now, it seems that the options available to landlords remain limited.

Company voluntary arrangements

A CVA is a procedure under the Insolvency Act 1986. The procedure allows a company to compromise its unsecured liabilities, provided 75% of the company's unsecured creditors support the CVA. ^[6]

Pre-pandemic, the CVA had become the tool of choice to implement restructurings of UK lease liabilities. Tenant groups have used the CVA to release rent arrears and reduce go-forward rent payments (sometimes to as little as zero, or by moving to turnover rents). The use of so-called "landlord CVAs" has been particularly apparent in the retail, hospitality and leisure sectors. Appetite for the CVA in these sectors continued through the pandemic. Recent high profile CVAs include New Look, Caffé Nero and Clarks Shoes.

Despite its popularity, the CVA is not without scrutiny. Stakeholders have expressed concern about the treatment of landlords and the use of CVAs in tenant restructurings. Media reports indicate that the Insolvency Service has appointed an external consultancy firm to review the treatment of landlords in CVAs. Landlords have been increasingly willing to challenge CVAs in court on grounds of "material irregularity" or "unfair prejudice". While successful challenges have been few and far between, ^[7] we wait to see whether this increased scrutiny will reduce the appeal of CVAs to large tenants.

Restructuring plans: a long-term alternative to the CVA for large commercial tenants?

The UK restructuring plan (the plan) is a recent addition to the UK's cross-border and domestic restructuring toolkit. Based on the scheme of arrangement, the plan provides distressed companies with a mechanism to bind dissenting groups of creditors or shareholders into a restructuring (often referred to as a cross-class cramdown). Further information on the restructuring plan, and some notable examples of how it has been used to date, can be found in our Restructuring Across Borders platform (see our factsheet titled England and Wales – schemes of arrangement, restructuring plans and voluntary arrangements, available here) and in our recent alert.

The cross-class cramdown mechanism makes the plan a flexible restructuring tool. Companies in financial distress have the ability to implement a restructuring of its financial and secured creditors, unsecured creditors, trade creditors and shareholders, all within one procedure. The Virgin Active plans demonstrate why large tenants and their stakeholders should take notice of the plan. The international health club operator used the plan to implement a comprehensive restructuring of its secured creditors, landlords and general property creditors. This was the first use of the plan to implement a restructuring with the support of secured creditors and certain landlords. The cross-class cramdown mechanism allowed Virgin Active to bind dissenting landlords and general property creditors into the restructuring.

The precedent set by Virgin Active may result in large corporate tenants moving away from the CVA as the restructuring tool of choice – particularly if "landlord CVAs" are increasingly scrutinised. In the face of the cross-class cramdown mechanism, the options for landlords of distressed large corporate tenants seem increasingly limited. Landlord groups may struggle to assess their "tenant covenant" going forward, when faced with a restructuring mechanism that can compromise (without their consent) their right to rent, any guarantees that support their rent, and any security for the non-payment of rent. On the other hand, while a plan can compromise the amount of rent due under a lease, a plan cannot deprive a landlord of its right to forfeit or terminate. While that right may have less practical significance if the landlord would have trouble re-letting the premises, that right could make a difference in the future if rental values increase.

The new ringfencing and arbitration regime, and the future for landlords and tenants

There is an expectation that the new ringfencing and arbitration regime will be of limited relevance for large tenants and their landlords. Reports suggest that many have already resolved any rent arrears that accrued during the mandated lockdowns of 2020 and 2021. However, large tenants, their landlords and other stakeholders continue to face economic uncertainty. The limited scope of the ringfencing and arbitration regime will result in large distressed tenants looking to other restructuring procedures to implement a holistic solution to their financial difficulties. 

_{1. "Business tenancy" means a tenancy to which Part 2 of the Landlord and Tenant Act 1954 applies. The working draft guidance for arbitrators in relation to the exercise of their functions under the Act, published by the government on 28 February 2022, states that a "Business tenancy is a tenancy to which Part 2 of the Landlord and Tenant Act 1954 applies.  That is, a tenancy comprised of property which is or includes premises that are occupied by the tenant for business purposes, or business and other purposes". We would note that this definition leaves the door wide open for interpretation and has generated substantial case law over the years.}

_{2. Subject to the Secretary of State's ability to, by separate regulation, apply the new regime to any period of coronavirus controls after 7 August 2021.}

_{3. We note that the Act provides that the Secretary of State may, by separate regulation, extend the initial six month period.}

_{4. We note that the Act provides that the Secretary of State may, by separate regulation, extend the initial six month period.}

_{5. Specifically, a voluntary arrangement, schemes of arrangement or restructuring plan.}

_{6. 75% by value of those unsecured creditors that respond in the decision procedure. Further, the CVA may only pass provided that no more than 50% (by value) of creditors unconnected with the company vote against the CVA.}

_{7. For example, the courts have recently rejected significant landlord challenge to the New Look and Caffé Nero CVAs.}