CVAs: a breath of life for insolvent companies?

people focusing on computer

In certain cases, a CVA can save a business from closure, safeguard the interests of directors and help them to avoid future accusations of wrongful trading.

A company voluntary arrangement (CVA) is often seen as the best option for insolvent businesses that could be viable in the future.

There are any number of reasons why a company may not be able to pay its debtors when payments become due. Poor sales, the loss of a key customer, ineffective credit control, the lack of proper financial forecasting, and even rapid growth, are just a few of the factors that can cause a once successful business to struggle financially.

This situation, known as insolvency, can cause sleepless nights for company directors and, if not resolved, can lead to the liquidation of the business.

In some instances, it may be possible to rescue an insolvent business without the requirement of a formal insolvency process. Seeking alternative forms of funding, increasing sales, reducing costs, selling assets, restructuring the company or simply improving collections processes are just a few of the strategies that can be used to get the business back in the black.

In other insolvency situations, it’s more difficult to turn the company’s fortunes around. In this case, there are four main formal insolvency procedures that provide measures for handling the insolvency: administration, receivership, liquidation and a CVA. Of these, a CVA is often seen as the best option for insolvent businesses that could be viable in the future, as it allows them to repay their debts from future profits and continue to trade.

The CVA process

If a company has a viable future but creditor pressure is mounting, then with the help of a turnaround or insolvency practitioner, its directors can propose a repayment plan to the creditors.

The creditors then vote on whether to accept the proposal. The directors of the insolvent business must work to maximise their creditors’ interests, so if it can be demonstrated that the CVA will lead to a better return for the creditors than an insolvent liquidation, it may be viewed positively.

The general stages involved in a CVA are as follows:

  • The company director will contact a turnaround practitioner to discuss whether a CVA is appropriate in their case.
  • A full review of the company will be carried out to determine its financial position, its future viability and any flaws in its current operations. Financial forecasts are also produced.
  • The turnaround practitioner will then work with the directors to create a ‘fit, fair and feasible’ payment proposal to repay all or part of the company’s debts. This will usually be in the form of a monthly payment, over a typical period of five years.
  • The proposal will then be lodged at court and given an originating number before being sent to all company creditors for their approval.
  • Creditors then have a minimum of 17 days to consider how they will vote before the virtual meeting (or physical meeting if 10 creditors, 10 percent in value or 10 percent in number request one) is held.
  • At the creditors’ meeting, the proposal is discussed and voted on.
  • If 75 percent, in value, of voting creditors vote in favour of the proposals, the CVA will be approved and all creditors will be bound by its terms.
  • Immediately after the creditors’ meeting, a shareholders’ meeting will be held to pass the resolutions approving the CVA.
  • Once approved, a CVA supervisor will be put in charge of collecting payments each month to distribute to creditors, usually annually. As long as all terms and conditions are adhered to as set out in the CVA, all interest and charges on the debts will be frozen, and creditors will be prevented from taking further legal action against the company.

When can a CVA be used?

A CVA is probably not used in as many insolvency cases as it ought to be, simply because many directors are not aware of the process, or don't understand the considerable advantages it can bring. In certain cases, a CVA can save a business from closure, safeguard the interests of directors and help them to avoid future accusations of wrongful trading.

A CVA may be a potential route out of insolvency if the following criteria are met:

  • The company is viable and capable of generating profits once its debts have been frozen.
  • The company will have the continued support of key customers and suppliers once the CVA is in place.
  • The directors are committed to the future operation of the business.
  • The directors and managers are ready and willing to restructure the company if necessary.
  • The company is capable of funding itself within established credit limits once the CVA is in place.
  • No winding up petition has been issued – although it is possible to discuss a CVA with the petitioning creditor to seek their support.   

The advantages of a CVA

If an insolvent company satisfies the above criteria, a CVA can have significant advantages over other insolvency procedures, including:

Continued trading

Undoubtedly, the most compelling advantage of a CVA over other formal insolvency procedures is that it allows a company to continue to trade. Even if a winding up petition has been advertised against the company, and bank accounts have been frozen, a CVA can provide the breathing space a company needs to obtain a validation order to reopen accounts and continue business as normal.

Maintain control

Unlike other insolvency options, a CVA allows company directors to retain control of the business throughout the process. There will also be no investigation into the conduct of directors, so they can continue trading without the worry this brings.

Existing contracts and accreditations can be retained

Some companies choose a CVA because it allows them to keep certain contracts and accreditations that might be lost if the company were to be liquidated.

The debt can be reduced

A CVA can reduce the debt amount that needs to be repaid and prevent further interest and charges from being added. Although many creditors will not be happy accepting less than the amount they are owed, a CVA will usually deliver a better return for creditors than other insolvency procedures.  

It allows the business to be restructured

A CVA can give businesses the breathing space they need to restructure the company. The directors and owners also benefit from the assistance of turnaround practitioner, who can help to formulate a plan for future survival.

Tax losses can be retained

If a company entering a CVA has accumulated tax losses, then they can be retained for three years and brought forward to offset future corporation tax liabilities on gains during profitable periods. When an administration begins, a new tax period is created, which means that tax losses can't be brought forward. This benefit will also be lost in liquidation.

An excellent tool while waiting for funding

A CVA can be an effective way to prevent legal action from creditors and stop further interest and charges being added to debts while the company waits for an injection of funds, or a one-off asset sale, which will enable a lump sum to be introduced. 

In the right situation, and with plenty of determination and hard work, CVAs can be the lifeline insolvent businesses need. With the right help, a complete turnaround can be achieved and the company can be returned to profitability.  

About the author

Mike Smith is a director at Company Debt, a member of the Turnaround Management Association.