K2 Partners (Rescue) Ltd 2013

Tony Groom

K2 Business Rescue 64 Lower Sloane St, London SW1W 8BP

tel 020 7720 8000 tel 0844 80 40 540

www.rescue.co.uk

 

A Practical Guide for Directors, Shareholders and Company Advisers prepared by

K2 Business Rescue a trading name of

K2 Partners (Rescue) Limited

Company Voluntary Arrangement (CVA) Guide when and how it is used

1. INTRODUCTION

This Guide has been prepared in order to assist you as a director or shareholder to find a solution for saving your Company when it is insolvent. Whether your intention is to save your business or cease trading we always recommend that you seek professional advice if your company is insolvent.

A CVA is a legal procedure for your Company to reach agreement with its creditors. It can be used to repay liabilities over an extended period of time, or to defer payment pending receipt of funds and it can also be used to write down debt so your Company only pays what it can afford.

This Guide is merely for illustrative purposes and neither the Authors nor K2 Business Rescue accept any liability for its content.

2. INSOLVENCY

A pre-requisite for a CVA is that your Company must be insolvent which in most cases means it cannot pay its current debts on time.

There are however four tests of insolvency (set out in the Insolvency Act 1986) any of which can be used to establish whether your Company is insolvent.

They are: Unsatisfied statutory demand: failure to deal with a statutory demand; Outstanding judgement: failure to pay a judgement debt; Cashflow test: when the company is unable to pay its debts on time; Balance sheet test: when a company’s liabilities are greater than its assents.

In spite of the belief by many who assume that insolvency is the end of a business, being insolvent under any of these tests does not necessarily mean that your Company must be closed down. There are a number of remedies that can help save your Company but if your Company is insolvent you are advised to take advice from a Turnaround Adviser or Insolvency Practitioner. They will help you carry

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out a review of your Company’s ability to continue trading. They will review any forecasts, the accounts, assets such as property, stock, work in progress and book and other debts, and they will also look at the liabilities. With their help, your Company may be able to develop realistic plans for it to survive and trade out of insolvency. One such method is to use a CVA.

A CVA involves preparing a proposal that incorporates repayment terms for creditors. These should be affordable, realistic and achievable so they can be paid out of surplus cash from future trading. While the proposed payment period can be much shorter, it normally allows for repayment to be spread over a period of two to five years. Proposals can offer to repay less than the amount due i.e. less than 100% of the debt if this is all your Company can afford.

Also you can make a one off payment to Creditors. This is a useful tool if your company is trying to attract investors who may not be prepared to fund all the past losses.

Providing 75% (by value) of those creditors who vote approve the CVA proposals and 50% of the non-associated creditors vote in favour then it is binding as a formal agreement on the remaining creditors.

3. CVA PROPOSALS

A CVA is an agreement for the repayment of all or some of the debt due to creditors and can include an agreement to write off debt.

You should only consider a CVA when you believe that your company is viable and can survive. You also need to be realistic about what changes should be implemented in order to reduce the risk of subsequent failure. In order for a CVA to be successful we at K2 believe a company normally needs to be restructured so that the reasons for its past losses are addressed. Too many proposals are prepared without dealing with the issues that led to the past losses.

Whilst the preparation of the proposal is the responsibility of the directors, complying with the Insolvency Act will require the assistance of a Turnaround Adviser or Insolvency Practitioner who has experience of preparing Company Voluntary Arrangement Proposals. When choosing your adviser you should be aware that few Turnaround Advisers or Insolvency Practitioners have much experience of CVAs.

The proposals should provide full disclosure of the company’s financial and commercial situation including how it got there, and a business plan covering future prospects and proposals for implementing fundamental change that is normally needed to justify support for the proposals.

Before preparing proposals, the Adviser will carry out a review the company’s financial situation and go through your alternative options to confirm that a CVA is right for you and your company. This options review involves preparing a statement of affairs and comparing your alternative options for saving the business. The statement of affairs is based on your company’s balance sheet but is formatted to show how much each class of creditor would receive under each of the different insolvency options.

Once you confirm a CVA is your preferred option, the Adviser will then help you develop a business plan that covers financial restructuring and operational reorganisation. He or she can also assist with preparing forecasts to show profit and loss, cash flow and balance sheet. The business plan is aimed at reassuring creditors that the company can be profitable and have positive cash flow. These will be necessary as most CVA proposals provide for repaying creditors out of future cash flow.

As part of any reorganisation, fundamental change should be considered as this is often necessary to make a business profitable. This might include the termination of not-needed or onerous contracts such

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as premises leases, plant & equipment hire, rental agreements, supply agreements, client obligations and employment contracts. The costs of terminating these agreements can be included as liabilities in the CVA which helps preserve cash during the restructuring process. Crucially these terminations must be notified to the creditor and included in the CVA. Liabilities crystallised after approval of a CVA are generally excluded from the CVA creditors and must be paid in full. Again your Adviser will be able to help you consider the implications and implement these.

The proposals must be fair to all creditors and must not prejudice any individual or class of creditor including those with specific rights such as leases or personal guarantees. These include trade suppliers, credit insurers, finance providers, employees, landlords and HM Revenue and Customs, the latter often being key in view of the arrears of VAT and PAYE that your company may have built up.

Your Adviser will also help you draft the CVA proposal that provides the necessary disclosure that deals with the fair treatment of creditors and incorporates your business plans.

Once a proposal is prepared it is reviewed by a Licenced Insolvency Practitioner referred to as a Nominee who then sends the proposals with his/her report to creditors who then can vote on the proposals. While most votes are submitted by fax or post, a creditors’ meeting is convened. The creditors’ meeting is purely to deal with three resolutions:

1. Accept, reject or modify the CVA proposals; 2. Appoint the Supervisor; 3. Appoint a creditors’ committee.

Acceptance of the CVA proposals is based on achieving requisite majorities. The votes are counted by value of claim where the requisite majority for approval is 75% of the votes cast. This is subject to a second vote to check that 50% of the non-connected creditors approve the proposals as in many instances directors, shareholders and their family members represent a significant vote and are treated as connected creditors.

In the event that a requisite majority is not reached, the creditors’ meeting can be adjourned for up to 14 days to allow for modifications to be considered as conditions for acceptance.

Once a CVA is approved normal business resumes and continues providing the company complies with the terms of the CVA. The key obligations in most CVAs are likely to involve:

1. making CVA payments to the Supervisor as agreed in the CVA (normally monthly contributions);

2. paying ongoing liabilities on time, in particular PAYE and VAT; 3. providing information to the Supervisor; 4. not paying dividends to shareholders; 5. filing accounts and returns on time.

CVA proposals for payment of creditors are entirely flexible and agreed up front as part of the contract. They can be relatively short, based on a lump sum payment such as from an investor, or the completion of a contract, or the collection of a large book debt, or payment out of successful litigation. Or they can be based on making payments over a longer period of time, often five years with payments on a monthly or quarterly basis.

However achieved, once the terms of the CVA have been complied with then the CVA is discharged by the Supervisor and the company is free from any further CVA obligations.

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4. CVA ISSUES

Banks & secured lenders

The secured lenders are excluded from the voting on a CVA because they have security and are normally paid in full. They can vote on the unsecured portion of a loan although from experience this rarely happens. Their rights are unaffected such that in most cases their loan agreements incorporate terms that refer to CVAs and compromising creditors that allow them to call in their loan or modify its terms. As a result you and your Adviser would normally meet with them to go through the CVA proposal and seek their support.

HM Revenue & Customs (HMRC)

HMRC can be a significant creditor in a CVA, often representing a blocking vote that allows them to insist on modifications if a proposal is to be approved. They also have considerable experience of dealing with CVAs through their dedicated unit, the Voluntary Arrangement Service (VAS). It is imperative that your Advisers have experience in dealing with the VAS so that HMRC’s requirements can be accommodated in your proposals if they are a significant creditor.

Employees

Employee rights remain with the company so there is no TUPE transfer liability. As a result if notice of their employment being terminated is included in CVA proposal then their claim is against the company such that their claim is included as a liability in the CVA.

This is a contentious area as many directors don’t want their employees to know what is going on. However, they normally do and their support is often key to future success of the business. Experienced Advisers can help and generally recommend a dialogue with employees to clarify their role and reassure them about their future.

However as part of the business review we normally recommend that Directors reduce employment to a minimum so as to only retain those who are necessary for trading the company. Although making employees redundant triggers a Redundancy Payment, this will be paid by the Government from the National Insurance Fund. For this to happen, employees need to be made redundant prior to the implementation of the CVA. The CVA allows a business to reorganise staff without the need to fund redundancy payments out of cash flow. If a company needs to reduce its workforce in order to survive, and does not have the funds to pay the Redundancy Costs, then a CVA may be the only option available to the company.

We at K2 believe that companies should consider redundancies as a way of reducing fixed costs as it is easier to take on more staff if you have made too many redundancies than to have to pay the costs of making staff redundant post the approval of the CVA.

 

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Landlords

Arrears of rent are generally treated as an unsecured claim in the CVA. However you should be aware of the landlord rights which may include the right to seize assets during the period prior to the creditors’ meeting. It makes sense to review the lease to know what rights of action a landlord has and if necessary seek advice on how best to avoid such action.

If you want to vacate the premises then the lease can be included in the CVA and the landlord can be treated as an unsecured creditor with a lease termination claim. Where the landlord has the right to distrain over assets on site, moving out needs to be managed carefully and be wary about using the premises as a car park afterwards.

You need to be aware that whilst the company can hand back a property to a landlord it might still be liable for future business rates until such time that the Landlord can find a new occupier.

Winding up petition

A winding up petition can normally be adjourned pending the outcome of a creditors’ meeting when the court is notified that a company is considering a CVA. However the company should be represented in court when seeking an adjournment. Once a CVA is approved then the petition liability becomes a creditor in the CVA and the petition is dismissed.

County court judgement (CCJ)

A CCJ crystallises a liability that is normally included in the CVA. Once the CVA is approved then the claimant is treated as an unsecured creditor for the value of the judgement debt. However you should be aware that prior to the creditors’ meeting, judgements can normally be enforced and you may need to seek advice on how best to avoid a bailiff or sheriff seizing assets during the period prior to the creditors’ meeting. This may necessitate making an application to court.

5. ADVANTAGES & DISADVANTAGES

Advantages of a CVA

Enables the company to survive; Improves cash flow; Benefits creditors by delivering superior returns than they would receive in liquidation or

administration; Approval stops winding up proceedings and enforcement by bailiffs and sheriffs on behalf of

judgement creditors; You and your co-directors and shareholders remain in control of the business; Frees you up to focus on running the business; You can use it to reschedule payments to creditors; You can use it to write off debt due to creditors; Payments to creditors are set at a level that the company can afford; CVAs justify balance sheet restructuring and operational reorganisation; CVA fees are deducted from contributions to creditors; You do not need to tell customers although in reality you should assume that they will find out; You can implement dramatic cost cutting and include the crystallised liabilities in the CVA; You can terminate employment contracts and include their claims in the CVA;

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The employee claims are paid by Redundancy Payments Service; Avoids TUPE liabilities that apply if business is transferred to a new company; Avoids liquidation; No investigation of directors and no report filed with the Director Disqualification Unit; Preserves asset value by allowing for the completion of work in progress and collection of

book debts as part of normal on-going business; Scope for early exit from CVA via a post approval variation; Avoids crystallising any personal guarantees given to bank and other secured creditors.

Disadvantages of a CVA

Many CVAs fail due to proposals being over optimistic and payments being set at too high a level that cannot be achieved;

Obligations imposed on the company by creditors can lead to directors becoming frustrated; It can be difficult to obtain credit from suppliers post CVA; Restricts exit via a sale of shares during the CVA; Competitors could use the CVA for their own commercial advantage; Some clients may decline to place business with the company.

6. SUMMARY

A CVA can be a very good way of saving a company that is facing cash flow problems.

Once approved a CVA is a formal agreement that is binding on both the company and the unsecured creditors.

It is supervised by a Supervisor who is a Licence Insolvency Practitioner with responsibility for ensuring the terms of the CVA are complied with.

It terminates either when it is completed with the agreed terms having been met, or if the company is unable to keep to them.

Early action improves the chances of a CVA being approved.

Fundamental change improves the chances of a CVA surviving to completion.

Experienced Turnaround Advisers are needed if you want to improve the prospects of a CVA being successful.