On 12 October 2020, R3 published a standard form COVID-19 Company Voluntary Arrangement (CVA) proposal and accompanying standard conditions for small and medium-sized enterprises (SMEs) whose businesses have been affected by COVID-19. In recent years CVAs have been used extensively by retailers to exit or compromise lease obligations with landlords. The aim of the R3 initiative is to recognise that CVAs can be used to defer or compromise all unsecured creditors in times of financial crisis and to recognise that CVAs were not designed exclusively to deal with leases and landlords.
What is a CVA?
A CVA is a legal process to enable a company to make an agreement with its unsecured creditors to compromise its existing, future and contingent debts. In its simplest form, a CVA can result in a legally binding agreement where payments to unsecured creditors are deferred for a period of time but there is no limit on exactly what kind of arrangement may be proposed by a company.
The key requirement for a CVA is that it must be subject to a vote of unsecured creditors and 75% in value of unsecured creditors must vote in favour of the arrangement. If approved, the CVA proposal will automatically bind any dissenting creditors and any creditors who would have been entitled to vote if they had received notice of the decision procedure. This means that once approved, a CVA binds both known and unknown unsecured creditors.
Why would creditors vote in favour of a CVA?
A rescue CVA is used where a company is at risk of insolvent liquidation. In an insolvent liquidation, unsecured creditors are paid only after the costs and expenses of the liquidation and after secured and preferential creditors have been paid in full. Very often, there is very little left for unsecured creditors and even after including recoveries (if any) from the "prescribed part" of floating charge assets, it is often the case that unsecured creditors recover very little in an insolvency process.
The promotion of a SME CVA by R3 recognises that unsecured creditors are more likely to get a better return if a company can avoid insolvent liquidation or administration. A CVA proposal will therefore include an assessment of recoveries from an insolvent liquidation for unsecured creditors compared with recoveries if they vote to approve the CVA. Unsurprisingly, by voting to approve the CVA and allow the company to continue trading, the forecasted return to creditors over a period of usually 2 – 5 years is usually significantly better than the alternative of insolvent liquidation or administration.
CVAs for SMEs
The R3 version of the CVA proposal for an SME provides for a delayed payment of 100% of the company’s debts and a moratorium period during which pre-CVA debts will not be paid or enforced. The moratorium period will depend on the financial circumstances of the company concerned but typically a CVA will last for a period of between 2 – 5 years.
Trading costs incurred during the CVA are to be paid out of new trading income and the continuation of the business allows regular contributions to be made to the CVA supervisor from operational cash flow. The R3 form of proposal can be amended to reflect the particular circumstances of the business concerned. For example, it can also include a debt composition (or write off) either immediately or as the CVA progresses and the company becomes better able to assess the impact of continued trading as the economy and trading conditions improve.
A CVA can last for any period of time set out in the proposal (although 2-5 years is usual). The CVA has to be fair and balanced, given that creditors' rights are being impaired, and so typically it will also volunteer a number of restrictions on management and shareholders. For example, it may include restrictions on declaring dividends, increasing directors’ salaries, incurring new borrowings, or selling the company's business or assets save in the ordinary course of business. Ultimately, it is for the directors and the CVA nominee to formulate a set of proposals that will win the support of 75% (in value) of creditors.
Position of HMRC
For many SMEs emerging from the COVID-19 pandemic, it is likely that HMRC will be a significant creditor, particularly if the option to defer VAT payments has been taken up. Helpfully, HMRC has published guidance on its position as an unsecured creditor in CVA's and, subject to certain conditions being complied with (including full disclosure and the promotion of a CVA which is fair) HMRC will aim to support such arrangements. The HMRC guidance note can be found here.
The CVA Process
In outline, the CVA process involves the company providing a written proposal for a CVA. A proposal will need to include the following:
- An explanation of why the creditors are expected to agree to a CVA
- A full list of assets, liabilities, guarantors and proposed guarantors
- Details of all credit facilities
- Identify all creditors to be compromised and set out how the liabilities to each creditor or category of creditor will be compromised
The directors must engage the services of a licensed insolvency practitioner to act as a nominee of the CVA. The nominee must within 28 days of the proposal submit a report to the court stating whether, in the nominee's opinion, the proposal should be considered by the company's creditors and members.
In practice, the nominee will work closely with the company's management team to devise a proposal and may also informally engage with certain creditors before the proposal is recommended to gauge the likely level of creditor support. This also allows the proposal to be refined before a creditor vote is called to ensure it stands the best chance of being approved.
After recommending the proposal to the court, the nominee has to seek the approval of creditors and shareholders. A creditors' meeting is convened (usually a virtual meeting although creditors may request a physical meeting).
A CVA cannot affect the right of a secured creditor to enforce its security except with its consent, meaning that debts owed to secured creditors cannot be compromised by a CVA. In practice, a CVA proposal may constitute an event of default under many loan agreements and so the nominee will also wish to discuss the CVA in advance with any secured lenders to ensure that appropriate waivers will be given to avoid any events of default or enforcement action by secured creditors.
The Position of Directors
The directors' position in a CVA remains unchanged. They will continue to manage the business as usual. The nominee will become the supervisor of the CVA if it is approved. The supervisor's role is simply to monitor compliance with the terms of the CVA and collect and distribute sums payable to creditors under the CVA. He or she will not have any other role in the management or affairs of the business.
In practice, it is not usually possible for the directors or the nominee to foresee all eventualities and outcomes when a CVA is proposed, and so the supervisor will remain on hand to deal with any unforeseen issues and, if necessary, seek amendments and variations to the original CVA proposal.
CVAs are typically seen as the preserve of large companies with significant leasehold portfolios rather than a restructuring option for SMEs.
However, the formulation of a draft proposal and standard terms and conditions by R3 has helped to make this process more accessible and more affordable to SMEs. The guidance note published by HMRC is also a helpful indication that HMRC will aim to support such arrangements.
Like any restructuring, time is needed to win creditor support and so the earlier his process is started the more likely it is to succeed. If there is a risk that a company will be unable to avoid insolvency before a CVA can be implemented it is unlikely a nominee will recommend the proposal to the court and creditors. Typically, it can take anything between 4 to 8 weeks to implement a CVA and so advance planning is needed before the business runs out of cash.
The directors will need to act in accordance with their usual legal duties and, where insolvency is a risk and creditors' rights are being impaired, the legal duty to consider the interests of creditors becomes ever more important.