LEGAL ANALYSIS: New Look faces dual operational and financial restructuring; CVAs back in fashion - Debtwire

LEGAL ANALYSIS: New Look faces dual operational and financial restructuring; CVAs back in fashion

02 February 2018 - 12:00 am

UK-based value fashion retailer New Look faces an uphill battle following an extended and accelerating sales slump. The struggling retailer – which operates almost 900 outlets, mainly in the UK but also across Europe, China and the Middle East – has recently overhauled its executive management team and is implementing strategy changes. It is now considering a company voluntary arrangement (CVA) to shed surplus stores and slash its rent bill in the UK. While the retailer has a favourable maturity schedule (with no term debt maturities until 2022) as well as some runway given still reasonable liquidity and an undrawn RCF, its annual interest bill and committed capex in FY18 suggest it is burning cash at a furious rate, making a financial restructuring seem increasingly inevitable.


In this Special Report, Debtwire’s legal analyst team takes a quick look at the background to New Look’s woes and considers options for implementing a potential retail sector restructuring, including CVAs.


Out of fashion


The past few months have been pretty bleak for New Look – in its interim results in November, majority-owner South Africa-based listed group Brait SE marked down its investment in New Look to nil until a turnaround strategy is implemented. Further, the retailer is under mounting pressure as several of its suppliers can no longer secure full credit insurance, with Euler Hermes among major creditor insurers to have ended cover for future deliveries to New Look, as reported. The situation may be exacerbated by New Look’s links to struggling Steinhoff – whose largest investor Christo Wiese also owns the majority interest in Brait – which have been detrimental to confidence in New Look’s ownership.


New Look’s sales performance has been steadily weakening, driven by its stock missing or being late to certain trends, not clearing ranges by the end of season due to organisational complexity, reduced flexibility and speed plus an increased costs base. The company hopes that recent management and strategy changes will rectify these issues.


New Look’s debt pile is in excess of GPB 1.2bn, comprising an undrawn GBP 100m revolving credit facility (RCF), GBP 700m and EUR 415m senior secured notes due July 2022 issued by New Look Secured Issuer plc and GBP 200m senior unsecured notes due July 2023 issued by New Look Senior Issuer plc. While the company has adequate liquidity for the time being, it faces an annual interest bill of GBP 75m and some GBP 70m of committed capex in FY18 while full-year EBITDA is expected to fall to as low as GBP 30m, which means the group could soon face a liquidity shortfall that could trigger a balance sheet re-work. CLICK HERE for the capital structure.


Certain bondholders have formed a committee and lined up legal advisers with other groups set to emerge. The different bondholder groups may pursue separate strategies depending on whether they are par holders or hedge funds that acquired the debt at a discount – with par holders likely to be playing a longer game.


CVA – a retail saviour?


New Look is considering a CVA to close around 60 of its c.600 UK stores and reduce rent for others, thus slashing its rent bill.


CVAs are a useful tool in situations where a potentially decent business is hampered by the costs of maintaining over-priced and/or underperforming leased sites. They are typically used by retailers to reorganise their lease obligations in one fell swoop. As well as high street retailers, CVAs have been used by gyms (Fitness First) and hotels (Travelodge).


The UK retail sector is one to watch in 2018 as retailers face mounting pressure from rising costs, reduced customer confidence resulting in the tightening of purse strings and changing spending habits. Specific thorns in high street retailers’ sides include the Brexit-induced fall in sterling value driving up the cost of importing goods; the irrepressible rise in online shopping – including most recently via mobile phones – forcing retailers to reassess their bricks and mortar store portfolios and invest heavily in internet and mobile technology; ever-increasing customer demand for next-day – or even same-day – delivery (once considered a market-leading USP and now simply expected as standard by many); and even the good old British weather. The National Living Wage (NLW) which became law on 1 April 2016 (and has since increased) has also had a significant impact on the retail sector, as have business rates charges which came into effect last year. Insolvency statistics show that the retail sector is one of the hardest hit.


A CVA is essentially a compromise between a company and its creditors under the Insolvency Act 1986 that – like a scheme of arrangement – is proposed on the basis that it should offer a better outcome for creditors than an administration or liquidation, hence why landlords (and other creditors) will be willing to engage with the process (see examples of the terms of some recent high-profile CVAs below). The business continues to operate with the CVA under the supervision of an insolvency practitioner.


The CVA process typically involves the directors (guided by advisers) devising a CVA proposal, followed by a creditor vote. The voting threshold is 75% in value of voting creditors (with a further test of 50% in value of unconnected creditors). All unsecured claims are entitled to vote (a wholly secured debt carries a nil value for voting) regardless of whether they are directly affected. Unlike a scheme of arrangement, there are no creditor classes, even if different categories of creditors will receive different treatment pursuant to the CVA (see below for examples of how creditors may be treated differently). CVAs cannot bind secured creditors without their consent.


There is a 28-day period when creditors can apply to court to challenge the CVA on the grounds of unfair prejudice or material irregularity. The requirement that a CVA must not be ‘unfairly prejudicial’ does not mean all creditors must be treated the same, and different agreements can validly be reached for different creditor categories. So, for example, ‘performing’ stores might see rent payment dates being changed from quarterly (rent for retail premises is typically paid quarterly in advance) to monthly, while the leases of non-performing outlets might be brought to an end.


The most talked about CVA of recent years is no doubt BHS (March 2016), which provides of a good example of how creditors can receive different treatment under a CVA. That CVA split the retailer’s 164 sites into three main categories, each to be treated differently. The most viable stores would not see a rent reduction, although payment terms would be altered from quarterly to monthly for a period, while rent reductions of varying degrees were imposed on other stores – although these landlords were given the chance to take their premises back. A particular problem for BHS was that certain of its leases were based on terms negotiated decades ago and were no longer appropriate in the current retail environment and the CVA sought to address this.


Unfortunately, CVAs often do not save a company from toppling into administration (or liquidation): BHS’ problems ran deeper than its onerous rents and included a hefty wage bill and huge pension deficit. As a result, its CVA ultimately failed and BHS entered administration in April 2016. Austin Reed suffered a similar fate, having agreed a CVA before entering administration. Over recent years several other high street names have plunged into administration following the approval of a CVA. There are, however, examples of successful CVAs, including Fitness First (2012). While CVAs may offer a stay of execution, they cannot solve myriad problems, hence why New Look almost certainly requires a financial restructuring as well.


Although the proposed terms of New Look’s potential CVA are not known, it is understood to be looking to shut around 60 stores and cut rent for others, so it is likely the stores will be divided into categories according to the treatment they will receive under the CVA. One issue that New Look and its stakeholders will be considering is that all unsecured claims have a vote – ie even if they are not landlords or subject to the proposed lease amendments, so it will not just be landlords New Look needs to get on board. As noted above, the creditors would vote together, with no division into classes (regardless of how creditors may be categorised under the CVA). The leases are likely to be made with operating companies that are separate from the entities through which New Look issued its bonds.


In New Look’s case, if a restricted company were to enter into a CVA, this could potentially constitute an event of default (EoD) under the ‘bankruptcy provision’ of the senior secured notes and senior notes documents, so a waiver would also need to be sought from a majority (50.1%) of both the secured and unsecured bondholders.


Aside from New Look, CVAs are set to be big news this year. Toys R Us agreed a CVA shortly before Christmas and House of Fraser has requested significant rent reductions from several landlords. The casual dining sector is also under pressure and expected to bring some restructurings this year: Byron burgers recently announced a CVA which completion of a financial restructuring is conditional on. The CVA splits the property portfolio into three with category one leases being retained at current rates, category two leases seeing a rent reduction and category three leases having a reduced rent for six months while the company negotiates with landlords to agree on the future of those sites. The creditors approved the CVA on 31 January. Jamie Oliver’s Italian is also in restructuring talks.


It is not just the retail sector where CVAs have been used in recent years – towards the end of last year a CVA was approved by creditors of collapsed broker MF Global (in special administration). Put very simply, the MF Global CVA, which dealt with future distributions to creditors and aimed to facilitate the winding up of the estate, provided creditors with options: agreeing to a cash distribution so they can walk away with 99.75 pence in the pound in their back pockets, or remain medium-term creditors, or remain creditors long-term and participate in funding of distributions and benefit from a potential upside. As well as benefitting creditors, this would aid the company by reducing the number of creditors, which was around 3,500.


Financial restructuring


Any CVA is likely to be followed by a workout of New Look’s financial debt, with a liability management exercise a likely option. The nature of any capital structure re-work will depend on the debtor’s specific circumstances and could range from a simple amend-and-extend through to a drastic haircut. A debt-for-equity swap will no doubt be mooted in New Look’s case.


With New Look’s unsecured notes trading in the high teens and the secured notes in the high 40s, the value clearly breaks in the senior debt, which suggests that the unsecured debt will be wiped out, although they may have nuisance value.


A consent solicitation process could be attempted to amend the notes. Although we have not seen New Look’s note indentures, we understand that the consent of 90% (in value) would be needed to amend fundamental terms such as principal amount, maturity or interest rate, as is typical for New York law governed bonds issued by European issuers. If any amendment would only amend one series of the notes the consent of 90% of the outstanding aggregate principal amount of notes in that series would be required.


An alternative strategy is an exchange offer, offering bondholders the chance to exchange their bonds for new paper (which may be longer-dated or carry a lower interest rate) or a debt/equity package. An exchange offer will generally be conditional upon a certain percentage (often 90% plus) of the bondholders consenting. Covenant-stripping, which would likely be subject to lower hurdle of 50.1%, can be used to reduce the appeal of retaining the existing bonds.


Back in November, Debtwire’s sister product Xtract Research looked at New Look’s debt capacity, in particular what debt can dilute or prime its senior secured notes. You can access the report HERE. The report concludes with an estimation of the restricted group’s potential additional debt (or exposure) capacity (and its priority) at: up to GBP 100m under the credit facilities basket, up to GBP 75m under the general debt basket, and that the group could add roughly GBP 72m of exposure under permitted trade L/C facilities.


If an out-of-court financial restructuring does not prove possible, New Look may look to use a formal procedure – such as a UK scheme of arrangement – to ‘cram down’ dissenting or apathetic creditors. Due to time constraints, a scheme may be planned in the background in parallel to negotiations to achieve an out-of-court deal, with the scheme being abandoned if a consensual restructuring is achieved. The threat of a scheme can motivate creditors to agree to a consensual procedure.


A UK scheme of arrangement is a procedure governed by the Companies Act 2006 that provides for a “compromise or arrangement” between a company and its creditors (or any class of them, so it could just be used for New Look’s bondholders, or a series of them). If a scheme receives the approval of the requisite majority of scheme creditors (a majority in number representing 75% in value of the creditors (or of each class of them) who vote) and the court sanctions it, it will bind all creditors subject to it, including any who do not vote or vote against it.


Schemes are highly flexible and can be used to achieve various types of restructurings, from amend-and-extends through to debt-for-equity swaps and full-scale workouts.


Both of New Look’s bond issuers are incorporated in England and Wales. Therefore, issues around establishing a ‘sufficient connection’ to the English jurisdiction – which are pivotal in schemes involving foreign debtors – would not arise. A scheme could still be used to restructure the bonds, even though they are governed by New York law: there are various precedents for this, most recently Bibby Offshore. In these circumstances, recognition of the scheme would need to be sought in the US under Chapter 15 of the US Bankruptcy Code.


The creditors involved form one or more class(es) to vote on a scheme. As a scheme must be approved by each class, the number of classes can be of crucial importance. The test that applies to the question of whether creditors should vote in separate classes is whether their rights are “so dissimilar as to make it impossible for them to consult together with a view to their common interest”. This involves considering both the creditors’ existing rights that the scheme seeks to vary, as well as any new rights the scheme confers. The focus should be on the creditors’ rights against the company, as opposed to interests such as commercial interests. A broad approach should be taken to avoid giving unjustified veto rights to a minority group. Working out whether creditors’ existing rights are the same or sufficiently similar that they can vote in the same class involves identifying the appropriate ‘comparator’ – eg, in a case where the alternative to the scheme is insolvent liquidation, the question is whether the creditors’ rights in liquidation would essentially be the same. It is established by case law that holders of different series of bonds can vote in the same class, regardless of differences such as maturity date.


Out-of-the-money creditors would not necessarily need to be included in a restructuring, ie the business and assets of the debtor could potentially be transferred to a NewCo, with in-the-money creditors getting rights (debt and/or equity) in the NewCo and out-of-the-money creditors being left behind. However, the unsecured bondholders’ nuisance value would need to be taken into consideration, ie whether they are needed on board for the restructuring.


Due to the uncertainty surrounding the application of Chapter II of the EU Judgments Regulation to schemes, in practice, the court must be content that it has jurisdiction over scheme creditors as well as the debtor. In recent cases scheme applicants have relied on either (or both) Article 25 (where the scheme creditors have submitted to the English court’s jurisdiction, ie where the relevant finance document contains an English jurisdiction clause) or Article 8 (where at least one scheme creditor is UK-domiciled and it is ‘expedient’ for all scheme creditors to be dealt with together to avoid the risk of irreconcilable judgments resulting from separate proceedings). For this reason, prior to instigating a scheme, the debtor’s lawyers would investigate whether any scheme creditors are domiciled in other EU member states and whether any are domiciled in the UK.


The company is working with Goldman Sachs, Houlihan Lokey, Linklaters and Paul Hastings while Deloitte is advising on its possible CVA. The ad hoc bondholder group hired Sidley Austin as legal adviser and Rothschild as financial adviser. Several secured bondholders are informally working with law firm Kirkland & Ellis while some secured bondholders are informally working with Hogan Lovells.


by Dawn Grocock


Disclaimer: We have obtained the information provided in this report in good faith from sources that we consider to be reliable, but we do not independently verify the information. The information is not intended to provide tax, legal or investment advice. We shall not be liable for any mistakes, errors, inaccuracies or omissions in, or incompleteness of, any information contained in this report. All such liability is excluded to the fullest extent permitted by law. Data has been derived from company reports, press releases, presentations and Debtwire intelligence.