What are voluntary company agreements?
The Insolvency Act of 1986 established the Company Voluntary Arrangement (“CVA”) as a rescue mechanism. It’s an insolvency procedure, but it’s more of a “soft touch” approach to saving a business, unlike administration or liquidation. When a firm is not yet reached the point on the business decline curve where there is no realistic hope of a turnaround, Company Voluntary Arrangements should be considered.
The CVA is essentially a business agreement presented to creditors in a proposal outlining how the firm’s directors propose to rescue the company and deal with creditor claims.
While the Company Voluntary Arrangements process necessitates the assistance of an insolvency practitioner (“IP”) in setting up and overseeing an arrangement, the IP’s role as CVA supervisor is primarily to ensure that the company is adhering to the terms of its proposal, as well as the company’s ongoing management with its directors (s).
An IP will examine a proposal to ensure that it is fit for purpose, strikes a reasonable balance between creditors and the company, and has a realistic chance of being executed effectively.
Company Voluntary Arrangements should provide a higher return on debt to creditors than the alternative, usually administration or liquidation.
What types of businesses are good candidates for a CVA?
A CVA is ideal for a company that has taken a one-time setback to its financial sheet. A huge bad debt due to a major customer’s insolvency, for example, or temporarily stopping to trade due to a government-imposed lockdown. It has lately proven to be an effective method for assisting firms with big retail portfolios in dealing with underperforming stores or restaurants.
A CVA allows a corporation to rationalize its operations (reducing costs and staff) to return to profitability. To ensure that a return to profitability is possible, management will need to establish conservative, realistic, and achievable profit and cash flow estimates.
For the general body of creditors to vote in favor of a CVA plan (where debt deferment and forgiveness are virtually always sought), creditors must be satisfied that:
- The directors’ proposal is reasonable and doable
- CVA provides them with the best chance of recovery.
The payment of monthly contributions (most commonly over a two to five-year period) by a company to its Supervisor out of funds generated from future profits into a CVA bank account (“the CVA pot”) is a prevalent term in most CVA plans. This fund is dispersed to creditors in the form of dividend payments made during and after the CVA – distributions made to total x p in the $ offered and accepted by creditors on day one.
If a company beats its profit prediction, a pot could be supplemented by a portion of any surplus profits (typically 50%), boosting the return to creditors.
A CVA proposal should provide an earlier conclusion of the arrangement, subject to creditor approval and payment of a minimal return. This can be beneficial to a firm because the stigma associated with a CVA may have harmed its credibility, ability to acquire credit from suppliers, and capacity to generate extra working capital.
Before entering Company Voluntary Arrangements, make sure you’re ready.
Directors should keep in mind that suppliers’ payment conditions may become less favorable (the firm is likely to undergo a credit squeeze), and lenders may want to reduce their exposure before engaging in a CVA and determining if a CVA is possible.
As a result, it’s vital to talk to major suppliers and lenders to see what help they can offer.
Based on their representations, cash flow estimates may be made, and the working capital required to move the company ahead can be determined.
HM Revenue & Customs (“HMRC”) is another major stakeholder in most CVAs. HMRC is frequently a major creditor, and while deciding whether to vote in favor of a proposal, it will take into account variables such as the company’s tax compliance record.
Before any CVA, we urge that a company bring up to date and submit any pending returns as soon as feasible. This will assist HMRC in proving its claim.
HMRC would recommend changes to any CVA, which the directors will have to approve if they want HMRC to endorse the CVA.
All common modifications are restrictions on director drawings, deadlines for submitting overdue pre-CVA returns, and requirements for the Supervisor to have enough funds to wound up the company if the CVA fails.
Fund for National Insurance
Finally, if a CVA fails or is terminated during the CVA time, and the firm is placed into administration or liquidation within the CVA period, employees have the right to be reimbursed from the National Insurance Fund (“NIF”). Employees laid off as a result of a future bankruptcy proceeding may lose their right to receive statutory benefits from the NIF. Only dividends from the administration/liquidation will be available to the affected employees.
CVAs have a high failure rate, owing to overly optimistic profit estimates (offering creditors an unaffordable rate of return) and unrealistic cash flow forecasts that fail to recognize the additional working capital required to fund a rescue.
Even with the best management teams, achieving a successful rescue over a 2-5 year period will be incredibly difficult, however providing:
- Forecasts are prudent, realistic, and attainable, with management rationalizing the business as planned.
- Working capital is made available to fund a rescue operation.
- There is open and honest communication with all stakeholders who want to track how the CVA is performing.
- This increases the chances of a CVA/company rescue succeeding.
Recent CVA innovations
In recent years, the CVA process has grown associated with the retail and hospitality sectors, with proposals focusing on leasehold portfolio restructuring. These CVAs mostly affected landlords, with trade suppliers typically untouched.
The JJB Sports CVA in 2009 was an early model, focusing on two sets of landlords representing open and shuttered stores. In exchange for a payment from a specially designated fund, liabilities related to closed stores and certain other contingent claims were compromised (aka Compensation Fund). Rent was paid on a monthly rather than quarterly basis for open establishments. The plan did not, in essence, attempt to change the terms of open store leases.
Following retail CVAs, landlords’ positions have been further weakened. Certain landlords with underperforming stores have seen huge rent reductions or, in some cases, no rent throughout the CVA term, with just service charges being paid.
Recent proposals have included turnover-based rentals, firms giving a share of any profits gained during the CVA period to compromised landlords through a Compensation Fund, and proposals for regular lease breaks to allow landlords to seek better terms outside of the CVA.
It’s fairly uncommon for retail CVAs to include up to seven different landlord categories, with different landlord “pots” based on performance, location (high street, retail park, shopping center, airport), etc. This adds to the complexity, and property brokers will be needed to advise both the company and the IP on which landlords fall within which categories.
Tests of fairness
A CVA proposal must also pass the vertical and horizontal fairness tests for landlord creditors, which require landlords to receive more than they would have received in an administration or liquidation (vertical test) and to be treated equally among landlords with similar lease quality (horizontal test) (horizontal test). Otherwise, the CVA will be vulnerable to a challenge under the unreasonable prejudice laws.
In recent years, landlords have challenged Debenhams and New Look, two well-known retail CVAs.
Landlord objections in the Debenhams case included proposed rent reductions (which they claimed created new lease terms, which a CVA could not do), restrictions on a landlord’s right to forfeit a lease, and unfair prejudice because the CVA affected some creditors but not others – a material irregularity.
Apart from the forfeiture issue, the landlords’ pleas were dismissed. According to the court, these are proprietary rights, and they must be protected. The court ruled that the rent cut was a modification rather than an attempt to impose new terms.
Four landlords objected to New Look’s CVA. The CVA proposed that businesses transition to a turnover-based rent system, with 68 landlords agreeing to take no rent for three years and as little as 2% of turnover for 402 others. The four landlords argued for the payment of a “basic minimum market rent.” Furthermore, the transition to turnover rent “fundamentally rewrote” leasing arrangements, and rent arrears were “unfair.” The challenge was likewise turned down.
The British Property Federation (BPF), which represents a large number of landlords, has been outspoken about the use of CVAs and has issued important information for landlords (Top 10 Red Flags provisions) to help them assess the appropriateness of a CVA proposal and specific conditions that may be suggested. This advice is also useful for IPs and businesses to ensure that they are not proposing terms that landlords will challenge.
Unaffected creditors (e.g., suppliers, employees) can vote (and have the same voting power) as landlords when contemplating a CVA plan, causing some anxiety among landlords. The current law permits all creditors affected by the CVA (excluding secured creditors) to vote on a CVA plan, regardless of whether or not their claims are compromised. We’ll see how things turn out. I sympathize with this situation, and it will be interesting to see how it plays out, whether landlords get their vote as a separate class (similar to a restructuring plan) or whether their vote is weighted differently than that of unaffected creditors.
Company Voluntary Arrangements: What Are the Alternatives?
The Scheme of Arrangement was the sole other option until recently, but the Restructuring Plan was launched in 2020.
The Corporate Insolvency and Governance Act 2020 created the Restructuring Plan, a court-supervised mechanism for when a corporation has or is anticipated to have financial difficulties that affect its going concern status.
The strategy will outline the rescue’s purpose and how it will eliminate, lessen, prevent, or alleviate the effects of any financial difficulties to support management with their turnaround plans. It must also specify how various creditor/member interests will be handled.
A fundamental advantage over a CVA or Scheme of Arrangement is that it can override the objections of a class of creditors. Suppose the court agrees to bind a dissenting class of creditors. In that case, it must be satisfied that the plan would deliver a superior return to all creditors than the most likely alternative scenario.
Like Voluntary Company Arrangements, the Restructuring Plan allows the company’s management to stay in place and continue to run the firm.
The plan must be approved by at least 75% of each creditor class (vote by value), and the court will consider any creditor class that objects to the plan. Any will bind the opposition to the scheme.
The Restructuring Plan can also be combined with an administration to create one of the exit routes out of administration (such as Company Voluntary Arrangements) where the first statutory objective – the business’s survival – has been met.
Overall, some valuable rescue tools are available to aid businesses of all sizes, provided that the directors seek advice early on. At the same time, the tools are still useful, and the company is not too far down the decline curve.
Andrew Jagger is an associate director of Moorfields, an insolvency firm.