CVAs: Necessary tools for business rescue
21 January 2021
Once more, Company Voluntary Arrangements (CVAs) are in the spotlight, with several high-profile cases currently in the news. Taking some recent critical comments about the CVA process at face value might lead a layperson to assume that this business rescue tool is critically flawed. While there is room for improvement, it is important to consider this issue with the full picture in view, as we set out below.
Designed explicitly as a way to try and rescue a business, a CVA allows the creditors of an insolvent company a voice in the rescue attempt, by giving them a vote on the procedure. The CVA cannot proceed unless creditors representing over 75% of the value of the debts owed to those unsecured creditors who are taking part in the vote agree to the proposals put forward by the insolvency practitioner overseeing the CVA, who is known as the supervisor.
CVAs are flexible and adaptable, with latitude for the supervisor to formulate proposals which are tailored specifically for the company in question. The voting process means they are transparent, and – unlike in most other types of corporate insolvency procedure – the existing management team stays in place to steer the company, with the supervisor ensuring that creditors’ rights are respected.
The procedure also allows companies with a large physical footprint to close or amend rent agreements on multiple outlets in a short space of time, which can be a vital survival tool, if, for example – as we saw last year, following lockdown – the external trading environment for a company suddenly changes, and affects ‘business as usual’.
Low in number, high in profile
CVAs attract a disproportionate amount of attention and commentary, given how few they are in number: In the period January-November 2020 there were just 216 CVAs in England and Wales, out of 11,409 corporate insolvencies, according to Insolvency Service figures – just 1.9% of the total. In the same period in 2019, there were 334 CVAs out of 16,128 corporate insolvencies, or just 2.1%.
So why do they get so much attention and spark so much debate? It is typically because CVAs have been used by a number of well-known brands, whose profile, and the fact they are entering an insolvency process, sparks interest in the CVA process, and the effect a CVA has on a business’s creditors.
But as with other insolvency procedures, CVAs are a symptom, not a cause, of corporate financial distress – a fact that often gets lost in the debate.
Business rescue or a softer landing
Whenever criticism about CVAs is aired, it is always worth asking in response: What would the alternative be? If a company is insolvent, its options are necessarily limited, and there are difficult decisions which must be made, in order to try and preserve as much value for creditors as possible.
In 2018, R3 published a report, “Company Voluntary Arrangements: Evaluating Success and Failure”, produced by academics from the University of Wolverhampton and Aston University, which looked at CVAs initiated in 2013, giving a five-year window for the researchers to follow up the different outcomes achieved.
The research found that 18.5% of those CVAs had been fully implemented, 16.5% were still ongoing, and 65% had been terminated without achieving all of their objectives. However, the research also found that the early termination of a CVA does not automatically mean the process has failed: terminated CVAs may return more money to creditors – the ultimate goal of any insolvency procedure – or otherwise be more beneficial for creditors than an administration or liquidation.
This is a vital point. The use of a CVA helps to preserve jobs, by allowing the company to keep trading; suppliers are also able to retain the company as a customer, which helps their own cashflow models, while customers can continue to make purchases (an important consideration if, for example, the company in a CVA sells components for which an alternative supplier cannot easily be sourced). Staff, suppliers, and customers are all key stakeholders in a CVA, and preserving relationships helps to keep the business ecosystem functioning.
In cases where individual creditors, or a group of creditors, feel they have been unfairly treated by the CVA proposals or process, they can always vote against the proposals, or seek redress through the courts if they believe the detriment to them reaches the bar for legal action.
Areas for improvement
While CVAs are an indispensable piece of the UK’s business rescue landscape, that is not to say they could not be improved. Our 2018 report made five main recommendations, namely:
· CVAs should be capped at three years - CVAs typically last five years, but, the research shows, long CVAs increase pressure on the struggling company, increase the risk of failure, and do not guarantee better creditor returns.
· A pre-insolvency moratorium should be introduced - Companies which used an existing, limited pre-CVA moratorium from creditor enforcement action, or which used the moratorium provided by administration, tended to have a higher chance of completing their CVA. The pre-CVA moratorium should be expanded to all sizes of companies, simplified and should be available for use ahead of any insolvency procedure. The moratorium would give companies more time to plan a CVA free from creditor pressure.
· Directors' and insolvency practitioners' duties should be more clearly defined - Directors should be required to address financial distress at an earlier stage than now, while the insolvency practitioner's role in a CVA should be clarified and reporting enhanced. Consideration could be given to extending the existing system of insolvency fee estimates to CVAs.
· Public sector creditors should have to explain why they won't support a CVA - The research found HMRC was the most likely creditor to oppose a CVA but that it provided little feedback on its reasons for doing so. This prevents an effective negotiation - and sometimes leads to a company's administration or liquidation, which can undermine returns to creditors, including the taxpayer.
· Standard CVA terms and conditions should be introduced - Standard terms would improve the consistency of CVAs, reduce costs, and help build knowledge among stakeholders about how the process works.
Since the report’s release, some progress has been made, notably on the pre-insolvency moratorium, which was introduced by the Corporate Insolvency and Governance Act last year. To make CVA proposals easier for creditors to understand, R3 recently published a Standard Form Covid CVA Proposal (England and Wales/Scottish versions), designed to be adapted for use for companies whose business models were upended by the pandemic, to try and aid business rescue attempts.
An essential part of the toolkit
With so many companies affected by the pandemic, business rescue will be a key theme of 2021, with CVAs likely to play a major role. In these unprecedented trading conditions, companies will require flexibility and creditor buy-in if they are to stand a chance of survival – both of which CVAs can provide. In order to save as many businesses and jobs as possible, CVAs will continue to be an essential part of insolvency practitioners’ toolkits – and of 2021’s business rescue landscape.
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