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.

Business Turnaround Process Involves Completing Three Phases

There are essentially three phases to a business turnaround which are the first, emergency phase to try to ensure survival, followed by stabilisation, which includes a thorough look at any fundamental changes needed to achieve a viable business and finally the growth phase to secure its future on solid foundations.

It is important that the main objectives of each phase are achieved before going on to the next one. This needs a clear understanding from all those involved of the objectives of each phase. The focus of activity changes throughout the process from hoarding cash, terminating contracts and limits on spending while trying to survive in the emergency phase is very different to funding marketing activities, new processes, training and other efficiency related initiatives during a stabilisation phase.

The turnaround process differs from the insolvency process in that the aim of turnaround is to achieve a viable company that can survive whereas insolvency is aimed at putting a business in the best shape to sell the assets and liquidate the company. 

The first phase can be likened to triage and is similar to the actions usually carried out by a paramedic at the site of a traffic accident.  The paramedic’s job is to stabilise the situation so that the injured can be moved to the surgeon (if needed) who would carry out the second phase of dealing with the damage.

Company doctors are the business equivalent of the paramedic, taking quick decisions to optimise survival, and the surgeon, focussed on becoming cash positive as quickly as possible by only paying essential suppliers and liabilities.

Once the adviser has had a detailed look at the accounts and the business operation to establish the essentials they can then also put together a proposal for ensuring that there is sufficient cash flow to deal with the immediate situation in a way that will allow the business to continue trading while a strategy is being prepared for the next phase.

It will depend on the state of each individual business what the adviser will suggest to stabilise the situation but there are a number of tools that can be used.

A rescue adviser works as part of the company’s team and even if some of the proposed “medicine” seems unpalatable it is worth keeping in mind at all times that their interest is in helping you to survive and that the big advantage to you is that they are able to bring a new and more dispassionate eye to problems within the company to which you may be too close to be able to identify.

Survival sometimes needs Fundamental Change

Any successful business would be expected to be constantly monitoring its activities and modifying them where necessary to improve the efficiency and its various offers.

Continuous business improvement does two things: it optimises existing processes and keeps them optimal by continually updating them. 

But on its own, especially when there are significant challenges in the wider economy, such as the current global economic downturn, continuous improvement may not be enough.

Such unexpected challenges can plunge a business into difficulties where its survival may be at stake and this may mean looking at a fundamental change to the way it operates.

Too often businesses struggling to survive, are characterised by hard work and trying to improve the existing business model before they fail.  Business improvement is all about laying foundations, tweaking the system and improving. 

In my view fundamental change is a more radical look at the whole operation but it also needs care to avoid throwing the baby out with the bathwater by looking hard at the business and what needs to be preserved in order to survive and grow in the future. However, if a business tries to grow before bedding in new foundations following fundamental change it will reinforce problems that had not been sorted out.

For example in a downturn it is an understandable reaction for a business to trim its costs when it may be better to have an in-depth look at its business model and be open to more radical changes.

This can all seem too much when a company’s directors are struggling to keep a business afloat at a difficult time.  It is possible to be too close to the problem, however, and a combination of worry and a sense of urgency is not ideal for taking an objective look at the whole business model.

This is where calling on a business turnaround adviser could make all the difference between success and failure.  The adviser is motivated to help a business succeed and will expect to work with committed managers and staff, but they are not so immersed in the day to day minutiae of the operation and can therefore look at all aspects of the business, identify what is viable, what processes are draining the company and what actions can be taken.

Working With Trades Unions to Promote Consensual Turnarounds

I have approached a number of UK trades unions with a view to forging a collaborative approach to dealing with companies in financial difficulties. 

In my view, currently, employees are rarely involved in the decision-making when a company’s survival is threatened, but a successful business turnaround relies very much on the support of its employees.

Unlike formal insolvency procedures, turnarounds are consensual. Leadership, teamwork and communication are key to implementing change. Engaging with staff and involving them in the business introduces accountability and responsibility to a business and is crucial to its success. This is even more so with a turnaround where change is necessary.

Historically turnarounds have been co-ordinated by banks as secured creditors, or by new investors who drive change from a purely financial perspective, oriented towards achieving single stakeholder objectives.  What gets measured, gets managed. 

Many stakeholders have compromised their credibility with employees by this pursuit of short-term objectives of repayment of their investments with little interest in a company’s survival.  

So who is really interested in the employees let alone securing their employment for the future?

The trades unions are still believed to be the true representatives of employees’ interests and while the relationship between management and union representatives has in some instances become polarised this is not helpful when trying to save a fragile business. It is rather like the surgeon fighting with his medical team when a patient’s life hangs in the balance on the operating table.

This new initiative to collaborate with trades unions is based on developing a mutual respect and understanding of each other’s objectives outside the constraints of a turnaround situation.

Union input can be valuable when considering the thorny problem of how to reduce staff costs, where hard choices might have to be made between cutting numbers, wages, hours, or benefits. Their involvement helps remove fear among staff by reassuring them that their interests have been taken into account when developing the turnaround plan.

A Business in Difficulty Can Terminate its Property Leases and be Fair to Landlords

In April 2009 the retailer JJB successfully proposed a CVA designed to save 250 stores and 12,000 jobs. It has become the model for subsequent CVAs in the retail sector.

The proposal included closing 140 unprofitable stores but made available a fund of £10m for the landlord creditors of these premises, equating to a payment of approximately six months rent and JJB also made a significant compromise in bearing the substantial costs of the business rates of the unprofitable stores.

No leases were ‘torn up’ by the CVA and it was left to individual landlords to decide whether they wished to accept a surrender, consent to an assignment or forfeit the lease. The landlords as a group recognised that there was a substantial risk that JJB would go into administration, with a loss of their payments of rent or business rates for the closed stores and appreciated being consulted in a transparent process and being offered a genuine compromise.

It often happens that the core of a struggling business is viable and it need not go into administration if it can be restructured to focus on the parts that are profitable.

That can be beneficial to the creditors too, because they will then see some return on what they are owed, as the above example illustrates. In many cases the creditors will include landlords who own the property or properties from which the business is trading.

The forced termination of a lease can only be done by a liquidator following a company’s liquidation. If a company goes into administration and is sold the Administrator can also force termination of those leases no longer required.

However, in the JJB illustration negotiation with the landlords to terminate some leases was made possible by proving to them how much they would receive in the event of a liquidation and showing that the alternative offer set up using a Company Voluntary Arrangement (CVA) was better than liquidation.

Forcing a change in the terms of a lease is extremely difficult and the courts will want to test whether or not a landlord has been treated fairly as a creditor in a CVA, regarded as vertical and horizontal tests.

Cash is King When a Business is Facing Financial Pressure

A company can be said to be insolvent on any one of four tests: the cash flow test, balance sheet test (negative asset value), an unsatisfied judgement (usually a county court judgement) or an outstanding statutory demand.

Of these four, the most crucial is the cash flow test which looks at whether a company can pay its liabilities as and when they fall due where late payment of creditors indicates that a company is suffering cash flow problems.

Running out of cash is the cause of most business failures and it happens chiefly  for three reasons: the bank freezing the company account, a restriction in the company’s ability to draw down funds possibly due to the lack of available credit and thirdly, a sales ledger issue where the company can’t draw down funds from factoring either because invoices have not been logged, or because of declining sales, or overdue or disputed invoices.

If the company’s relationship with its bank is under pressure then the causes and effects must be examined. Banks generally would prefer not to close down businesses and only usually start to get tough if  a business consistently tests its overdraft limit, company cheques cannot be honoured and the business does not communicate or  provide sensible financial information if asked for.

It may be that the company is forced into an onerous factoring arrangement that will benefit the bank but can reduce funds available putting further pressure on cash flow.

If the sales ledger system is not being kept up to date accurately or there are issues with suppliers over invoices then the system needs to be looked at thoroughly and a more robust set-up may need to be put in place.

In terms of cash outflow, there are two main tensions that can result and they are the inability to pay outstanding bills and the inability to pay future bills. In this situation prioritising payments becomes essential.  This is critical if a company has decided it is insolvent because it must act in the best interests of its creditors and needs clear principles for making payments to avoid personal liability.

In these circumstances unless a company is familiar with this sort of situation it would be advisable to take advice from a specialist restructuring adviser, who will have a number of strategies available to help and it may be that at its core there is a viable business waiting to be unlocked.

A cash flow crisis is an alarm bell sounding that should indicate that the business needs to be properly assessed with experienced outside help.