The definition of insolvency is when a company can no longer pay its bills because its income falls short of its liabilities. Obviously, this is not a great situation for any business to be in. If left unremedied it will eventually lead to a complete collapse of the business. Or what is more formally known as liquidation.
But that doesn’t have to be where insolvency leads. The whole purpose of insolvency procedures like administration, regulated by company law, are to help turn the fortunes of struggling companies around and return them to solvency. If every business that slipped into the red ended in failure, markets would be highly unstable and chaotic places to operate. That’s not in anyone’s interests.
Another insolvency process aimed at reversing flagging fortunes is a Company Voluntary Arrangement (CVA). A CVA is a legally binding agreement between a company and its creditors to restructure debts and adjust the timeframe for repayments to be made.
The purpose of a CVA is therefore to enable a struggling company to continue trading while continuing to pay off its debts. On one level, the CVA approach stems from simple common sense. If you’re struggling to pay someone you owe money too, the obvious solution is to talk to them about it to see if you can come to some sort of arrangement. A CVA puts this on a formal footing, following a clearly defined process that is set out in law and administered by an insolvency practitioner (IP).
The CVA process
The CVA process is instigated by a company’s directors when they recognise action is needed to keep up with financial obligations. Once an IP is instructed, a proposal is drawn up for how debts and repayments could be restructured in a way that would help the business get back in the black. This plan will also typically involve an overall reduction in the amount of debt repayed over time.
The proposal is then put to creditors and must be approved by at least 75% of them by value. If accepted, the terms of a CVA will usually last between three to five years. Within that time, the company is legally bound to keep up with the agreed payment schedule. The company’s directors must also provide regular reports to the creditors to show that the terms of the CVA are being met.
Pros and cons of CVAs
One of the key advantages of a CVA is that it allows a company to continue trading without the uncertainty and reputational stigma of administration, which can be important for both the company’s employees and its customers. It also allows an insolvent company to avoid hostile actions from creditors such as winding up petitions and potential liquidation, all while returning liabilities to something that is affordable and sustainable for the business.
A CVA isn’t suitable for every company that finds itself struggling with debt. The decision to pursue a CVA is taken by an IP based on an analysis of a company’s ability to generate income over the long-term. Furthermore, creditors must be convinced that the business is essentially viable and just needs to create some extra headspace in order to return to profitability. It’s unlikely that a business with a poor trading record would be recommended for a CVA.
Winning over creditors is critical, especially as they might be asked to accept a lower overall remuneration, not just a delay. They will only accept this if a convincing case is made that the business is at imminent risk of collapse if action is not taken, and if it was liquidated, they as creditors would stand to receive an even smaller proportion of what they are owed. Companies that have strong relationships with creditors and suppliers also tend to fare better in getting CVAs agreed.
In conclusion, a Company Voluntary Arrangement can be an effective tool for a company that is struggling with debt but still has a strong trading record. A CVA allows a company to continue trading while paying off its debts over a longer period of time, and perhaps lowering its overall liabilities. Once agreed, a company is legally bound to the terms of a CVA so it is important to work closely with an experienced IP to put together a proposal that both satisfies creditors and is a viable solution for returning the business to solvency.
For more information, contact our corporate insolvency team.
