Michael Thomson: Doubts rising over CVA effectiveness
Company voluntary arrangements (CVAS) are very much in vogue. Why? Growth of online shopping, Brexit uncertainty, increased export costs, drop in consumer confidence and spend, increases in business rates, rising labour costs and long-term inflexible lease costs. All of these been cited as factors contributing to financial difficulties for bricks and mortar operators in the UK retail, fashion and casual dining sectors. Michael Thomson summarises recent scrutiny of the CVA process.
In 2018, these sectors have seen huge uptake by tenant companies as a means to secure more amenable lease terms or to discard lease liabilities altogether. In response to the wave of retailers and restaurant chains proposing CVAS, doubts about their effectiveness and questions about their treatment of landlords, trade associations for the retail sector and insolvency profession are subjecting the CVA process to scrutiny.
A CVA is a process used by a company to compromise liabilities with its creditors. The company proposes the CVA to its creditors and if the required majority vote in favour, the CVA is implemented by the directors under the supervision of an insolvency practitioner. As long as the required majority vote in favour, the CVA binds all creditors entitled to vote. In CVAS dealing with lease liabilities, market practice has built up to split leases into three separate categories: leases for profitable units, which are left largely untouched by the CVA; leases for marginal units, upon which a significant rent reduction will be imposed; and leases for unprofitable units, which will be terminated.
So there are winners and losers. With the number of landlords potentially adversely impacted (the recent House of Fraser CVA proposal, for example, proposes the closure of 31 of 59 stores), there has been inevitable criticism of the practice that has built up to use CVAS to discard lease liabilities.
This is particularly so when the success rate of CVAS on the high street has been regarded as poor. BHS, JJB Sports, Focus DIY and Oddbins are all examples of previously successful names attempting to go down this route, only to experience subsequent collapse and insolvency.
Failure is often attributed to the absence of a strong restructuring plan in the proposal, insufficient capital or debt to fund the restructuring plan (where one is envisaged by the CVA), or lack of experience of management in restructuring to deliver the plan during the process.
R3 (the trade association for insolvency, restructuring, advisory, and turnaround professionals in the UK) has recently researched and reported on the effectiveness and legitimacy of CVAS as a business rescue tool and reasons for their success or failure.
R3 suggests a number of reforms to improve perception and transparency of the process. These range from capping the maximum duration of CVAS, to standardising their terms and conditions, and increasing clarity on the duties of directors and insolvency practitioners in proposing and administering the arrangements. R3 also suggests measures to increase the prospects of success. These include better engagement with public sector creditors (who traditionally might have refused to support CVA proposals) and making available a moratorium (ie a stay on creditor action) while the proposal is being prepared and considered to stop creditors taking enforcement action and potentially frustrating the process.
The British Property Federation has also called for a rethink. Representing the interests of the UK residential and commercial real estate companies, its approach has been to call for an urgent, independent review. Citing a need for property owners looking after savers’ and pensioners’ money to protect against unfair action that penalises their interests, the BPF has called for the review to tackle what it perceives to be a lack of transparency and regulation, and discrimination between different creditors.
The wave of CVAS in retail and casual dining is not showing any signs of abating. The more that are proposed, the more likely it seems that landlords and other interested parties will call for change. Insolvency bodies and regulators will also want to protect the perception of the profession.
It seems likely that if the surge in popularity of CVAS (at least in terms of uptake) continues, there will be a clear need to decide if they remain open for business, or need to be closed down.
- Michael Thomson is a partner at Burness Paull LLP