Company Voluntary Arrangements (CVAs) in the current climate
December 3, 2020
A Company Voluntary Arrangement (CVA) is essentially a deal with unsecured creditors to pay a percentage (or all) of sums owing. There are also similar Voluntary Arrangements for both partnerships and individuals.
Current Climate
Due to Covid-19 there are likely to be many entities that are unable to pay their debts as a result of falling asset values (such as difficulties in collecting debtors or selling stock) and trading losses. The knock on affect is that many companies are therefore finding themselves unable to pay suppliers, landlords, business rates and employees on time. The government has stepped in to restrict landlords’ ability to take enforcement action, to provide business rates holidays and reliefs and to provide furlough monies to protect employees. In addition, the introduction of both the Coronavirus Business Interruption Loan Scheme (CBILS) and the Bounce Back Loan Scheme (BBLS) have provided urgently required funding to bolster ailing cashflows, which although timely, still leaves the entity with debt that needs to be repaid. Unfortunately, for too many businesses even this largesse from the government will not be enough on its own, so some form of financial restructuring will still be necessary if they are to survive and eventually thrive once more.
Qualification criteria for a Company Voluntary Arrangement
To qualify for a CVA the company must be insolvent, insolvency is defined as either liabilities exceeding assets or the inability to pay debts as they are demanded for payment. Another essential criteria for a CVA is that the business is viable without the burden of its current debt. In most CVA’s the directors propose a monthly contribution (effectively from future profits) into a pot for the benefit of the unsecured creditors. This pot of funds is maintained by a Supervisor (Insolvency Practitioner) whose powers are mostly contained in the CVA proposal and who then distributes funds to creditors at agreed intervals. Under the terms of a CVA, the dividend on offer to creditors must be better than they would achieve on a liquidation.
When is a CVA used?
A CVA is generally considered as an honourable way to deal with an insolvency situation, compared to an Administration (pre-pack or trading) or Liquidation. The attractiveness of a CVA for creditors is that they still have an ongoing party to trade with (even if it may be on a proforma payment basis), receive a dividend and that the costs of the procedure are lower than a Liquidation or Administration, thereby improving the return. However, the statistics show that there is a high failure rate for CVA’s partly because it is not unusual for the director to over promise and partly because creditors may demand a return that isn’t realistically achievable before they will accept the deal. It’s also too often the case that “leopards can’t change their spots” so leaving the directors in charge without making fundamental changes can lead to the company simply running into the same problems all over again.
It is the role of a qualified Insolvency Practitioner to review the forecasts underlying the CVA deal and consider creditor requirements, whilst satisfying themselves that the proposal is fit, feasible and fair, balancing the interests of the company and its creditors.
CVA’s today
Now more than ever it is time to look at CVA’s in a different light. The government is following through with its promise to restrict connected party pre-pack deals and has already drafted new legislation making it harder for directors to re-start in business immediately. HMRC have also put additional restrictions on directors re-starting as well, following decades of criticism of ‘phoenix’ rescues where assets are sold back to directors but not the liabilities, leaving creditors out of pocket.
The CVA is a very flexible tool; allowing creative deals to be proposed, whether they are lump sum offers from an investor, the continuation of litigation or the restructuring of a company’s liabilities (landlord, leases or redundancies). For the creditors, it is better to receive a percentage of something through a CVA, rather than nothing in a Liquidation.
CVA Case study 1: IT support company
This first case study is for a CVA that was approved in 2002. The reason for using an old case study is because from 1 December 2020 crown preference has been reinstated to a similar position to that prior to 2003. Therefore CVAs will once again need to incorporate these changes into the proposals. In this case the company provided IT services and solutions to SMEs. A bad debt led them to considering their financial options. The company had many good contracts with sizable businesses, had been trading successfully for many years and was well established. The directors did not want to shut down and restart both on principle and also as in their view they would find it difficult to win back clients to work with a new company. The proposal was drafted offering a 5 year term of monthly contributions equating to an estimated dividend of 100p in the £ for preferential creditors and 43p in the £ for unsecured creditors before costs. Although the secured bank lending was not bound by the CVA, the bank was contacted and agreed to convert the overdraft into a bank loan repayable over a similar period as the CVA.
As part of the proposals the directors thought carefully about the business and proposed some changes to take the company back to profitability without the major client it had lost. This involved a few redundancies (where a claim was made against the Redundancy Payments Service to maintain cashflow) and also a strong message prepared for the company’s clients to ensure that they were satisfied that the company could still continue to provide the level of service they required. Although customers and clients are generally not advised of a CVA per se (usually only unsecured creditors are consulted), the fact that a company even proposes a CVA tends to leak out and although the actual CVA proposal is not filed at Companies House the fact that the company is under a CVA is noted. Trade magazines commonly report on CVAs so it is advisable to have a press statement ready and for the directors to be prepared to speak to each customer or client before they find out about the CVA from another source. In this case, there was a positive reaction from customers as the directors were seen as being honourable in offering a CVA and also continuing to supply the same service, at the same prices and with mostly the same personnel. It is common for contracts (leases, provision of service etc) to have an insolvency clause whereby the customer or supplier “may” terminate the contract on a trigger event such as insolvency, but we found that this was not taken up in this case. Following approval of the CVA, the company continued to trade and made monthly contributions for 2 years, at which point the directors decided to take out a personal loan and introduce these funds as a full and final settlement offer to creditors. They therefore offered the lump sum on condition that a modification was agreed by the requisite majority of creditors to end the CVA early. Creditors jumped at the chance of an early return albeit at a lower return of 13p in the £ and the CVA revision was approved. The company is still trading successfully to this day.
CVA Case study 2: Charity service company
Certain types of businesses generate significant tax liabilities due to the nature of their trade. IT businesses, recruitment and labour-only businesses with large numbers of employees and minimal VAT inputs can quickly generate huge HMRC indebtedness within a short period of time. One such business provided support to the charity sector with a very large payroll of over 1,000 staff, operating from multiple UK locations. The loss of a key client and a change in GDPR legislation was the perfect storm for the business, resulting in a projected severe cashflow squeeze. Fortunately, the directors sought advice at an early stage. While a restart with a new entity was mooted, there was concern over the reputational damage and potential loss of contracts, so a CVA was proposed providing for the full payment of creditors over 4 years.
As well as a significant HMRC debt, the company occupied many UK properties. The company benefitted by deferring its business rates liabilities for the year, because the liability for the whole year’s business rates fell into the CVA. This cash flow relief, combined with ongoing debtor receipts and the outstanding VAT and PAYE liabilities also being deferred under the CVA, meant the company was in a good position to continue to trade post CVA. In a similar way to the case study above, the customer and client relationships were well managed by the directors, which resulted in most clients reacting well and continuing to work with the company. The directors also identified certain shortcomings in its current business model and sought to change these with new IT systems and staff bonus structures.
The CVA was subsequently approved at the creditors meeting. Although post CVA trading looked positive for the first few months, it became apparent that, even with the major structural changes undertaken for the CVA, that there were still fundamental flaws in the business model. Although the CVA failed, it had given the directors the opportunity to turn around the business. The key message is that this opportunity should not be wasted and an in depth review of the business and its operations is crucial to ensure that the second chance represented by a CVA is fully utilised.
Forecasting for the future is always difficult and as a result of Covid-19, there are now greater uncertainties. Hopefully, we will soon come out of lockdown and as trading moves back towards pre-Covid levels then a CVA may be the answer to the conundrum of what to do to manage excessive debts built up before and during the pandemic.