How to decide between a CVA and alternative insolvency processes - ReSolve Group UK

How to decide between a CVA and alternative insolvency processes

ReSolve Group UK

How to decide between a CVA and alternative insolvency processes

In an article published in Accountancy Daily our partner, Lee Manning, considers how to decide between a CVA and alternative insolvency processes.

Many, if not all, of us are eager to see the end of COVID-19 so that our lives – both professional and personal – can return to normal. However, in the rush to get back into the swing of things, it is important to not be hasty with our actions as they can lead to unplanned outcomes or lost opportunities.

This certainly applies to a business that is still suffering from COVID-19’s impact to its trade. Business owners facing financial challenges have several options but the two that have been most-often championed during COVID-19 have been undertaking a CVA (Company Voluntary Arrangement) and entering alternative insolvency processes.

In some cases, business owners who have been badly impacted by COVID-19 might choose whichever is the “quickest” solution to stem the negative drain on their company’s resources. However, in my opinion the duration of the process should not be the primary consideration when evaluating options. Be careful of advisers who suggest Liquidation or Administration as the least painful or easiest route, without addressing the merits of a negotiated restructuring with key creditors or considering the benefits of a CVA.

When a CVA makes sense

CVAs are well suited to companies that are dealing with a temporary cash flow crisis due to a COVID-19-related fall off in trading but still otherwise healthy and have a viable future. “Healthy” can be subjective however in my opinion what defines a healthy business is one that has products and/or services that are still desired in a post-COVID world. The size of the market is also important because not only does the company need to be able to generate sales that will cover its ongoing cost base but it must also be able to generate sufficient surplus cash to enable it to pay down at least some, if not all, of the debt it accumulated during lockdown.

Business owners emerging from the economic crisis will need to address the use of their company’s funds in a manner that makes it profitable once more and fixes the problem of too much historic creditor debt on its balance sheet. Working with restructuring professionals, business owners should be able to construct a set of proposals to put to their creditors that will allow the respective companies to compromise on some (or sometimes all) of their accumulated debts, give the company time to repay the element of debt that is not being written off, and provide for the rescue of the company. Such a plan must demonstrate to the creditors being compromised that it is likely to give them a better return than they could otherwise expect from an Administration or Liquidation.

Just because a company (working with its advisors) has pulled together a set of formal CVA proposals and sent them to its creditors, it does not mean the approval of the CVA should be regarded as a foregone conclusion. To be legally binding on creditors, the proposals need at least 75% of the creditors in value of claim to vote in favour. If some of the votes in favour are from connected parties, such as shareholders or inter-company claims, then a second test is applied which effectively requires at least 50% of the unconnected creditors’ vote to be in favour. This means that the senior management teams of companies proposing CVAs may need to spend some time lobbying creditors to support the proposals and that is why it is crucial that they are realistic and not overly optimistic or, in the alternative, appear to heavily favour the company proposing the CVA.

What would lead a creditor to voluntarily accept a reduction in its debt due from a company proposing a CVA?

There are a few examples that fit the bill. Consider a creditor whose viability depends on said company’s success – for the most part this would make them either a supplier or a customer. This would also include creditors that understand that short-term pain will hopefully lead to long-term survival and a successful business relationship with the debtor who (in many cases) may have been an innocent victim of the economic crisis caused by the lockdowns.

Turnover rents are likely to be a much-applied solution within CVAs as are the relatively new Part 26A Restructuring Plans. This is especially the case for consumer businesses that need to rebuild their customer and sales numbers once all restrictions are lifted.
We are seeing increasing use of these techniques gaining support of the courts, in cases such as New Look and Virgin Active, and we can expect more companies to introduce them as flexible methods of helping troubled businesses remain as going concerns.

When an alternative insolvency process makes sense

In some cases Administration or Liquidation does make more sense.

If a company was already loss-making before COVID-19 impacted the economy and its owners remain doubtful about its viability, even if it was able to compromise sufficiently on its historic debts, this may be the right time to enter into Administration or Liquidation and see if a willing buyer can be found for the company’s business and assets.

The company’s market may have changed fundamentally so that there is no longer a demand for its products or services, or perhaps there is demand but the company just does not have the necessary capital it needs to invest for the future. Another reason can be if a company has several business units that vary in viability. In this case, a company can be placed in administration and ailing divisions closed, with a focus on selling the service lines or subsidiaries that remain.

How do you know which restructuring procedure suits your company best?

The answer is to not to decide in a vacuum but to speak to a restructuring and insolvency professional to discuss your options. Before you pick up the phone you can do some calculations yourself and forecast what you believe your business will turn over in the coming quarters. When doing this you must be as realistic as possible and be prepared to be challenged by your professional advisors about the assumptions that underpin your trading and cash flow forecasts. Approximately 50% of CVAs fail within 15 months because the management team was too optimistic about how quickly their company’s fortunes would improve, or simply offered too much, too quickly, to their creditors when more caution in what is proposed in the CVA may have avoided the eventual collapse of the company.

Restructuring and insolvency professionals have vast experience in working as trusted advisors alongside management teams of businesses in difficulty. Almost without fail, their professional advice will add value to management’s restructuring plans and enhance a business’s prospects of returning to a sustainable level of trading.

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