A Landlord’s Vote in a CVA: A Worked Example

Scenario

Let’s assume that we are the landlord of a 2,500 square foot commercial premises, let on a ten year lease.

There are seven years left of the term, but the tenant has a break option exercisable in two years’ time. Rent is £100,000 per annum and service charge and insurance £16,000 but, following non-payment of the March quarter, the tenant owes £25,000 of rent and £4,000 in other sums.

If the premises are taken back, it will likely take 12 months to re-let and the marketing, legal and agents’ costs of doing so may be in the region of £12,500. Any incoming tenant will seek six months’ rent-free, but in a declining market any new rent achieved will likely be at only 65% of the current level.

The calculation

Since a CVA is proposed as an alternative to more nuclear insolvency options, the only fair basis for calculating a landlord’s claim is to assume that the lease is to be immediately terminated. This allows the Nominee (the insolvency practitioner who compiles the proposal) to work out what the landlord would claim for, if it suddenly lost the benefit of the lease going forward.

Existing arrears

Uncontroversially, the calculation will always admit pre-existing arrears at their full value, like any other debt. So, in our example, the £29,000 arrears are allowed without deduction – and for that reason, they are applied to the calculation last. So we will park them for now, and look at how future amounts are dealt with.

Future rent

Technically, the insolvency legislation states that future claims can be admitted for as little as £1 since they might never come to pass. However, given the relative certainty that contractual lease claims will in fact arise, CVA Nominees will commonly attribute a far more realistic value than the notional £1.

They will begin by working out the rent and other sums that will fall due over the remaining term of the lease – or until the next tenant break date. Here, that means two years’ rent (£200,000) and two years’ service charges/insurance (£32,000).

Re-letting

Added to this will be the £12,500 cost to the landlord of having to market and re-let the premises, and an allowance for dilapidations. Although this will vary with the type of property and the surveying advice received by the Nominee, something around £10-£12 per square foot is typical. So, at 2,500 square feet, our dilapidations figure might be taken as £27,500.

The subtotal of our future claim to this point is, therefore, £272,000.

Against this, the landlord will be expected to give credit for its ability to re-let the premises (which, in the current market, might or might not be a justified assumption).

We know that our unit will take 12 months to re-let, and that the incoming tenant will be given six months’ rent free (but no discount on service charges or insurance). The new rent stream therefore kicks in 18 months from now, and we will receive six months’ rent – and a full year’s service charges – from the new tenant before we reach what would have been the break date in the current lease. Since our new lease will be at a reduced rent of £65,000 per year, we will have to give credit for £32,500 in rent and £16,000 in service charges/insurance rent that the hypothetical new tenant will be paying.

Acceleration

At this point, the Nominee will calculate the “net present value” of the future amounts being looked at. Essentially, this is to reflect the fact that – for the purposes of the calculation – the landlord is not having to wait to receive its income over the course of two years. Of course, receiving future payment up front would be of value to any landlord, so to off-set this the Nominee will discount the future claim by around 5% per year. In our example, that results in a discount of around £21,100.

Speculation

Finally, the “future” element of the claim will again be reduced, to reflect that it is, ultimately, speculative. The landlord itself could go bust in the next two years. It could sell its interest, or the Covid fallout could result in a complete re-negotiation of the lease terms. Any number of events could occur between now and the end of the lease (or, in our example, the next tenant break date), and this is usually reflected by reducing the future element of the landlord’s claim by 25%.

The claim

Taking all of the above into account, our claim can be expressed as follows:

* Re-letting costs are generally excluded from the NPV deduction.

Here to help

This week alone, several more household-name retailers have proposed CVA’s as they look to survive both the short and medium term impact of the Covid pandemic. At the same time, many landlords will be subject to their own financial pressures and will want reassurance that the value and income represented by their interest is secure. It will be of natural concern, then, that most retail CVA’s run into the hundreds of pages, comprised of inaccessible drafting and references to obscure parts of the insolvency legislation.

If you require any help with understanding a CVA presented by a retail tenant, or in checking the value of your claim and submitting it as part of the creditors’ vote, the team at Memery Crystal are on hand to guide you through the process.