updated on 24 July 2018
QuestionWhy are so many high street retail chains in distress and will company voluntary arrangements (CVAs) and administration filings help them?
Over the last 18 months UK retailers have faced challenging headwinds that are showing few signs of abating. Businesses that were once staple fixtures of the high street have struggled to survive due to increasingly poor financial results and many have closed their doors. Legal tools, such as CVAs and pre-pack administration sales, while not a silver bullet for an ailing retailer, may, in the right circumstances, limit the damage to the business and provide a platform for recovery as the sector bridges towards a new retail landscape.
In 2018 over 7,000 people have lost their jobs in the UK retail sector, with around 9,500 more positions at risk as a result of further store closures. Stories of retail casualties are a frequent sight in British newspapers, a recent example being the administration of Poundland that has endangered over 5,000 more jobs. It has also been widely reported in the print media that stores are closing across the UK at a considerably faster pace than they are opening.
There are many reasons why UK retailers have struggled over recent years. However, certain common themes often seen across distressed retailers include (i) having too large a physical footprint, (ii) struggling to handle increasing cost pressures, and (iii) poor historic and/or current management.
Certain distressed retail businesses operated a business model in the late 20th Century and early 21st Century that rewarded aggressive expansion and which was highly focused on revenue growth. Such stores were often leased on long-term contracts (in some cases up to 40 years) with only upwards rent review provisions and limited termination rights for the tenants resulting in many retailers being locked into expensive contracts.
Management of retail businesses have additionally, in some cases, been criticised for a lack of creativity and unwillingness to change when faced with a target market pursuing a channel shift away from physical stores to online platforms and ‘replacement retailers’ such as Amazon and the large supermarkets, which have each steadily encroached on the territory of specialist retailers and department stores.
Turning to external factors, there are clear indicators that people are simply spending less in retail stores and more on leisure pursuits, with a greater proportion of household income now being spent on non-physical items such as gym memberships, subscription services and so-called ‘experience-based’ activities. This is further compounded by the challenging macroeconomic climate in the UK, which is experiencing flat growth and poor consumer confidence, particularly as uncertainty remains as to the parameters and impact of the UK’s departure from the European Union. The weakening of the pound since the 2016 EU Referendum has also had a considerable impact on retailers, as many are reliant on imported goods that have become considerably more costly and profitability is therefore negatively affected.
Many businesses in the retail sector have contrastingly adapted well to the changes that have swept the sector and continue to prosper (albeit to varying degrees), particularly in the online retail space. ASOS, Net A Porter and Amazon are examples of businesses that have managed to remain profitable in a challenging market, and have avoided the pitfalls of the traditional retailers; such businesses particularly standing out through their use of technology, efficient and easily navigable websites, and effective online marketing to establish and grow their brands.
The ‘fast-fashion’ industry has also flourished with certain online retailers having highly scalable and nimble businesses which are appealing to investors. This business model allows for a quick turnover of stock online and in-store (if indeed they have any stores), meaning retailers can react quickly to new trends and have new stock available (rather than being limited to quarterly-lines) to the benefit of both vendor and customer.
In addition, the last decade has also seen the rise of destination sites such as the Bicester Village luxury shopping outlet in Oxfordshire, which has enjoyed consistent popularity and offers a very different proposition to the old-style retail park in a niche area of the market.
There are a number of legal avenues that companies and creditors can pursue when a business is stressed or distressed, ranging from ‘light-touch’ actions to more wholesale debt and operational restructurings.
In certain situations where retailers have been unable to negotiate fully consensual restructurings with their various creditor groups, CVAs and, to a lesser degree, pre-pack administration sales have proved popular with retailers and their creditors.
A CVA is a compromise or arrangement between a company and all of its unsecured creditors, governed by the English Insolvency Act 1986. CVAs can only be proposed by a company’s directors and require the approval of 75% of creditors by value, and a simple majority of unconnected creditors, who vote together (rather than in separate classes or categories).
Rents are often one of the biggest financial liabilities of UK retail businesses and CVAs are commonly used to restructure rent liabilities to landlords. When formulating a CVA proposal to its creditors, a company will often group its landlords and leases according to their profitability, for example:
Examples of recent retail CVAs are Blue Inc (March 2017), Toys “R” US (December 2017), New Look (March 2018), Select (March 2018), Carpetright (April 2018), Mothercare (May 2018) and House of Fraser (June 2018).
A key benefit of using a CVA to address certain liabilities is that, in theory, minimal disruption should be caused to the business. This strength of the CVA can also be its weakness, in that an arrangement in respect of only certain unsecured liabilities (eg, rents) may not fix the business as a whole, and a broader financial and operational restructuring may be required in certain circumstances.
Pre-pack administration sale
A pre-pack administration sale involves the sale of a business or its assets by administrators of a company, with such sale negotiated with the relevant purchaser and the administrator prior to the company entering into the formal administration process. The purchaser is often (though not always) already associated with the company, its shareholders, management or creditors.
One of the great advantages of a pre-pack administration sale is that the sale can represent something of a ‘clean slate’ for the business and the management team is likely to change. In certain cases, the transfer of the business can have the dual benefit of taking the business away from incumbent management who may have been responsible for its downfall, and providing the means by which certain other liabilities can be left behind in the old structure.
That said, pre-pack administration sales do not offer a cure for all the ills of a company, and it will be incumbent on the new owners to ensure better ongoing management and the implementation of a strong business plan to revive the business once the sale has been completed. An administration process is also highly public and constitutes an insolvency process which may have negative impacts on the key contracts of a business and its reputation with customers and suppliers.
Consensus in the market is that the UK retail sector, and particularly UK high streets, will likely undergo considerable change, but retail will continue to be a major employer and contribute considerably to the national economy.
Some of these changes can already be seen, for example in those businesses that operate almost entirely online but who have a handful of showrooms or open pop-up shops in prominent locations around the country.
Consumers now appear to be demanding more from retail and their shopping experience and retailers are therefore becoming increasingly diversified and offering something extra alongside sales. Sportswear retailer Lululemon, and other lifestyle brands, now offer yoga and pilates classes in-store, IKEA has started a supper club where consumers are catered for by an IKEA chef while dining in an IKEA showroom/shop, and many cafés also operate some form of retail element in parallel with their food and drink offering.
Those retailers that do not manage to keep up with these developments and adapt to the new retail environment, or those for whom legacy issues represent an unsustainable burden and so require wholesale financial and operational restructurings, may find themselves needing to use restructuring tools to provide them with a platform to rescue their business. These tools will however simply provide the platform for survival, and the fate of any retail business will ultimately depend on the strength of its management and implementation of a robust business plan.
Associate Adhuv Prinja and partner Ian Wallace are both in the financial restructuring & insolvency group of White & Case.