There’s been a lot of bad press lately for company voluntary arrangements (CVAs). As an insolvency practitioner, I’d like to share my thoughts.
Before last year the sale of the business via an administration, often on a ’pre-pack’ basis was the preferred solution for companies with underperforming leasehold units. This allowed a purchaser, sometimes but not always consisting of the original management team, to take on the business including the “good “units and leave behind the “poor” ones. Now practically every client I meet from a company with underperforming leasehold units, asks me for advice on the CVA process.
Of course, retailers have been badly affected by the recession. In the last year there’s been a real glut of retailers presenting CVA proposals to their creditors – usually with the idea of dropping several non-performing leasehold premises. And this situation also applies to bars & restaurants, nursing homes and hotels, for example.
So what is a CVA?
Basically it’s a proposal to creditors asking them to agree (usually) to a debt forgiveness in return for a distribution and (often) to a variation of terms as well. The directors prepare the proposal and in simple terms if 75% of the creditors vote in favour the proposals are accepted in the process binding all creditors including landlords.
They’re often proposed by directors of companies who believe the business is viable but where a small number of non-performing assets are preventing it from generating profits. The existing management team retains control in a CVA unlike an administration, where the management transfers to the administrators. And administrators have a duty to get the best price – so whilst there’s nothing to prevent the management making an offer, there’s no guarantee it will be accepted.
CVAs aren’t advertised, so they’re often a more discreet process than administration. Creditors are often consulted before proposals are circulated to sound them out early on. Another advantage is that the corporate entity is preserved in a CVA, and with it any tax losses and ultimately, if successful, value for the shareholders.
In CVAs creditors get to see the proposal’s, propose amendments and vote on whether the directors’ proposals should be adopted. This all sounds fine, in particular, when compared to a pre-pack admin where creditors and landlords of units that are left behind are presented with a fait accompli.
So why the bad press?
The main issue is that if the CVA is approved any revised terms are imposed on all creditors – whether or not they have voted for the arrangement. In recent CVAs this has impacted not only on landlords of stores which are to be closed but also those to be retained.
The “normal” proposal in recent CVAs has been to close loss-making stores and the landlords to be offered six months' rent plus continuation of rate payments for a fixed period. However, a more recent case proposed not to close any stores immediately. Landlords of the loss-making stores were offered a reduced rent for 18 months, during which time the stores would continue to trade. The landlords could source new tenants, giving the company 45 days’ notice to vacate if they found someone during that period.
Open store landlords are normally paid according to the terms of the lease, but it is possible to propose a change in payment date (like moving to monthly from quarterly payments).
The key question is whether it is OK to vary the terms of a lease in that way? The fact is until this issue is challenged under the Unfair Prejudice rule, there’s no clear legal guidance.
Landlords may be bound by the CVAs terms if the arrangement is approved. Usually all other trade and expense creditors’ debts are paid in the ordinary course of business and it’s rare that variations of terms are proposed. Is this inconsistent treatment of creditor groups fair? What about the open landlords who are being paid in full but on different terms?
Who are the landlords I’m talking about? For larger retailers, they’re probably institutions. But as CVAs become more popular, smaller investors are also affected. Whilst larger institutional landlords may cope with the return of a closed unit, smaller investors may struggle to meet their own banking covenants. In the current economic climate re-letting of units in secondary locations on the same or similar terms won’t be straightforward.
The British Property Federation (BPF) issued a press release in February in which property chiefs warned that any future CVAs would only be supported in genuine cases of hardship – and not where firms wished to use them to strategically downsize and hive off underperforming stores. The BPF said the industry would stand firm against future CVA proposals that it considered a misuse of the system.
Whether or not the current round of CVAs is pushing the boundaries of insolvency legislation, they are, on the face of it, a very useful restructuring tool. For a CVA to be the right solution there must be a fundamentally sound business or the potential for one, within the current operation. And it’s one that has little or no chance of survival without the restructuring of the balance sheet. But if there is severe restraint on cash in the short-term, administration may be the only option.
There’s no doubt CVAs bring many benefits for corporates – the preservation of the business, retention of control by existing management, and the saving of jobs. But each case has to be looked at on its own merits. Many companies will be facing financial hardship over the coming months. The question for property bankers is: how many of your commercial property investment customers are at risk of being on the wrong end of a CVA proposal or pre-pack administration? And have you identified them?Sarah Rayment
Partner
Business Restructuring
BDO LLP
