What are Company Voluntary Arrangements?
The Company Voluntary Arrangement (“CVA”) was introduced in the Insolvency Act 1986 as a rescue tool. It is an insolvency process but unlike an administration or a liquidation it offers more of a “light touch” solution aimed at rescuing a company. Company Voluntary Arrangements should be considered when a company is not yet at the point on the business decline curve where it has no realistic prospect of a turnaround.
The CVA is essentially a commercial agreement put forward by a company to its creditors in the form of a proposal setting out how its directors plan to rescue the company and how they intend to deal with creditor claims.
Whilst the Company Voluntary Arrangements process requires an insolvency practitioner (“IP”) to assist in setting up and overseeing an arrangement, the role of the IP acting as supervisor of the CVA is primarily to ensure that the company is adhering to the terms of its proposal, the on-going management of the company rescuing with its director(s).
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An IP will review a proposal to ensure that it is fit for purpose, striking a fair balance between creditors and the company and satisfy himself/herself that there are reasonable prospects of it being implemented successfully.
Company Voluntary Arrangements should offer creditors a better return on their debt than the alternative, which would typically be an administration or liquidation.
What kind of companies suit a CVA?
A CVA lends itself well to a company that may have suffered a one-off hit to its balance sheet. For example, a large bad debt due to the insolvency of a major customer or temporarily ceasing to trade due to a government-imposed lockdown. More recently it has been a useful process to assist companies with large retail portfolios to deal with underperforming stores or restaurants.
A CVA will provide a company with the opportunity to rationalise its operations (cutting costs and its workforce) with a view to returning to profitability. Management will need to prepare conservative, realistic and achievable profit and cash flow forecasts to satisfy themselves that a return to profitability is feasible.
CVA proposal
For the general body of creditors to vote in favour of a CVA proposal (where debt deferral and forgiveness will almost certainly be sought), creditors will want to satisfy themselves that:
- The directors’ proposal is realistic and achievable and
- That a CVA offers them the best recovery prospects
A common term of most CVA proposals relates to the payment of monthly contributions (most usually over a two to five-year period) by a company to its supervisor out of cash generated from future profits into a CVA bank account (“the CVA pot”). This pot is distributed to creditors in the form of dividend payments made during and at the conclusion of the CVA – distributions made to total x p in the £ offered and accepted by creditors day one of the proposal.
A term of a proposal could be that if a company outperforms its profit forecast a pot be supplemented by a share of any excess profits (usually 50 per cent) which would boost the return to creditors.
A CVA proposal should allow, subject to creditor approval and a minimum return being paid, an arrangement to conclude earlier. This can be advantageous to a company, as the stigma of a CVA may have adversely affected its credibility, ability to obtain credit from its suppliers and ability to raise additional working capital.
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Before entering Company Voluntary Arrangements
Prior to entering into a CVA and when considering whether a CVA is feasible, directors should bear in mind that suppliers payment terms may become less favourable (the company is likely to experience a credit squeeze) and lenders may wish to see a reduction in their exposure.
Discussions therefore, with key suppliers and lenders, are critical to ascertain what support they will provide.
Cash flow forecasts can then be prepared based upon their representations and working capital needed to drive the business forward can be identified.
The role of HMRC
Another important stakeholder in most CVAs is HM Revenue & Customs (“HMRC”). HMRC will often be a major creditor and will wish to consider such factors as the company’s tax compliance record when assessing whether to vote in favour of a proposal.
We would recommend that a company brings up to date and submits any outstanding returns as soon as possible prior to any CVA commencing. This will help HMRC establish its claim.
HMRC is likely to propose modifications to any CVA which the directors will need to approve if they are to secure HMRC’s support for the CVA.
Typical modifications will range from restrictions to director drawings, deadlines for the submission of outstanding pre-CVA returns and requirements for the Supervisor to hold enough funds to wind up the company in the event of the CVA failing.
National Insurance Fund
One final thing to bear in mind is the rights of employees to be paid from the National Insurance Fund (“NIF”) if a CVA fails or is terminated within the CVA period and the company is placed into administration or liquidation during the CVA period. The employees who are made redundant as a result of any subsequent insolvency process may lose their right to claim their statutory entitlements from the NIF. The affected employees will only be able to rely on any dividends arising out of the administration/liquidation.
CVA’s have a high failure rate, primarily due to the preparation of over ambitious profit forecasts (promising creditors a high, unaffordable rate of return) and unrealistic cash flow forecasts which fail to recognise just how much additional working capital is required to fund a rescue.
To achieve a successful rescue, often over a 2-5 year period will be extremely challenging even for the best of management teams but providing:
- Forecasts are conservative, realistic and achievable, with management rationalising the business as set out in the plan
- Requisite working capital is made available to fund a rescue
- There is open and honest communication with all stakeholders who will wish to monitor performance how the CVA is tracking
This affords a CVA/ company rescue best chance of success.
Recent developments in CVAs
In more recent years the CVA process has become synonymous with the retail and hospitality sectors as proposals have focused on restructuring leasehold portfolios. These CVAs targeted mainly landlords with trade suppliers usually remaining unaffected.
An early example was the JJB Sports CVA in 2009, which focused on two groups of landlords representing open and closed stores. Liabilities relating to closed stores were compromised along with certain other contingent claims in return for a payment from a specially designated fund (aka Compensation Fund). For open stores rent was paid on a monthly basis rather than a quarterly basis. Essentially the proposal did not seek to amend the terms of open store leases.
Subsequent retail CVAs have successfully compromised the position of landlords even further and certain categories of landlords where stores have been underperforming have experienced large reductions in rent or in some cases received no rent throughout the CVA period, with just service charges being paid.
More recently we have seen a move towards proposals offering turnover-based rents, companies paying a share of any profits made during the CVA period to compromised landlords via a Compensation Fund and proposals offering regular breaks to leases to allow landlords to seek better terms outside of the CVA.
It is not uncommon for retail CVAs to have up to six or seven different categories of landlords with various landlord “pots” designated to performance, location (high street, retail park, shopping centre, airport) or both. This adds to the complexity and will require assistance from property agents to provide advice to both the company and the IP as to which landlords belong to each category.
Fairness tests
A CVA proposal also needs to ensure it passes the vertical and horizontal fairness tests to landlord creditors i.e. landlords must receive more than they would have under an administration or liquidation (vertical test) and be treated equally amongst landlords of similar quality of leases (horizontal test). Otherwise, the CVA will leave itself open to challenge under the rules around unfair prejudice.
Two notable retail CVAs have been challenged by landlords in the last couple of years, Debenhams and New Look.
In the case of Debenhams, landlord objections related to proposed rent reduction (which they felt created new lease terms and a CVA could not do this), restrictions on the rights of landlord to forfeit a lease and unfair prejudice as the CVA affected some creditors and not others – a material irregularity.
The landlords’ submissions were rejected apart from the forfeit issue. The court felt that these are proprietary rights and must not be affected. In respect of the rent reduction, the court deemed this a variation and not an attempt to impose new terms.
New Look’s CVA was challenged by four landlords. The CVA proposed stores switch to turnover- based rent with some 68 landlords bound into accepting no rent for three years and as little as 2 per cent of turnover on 402 others stores. The four landlords advocated that a “bare minimum market rent” should be paid. Furthermore, the switch to turnover rent “fundamentally rewrote” leasing agreements and, rent payment in arrears was “unfair”. This challenge was also rejected.
The British Property Federation (BPF), which represents a large number of landlords, have been very vocal about the use of CVAs and have produced useful guidance for landlords (Top 10 Red Flags clauses), especially smaller landlords to help them gauge the appropriateness of a CVA proposal and particular terms that may be proposed. This guidance is also a useful tool to IPs and companies to make sure they aren’t proposing terms that landlords are going to challenge.
A current concern in the landlord community seems to center around the fact that unaffected creditors (e.g. suppliers, employees) can vote (and have the same voting power) as landlords when considering a CVA proposal. The current legislation allows all creditors affected by the CVA (excluding secured creditors) to vote on a CVA proposal, irrespective of whether their claims are being compromised or not. We shall see how this plays out. I have some sympathy on this particular issue and it will be interesting to see whether this develops and whether landlords have their own vote as a separate class (akin to a Scheme of Arrangement of Restructuring plan) or whether their vote is weighted differently to an unaffected creditors.
Alternatives to Company Voluntary Arrangements?
Until recently the only other rescue process was the Scheme of Arrangement but in 2020 the Restructuring Plan process was introduced.
The Restructuring Plan was introduced through the Corporate Insolvency and Governance Act 2020 and is a court-supervised process for when a company has or will be likely to suffer financial difficulties enough to affect it going concern status.
The plan will set out the purpose of the rescue and set out how it will eliminate, reduce or prevent, or mitigate the effect of, any of the financial difficulties to assist management with their turnaround plans. It must also set out how different creditor/member interests are treated.
A key advantage over a CVA or Scheme of Arrangement is that it can overrule a class(es) of creditor(s) who may object to the plan. The court will need to be satisfied that the plan will provide a better return to all creditors than they may reasonably expect in the most likely alternative scenario if it is to agree that a dissenting class of creditor be bound.
Like Company Voluntary Arrangements, the Restructuring Plan allows the company’s management to remain in place to manage the business going forward.
The plan will require approval from at least 75% (voting by value) of each class of creditor and the court will consider any creditor class that objects to the plan. Any overrule will bind the dissenting class to the plan.
The Restructuring Plan can also be used in conjunction with an administration and form one of the exit routes (like Company Voluntary Arrangements) out of administration where it has been possible to achieve the first statutory objective – the survival of the business.
Overall, there are some very useful rescue tools available to help all sizes of companies provided of course the directors seek advice at an early stage, where they can still be of use and the business is not too far down the decline curve.
Andrew Jagger is associate director at insolvency practitioners Moorfields