You would be forgiven for assuming that when the going is good, commercial landlords care more about how much rent is coming in than who is paying it. The thinking goes that if the tenant fails to pay the rent, you simply take possession of the asset and re-let it to a new business. If the economy is going great guns, or it is a particularly desirable asset or location, you may even be able to increase the rent – what an easy life!
Indeed, if you ask an average accountant, they will probably advise that when putting your accounts together, the “loss given default” of a lease asset should be very low – you own the asset after all, and can just take it back.
Sadly, things are rarely this simple. Though the law is usually on the landlords’ side; in most cases a landlord can simply renter the premises and take possession for unpaid rent, there is still the issue of all the costs involved. Cleaning and repairing the asset as well as the estate agent fees for reletting can soon see returns for the year go negative.
So it wasn’t all that easy beforehand and the coronavirus pandemic has made things much harder. Section 82 of the Coronavirus Act 2020 which prevents landlords from forfeiting business tenancies has been extended until 30th September 2020, and there are provisions in place for this to be further extended. What this means is that Landlords have not been able to take possession since the lockdown began in March.
At this point, wise heads will be dreading the next three letters: CVA.
A Company Voluntary Arrangement or CVA is a process which allows an insolvent company to pay creditors over a fixed period. If creditors agree, the company can continue trading, rather than be wound up.
The process is relatively simple, an insolvency practitioner will be appointed to work out an ‘arrangement’ covering the realistic amount of debt the company can pay, and a new schedule of payments. To keep the company trading this is a quick process, legally it has to happen within a month.
It is then up to the company’s creditors to vote on the arrangement and the CVA is approved if 75% (by debt value) of the creditors who vote agree.
This means that if the lease you hold as a commercial landlord is worth less than 25% of the total company creditors, then you can be bounced into taking a significant rent cut with no recourse – the new rent cut is the rent, and as long as they pay it and stick to the other terms of the lease, there’s nothing the landlord can do about it.
With all of this in mind, it is vital that commercial landlords are ready for this gathering storm. The first step is to ensure that you understand the debt structure of any tenant – if a CVA occurs, who is calling the shots?
Secondly, it is important that the creditworthiness of tenants is given more than a cursory glance, both when the lease is signed and on an on-going basis; a landlord can’t prepare, if it doesn’t know there’s a problem.
Thirdly, you need to assess the impact of a CVA on your overall returns. Does the potential for a loss of rental income make commercial property investments less attractive? With all of the fixed costs involved in commercial property ownership it may be the case that the risk is too great.
Finally, if the CVA process is entered into, its important to get independent financial advice through the process; to understand what the impact of a CVA would be compared to liquidation, and how the landlord should vote.
Arlingclose can assist clients with any part of this process. To discuss this please contact Stephen Kitching, Consultancy Director skitching@arlingclose.com