Guide to Company Voluntary Arrangements (CVA) and When to Use Them

A Company Voluntary Arrangement (CVA) is a binding agreement between a company and those to whom it owes money (creditors).

It is based on a proposal that will include affordable, realistic and manageable repayment terms. It normally allows for repayment to be spread over a period of three to five years and can also be used to offer to repay less than the amount due if this is all the company can afford.

The proposal is sent to the Company’s Creditors along with an independent report on the proposal by an insolvency practitioner acting as Nominee.

Creditors are invited to respond to the CVA proposal by voting to either accept it, or reject it, or accept it subject to modifications that the Creditor proposes as a condition of their vote for acceptance. 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.

A CVA can only be used when a company is insolvent but it can be used to save a company rather than close it when creditors are pressing including when a debt related judgement can’t be satisfied or a creditor has filed a Winding Up Petition (WUP).

In addition to proposing terms for repaying debt, it helps to include details of any restructuring and reorganisation along with a business plan so that creditors can assess the viability of the surviving business. The proposals must be fair and not prejudice any individual or class of creditor including those with specific rights such as 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 many companies have built up.

A CVA should only be used when the company’s directors are willing to be honest with themselves and face up to the position the company is in, preferably with the advice and guidance of an insolvency practitioner or experienced business rescue advisor but used properly it can improve a company’s cash flow very quickly by removing onerous financial obligations and easing the pressure from creditors.

Save Your Company by Terminating Onerous Contracts to Cut Costs

Many directors are afraid of terminating contracts and agreements when their companies are in financial difficulties normally out of a concern that termination will lead to a cancellation payment that the company cannot afford.

If a company is experiencing fewer orders or lower sales, for example, generally it will need fewer staff but the worry is that terminating contracts of employment will trigger costs, particularly where senior staff are involved.

Similarly, a reduction in orders may mean that the company only needs two of the five fork lift trucks it has where terminating a hire purchase, hire or lease arrangement ahead of the agreed contract period will trigger a termination settlement or a contract termination liability.

Equally it might now no longer be able to afford the 12-month advertising contract it agreed six months previously. Even terminating contracts with advisers can be expensive.

A company in financial difficulties does not have the surplus cash to meet these obligations.  But while it puts off terminating arrangements it no longer needs it continues to bear the costs.

It is often better to cut the cash flow if this reduces costs that mean the business is viable: profitable with positive cash flow. There are remedies that can be used if necessary to deal with the crystallised liabilities when a company cannot afford them.

Negotiating terms for informal arrangements with creditors is sensible. It may involve negotiating terms of payment, such as a Time to Pay (TTP) arrangement with HMRC for PAYE or VAT arrears, which have been very effective in helping companies out of insolvency.

Many companies leave it far too late to reach informal arrangements that would have allowed them to terminate contracts before the company finally runs out of money.

But there is a solution that allows companies to terminate contracts and not pay for them immediately on termination. A Company Voluntary Arrangement (CVA) avoids liquidation of the business and closing it down. It allows for paying the contract termination out of profits.

Guide to Insolvent Liquidation and When and How it is Used

Insolvent Liquidation involves a formal process to close a company. It happens when a company is insolvent, which means it does not have enough cash or liquid assets to pay its debts and the directors have concluded that continuing to trade will be detrimental to creditors.

There are four tests (set out in the Insolvency Act 1986) any of which can be used to establish whether a company is insolvent.  The tests don’t necessarily mean that the company will have to close down, although often directors assume that it must.  However, there are remedies that could save the company if at this stage it calls on a licensed insolvency practitioner or business turnaround adviser, who would carry out a review of the accounts, the assets including property, stock and debts and the liabilities. With help from the adviser, the company can develop realistic plans for it to survive and trade out of insolvency.

Once it is decided that the company is insolvent, and cannot be rescued, it should be closed down in an orderly fashion which means via a liquidation process. This involves the company’s assets being turned into cash and used to pay off its debts to creditors.

There are two types of liquidation, one compulsory and one voluntary and both are legal processes.

Voluntary liquidation through a Creditors’ Voluntary Liquidation (CVL) is when the directors of the company themselves conclude that the company can no longer go on trading and should be wound up.

Normally they would engage an insolvency practitioner to help guide the directors through the formal procedure, which involves a board meeting to convene shareholder and creditor meetings.

The nominated liquidator normally sends out notices to shareholders and creditors having obtained their details from the directors and helps directors prepare the necessary formal documentation that is legally required.

The nominated liquidator must be a licensed insolvency practitioner who provides his consent to act which must be available for inspection at the meeting.

If the directors have left consulting too late they can then find themselves facing the court winding up procedure rather than having the option of a CVL.

Compulsory liquidation is triggered by a creditor formally asking the courts to have a company closed down by submitting a Winding Up Petition (WUP. In this case the court decides whether or not to support the petition by ordering that the company be wound up (compulsorily liquidated).

Upon a winding up order being made, an officer called the official receiver is automatically appointed to take control of the company to oversee the process of closing it down.  The official receiver may, if he/she wishes, appoint a liquidator to assist in dealing with recovering and selling any assets.

Dealing with the Bank When Considering a Company Voluntary Arrangement

The large number of companies in financial difficulties is swamping the banks and as a result there is a lack of experience in banks when dealing with companies in the process of restructuring.

If a company is subject to a Winding-up Petition (WUP) the bank can be held liable for any funds that are paid out of its bank account once the Petition has been advertised in the London Gazette. As a result banks tend to freeze the accounts of any company with an outstanding WUP as soon as they become aware of it. The only way for a company to free up money in a frozen account is via an application to Court for a Validation Order.

When attempting to save a company where there is no WUP, however, the lack of experience among banks means that in some instances they are behaving as if there were a WUP and this is getting in the way of attempts to restructure because banks do not understand the distinction between the various restructuring tools.

An example of where this is happening is when a Company Voluntary Arrangement (CVA) is being proposed.  The process of agreeing a CVA involves notifying creditors of the intention and allowing time for a meeting to be set up for creditors to approve the CVA proposals. Usually there is a hiatus period of at least three weeks between notification and the meeting, which allows creditors to consider the proposals and make any comments or request adjustments before the meeting.

However, banks’ inexperience of CVAs is leading some of them to freeze company accounts during the hiatus period and this has an adverse effect in that the company is no longer able to trade. While banks generally do not have the right to freeze their clients’ bank accounts unless there is either a WUP, an order by the Court or a breach of contract, they may take precautionary action out of fear when they don’t know what is going on. Concern about fraud can always be used to justify such an action.

It therefore makes sense for a company to talk to its bank beforehand to let them know what’s going on. Where the company is overdrawn clearly the bank is a creditor and should be notified of any restructuring proposals, in particular where there is a CVA.

An Outline of Shareholder and Director Liabilities When a Business is in Difficulty

When a company is insolvent the duties of the directors as its officers move from a primary duty to shareholders to a primary duty to protecting the interests of its creditors.

Shareholders’ liabilities are limited to the value of their equity and are protected from liability to creditors under what is known as the “corporate veil”.

However, if the shares are only partly paid for and the company enters formal insolvency the creditors can, via the appointment of a liquidator, demand that the shares be fully paid in order to discharge the creditors’ liability.

It is also possible that a company’s shareholders might have given a personal guarantee at some stage during their involvement with the company.  It might be that at start-up for instance, particularly when a family member has started a small business, or when the company subsequently entered a contract such as a lease, some or all of the shareholders personally guaranteed the contract and then later forget about it, especially if they are no longer directors or officers of the company as they may have been in its early days.  It can also be an issue after the shareholders have sold their shares but not discharged their personal guarantees.

Directors, on the other hand, can be held to be personally liable under the Insolvency Act 1986 for money owed to creditors. They must not sell any assets under their market value. They must not pay some creditors and not others in a way that seeks to prefer those being paid.  The fiduciary duty imposed on the directors of an insolvent company leaves them with personal liabilities that are not imposed on shareholders.

However, it is often the case with small companies that the director and shareholder are one and the same and in those situations the director must remember that he or she wears different hats as director, shareholder, employee and also as a creditor, if they have lent money to the company. This is in particular an area where repaying director loans can attract a charge of preference referred to above.

It therefore makes sense to get outside help from a business turnaround or rescue adviser if you are involved in a business as both a shareholder and as a creditor. It is in the advisor’s interests to offer realistic solutions to help restructure the company.

Guide to Creditors Voluntary Liquidation (CVL) from K2 Business Rescue

Creditors’ Voluntary Liquidation is a process by which the directors of an insolvent company can close it down in an orderly fashion without involving a court procedure. There are four tests of insolvency laid down in the Insolvency Act 1986.

Insolvency does not necessarily mean that a company should be closed down, but depends crucially on whether or not continuing to trade will enable the company to emerge from insolvency and will improve the position for creditors.

If the company does continue to trade, the directors should seek professional advice as they have a legal obligation to act in the best interests of the company’s creditors and if the company eventually does have to be closed down they will need documented proof of this or they risk becoming personally liable for the company’s debts.

The CVL procedure is defined by the 1986 Act and involves a board meeting at which the directors formally agree that the company should cease to trade. The next step is to seek shareholder consent. At least 75% of the shareholders must approve the directors’ proposal and at least 50% must approve the nominated liquidator. The shareholders may disagree and wish to appoint new directors to save the company.

Documents must be prepared including Statutory Information on the company, a history of the business, historical financial information of the company, deficiency account, a statement of affairs and a list of creditors.

A creditors’ meeting is also convened to confirm the nominated liquidator or appoint the creditors’ own nominee, who will need approval by at least 50% of the creditors. All nominated liquidators must be licensed insolvency practitioners who have provided consent to act, which must be available for inspection at the meeting.

The liquidator’s duties include dealing with assets which are normally sold, accessing creditors’ claims and distributing surplus cash to creditors following a strict order of legal priority. They must also investigate the accounts and activities of the company and in particular look at the transactions prior to the company being placed into liquidation. Having done this they report to the Insolvency Service on the conduct of the directors.

A CVL is a very efficient procedure with the liquidator taking over responsibility for dealing with creditors and closing down the company. It also demonstrates that the directors were responsible in carrying out their duties by closing down the company in an orderly manner when they believed it should cease to trade.

Directors Could be Storing Up Trouble for Later by Sacrificing Pay and Drawings Now

In the current economic crisis company directors are cutting their drawings and foregoing their salaries in order to save their companies still hoping that the market will recover.

As a result they are retaining costs that their companies cannot afford by sacrificing their personal drawings on the company today.

For how long can, or should, directors sacrifice their income and dividends in order to retain the company’s capacity for growth in the hope the order book fills up?

Once a company’s creditors are affected by a worsening balance sheet then there is a risk that the directors could be held personally liable for the increasing debt if they do not take decisive action to get the situation under control, for example by consulting a business turnaround adviser.

In any event no company can continue in a situation of insolvency for long in the hope of an upturn in the market without taking some measures to try to move it back to profitability.

At the time of writing it is estimated that there are more than 370,000 Time to Pay arrangements between businesses and HM Revenue and Customs (HMRC). Such a huge number suggests that a lot of directors have sacrificed their drawings in order to prop up their company to keep it going in the short-term by deferring payments rather than restructuring the business for long term survival. This highlights the need for a lot of companies to change their business model and significantly cut their costs.

Doing so would benefit a company’s directors, who could then start to pay themselves once the company resumed profitability.

While it may be easy in such circumstances to cut your drawings, pension contributions or health insurance this can only ever be a short term measure. 

Without a proper review of the company or the ability to make profits you may be prejudicing your personal futures.

It is a very rare company that does not need to review its business model from time to time, and it may also be that there is a viable core business buried under the current problems that an objective but supportive turnaround adviser may be able to identify and help the directors to nurture.

Turnaround Forecasting is About Reality, Not Wishful Thinking

Most forecasting is generally done for lending, fund raising or other investor related purposes and therefore with hope of future growth built into the forecast. Such forecasts show how loans will be repaid and investors will achieve a return on their money. Such forecasts are often more about hope than reality.

On the other hand, a turnaround forecast must be achieved and ideally exceeded and is more oriented towards improving cash flow than making future profits.  Low expectations are set so that the business does better than forecast, especially if the business is looking for support from the bank or additional finance that tends to have expensive penalties for failure. Therefore turnaround forecasting will deal with a level of detail where a turnaround business plan is essential.

So the turnaround forecast is used to show the pre-turnaround business model, and then the costs of implementing the turnaround and then the post-turnaround business model. To illustrate this take the situation of a company recently helped by K2 Business Rescue, that has shrunk and no longer needs two factory units and is looking to consolidate into one to reduce premises costs.

The less expensive but ideal unit needs three-phase electricity installing to operate the heavy equipment that is in the second unit, but the electricity supplier has switched off the power in that unit due to an overdue account. The cost of reinstating the existing supply, however, is similar to the cost of installing the new three-phase supply.

K2’s turnaround forecast showed a significant cash saving if the move was brought forward by investing in the three-phase installation which both cut premises costs and saved the cash that would otherwise have been needed to pay to reinstate electricity as well as install the three-phase. The focus on cash helped make this decision, the profit and loss benefit helped justify it. And the electricity supplier liability was bound in a CVA (company voluntary arrangement).

It challenged the orthodoxy that not spending money is going to save money whereas investing a little now could save a lot later. 

The essential point is to distinguish between short term and medium turn benefits and a turnaround forecast is looking at cash flow in the short and medium term rather. It is dealing in reality rather than hope and incorporated into the medium term is the effects of what fundamental change is being made in the short term.

A Frozen Bank Account Need Not be the End of a Business

If a bank takes action to freeze a company’s bank account it is an indication that the bank is nervous and under its bank facility terms and conditions has exercised its right to not release funds.

A bank’s behaviour is monitored by its facility people and triggering action to freeze does not imply any expression of judgement or opinion on the business itself.

There are two other circumstances that can trigger a bank account freeze.

The first is when a winding up petition is advertised in the London Gazette, which is a legal requirement before a petition can be heard in the High Court.  In this situation the bank is required to freeze the business account because the bank can be held to be liable for any funds paid out of the account.

A second situation that can trigger a bank account freeze is when there are not sufficient funds in the account, which makes it effectively frozen, even if it hasn’t been done formally by the bank.

It is most likely to happen because the company is not paying money into the account, possibly because its factoring company is not remitting funds to the bank.

A company’s relationship with its bank is aggravated if the company fails to take steps to deal with this situation, putting the bank in the embarrassing position of having to return cheques or direct debits.

Payment returns can also cost a company a great deal of money, adding to the pressure on its cash flow by charging fees but it also causes the bank to more actively monitor the account because the company’s directors are failing to manage it within the facility that has been agreed.

In a situation like this when there are insufficient funds but the bank account is not formally frozen, the directors need to take prompt action, including stopping the release of cheques, cancelling all standing orders and direct debits and taking control of the cash to manage all future payments. This creates a hiatus period during which cash is only released if there are sufficient funds.

During this hiatus period when survival is in jeopardy, directors must manage the company in the best interests of creditors. Payments are only made to meet ongoing costs and those crucial liabilities that need to be paid for to keep the business going.

If, however, the bank account has been formally frozen the directors can only make payments either with the bank’s approval or with an order from the courts.

Is Your Business Structure Holding Back Your Success?

The structure of a business is crucial to its success and often it can get in the way of growth.

If a business needs to build another factory, say, then if the funding is not in place to do so that will get in the way of growth. This should be factored into the business model.

Often, in order to correct this kind of issue a business needs to be restructured to give itself the flexibility it might need to survive and grow.

Ideally a regular look at the business structure would be part of the process of continuous improvement to ensure a business is in the best possible shape to meet short term problems,  like an economic downturn and a consequent drop in orders, and to enable it to thrive, grow and expand long term.

Restructuring more often is carried out as a consequence of a business struggling to survive and is one of the tools available to business rescue advisers called in to help a company in difficulties.

An example of what a restructuring adviser can do is the case of a company K2 was involved with that had a break-even point of £3.5 million and whose turnover had declined from £5 million to less than £2.5 million.

In this situation it was clear that, although viable, significant changes were needed. They included closing a factory, getting rid of onerous financial arrangements, terminating some employment contracts and reducing other fixed costs.  The outcome of these actions was to reduce the break-even point to £1.8 million.

A reduction of sales to just under £2.5 million then became a healthy profit rather than a significant loss.

It meant that the unit cost of production was also reduced once it was free of the burden of the finance drain on the equipment.

It might seem that this should have been obvious to those running the company, but it is possible to be too intimately involved in the day to day running of a business, especially one under this kind of stress, and to be unable, therefore to stand back and look at the elements in the structure of the business that are impeding a solution to its changed circumstances.