Introduction The last twelve months have seen a marked growth in the use of Company Voluntary Arrangements (CVAs) as an increasing number of corporates (including, for the first time, listed companies) have successfully employed the procedure, often without the protective wrapper of administration, to address their financial issues in preference to other forms of (more intrusive) insolvency procedure. This experience has shown that, in the event that more than 50% of unconnected, unsecured creditors support a restructuring proposal, CVAs offer an extremely flexible, management-led restructuring tool which can deliver a better outcome for creditors and stakeholders than the alternatives. Crucially, if utilised appropriately, CVAs may create additional value for shareholders whilst allowing management teams to remain in place throughout the restructuring process and beyond. This note is intended to provide a brief overview of how CVAs operate and to highlight some of the legal and commercial factors to be considered by Turnaround Professionals when assessing the viability and attractiveness of a CVA in a workout scenario. Because every real-life situation is different, the note cannot be definitive and you are recommended to obtain specific specialist advice in each particular situation. Overview A CVA enables a company to propose and agree a compromise or other arrangement with its creditors in respect of outstanding unsecured debts. Although a CVA is a court sanctioned procedure under the Insolvency Act 1986 (and therefore benefits from the protections of court approval), there is only limited involvement by the court; the CVA is subject to the supervision of an independent insolvency practitioner nominated by the company (known as the "nominee" prior to implementation of the proposals and the "supervisor" afterwards). It therefore presents an opportunity that can be cheaper, quicker, more constructive and less destructive than other workout or insolvency procedures. Because a CVA constitutes an agreement between a company and its stakeholders, the nature of the arrangements which can be implemented are typically broader and more flexible than other insolvency procedures and can be tailored to the needs of the company's business. For instance, a CVA may include a combination of: 1. a partial write-off of selected liabilities; 2. a deferral and/or re-scheduling of payments; and/or 3. the injection of new third party funds which would not otherwise be available. In practice, a company will need to work closely with the nominee and its legal and financial advisers to develop the CVA proposal. Key creditors will often also need to be consulted. IFT Information Note 97 Page 1 of 5
To become effective, any proposal put forward by way of a CVA requires the approval of a majority of 75% in value of a company's (unsecured) creditors present and voting at a meeting to consider the arrangement (see Voting Rights and Requisite Majorities below). This majority may include connected creditors (for example, intra-group creditors). However, the 75% requisite majority must also include more than 50% of unconnected creditors. In circumstances where there is significant, supportive intra-group debt therefore, the 50% unconnected creditor threshold will often represent the operative threshold for CVA approval. In practice, creditor analysis and negotiation will be required before the creditor meeting to achieve, as far as possible, the buy-in of key creditors (this will likely include secured creditors who, although outside the CVA procedure, will, in reality, need to be supportive). If approved, a CVA will bind all of the company's creditors who are entitled to vote at the meeting (whether or not they actually voted). Also, provided it does not unfairly prejudice any creditor (see below), a CVA has the flexibility to treat different classes of creditor differently without the requirement to obtain the separate consent in relation to each class. In this respect, it is less cumbersome, cheaper and usually quicker than a scheme of arrangement. NB: a CVA may not affect the rights of secured creditors or preferential creditors without their agreement. Overview of CVA Procedure and Timetable A proposal for a CVA can be made by a company's directors or by an administrator or liquidator (where the company is in administration or is being wound-up). The directors give the nominee a summary of their proposals for a CVA together with a statement of the company's affairs containing details of the company's creditors. The nominee must, within 28 days (or such longer period as the court may allow), consider the proposal and report to the court as to whether it should be submitted to creditors. In reality, the insolvency practitioner consulted is likely to have developed the CVA proposal in conjunction with management and their other advisors prior to its final submission. The nominee then summons meetings of creditors and shareholders. Each creditor of the company of whom the nominee is aware should be given at least 14 days notice of the meeting which should be held between 14 and 28 days from the date on which the nominee's report is filed in court. There is no formal register of CVA proposals nor does the party proposing the CVA need to publicly advertise the proposal or the creditors meeting called to consider the proposal. Voting Rights and Required Majorities The CVA proposals are put before meetings of both the company's shareholders and creditors. Each meeting can approve, reject or modify the proposals. The CVA takes effect if the creditors' meeting approves it notwithstanding the outcome of the shareholders' meeting (although, if the IFT Information Note 97 Page 2 of 5
shareholders' meeting does not also approve the CVA by simple majority, any shareholder may apply to the court to challenge the decision within 28 days). Every unsecured creditor who was given notice of the creditors meetings is entitled to vote. This includes connected creditors (for example, intra-group creditors). However, secured creditors are only entitled to vote on the proposal to the extent that there is a shortfall in the current value of the secured assets (i.e. to the extent to which their claims are unsecured). Votes are calculated according to the value of the creditor's debt as at the date of the meeting. Where some or all of a creditor's claim against the company is unliquidated or unascertained (which may be the case where a landlord submits a claim for future rent), the unliquidated element will carry a value of 1 for voting purposes unless the chairman of the meeting (usually the nominee) agrees to place a higher value on it. In such circumstances, the nominee will make reasonable efforts to ascertain the value of such unliquidated/unascertained claims and would typically construct a methodology for their calculation. As noted above, if 75% by value of creditors voting at the meeting approve the proposal (including more than 50% of unconnected creditors), it will bind all unsecured creditors, whether they voted in favour or not. Grounds for Creditor Challenge A creditor who feels unfairly prejudiced by the CVA may apply to court within 28 days of the CVA meeting for an order revoking the CVA or convening more meetings to consider a revised CVA. What will constitute unfair prejudice is a question of fact but the ground is unlikely to apply if the CVA provides for compensation for any prejudice suffered by a creditor and, in particular, if the outcome of the CVA is better for the creditor than the likely outcome under an alternative insolvency scenario, such as administration. A CVA can also be challenged on the grounds that there was a material irregularity in the conduct of the meetings called to consider the CVA proposals. Position at Completion Following the approval of a CVA, a creditor is not permitted to take any step against the company to recover any liability that falls within the scope of the arrangement or to enforce rights against the company that arise from the company's failure to pay the debt in full. Where a landlord is bound by a CVA all rent arrears will be caught by the terms of the CVA as well as the tenant's liability for other sums that are due or will become due under the lease (including future rent unless excluded under the terms of the CVA). IFT Information Note 97 Page 3 of 5
Advantages of CVAs There are various potential benefits to implementing a restructuring through a CVA as against other formal or informal insolvency procedures. In particular, a CVA: 1. offers a quick, economic and flexible tool by which a company can renegotiate certain of its liabilities with its unsecured creditors thereby reducing stresses on its cashflow; 2. allows existing management to shape the restructuring proposal and to remain in place following the implementation of the procedure while avoiding the operational and reputational disruption of administration (in the case of listed companies, for instance, it has been possible to implement a CVA while avoiding share suspension); 3. offers the opportunity for a solvent restructuring allowing the company to survive (thus preserving an interest for shareholders); 4. allows a company to deal with the different classes of its unsecured creditors separately this has proven to be particularly attractive to corporates with a significant number of leasehold properties as it gives them the ability to vary the terms of, for example, leases of closed or unviable stores; 5. can, where there is a large, supportive connected creditor base (for example, intra-group creditors), effectively be implemented with only 51% of unconnected creditor support; as a result, a relatively low threshold of unsecured creditors can implement the proposal which (subject to considerations of fairness) will bind all unsecured creditors; 6. is likely to offer a better return to unsecured creditors and shareholders than a straight administration; and 7. offers both creditors and the company the protection of court approval of the restructuring. Disadvantages of CVAs Unlike administration, a CVA does not automatically result in a statutory moratorium protecting the company from creditors taking action to recover their debts (through, for example, forfeiture or initiating winding-up proceedings). It therefore remains possible that a company's creditors will seek to recover their debt during the CVA implementation process causing disruption to the company's operations and potentially undermining the process. IFT Information Note 97 Page 4 of 5
As a result, CVAs have historically been coupled with administration so that the company benefits from the protection of the moratorium on creditor action that applies in administration. However, combining the CVA procedure with administration can greatly increase the costs of the exercise and may also undermine many of the benefits of the CVA procedure as well as having a destabilising affect and depressing values. A moratorium was introduced for CVAs undertaken by small companies 1 as a result of the Insolvency Act 2000 and at the time of writing it remains under consideration whether this provision should be extended. In practice, a CVA will often present unsecured creditors with the possibility of a better recovery than alternative action and such risks therefore remains more theoretical than real. In addition, a CVA cannot affect the position of secured creditors to enforce their security without their concurrence. As a result, a CVA does not present a means by which secured creditors can be 'crammed down' absent their consent. Other Practical Considerations for Turnaround Professionals Prior to commencing a CVA process, Turnaround Professionals will need to consider in detail the capital structure of the group. In particular, if liabilities have been incurred across a number of group companies, this may require separate CVAs for each relevant company and may complicate an assessment of whether the requisite creditor majorities can be obtained. In addition, consideration should be given to whether addressing unsecured debt alone will adequately deal with the company's financial issues without also addressing the company's secured debt and/or equity base. Consideration should also be given to the terms on which the requisite creditor majorities could likely be obtained in light of an analysis of the company's connected and unconnected creditor base. If there are common directors between the company implementing the CVA and certain intra-group creditor companies, such directors must be mindful that any decisions they take on behalf of the intra-group creditor must be consistent with their duties to that company. 1 A small company is defined for these purposes as a company which (taking into account the position of its subsidiaries) meets two of the following criteria: (a) has a turnover of less than 250,000; (b) has assets of less than 1,400,000; and (c) has fewer than 50 employees. IFT Information Note 97 Page 5 of 5