Company voluntary arrangements (CVAs) in the UK are a little like half-mast trousers. When they first came out, they were very popular and there was a lot of excitement. After a while, they became distinctly uncool and were usually on the radar for all the wrong reasons. And then, like many cyclical fashion trends, ankles were everywhere. But is a CVA (still) a valid restructuring tool for struggling businesses or does it just delay an inevitable terminal event for a business?
How do CVAs work and what to watch out for?
CVAs were introduced in the UK as a more flexible and cost-effective route to restructuring a struggling business without the need for a more cumbersome scheme or a formal, and perhaps terminal, insolvency process. It essentially works like an agreement between the company and its creditors to reach a compromise over existing debts to allow the company to continue to trade and creditors to get a better return than if the company went into a form of insolvency process. The directors of the company remain in office and in control of the company, albeit under the supervision of an insolvency practitioner – to ensure compliance with the terms of the CVA. CVAs typically last five years and usually involve reaching compromises with creditors – reducing future payments (such as rent) and paying sums from ongoing trade or a supporting shareholder into a pot for the benefit of creditors. The company therefore has to persuade creditors that, despite its being in this mess in the first place, with the adjustments there is an underlying good business that can continue, and it can pay its debts as they fall due going forward and, perhaps, also contribute extra from trading receipts. Against the backdrop of already being in distress, that can be a difficult argument to win.
After the initial interest in CVAs, the market became a little sceptical of their use, partially due to some rare cases of the process being abused. The success rate of CVAs was not good; some statistics have shown that over 60 percent of CVAs were terminated before the end of their term and the company was placed into administration or liquidation, by which time significant costs had been incurred. All practitioners have seen cases where there was little real prospect of the CVA succeeding (often based on overoptimistic and unrealistic forecasting), or indeed cases where voting during the approval process was manipulated to push it through (such as using “friendly” creditors).
Since then, CVAs have taken on a new lease of life, particularly in the multi-site retail and hospitality sectors. The reason is the possibility of structuring a CVA in such a way as to compromise on existing debts, but also restructure the ongoing obligations of the company, in particular its rent, for the period of the CVA. This has typically manifested itself in very detailed and lengthy CVA proposals where the pool of landlords is split into a number of different categories which are then treated differently in the CVA proposal in accordance with the profitability (or not) of a particular store or restaurant. The CVA may seek to relinquish certain underperforming leases, whilst reducing rents by perhaps 25-75 percent across other sites or switching to a rent based on the turnover of a site.
Because of the prevalence of this approach, this has become very unpopular with many landlords, as it is seen as an attack on their proprietary rights and because in many CVAs the landlords are singled out for reductions of future rent. Some have argued that this in some ways represents a recalibration of the rental market that reflects the wider crisis faced on the UK high street. This has led to a number of well publicised legal challenges over the terms of the CVA and has resulted in the development of a more defined process of analysis as to whether a CVA is appropriate and legal. This analysis is driven by the two mechanisms available to creditors by which to challenge a CVA: (1) that there has been a material irregularity in the CVA procedure (often an anomaly in the formal voting process); or (2) that the CVA is unfairly prejudicial to a particular creditor or class of creditors (the question being whether certain creditors are prejudiced by the CVA proposal, and whether that prejudice is justifiable in the circumstances). It is the latter that landlords have focused on in recent challenges.
In short, when preparing a CVA, there must be a “vertical” comparison of whether there is a better projected return to creditors by entering a CVA as opposed to another form of insolvency process (it effectively sets a bottom line), and also a “horizontal” comparison of whether specific categories of creditors could be seen to have been treated differently and whether that treatment is unfair. One of the benefits of a CVA is that there is nothing wrong with treating creditors differently, so long as it is fair and there is a justification for that treatment (that is, it is a necessary step and the only way to ensure business continuity without the significant impact of an insolvency process).
The most recent challenge, which generated widespread press coverage, was that funded by Mike Ashley’s Sports Direct group in relation to the department store chain Debenhams. Save for the court reiterating that a CVA cannot affect a landlord’s right to forfeit the lease as this was a proprietary right, those challenges largely failed; but further challenges highlighting the targeting of landlords in particular continue to be made.
For a CVA to be approved by creditors, it must have the approval of 75 percent by value of the creditors who vote. One of the benefits, therefore, of a CVA is that if the company receives the requisite number of votes, the CVA binds even those that voted against it. This enables the company to proceed without constantly defending against dissenting creditors and gives the company the space to facilitate a successful outcome at the end of the CVA.
A valuable tool if utilised well
But CVAs, used in the right way, can represent a very useful tool to avoid the detrimental consequences of a formal insolvency process. This requires appropriate planning and advice, ideally at an early stage, including in relation to the property aspects, such as proposed reductions, whether the new proposed rent is below market value and the realistic impact and options for landlords of affected sites. The directors continue to manage the company, albeit within the confines of the CVA, and would typically have forced some concessions from certain creditors (landlords in particular) to give a lifeline to ongoing trade and an exit to normal trading after the period of the CVA. However, it doesn’t end with the approval process; the management need to engage with creditors and stakeholders to ensure the CVA is successful and avoid wasting funds that would otherwise have been available to pay creditors. Importantly, the return to creditors should, in theory, be better; whilst they are fact-specific, returns to creditors in liquidations may be around 1-10 percent, and CVAs perhaps around and possibly over 25 percent. With the distress on the UK high street, which has filtered up to the landlords, and the changing dynamics of British cities in particular, CVAs are still particularly relevant and can be a viable restructuring option.
The popularity of CVAs in the hospitality and retail sector and the associated legal challenges in relation to the treatment of landlords have also led to changes in the way that CVAs are proposed. It is now not unusual to see a “fighting fund” set aside in order to deal with a legal challenge. Perhaps if that fighting fund were to be returned to the pot for the benefit of CVA creditors, it may actually incentivise creditors to think twice before challenging a CVA, as they may actually enhance their overall return. That is combined with the fact that CVAs are already an expensive process. There are many recent retail and hospitality CVAs that have run to hundreds of pages of complex drafting, as well as nominee and supervisor fees in the many hundreds of thousands of pounds. Although the intention behind CVAs was a quick and cheap process to avoid an insolvency procedure, in some cases a CVA could still result in a better outcome for creditors, employees, suppliers and other stakeholders than the ultimate risk of a terminal liquidation.
Like the fashion for trouser length, CVAs will continue to be utilised and, indeed, progressively adapted to suit the prevailing environment. The continuing distress in the retail and hospitality sectors has been further exacerbated by the pandemic, with what might be a short, medium and even long-term impact on the way people live, shop and work, and the knock-on effect on the way we use UK cities. That is going to cause further issues with multi-site operations, especially those with large workforces, many of whom have received the benefit of the UK government’s ongoing support through the employee furlough scheme. That security blanket cannot last forever and so plans need to be formulated to ensure that those with fundamentally viable businesses survive, and CVAs can, with careful thought, play a vital role in that recovery.
About the Author
Edward Starling is a Partner at Wedlake Bell, specialising in insolvency and restructuring. He specialises in bringing and defending claims brought by liquidators and trustees in bankruptcy including transactions at an under value, voidable preferences, wrongful and fraudulent trading, and breach of duty. Ed also acts as an independent Supervising Solicitor overseeing search (and seizure) orders obtained in civil proceedings.