AdvisoryMatters

If you are in a fixed overheads hole and struggling to keep your company afloat, we explain the benefits of CVAs.

In times of economic downturn, it is often the inability to reduce fixed costs, primarily rent and employees, which can force a business into insolvency. Many companies cannot afford to make employees redundant or they are subject to a lease signed in a more buoyant property market. For them a Company Voluntary Arrangement (CVA) may offer a solution

A CVA is a contract between a company and its creditors within a statutory framework (the arrangement). It is overseen by a licenced insolvency practitioner (the ‘supervisor).

An arrangement will offer creditors a better return than they might expect if the company had to enter into an alternative insolvency process, such as administration or liquidation.

Typically the company makes periodic contributions from profits made during the course of the arrangement (usually three to five years). These are then distributed to creditors. In return, the debts are removed from the company’s balance sheet allowing its directors to seek investment more easily and preserve the company.

At least 75% (by value) of the unsecured creditors who exercise their right to vote is required to approve the arrangement and such approval binds all creditors.

Complications for leasehold premises

In recent years several high street retailers have taken advantage of the CVA process to either exit or vary unprofitable leases, generally to a turnover-based arrangement (for example, women’s fashion store New Look). They have also used CVAs to seek rent concessions.

The New Look CVA was challenged by a consortium of landlords on the grounds that, among other things, being forced to accept turnover rent rather than contractual rent was unfair. The High Court rejected this argument. The landlords turned to the Court of Appeal but the matter was settled before the hearing. The terms of the settlement have not yet been released.

On the face of it, it seems unjust that a landlord’s claim can be compromised by a process in which they are swamped by creditors who are not losing out in the same way (if at all). But the High Court found that the comparison was not valid. It said that other creditors tended to charge prices that reflected the current market rate. This was unlike rent which could far exceed the value of the lease on the open market, given changing economic conditions.

So the High Court considered it was not unfair for a CVA proposal to modify future rent, or the basis upon which rent was paid. This was provided the landlord had the option to terminate the lease and find a new tenant, rather than being forced to accept the modified lease.

This situation is not, of course, confined to chain stores. There is absolutely no reason why a company operating out of only one leasehold premises could not propose something similar. The proviso would be that the business could easily be moved if the landlord exercised the option to terminate the lease (and giving the landlord this option is not negotiable).

Useful guidance

The British Property Federation (BPF) has set out guidance for companies thinking of proposing a CVA. This includes the following:

• CVAs should not vary any other terms of a lease except to impose a rental discount.
• The ability given to property owners to terminate leases is the quid pro quo for the rental discounts imposed on them by the CVA. Where the property owner only has a short period to exercise the right, this can make it inoperable.
• Property owners must always be given a rolling break so that, as a minimum, they can serve notice at any point in the first year of a CVA.
• No rent reductions imposed by the CVA should entitle landlords to receive less than the market rent for a property.

It’s important to remember that this is only guidance provided by an organisation that supports landlords. The purpose of a CVA is to ensure the survival of the company. And this may mean seeking approval for matters which do not comply with the BPF’s recommendations. It will inevitably be helpful to consult the landlord before proposing a CVA. That way the proposal should be understood in the context of the company’s financial predicament. Don’t forget that a CVA is a compromise, so it’s best to approach negotiations regarding its detail in that spirit.

What to do about employees

Businesses are again often caught between a rock and a hard place when facing insolvency. They need to reduce their payroll but may not be able to afford the costs of redundancy.

There are two possible solutions to this dilemma:

• The Government’s Financial Assistance Scheme, operated by the Redundancy Payments Service, will advance the required funds in certain circumstances. The redundancies must lead to the preservation of a significant number of jobs and / or secure the solvency of the business.
• The workforce is rationalised as part of a cost reduction programme underpinned by a CVA. The redundancy costs form part of the employees’ claims in the arrangement. They must also be underwritten by the Government, subject to statutory limits. They are then paid (in full or in part) alongside other creditors’ claims over the lifetime of the CVA.

A CVA can therefore be used by financially distressed businesses to reduce their fixed costs with the aim of the survival of the company.

There are other benefits too:

• The ability to raise additional investment, avoiding prohibitive due diligence (as all unsecured liabilities are caught by the arrangement).
• Retention of existing corporate infrastructure including company name, number, bank account(s), VAT registration, PAYE reference, and so on.
• It is in the creditors’ interest to continue trading with the company to ensure the success of the arrangement.
• Secured lenders are generally excluded from the arrangement and are usually supportive of the process.

If you would like further information on CVAs, please contact Stephen Goderski.

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