A Q&A on CVAs

 

1. What is a CVA?

A CVA is a form of insolvency process which allows a company to continue trading whilst it seeks concessions from its creditors. A CVA typically provides for a rescheduling of debts or reduction in payment to unsecured creditors which, nonetheless, achieves a better result for creditors overall as the company is able to continue to generate an income rather than shutting up shop altogether. Retailers have recently sought to utilise CVAs to obtain a reduction in onerous rent obligations imposed by their landlords.

A CVA is commenced by the directors of a company who draw up a proposal (under the supervision of a nominee (it has to be a qualified insolvency practitioner)) for approval by its creditors. If the proposal is approved by a majority and at least 75% in value of creditors (unless more than 50% (by value) of any creditors who vote against it are unconnected with the company) it will bind all unsecured creditors whether or not they were in favour or indeed voted on the proposal. A CVA can be challenged in court on the grounds of unfair prejudice or material irregularity within 28 days of the approval being reported to court or, in the case of a creditor who was not given notice of the creditors' meeting, within 28 days of the day on which the creditor became aware of the decision procedure having taken place. A number of landlords have sought to challenge CVAs on the grounds of unfair prejudice, although whether there has been any unfair prejudice is often though a question of fact and is determined on a case-by-case basis. A CVA may treat different unsecured creditors e.g. landlords in different ways and hence may be prejudicial to those creditors, but the question of fairness depends on the overall effect of the CVA.

A CVA does not affect the rights of secured creditors or preferential creditors unless they agree to the proposals.

2. Why are CVAs proving so popular?

Various reasons have been identified to explain why so many retailers and casual dining operators have been looking to CVAs to facilitate continued trade. These include: the rise of the “Netflix and chill generation” with consumers spending less money and time socialising outside the home; problems with leases, including being locked-in to 25-year lease terms with over-inflated premiums and high annual rents; rising business rates; increasing staff salaries with the rise of the ‘living wage’; too many competitors in a squeezed market; the fall in the pound and comparative rise in the cost of imported products; falling consumer confidence; and increased competition from the supermarkets. More recently, the wrong kind of snow appears to have kept shoppers away from the high street during March, having a negative impact on profits for many on the high street. House of Fraser has confirmed reports that it has engaged KPMG to explore its future options, although reports that it too may seek a CVA have been played down thus far. Meanwhile, the Carpetright CVA was last week approved by creditors and Poundland is said to be planning the closure of 100 stores as it considers entry into a CVA.

3. Have there been any successful CVAs?

Companies are unlikely to contemplate entering into a CVA unless they are facing considerable pressure from creditors and their only alternative is to enter a more formal (and potentially terminal) insolvency process. Often this means that CVAs only have the effect of delaying the inevitable i.e. entering an insolvency process such as administration or liquidation. A good example is Toys ‘R’ Us’ dalliance with a CVA which didn’t end well, with the company unable to meet a VAT bill of £15m and unable to find a buyer, which ultimately forced it into administration. But there have been some notable examples of successful CVAs – among them Travelodge, Game, HMV and Dreams.

4. What are the key components of a successful CVA?

A CVA alone is unlikely to provide all of the answers to a company’s troubles. More likely it has to be part of a wider restructuring solution, perhaps also involving a change of management and/or an equity injection. Commonly businesses will seek to enter a CVA within the context of administration in order to gain the protection of the statutory moratorium on creditor action. In addition, as the use of CVAs grows, we can expect landlords (commonly significant creditors of struggling businesses) to become more skilled at responding to them. Those promoting CVAs would do well to engage with landlords and other key creditors as early as possible during the process in order to try and obtain a successful result. Circulating a CVA proposal only once facing creditor demands can be a risky path and may frustrate and alienate creditors who otherwise may have been keen to do a deal.

5. What happens if the CVA isn’t approved?

If a CVA is not approved by the requisite majority of creditors, often the company will have little choice than typically to enter administration or liquidation. The same result can also follow when a company is unable to comply with the terms of its own CVA, for example because it has been unable to generate a sufficient trading profit to make the agreed repayments to its creditors. In such circumstances, it will usually be a term of the CVA that the supervisor petitions for the company to enter liquidation or administration following such a breach. Creditors will revert back to the pre-CVA position and can claim for their full debts, unless the termination provisions in the CVA provide otherwise.

Interestingly, in the recent case of Re SHB Realisations Ltd [2018] EWHC 402 (Ch) the Court considered whether termination provisions in a CVA which required payment of pre-CVA rent were unenforceable as a penalty. The Court held that the term, which permitted landlords to be paid the full amount of rents owed upon termination rather than the lower sums payable within the CVA, was not a penalty for the following reasons:

(A) Although CVAs have contractual effect, they are not subject to all the usual principles of contract law. For the clause to constitute a penalty, the debtor would need to have been subject to oppression in agreeing such a term. In circumstances where a CVA proposal is drafted and circulated by the directors of the debtor company, it is difficult to see how the clause could be construed as a penalty.

(B) The CVA did not replace the original obligations under the leases to pay rent or comprise a new reduced rental obligation, it merely constituted a compromise of the original obligation subject to the company complying with the terms of the CVA proposal. It was a condition of the creditor agreeing to that arrangement that the pre-CVA debt be reinstated in the event of termination of the CVA. The Court considered that the landlords had a legitimate commercial interest in agreeing to that arrangement, which was not unreasonable or exorbitant.

(C) The CVA did not constitute a variation of the rent provisions under the lease. The lease was made by way of deed and could not be varied by a simple contract.

Accordingly, the Court found that termination provisions under a CVA which reinstate pre-CVA debts do not fall foul of the rule against contractual penalties.

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Lucy Walker, Tim Carter

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