Could 2018 be the year of the CVA?Print publication
Following the approval of the company voluntary arrangement (CVA) by the creditors of Toys “R” Us in December 2017, the start of 2018 has seen another high profile CVA. Troubled burger chain Byron announced at the end of January that it had also restructured its business with the use of a CVA. It could be that with the current economic pressures on high street retailers, 2018 may see an increase in the use of the CVAs as an alternative to formal insolvency procedures.
The high street continues to be a difficult place to trade at the moment for both retailers and food outlets alike. Businesses are continuing to face a squeeze from a number of factors, including the continued growth of online shopping, soaring labour costs, business rates, the popularity of food delivery companies and a drop in consumer spending amid economic uncertainty.
With this market background, it is unsurprising that a number of companies are considering CVAs in an attempt to restructure their business in the hope that they can weather the storm.
Although not the most common insolvency procedure in the UK, a CVA is often considered when a company has a large number of leasehold real estate interests which it needs to restructure to survive. In many cases, long term leases will have been entered into several years ago which include rent, rates and other obligations which are no longer viable in today’s market.
What is a CVA?
Although an administrator or liquidator can propose a CVA, in the current climate CVAs are being proposed with the intention of avoiding the company going into administration or liquidation. In this context, a CVA involves a proposal by the company’s directors to its unsecured creditors for a compromise or arrangement in satisfaction of its debts. It should be noted that a CVA cannot affect the rights of a secured lender to enforce its security without its specific consent.
In theory at least, a CVA should produce a better financial return for unsecured creditors than if the company was placed in a formal insolvency procedure. In contrast to other insolvency procedures, the directors remain in control of the business which continues to operate, subject to the terms of the CVA and under the supervision of an insolvency practitioner.
A CVA allows much greater flexibility than insolvency procedures such as administration or liquidation. The company and its unsecured creditors effectively agree when and what percentage of the company’s debts will be paid and in real estate focussed CVAs (see below) can amend the company’s lease obligations. The directors, along with their advisors, will draw up proposals for the restructuring (which commonly include a redrawing of the lease terms) and all unsecured creditors then vote to either approve or reject the proposal. The CVA must be carefully drafted to ensure that it provides a more commercially attractive outcome for the creditors than an administration or liquidation.
If 75 per cent. or more in value of the company’s unsecured creditors vote in favour of the proposals, they become binding upon all of the company’s unsecured creditors, including those who voted against the proposals and/or were eligible to vote but did not receive notice of the proposals.
Challenging a CVA
Once approved by the requisite majority, a creditor cannot take any step against the company to recover any debt or enforce any rights that fall within the scope of the CVA. The only challenge to a CVA that a creditor can make is by an application to court. The application has to be made within twenty eight days of the CVA approval 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.
A CVA can only be challenged on the basis that the arrangement unfairly prejudices the interests of a creditor of the company, or there has been some material irregularity at or in relation to either the decision procedure or (if requested) the meeting at which the arrangement was approved.
The concepts of prejudice and unfairness are questions of fact and are distinct considerations. A CVA can be prejudicial in the sense that it can treat different unsecured creditors in different ways. This is precisely the approach retail CVAs have adopted in treating landlords differently from other unsecured creditors and also treating landlords differently as between themselves. The question of fairness depends on the overall effect of the CVA.
The court will consider whether any creditor has been unfairly prejudiced by the CVA but challenges are not common. This may because the evidential burden on the creditor is likely to be high and the time period to bring a challenge is relatively short. In addition, for PR reasons a major creditor may not want to be responsible for challenging a proposal which is intended to save a business and in the case of a national chain, possibly hundreds of jobs. Finally, if the CVA does fail following a challenge and the company ends up in administration or liquidation, the outcome for the creditor is likely to be worse than if the CVA was implemented.
Reasons for using real estate CVAs
The use (or attempted use in the case of BHS) of CVAs for companies with large property portfolios (such as retailers, food chains or hotels) has increased in recent times, as evidenced by Travelodge, BHS, Toys “R” Us and Byron Burgers and going back further, JJB Sports, Focus DIY and Blacks Leisure. A CVA offers a mechanism that allows the tenant company to restructure its lease obligations on a mass scale, without the need to negotiate with each individual landlord. A CVA can significantly reduce the real estate overheads of a company and can bring about the closure of unprofitable stores even where an individual landlord does not approve the CVA.
Real estate CVAs have commonly used an approach whereby properties are split into different categories. Leases of profitable stores may be left unchanged, save in some cases for the rent moving from quarterly to monthly to assist cash flow. Leases of marginal stores may be amended to provide for sizeable rent reductions and the option for substantial lease renegotiation. Finally, unprofitable stores which are unlikely to be viable are closed and the lease obligations brought to an end.
A CVA will not suit all situations but retailers and other businesses struggling with large lease liabilities should consider a CVA as a potential option to reduce those liabilities and help with overall profitability. It could be that Byron is one of many companies in 2018 that use a CVA to restructure their business and speculation is rife that other large retailers and food chains may follow suit soon.
At Walker Morris we have a team of restructuring lawyers who have experience in both putting CVAs in place and challenging their validity. If you think that a CVA could help your business survive or you are a creditor on the wrong end of one, please get in touch and we can see how we can help.