By Gavin Jones, partner and licenced insolvency practitioner Hill Dickinson LLP
Company Voluntary Arrangements (CVAs) were introduced by the Insolvency Act 1986. They are a formal insolvency procedure by which a company can make a proposal to creditors to deal with its debts. Although available in the toolbox of the insolvency practitioner for in excess of 30 years, they make up a very small faction of the overall number of corporate insolvencies in the United Kingdom. They have seen a recent spate of publicity in the last year due to a raft of companies in the retail sector using the CVA procedure to manage their debts, and in many cases restructure their property portfolios. In the last twelve months CVAs have been proposed by Byron Burger, Toys R Us, Prezzo and most recently House of Fraser, Mothercare and Carluccios.
This extensive publicity on the use of CVAs is borne out by recent statistics published by The Insolvency Service. In the first quarter of 2018 the use of CVAs increased by 86% over the previous quarter, but this was from an historically low number, and even now as a percentage of all corporate insolvencies, CVAs comprise less than 1.5 % – a tiny proportion. It is clear a large amount of this increase relates to proposals being made by retail companies, in particular those within the casual dining sector, as the list of companies outlined above indicates.
What are they and how do they work?
In essence the company, acting by its directors, will make a proposal to its creditors setting out how it is going to deal with its debts and liabilities. That proposal is considered by creditors at a meeting of creditors, where if 75% of creditors by value support the proposal, it is approved and becomes binding on all creditors, including those who voted against it or did not vote at all. In addition, shareholders of the company need to approve the proposal by Ordinary Resolution, however in the event that the creditors approve and the shareholders reject the proposal, the creditors’ decision takes precedence. Then, subject to compliance with the CVA terms, the company will be released from the debts comprised in the CVA and its balance sheet should be restored.
There are some safeguards to prevent proposals being railroaded through by connected parties, to the extent that a proposal opposed by 50% of its independent and unconnected creditors will not be approved. An approved CVA proposal can be challenged by a dissatisfied creditor on two grounds: firstly, on the basis that they believe that the proposal is “unfairly prejudicial”, or secondly that there was some “material irregularity” in relation to the conduct or voting at the creditors meeting.
One reason why the CVA has been of limited use up to this point is that for most companies, it provides the benefit of a moratorium or freeze on creditors’ enforcement action before the creditors meeting. Consequently, a CVA can be preceded by administration, to allow a period of protection for the proposals to be prepared. Another reason the CVA has been relatively underused is that it cannot be used to prevent a secured creditor with a security, such as a bank, from taking enforcement action, so it may only realistically be viable with the support of the company’s bankers or where the company is primarily financed by some other type of funding, e.g. private equity etc.
What are the advantages?
The real strength advantage of a CVA is its flexibility. Within reason, and subject to the parameters of challenge outlined above, the CVA proposal can deal with its debts and liabilities as it sees fit, subject to the approval of the creditors.
From the creditors’ point of view, the principal advantage would be that a CVA is a less structured form of insolvency process, therefore the involvement of insolvency practitioners is limited to a supervisory role. This means the cost of realising assets and distributing to creditors should be reduced, enabling a better return. Equally, however, the directors of the company are able to maintain control of trading due to the reduced level of intervention, as a supervisor does not have the statutory powers of investigation of an administrator or liquidator, and has no equivalent duty to make a report on the conduct of the directors to the Director’s Disqualification Unit.
Recent publicity has underlined current concerns in the retail property community, who assert that recent CVAs are tantamount to an abuse of these procedures. The British Property Federation has called for an urgent review by the government (https://www.bpf.org.uk/media-listing/press-releases/british-property-federation-calls-government-urgent-review-cvas). Landlords argue that they unfairly and disproportionately bear the brunt of the write downs on retail CVAs, and which are being advanced to simply improve profit margins, and to overcome the inconvenience of upwards only rent review provisions and surrender costs.
What’s the alternative?
Whilst CVAs do have their faults, administration is the usual alternative to CVA, which from the point of view of the both the creditors, directors and shareholders would usually involve a worse outcome, often involving a “pre-packed” disposal of the business and assets. Particularly in circumstances where this type of disposal is to a connected party, there has been much adverse publicity on this in the last decade, such that the government introduced enabling subordinate legislation which enabled them to take tighter control of pre-packed sales in insolvency. Neither procedure is without criticism.