Court dismisses landlord's challenge to Caffe Nero's CVA

The High Court has dismissed a challenge to Caffe Nero's company voluntary arrangement (CVA) in Young v Nero Holdings Limited. The Applicant in the proceedings, Mr Young, was a landlord of premises let to the First Respondent, Nero Holdings Limited (the Company) and challenged the Company's CVA under s 6(1)(a) and (b) of the Insolvency Act 1986 (the Act). Mr Young alleged that the Company's CVA was unfairly prejudicial to the rights of creditors and that the procedure and circumstances around the approval of the CVA were materially irregular.

Mr Justice Green firmly rejected all of Mr Young's allegations of material irregularity and unfair prejudice and dismissed the challenge application.

Travers Smith acted for the nominees, Mr William Wright and Mr David Costley-Wood (both then partners of KPMG LLP), who were named as co-respondents to the application.

        
        Key takeaways at a glance:
    
Electronic voting procedures can be used for CVA processes, but the procedure for adjourning or postponing the voting deadline if this becomes necessary or desirable is uncertain.

Nominees of CVAs will be judged on whether they acted rationally and in good faith. The court will only interfere where the nominee has done something that no reasonable nominee would have done in the circumstances.

A material irregularity challenge to a CVA will only be successful where there is a substantial chance that it would have made a material difference to the way in which creditors consider and assess the terms of a CVA.

Modifications to CVAs can be introduced during the course of an electronic voting procedure after creditors have begun voting. Aggrieved creditors' redress in this instance would be to commence challenge proceedings post-approval of the CVA.

Last-minute offers to acquire a business may be unlikely to de-rail an electronic voting process. Bidders would be recommended to take earlier action if they wish to delay a CVA vote while a potential transaction is considered.

Now Reading

Background to the Challenge Application

The challenge to Caffe Nero's CVA is the latest in a number of recent challenges reaching the court in relation to CVAs. Whilst other CVA challenges (including, for example, the Debenhams and New Look CVA challenges) have focussed on the content and effect of the relevant CVA, the challenge to Caffe Nero's CVA primarily turned on various decisions made by the directors and the nominees in the lead up to the approval of the CVA.

Like many other companies in financial difficulties with substantial leasehold portfolios, the Company sought to address its financial difficulties through the use of a CVA, which, amongst other things, was intended to rationalise the Company's lease portfolio. Due to the ongoing restrictions imposed by the COVID-19 lockdown measures at the time, the decision was made to obtain creditor approval for the Company's CVA by way of electronic voting. The provisions of the Act and the Insolvency Rules 2016 (Rules) in relation to electronic voting allow creditors to vote at any point up to the deadline for voting, but creditors cannot change their vote once it has been cast.

The day before the deadline for voting, EG Group Limited (EG), majority owned by the brothers Mohsin and Zuber Issa, made an offer for the shares in Nero Group Limited (NGL) (the Company's parent), including an offer to pay all the Company's landlords' rent arrears in full (EG Offer). EG claimed that it wanted the Company's CVA to be approved following the sale of the shares, but with those enhanced terms for the landlords included and asked for the CVA vote to be postponed while the EG Offer could be properly explored and negotiated. The following day, the EG Offer was rejected by the shareholders and the decision was made to allow the deadline for voting to continue as originally scheduled, with a modification being made to add a term to the CVA that the enhanced terms offered by EG would be given to landlords in the event that a sale to EG did proceed (the Modification). The CVA was approved by the requisite majority of creditors and by the Company's shareholder.

Challenge Application

EG funded Mr Young in bringing a challenge application against the Company's CVA. Mr Young relied on the following five alleged material irregularities:

The failure to adjourn or postpone the creditors' voting procedure in light of the EG Offer;
The failure to engage with or seek further information from EG or its advisors in relation to the EG Offer;
The content of the announcement made to creditors about the EG Offer (the Announcement), in particular that it did not fully explain and set out the terms of the EG Offer;
The terms of the Modification and the effect of the creditors' votes already cast by the time the Modification was proposed; and
The failure to update the nominees' report on the likelihood of success of the CVA.

In addition to the material irregularity arguments, Mr Young's unfair prejudice challenge was based on the assertion that the relevant counterfactual to the CVA was not an administration with a minimal return to unsecured creditors but, instead, would be a sale of the business to EG in which arrears owing to landlords would be paid in full.

The decision not to adjourn/postpone

The directors and nominees provided evidence to the court that the decision not to adjourn/postpone the vote was made for multiple reasons. In particular: (i) the timing and nature of the EG Offer and the fact that the shareholders had rejected it; (ii) that the group had a large syndicate of lenders and it was feared that there was a fragile consensus among the lenders which could collapse if the previously granted waivers had to be re-negotiated; and (iii) the change to the Crown preference rules from 1 December 2020 would result in HMRC becoming a preferential creditor for approximately £1 million and it would not have been possible to compromise that claim under the CVA. In addition to these factors, the Rules do not contain provisions for the adjournment of an electronic vote.

Mr Justice Green concluded that the nominees "acted in good faith, in accordance with their professional duties and reached a perfectly reasonable decision that it was not in the best interests of the creditors to postpone the CVA Process…Balancing all the relevant factors and the risks involved, under considerable time pressure and without any clear route for postponing an electronic voting procedure, the conclusion that the nominees came to was well within the range of what a reasonable nominee could have come to in those circumstances". He concluded that the directors could not be criticised for making the same decision.

        
        Key takeaways:
    
The electronic voting process: Mr Justice Green commented that the issues that arose in this case were largely a result of the inflexibility of the electronic voting procedure. The Rules do not allow creditors to change their vote after they have voted and do not specifically cater for a situation (like in this case) where a major development occurs late in the CVA process. However, Mr Justice Green did not criticise the nominees for choosing the electronic voting procedure and noted that they were bound to use it (or another qualifying decision procedure other than a physical meeting) by the Rules unless there was a good reason for them not to do so.

Postponing an electronic vote: In circumstances where there is no power to postpone an electronic voting procedure (unlike the rules relating to a physical creditors' meeting), Mr Justice Green was clear that a decision not to postpone the CVA process following a last-minute offer did not amount to a material irregularity. The Judge noted that this lacuna in the Rules may need to be looked at by the Insolvency Rules Committee. In the absence of any statutory provision dealing with postponements of an electronic voting procedure, the only option open to the directors and nominees was to apply to court. The judge acknowledged that this would be a novel approach which would have carried risk and it was uncertain that the court could have done anything meaningful in relation to the Company's CVA.

Nominee conduct: The judge reiterated that nominees are to be assessed by reference to whether they acted rationally and in good faith, and that, in the absence of fraud, the court will only interfere if the nominee has done something that no reasonable nominee would have done in the circumstances. Whilst all insolvency practitioners should be seeking to act in accordance with their various duties, it is helpful that the court recognises the limited role that nominees will have in relation to the proposal of a CVA.

The failure to seek further information in respect of the EG Offer

Mr Young raised the issue as to whether the nominees and directors should have sought to engage with EG or its advisers in the 27 hours between receiving the Offer and the vote closing. Mr Justice Green considered that the decision not to adjourn or postpone was made separately by the nominees and the directors for sound reasons and the failure to engage with EG did not undermine the basis for that decision, and could not, in itself, amount to a "material irregularity".

The Announcement

The Announcement was prepared collectively by the nominees, the directors and their advisers (with PR input). Mr Young argued that it failed to provide a fair and accurate summary of the EG Offer and instead put forward a slanted view, omitted key information and was generally misleading. Mr Young made no allegation against the nominees in this respect.

Mr Justice Green considered the Announcement in detail and concluded that it was fair and reasonable. The relevant terms of the EG Offer disclosed in the Announcement were well within the “margin of appreciation” that the court allows. Mr Justice Green did not consider that the criticisms of the Announcement made by Mr Young were material in the sense that the CVA vote would have been different had the alleged omissions or inaccuracies not been made.

Key takeaway:

Material irregularity: This case follows the judgment in the Debenhams CVA that an irregularity in relation to a CVA will only be "material" if there is a substantial chance that it would have made a material difference to the way in which creditors consider and assess the terms of a CVA. This will be assessed objectively, rather than looking at the subjective approach of individual creditors. Therefore, it is not enough to allege that specific creditors in a case would have changed their assessment of the CVA. The question is whether the court considers that an objective creditor would have done so.

The Modification

Following the issue of the Announcement, it was decided that the Modification should be made to the CVA proposal to provide a degree of further protection to creditors if a sale did eventually take place to EG within six months of the implementation of the CVA.

By the time the Modification was notified to creditors, the CVA had already passed the voting threshold. Mr Young argued that the CVA Proposal therefore changed by virtue of the Modification before the time it would have been deemed to take effect but after almost all voting creditors had voted. Mr Justice Green considered that the Modification objectively improved the terms of the CVA Proposal for the creditors. He considered that in such circumstances, there could be no basis that it could constitute a material irregularity.

Key takeaway:

Modifications after electronic votes have been cast: Mr Justice Green held that it was possible for a modification to be introduced during the course of an electronic voting procedure after creditors have begun voting and if the proposal is approved, the modification should be treated as having been approved "so long as the company has also consented." The Judge regarded any other approach as being "impractical, inconvenient and contrary to the interests of creditors and the clear Parliamentary intention that CVAs should provide a flexible tool responsive to the needs of insolvent debtors and their creditors." He said that, if a creditor were dissatisfied with the inclusion of a modification after they had cast their vote, then the correct recourse is to bring a challenge under s.6 of the Act, but that such a claim would clearly be difficult to sustain where the modification was for the sole benefit of creditors, as it was in this case.

The Nominees' Report

Mr Justice Green did not consider that there was any obligation on nominees to update their report to reflect receipt of the EG Offer. Mr Wright made clear in his written evidence that his opinion in the nominees’ report had not changed in light of the EG Offer, including “that there was no manifest, unavoidable prospective unfairness in relation to the CVA Proposal.”

Unfair prejudice

Mr Justice Green noted that the unfair prejudice argument was underdeveloped. He concluded that the CVA was not unfairly prejudicial to Mr Young’s interests as a creditor, and that there was no basis to conclude that the likely alternative in the CVA should have changed to reflect the EG Offer. He noted that an argument that the likely alternative should have changed was based on vague and speculative scenarios of what might have happened. He saw no basis to conclude that the relevant alternative to the CVA was a transaction with EG in which all the landlords’ rent arrears would be paid in full. Such a conclusion would be contrary to the way the relevant parties would have acted in their own commercial interests and there was great uncertainty over what would have happened if the CVA had failed. The relevant alternative being proposed by the applicant could not therefore be considered a likely, still less the relevant, alternative to the CVA.

Concluding remarks

This case has given welcome clarification to directors and insolvency practitioners that last-minute offers to acquire companies in financial distress (intended to exert pressure) are unlikely to succeed in disrupting a CVA, even if the offer purports to offer a better return to creditors. Instead, interested bidders will need to ensure timely communication with distressed targets to enable meaningful engagement.

The number of recent CVA challenges is bringing further clarity for those proposing CVAs in future. Challenging creditors have had limited success in bringing CVA challenges to date, but the judgments help define the parameters which should be worked within. Whilst this challenge was certainly specific on its facts, it brings further clarity to advisors who are dealing with rapidly developing events in a CVA process.

Our experience

Travers Smith's involvement in this CVA challenge adds to our wealth of cross-disciplinary experience and expertise in high-profile retail and leisure restructurings. This has included acting on the CVAs of Carpetright, Carluccio's, House of Fraser, Debenhams, Gaucho, Powerleague Fives, itsu, YO! Sushi, Harding Brothers and Dune of London, as well as the administration sales of the Azzurri Group and Laura Ashley, and Virgin Active's successfully sanctioned, ground-breaking Restructuring Plan.

Read Hannah Drury Profile