Lecture 5: Company Voluntary Arrangements

Question 1

When were CVAs introduced?

Answer 1

By the Insolvency Act 1986

Following the Cork Report

Question 2

What was the intention of incorporating CVAs into legislation?

Answer 2

Intended to help foster a rescue culture.

Question 3

What is a CVA?

Answer 3

The directors of a company may make a proposal to the company and to its creditors for a composition in satisfaction of its debts - an agreement between a company, its shareholders and creditors.
Voluntary agreement made by directors with financial advisors, make a proposal to creditors for satisfaction of its debts.

A CVA is a formal insolvency procedure, however it is more informal in its process.
Similar to a scheme of arrangement.

The company doesn’t have to be insolvent or unable to pay its debts.

• Similar to administration - think of as a moratorium. Giving the company breathing space.

Question 4

What can a CVA involve?

Answer 4

Delay of payment to creditors. 
Payment by installments
Quite often a debt for equity swap.
Payment of less than 100p in the £
Appropriate management and financial controls and personnel.

Question 5

In the agreement stage (before approval) what is the role of an IP?

Answer 5

Nominee.
He must report to the court within 28 days of receipt of the directors’ proposal
Will recommend that creditors and shareholders meetings be called if he thinks the CVA stands a chance of approval.

• Key document that needs to be filed at the court is the nominees statement - nominee has to conclude whether the proposal (prospects of the CVA) is reasonable.

Question 6

What is required for a CVA to be successful?

Answer 6

Needs to be a persuasive business case - how the company is going to turn around and deliver what is promised.

Nominee needs to be convinced that there is a business worth saving – need to go through business plan, go through accounts

Part of this assessment will be driven by the nominee’s opinion of the directors. Skills, if they meet requirements.

Need 75% in value of u/s creditors to agree and 50% in value of shareholders to agree
• If approved, proposal becomes binding on the company and its creditors

Question 7

Can the rights of secured creditors vary in a CVA?

Answer 7

No, unless agreed to by the creditors.

Question 8

What is a significant problem with the CVA process?

Answer 8

Only when creditors have voted that the company is legally protected.

Period in between whereby there is nothing to stop a winding up proposal being put forward.

Question 9

What happens after a CVA has been approved?

Answer 9

A supervisor then takes over responsibility for implementation of the CVA - normally the same person as the nominee.

Question 10

Why is the role of directors crucial in a CVA?

Answer 10

They remain in control.
CVA requires specification of a clear turnaround strategy.
Abilities of the directors may be an advantage or a potential barrier to a successful CVA.

Debtor (director) in possession system.

Question 11

What is the objective of a CVA?

Answer 11

Ultimately to rescue the company.

Question 12

What is the role of the supervisor in a CVA?

Answer 12

Monitor compliance with terms of the CVA.
Check that the directors are fulfilling the terms of the proposal.
Directors competence is a potential barrier to a CVA.

Question 13

When is a CVA complete?

Answer 13

When all creditors are paid what the CVA promised.

Question 14

What is the Small Companies Moratorium?

Answer 14

Came into effect on 1 January 2003 (insolvency act 2000)

Provides a moratorium when proposing a CVA for small companies only.

Protects a company against winding up petitions, administration orders, appointment of receivers, enforcement of security, repossession of hire purchase goods (except with leave of the court).

Question 15

What are the criteria for a small companies moratorium?

Answer 15

Must meet two or more of the following criteria:

• Turnover not more than £10.2m per annum
• Fewer than 50 employees
• Balance sheet total does not exceed £5.1m

Question 16

Why has there been a low uptake of the CVA procedure?

Answer 16

Very low take up since 1986
• Between 1998 and 2006, CVAs in E&W accounted for between 3 and 4.5% of all corporate insolvencies
• Reasons for this may be linked to the cost of the procedure

• Fixed costs of CVAs may make them unpopular for very small companies (Cook et al, 2001)
  
  • From Cook et al (2001) paper, approximately 80% of companies doing CVAs have turnover less than £3m

• R3 find a 74% preservation rate

• Mixed evidence on whether CVAs ensure survival of the company (continuation of trading)
• Cook – report a 22% survival rate. Means that 22% are continuing and the rest of them fail and move onto another insolvency procedure.
• There may be a preference for liquidation over CVAs
• Other factors: lack of knowledge and experience on the part of directors and insolvency practitioners; leaving things too late; lack of funding

• IPs are not in full control. SO don’t like the situation as they have to be in a relationship with a CVA that might fail.

Question 17

What is the relationship that has been found between size of a company and dividend payouts?

Answer 17

• Empirical results actually reveal a U shaped relationship between size of company (measured according to turnover categories) and dividend payouts
  
  • Thus small companies are still able to achieve high recovery rates

Research in 2012 by R3 – CVAs giving a return to unsecured creditors of 17p pence to the £ and other methods giving 5.4p -6.3p to the £.

Question 18

What were the finding of the research published by ICAEW and R3?

Answer 18

Mainly used by small and micro companies. But these companies are not making use of the statutory moratorium.

Wide range of industries making use of CVA process.
Construction/ repair of motor vehicles/ manufacturing/ admin and support services/ accommodation and food services.

trading under a CVA appears to be difficult - proposals may not make sense.

Could be zombie companies.

• There is often a significant gap between the expected level of dividends and the actual dividends

• For CVAs lasting six quarters or less, dividends to unsecured creditors were very rare
Attributed to the costs of the CVA process

• For CVAs lasting between six and eighteen quarters, a dividend was paid in over half of the cases.

• HMRC seen as the one most likely to vote against a CVA
• Possibility that pre-pack administration is favoured over CVA

Question 19

Why are HMRC against CVAs?

Answer 19

• Failing to take a commercial attitude towards CVAs
• Failing to take a long term view
• Even with abolition of crown preferential status, HMRC support for CVAs has not materialised
  
  • Moral dimension to tax body’s position
  • Would rather get nothing than rescue the company

Question 20

For what reasons can a creditor who was entitled to vote at the creditors meeting apply to court to challenge the CVA?

Answer 20

Unfair prejudice:
All creditors vote together - there is a potential for one class of creditor to be treated differently. 

Have to put creditors into different classes. How you come up with classes is up to the directors. Based on financial interests and their rights.

For example, a debtor can offer different deals to landlords of premises that it wishes to continue to occupy and to landlords of premises it wishes to vacate
• Landlords are most likely unsecured creditors.
• All unsecured creditors vote within that group, but vote for different terms.
• According to the courts, such differential treatment does not necessarily constitute unfair
• Essentially only a case for unfair prejudice if you find that creditors are worse off under the terms of the CVA than terms of the liquidation.

Material Irregularity:
Means that the statutory process hasn’t been followed.

Question 21

When might CVAs be useful?

Answer 21

Where there is a core business capable of surviving.

Where secured creditors support the proposal - need funding (no funding leads to trading problems)

Where there is strong management

Where landlords and key suppliers support the proposal

Where there is clear communication between all parties.

Question 22

Why has the retail industry been struggling recently?

Answer 22

• Up until fairly recently, retailers enjoyed a long period of rising real incomes and growing demand in an immature market.
• This has now ground to a halt as market saturation, declining consumer confidence, effects of the recession and outdated business models come into play
• Retail is a high fixed cost/ low margin business
• Majority of retailers have too many stores
• With significant pressure on cash flow, retailers are facing seriously tough times

Question 23

What are examples of retail CVAs?

Answer 23

• Stylo (AIM listed footwear retailer)
  
  • CVA was rejected in 2009
  • Landlords asked to compromise claims for rent arrears for a % of shop turnover
  • Landlords rejected on the basis that they would have been subsidising the other creditors - didn’t want to set a precedent
• JJB sports (did two CVAs in 2009 & 2011)
  
  • Both were approved
  • In 2009, KPMG adopted a ‘roadshow approach’ to ensure transparency and communication with creditors
  • Landlords of closed stores were offered a sum from a fixed pot of cash – better for them than liquidation
• House of Frasers
  
  • Key issues for landlords are therefore:
    
    • What would their position/ return be in the event of liquidation?
    • Are they likely to secure a new tenant immediately?
    • What is the value of their claim for voting purposes?

Question 24

What is the London Approach?

Answer 24

Traced back to the 1970s.

• The start of multi bank borrowing
• The beginning of refinancing packages
• Originally brokered by the Bank of England

It is an informal rescue mechanism used by large companies.

* A ‘super CVA’ or
* ‘club, in which every player knows the etiquette and abides by it’
* Based on philosophies of informality, flexibility, moral suasion, shared values and favours

Question 25

Why was the London Approach established?

Answer 25

In 1970s it was a shock if a large company failed - banks had to put in some procedure if this happened.

Question 26

What are the four phases of the London Approach?

Answer 26

• ‘Standstill’ requiring all bank support
• Accountants investigation
• Lead bank negotiations with other banks – hopefully restructuring
- Ongoing monitoring

Question 27

Why is the co-ordination amongst banks important for the London Approach?

Answer 27

• Equal sharing of the pain (linked to enlightened self-interest)
• Want to keep other banks happy.

• Idea of bank reputation at stake

Question 28

What is the role of insolvency practitioners (IPs) in CVAs? (characteristic wise)

Answer 28

• Flood et al (1995) discuss ‘the role of character work’ and its importance to corporate rescue
  * Personalities seen as important
  * Generation of trust (forum approach)
  * ‘symbolic power’
• Also, ‘professional relationships across jurisdictional boundaries are crucial to the satisfactory resolution of something like a CVA’ (Flood et al, 1995, p23)