One of the frustrations when a company gets into trouble can often be that the underlying business is profitable but the firm is held back by debt.
A Company Voluntary Arrangement or CVA can be a way for a good business to gain itself some space to get back on an even keel.
A CVA is a legal agreement, between the creditor and the debtor that the debtor will pay the debt off at a reduced rate over a defined period of time. This means that the firm is faced with a lower cash requirement and can use the arrangement as a period in which it can take stock and adjust its business model.
There are however some requirements for a CVA to be agreed.
Firstly the Directors of the firm and the Insolvency Practitioner appointed must have a realistic belief that the company has a genuine prospect of survival if an agreement is reached.
Secondly the company concerned must be insolvent using at least one of the two tests for insolvency (the Cash Flow and Balance Sheet tests). This can include Contingent Insolvency, where the business may not be immediately insolvent but faces the prospect of becoming insolvent if a liability crystallises.
The final requirement is that the company must have projections that show that it will have sufficient free cash to make the agreed payments under the CVA.
What are the benefits of a CVA?
There are some significant benefits for companies that enter into a CVA.
Unlike insolvency, the directors remain in control of the business and are free to run it as they see fit, provided that they make payments in accordance with the agreement.
The firm should immediately feel the benefit from lower creditor pressure as they cannot chase debts included in the CVA and are unable to take legal action.
The cash requirement for the company to pay its debts will be lower as the debts will be rolled up into a single payment over a longer period of time. It will also aid cash flow forecasting as the company will have a single payment to make each month or quarter to service the agreement rather than many competing debtors that all require immediate payment.
The firm may also benefit in that the creditors may agree a lower settlement figure to be included in the CVA than the value of the outstanding debt. The benefit for the creditor in this case is that they have a legal agreement that assures them that they will be paid, albeit over a longer period. Companies will often take the view that having a stable debtor paying less money is better than a company that could go into administration leaving only a small amount to be distributed to the unsecured trade creditors.
One of the major benefits is that a CVA can also stop a winding up order, provided that it is agreed within 7 days of presentation and, unlike insolvency proceedings a CVA does not involve a lot of court time and as such is a much cheaper alternative.
As ever in the field of insolvency speed is of the essence. When an insolvency practitioner is called in to work on a CVA proposal it is always better for the directors to act sooner rather than later.
Once an Insolvency Practitioner (IP) has been contacted they will immediately assess the situation and advise whether the CVA is the best course of action for the company concerned and of course its creditors. If the CVA is selected as the best option then the directors will need to formally appoint the IP.
The IP will then set about drafting a CVA proposal. It is always much easier if the company concerned has good accounting records and it is able to dedicate some accounting resource to providing information.
The proposal stage will require the directors and IP to work as a team and to adopt a realistic attitude. An unworkable proposal can be refused by the creditors and so it is important that the company can show that it can adhere to the plan and will be able to make the payments as agreed. It is also important to recognise that the directors will need to understand where things went wrong and, although it may be a little uncomfortable should be honest about the shortcomings in their own management of the company finances.
Once a proposal has been produced it will be sent to the creditors along with a statement of affairs and a report sent to the court recommending that a meeting be held. A little ‘stakeholder management’ may be useful here as being hit with a sudden CVA proposal as a creditor can be a shock. Keeping suppliers on side will be vital if the company is to continue to trade.
The IP will then convene a meeting of shareholders and creditors to discuss the proposal. A vote on the CVA will be taken with votes being weighted according to the amount of debt owed. As long as 75% of the creditors by value agree to a proposal or an amendment to the proposal then it will be carried. This is where the stakeholder management will come in useful as it’s often possible to gain the 75% agreement before the meeting with creditors not even turning up to the meeting but simply voting by proxy.
Immediately following the meeting the IP will send a report to the court detailing the result of the meeting. They will also send a report to all of the creditors and a chairman’s report to the registrar of companies.
From the point of the meeting everybody who was entitled to vote is then bound in the agreement. The company continues to trade and will manage the agreement itself.
It is important to understand that if the company misses a payment, or breaks any conditions that are part of the agreement then they may face a winding up petition from a creditor and this is why being realistic during the drafting stage is important.
The desired outcome of a CVA is that the company pays off its debts over a manageable period of time and exits the agreement a few years hence. The employees will have retained their jobs and the company will hopefully be fitter with directors who may have a newfound respect for financial management.