CVA FAILURES – Causes & Solutions
Despite the CVA process not having changed much for years, CVA’s are still very popular as an insolvency process for allowing an insolvent business to continue to trade whilst also buying time with creditors. However, for many reasons, the numbers of CVA’s that are actually completed as proposed are believed to be in the region of only 30-40%.
Therefore, this article covers the top 10 causes of CVA failures together with some tips to avoid having to fail your CVA.
Most CVA proposals contain clauses which state that if the Company fails to make the CVA payment contributions, as proposed, then the Supervisor must take steps to fail the CVA and petition to wind up the Company. This is usually if 2 or 3 installments are left unpaid, or are late. Therefore, if the Supervisor fails to take action to fail the CVA once this happens, then they can be critisised by their authorising body and risk disciplinary action themselves. As a result of this, Supervisors will usually act swiftly to fail a CVA despite it usually being within their discretion to take action as they see fit.
To avoid a Supervisor failing the CVA due to unpaid contributions, you should maintain regular contact with the Supervisor, to inform them as to why payments are late and when they can be expected. I also recommend that the Company pay what it can afford, even if it is only a fraction of the contribution due, as this is likely to demonstrate to the Supervisor that all is being done to rectify the position.
I do not recommend avoiding payment of current liabilities in order to pay the contributions as this too can be a cause of CVA failure.
Whilst historical debts up to the point of the CVA are included within the CVA, any post CVA liabilities from the continued trading must be paid for in the ordinary course of business. Therefore, if the Company fails to pay their ongoing tax liabilities (or any trade, or other liabilities for that matter) the supervisor is likely to be informed and may be forced to fail the CVA due to the Company not complying with its proposal terms of payment in full of its current debts.
A great deal of scrutiny is placed on insolvency practitioners (“IP’s”) who act as supervisors, to ensure that they monitor whether companies in CVA keep on top of payment of their ongoing taxes and in some cases IP’s are subject to personal legal actions from HMRC for recovery of unpaid taxes if they fail to monitor the payment of taxes of their CVA’s. Therefore, IP’s will not risk personal liability and as a result will fail CVA’s immediately that do not meet these requirements.
Similarly to the CVA contribution advice above, I recommend you simply ensure that constant contact is maintained with HMRC to inform them if payments are to be late and when they are likely to be paid. The Company should also pay what it can afford and save as much as possible from sales to set aside sufficient funds to settle the current tax debts.
Unrealistic Sales Targets
As CVA’s are essentially agreements to repay creditors over a set period from the profits of the Company, in order to get a CVA agreed, forecasted cash flow statements are produced which often include unrealistic sales estimates.
To avoid this, directors should be pessimistic when forecasting (but meet the IP’s recommended levels) and regular management accounts, performance reviews and marketing should be done.
Change of the aims of the Director/Shareholders
Many IP’s that recommend CVA’s over other insolvency processes neglect to mention to director/shareholders that the CVA essentially means that they are burdened with paying the Company’s profits into the arrangement for up to 5 years. When the other processes often allow for, any shortfalls to creditors after asset sales to be effectively written off.
It should always be the aim to repay creditors in full however the fact of the matter is that the vast majority of CVA’s fail when directors get 6-24 months into the arrangement and are fed up of the restrictions of the CVA and therefore decide to either, close completely, or do a phoenix liquidation.
To avoid this we ensure that director shareholders are fully aware of the CVA restrictions, the burden of the timescale and payments and that they have considered the other options but still prefer a CVA.
To avoid this during a CVA we always try to ensure that the CVA proposals allow for 50% of any profits made can be kept by the Company so as to maintain motivation to continue with the arrangement rather than receive nothing for their hard earned successful trading.
Whilst a CVA is considered a form of business recovery and therefore not as final as the other insolvency processes, often suppliers see the process no differently and refuse to continue to offer the same credit terms. Cash flow can suffer if supplies have to be paid for up front or over a shorter period therefore careful consideration must be given to the relationship you have with your suppliers before proposing a CVA so as to gauge their likely reaction to the CVA.
The Company should also shop around for its supplies and do deals if it is to the ultimate benefit of the Company.
Loss of Staff
Staff are key to every operation therefore everything should be done to reassure staff that their positions and employment generally are safe.
Many assume that staff are always grateful to receive their continued employment on the same terms (that a CVA offers). However, if an employee has worked for the Company for 2 years or more, then they are likely to be entitled to redundancy, along with other entitlements, in the event of any of the other insolvency processes being chosen. The Company’s ability to pay these entitlements is not a factor as the government pays these sums (up to their statutory limits) when the insolvent Company cannot afford to. Therefore, be prepared for some fallout if employees have worked for the business for many years and realise the decision to continue through a CVA (rather than a phoenix business after a break in trade) has resulted them receiving considerably less entitlements.
Loss of Contracts
A little known fact about CVA’s is that a CVA is still likely to terminate many contracts which the Company has with its customers because most customers include termination clauses within their business contracts meaning that their business ends with the Company upon any insolvency event.
All customers are also still required to be informed that the Company is in CVA, even if they are not a creditor of the Company. Therefore, careful consideration must be given to a CVA if the Company is likely to lose business as a result.
Director/shareholders should avoid telling customers about the CVA until the last minute, as customers then have little option but to proceed with its work with the Company in the short term as there is no time to source an alternative provider without their being a break in trading or risks to quality or service.
As most of you will know, customers can come up with all kinds of excuses as to why they should avoid paying their debts therefore notification of a CVA is one in a long list of reasons as to why a debtor may avoid paying. Whilst a CVA doesn’t mean that they should not pay their debts, customers are aware of the increased cash flow pressures CVA companies are under. These pressures can result in either less funds being available to take recovery action, or directors being more likely to accept a reduced payment, for quick payment, therefore margins are forever squeezed.
To avoid bad debts, the controls must be watertight, in that sign offs of delivery and of quality or work levels should be done, as well as sufficient supporting paperwork on work ordered and work levels achieved should be kept to evidence their obligation to pay. I am also of the belief that more customers, representing smaller percentages of their total business, should be taken on, rather than one holy grail customer. Because funding a large customer is difficult and they often prove to be the worse payers which only increases the risk to the business.
Less frequently, but still a cause of failure, is where the proposals are materially different to the true position (such as more creditors being found to be due than were included in the proposals). If a revision to correct the proposals is not agreed, either by the required percentage of creditors, or by the director/shareholders themselves then the CVA will fail.
To avoid this, all books and records should be brought up to date at the time of proposing the CVA in order to ensure that the proposals are wholly accurate. If there is a risk of a contingent creditor falling due then this should be written into the proposals to ensure that it doesn’t invalidate the proposals and no revisions are then required.
It should also be said that we have found that many of our competitors seem to be proposing CVA’s when the facts don’t quite suggest that a CVA is the right solution. We feel that this is due to the likelihood of them pushing for a fee to propose the CVA then when it isn’t accepted, or when it fails, a second fee can be received from a subsequent liquidation. Therefore take care to ensure that if you are proposing a CVA, your IP gives you assurances that it will be accepted and never propos a Liquidation with an IP that couldn’t get a CVA through for you.
Statutory Filing Compliance Failures
A simple one this, but often neglected, is the requirement to keep on top of the Company’s filing requirements. As a trading business it is still required to complete the returns and accounts as normal along with submit its tax returns on time and therefore failure of this may require the supervisor to fail the CVA.
There is no excuse for not complying with this requirement as no diligent director would fall down here therefore simply do it even if you can’t afford to pay the sums shown as due on the returns right away.
If your CVA is failing or of you want help and advice to consider whether a CVA is right for your Company then please contact us on 0800 612 6197.
For our main CVA page see here Company Voluntary Arrangements
For tips on when a CVA is most suitable see here – IS A CVA RIGHT FOR ME?