Why do so many CVAs fail?

failed CVAs? boarded up shopsMy blog earlier in the year (17 May) asked whether the use of CVAs was “a triumph of hope over reality” as they had been increasing noticeably in the High Street retail sector, which has suffered an escalating rate of insolvencies.

A CVA (Company Voluntary Arrangement) is generally used to help a company in financial difficulties by restructuring its balance sheet and reorganising its operations to survive and trade its way out of insolvency. A key aspect of the financial restructuring is reaching agreement with creditors for payment of a lump sum or regular payments over a defined period which is typically three to five years where the payments may be less than the amount owed.

Instigated by the directors, approval of a CVA requires 75% of unsecured creditors where the payment terms are binding on any dissenting creditors providing they are less than 25%. Generally, the earlier a business enters a CVA the better, although they can be used as a means of dealing with a minority creditor who has lodged a Winding Up Petition (WUP) in the courts.

It is too early to say whether this latest crop of retail-related CVAs will succeed or terminate early, but R3, the trade body for the insolvency profession, has published a comprehensive, 90-page, report that examined 552 CVAs started in 2013 to determine success and failure rates and analyse the reasons behind them.

It found that CVA use was “dominated by SMEs, with 514 of the 552 companies reviewed classified as small (or micro) based on Companies House records.” Of these the early termination (generally failure) rate was 65.2%, with early termination in certain sectors dominating: Construction (64.8%), Repair of motor vehicles (73.6%), Manufacturing (66.2%) and Administrative and Support Services (70.5%).

The research also conducted interviews with creditors of companies involved in CVAs, to add some depth to its findings.

What are the main reasons for early termination or failure of CVAs ?

As I said in my earlier blog a CVA will only work if the CVA proposals and any agreed modifications are realistic, achievable and sustainable. Essentially my argument was that most CVAs need fundamental change based on a reorganising the business and often the business model.

The R3 research tends to support my view; its findings are summarised as:

The viability of the terms of the CVA agreed at its outset (or subsequently varied) was often questionable.

Often directors did not implement necessary changes or failed to identify and tackle fully the problems identified in the CVA.

Companies failed to make regular contributions and those contributions that were made simply covered the costs of the CVA process.

Some CVAs returned very little to creditors over their lifetime; either because contribution payments were repeatedly missed or because contributions were only sufficient to cover the costs of the process.

HMRC was seen as the most engaged creditor and the one most likely to vote against a CVA whether for policy or commercial reasons.

Creditors also questioned the length of some CVAs, suggesting that five years was too long, and the competence and objectivity of the nominee(s) – usually an Insolvency Practitioner – overseeing the process.

In 2016 the Government launched a consultation on proposed changes to the insolvency regime, which included a mandatory pre-insolvency moratorium to give time for the details of a CVA to be defined and mandatory protection for suppliers.

Given R3’s research findings and the policy intention of a greater focus on helping businesses to restructure and survive I would argue that it is now time for action to improve and refine the insolvency regime.

The missing research into CVAs

My own assumption about CVA failures focuses on a lack of realism when considering the operational reorganisation necessary to achieve a viable business and then the lack of experience with implementation. The issue therefore is who is best placed to help the directors given that CVA proposals are the directors’ proposals.

I have for some time advocated a distinction between those who prepare and implement CVA proposals and those who act as Nominees and Supervisors of the CVA. All too often CVA proposals are prepared by the Nominee albeit in consultation with the directors. Setting aside the conflict of interests of an insolvency practitioner developing a plan that they will then police, the issue is one of who is best placed to plan and implement change to achieve a viable business. The skills and experience needed for this are more to do with start-ups and investment which are rare among insolvency practitioners.

Replacing directors might seem an obvious answer and in larger companies this may be the right one but I would advocate that CVAs for owner-managed SMEs need independent turnaround specialists.

For those interested in learning more about how to achieve a successful CVA, you might like a copy of my free guide, please follow the link: Guide to Company Voluntary Arrangements.

 

One Response to “Why do so many CVAs fail?”

  1. Tony Armitage

    It is no surprise that CVA’s are mainly for SME’s and that the failure rate is high.

    They are simply seen as “‘another job” by the IP and a postponement of debt by the directors. As you say too little attention is paid to the “work out process” and its supervision hence the high failure rate.

    All CVA’s should be “proposed” on an agreed introduction of new capital to be set aside with the Supervisor to satisfy the reasonable IP costs, payment in full of the preferential creditors and the dividend expectations of the unsecured creditors, all as per the CVA proposal.

    The new investor would then become the only post CVA creditor of the subject company for the capital introduced to satisfy the CVA creditors and any additional advances to provide working capital.

    If the proposed new investment is not provided immediately after approval of the CVA, the CVA will fail. If the CVA is approved and the new investment is provided the creditors will look to the Supervisor for their dividends as per the agreed CVA proposal and the subject company will trade on as a newly funded entity.

    The CVA and the subject company are effectively separated with actual funds being held by the Supervisor to pay agreed costs and dividends to creditors when the claims when agreed.

    My concept will require refinement and new legislation but it is the framework for a new style CVA to replace the existing format which clearly is no longer fit for purpose.

    Tony Armitage
    FIPA, FCICM

    Reply

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