Challenges to CVAs – Checks and Balances Restructuring

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As the UK endures another lockdown in which all but essential shops and services are closed, the press frequently reports on the difficulties facing businesses, both large and small. Unsurprisingly, pessimism seems to be most prevalent in the retail and hospitality sectors with the insolvency of well-known high street brands often hitting the headlines.

Against this backdrop, many companies are looking to insolvency professionals for advice. As a rescue package that sees directors retain control of the business, a company voluntary arrangement (CVA) is often seen as a better alternative than administration or liquidation with the expectation of greater returns to creditors. This is particularly true when the CVA is one element of a wider restructuring and/or refinancing plan, which is often dependent on the CVA first being approved.

However, even with the bar for requisite majorities to approve the CVA set very high, it is almost inevitable that some creditors will be dissatisfied by the proposed terms.1This is often exacerbated as all creditors are bound by the approved CVA, even if they did not vote or voted against.

This is acknowledged in the insolvency legislation which allows creditors to challenge the CVA at court within 28 days of it being approved. Such a challenge must be on the grounds that either the CVA unfairly prejudices a creditor’s interests or because the approval process was not conducted properly (i.e. a material irregularity).

Unfair Prejudice

Establishing that a CVA is prejudicial may be easy (indeed, any CVA which leaves a creditor in a worse position that before the CVA shows prejudice); however, it is more difficult to demonstrate that the prejudice is “unfair.”

In such cases, the court will consider the challenger’s position in comparison to that of other creditors or classes of creditor (the “horizontal comparison”). The court will also consider whether the challenger’s position would have been different in an administration or liquidation scenario (the “vertical comparison”).

Notably, in many recent retail and casual dining CVAs, it is often the landlords who have been asked to make the greatest (or sometimes only) compromise. The difficulty for landlords is that all creditors, including connected creditors, can vote on the proposals even if they are not affected by it.

Furthermore, recent CVAs have also sought to make permanent changes to the terms of the lease, which will continue to be effective after the CVA itself has been completed. This is another bitter pill for the commercial landlord to swallow. Further clarity on this point was handed down following the landlords’ unsuccessful challenge to the Debenhams CVA. The court found that proposals to reduce the rent payable under a lease were only a variation of the lease through the CVA and did not therefore seek to impose new terms upon the parties. However, in the landlords’ favor, the court upheld that the CVA is not able to affect the landlords’ rights to forfeit the lease as these were proprietary in nature.

Material Irregularity

Similarly, demonstrating that the mechanism to approve the CVA (i.e. shareholders meeting or creditors decision procedure) was not carried out properly is not straightforward.

When considering a challenge on the grounds of material irregularity, it is crucial to understand a number of relevant factors such as:

  • All required information was provided in the CVA proposal

  • The values of creditors’ claims were correctly calculated and recorded

  • The votes were accurately recorded, including any proxy forms held by the nominee as chairman of the meeting/convenor of the decision procedure 

  • The requisite majorities for approval were met

In practice, nominees of a proposed CVA go to great lengths to ensure that all procedural requirements are strictly adhered to. However, that does not preclude lapses of judgement or other errors from slipping through the net of even the most experienced insolvency practitioner.

Other Hurdles to Challenging a CVA

When considering filing a challenge to a CVA, it is important to bear in mind that the company is in acute financial distress and may not survive if the CVA is not immediately implemented—such actions being necessarily delayed if a challenge is made. For example, hairdressing chain Regis went into administration before a challenge to its CVA could be heard. In such circumstances, a creditor’s hope of improving their position under the CVA is eradicated as they are lumped together pari-passu with the other unsecured creditors.

However, all is not necessarily lost. Going back to the Regis example, notwithstanding the company entering administration, the landlords continued to pursue the CVA challenge. The supervisors applied to strike out the CVA challenge, but this was denied by the court. In such circumstances, a successful CVA challenge may result in the court making a costs order against the supervisor and consideration being given to whether the conduct of the supervisor is such that they should be ordered to repay their fees.

Another hurdle to overcome when looking to challenge a CVA is the cost to the creditor(s). It is common practice for the nominee to request the that company ringfence a significant sum of cash to cover the costs of defending a potential challenge. Consequently, the aggrieved creditor(s) should ensure they are in a position to (a) cover their own legal costs to file a formal challenge at court and (b) settle the (adverse) legal costs of the supervisor should the court’s decision go against them. These costs are likely to be material and the court may wish to see evidence of funding before allowing the challenge to be heard.

Successful Challenges

At a hearing to consider a CVA challenge, the court has the power to make an order to revoke the CVA, convene a meeting to consider a revised CVA or dismiss the application.

Nevertheless, CVA challenges are rare and successful challenges are even rarer.

If there is any ambiguity in the CVA terms, entering into an early dialogue with the debtor company to clarify the position will help to understand the impact on a given class of creditor.

It is also worth noting that creditors are entitled to propose a modification to the terms of the CVA which may assist to improve the outcome for a given (class of) creditor. However, it will be the directors’ decision whether to allow the modification and amend the CVA to be voted upon. An informed and well-considered modification will have a much greater chance of success of “making the cut.”

Alternatively, if there is sufficient creditor support (by number and/or value), consideration can be given to the merits of requisitioning a physical meeting of creditors (subject to Covid restrictions), noting that any application must be made within five business days of receiving notice of the CVA decision procedure. A physical meeting often allows the voice of the aggrieved creditor(s) to be heard more loudly, particularly if represented by an experienced insolvency professional. Where the voting numbers to approve the CVA hang in the balance, such action may be sufficient to swing the vote “against.”

Conclusion

In summary, the CVA is a useful tool in the insolvency practitioners’ arsenal when used appropriately but proactive engagement with the key stakeholders is desirable and care must be taken when drafting the CVA to consider the outcomes for each class of creditor.

However, if a creditor is unhappy with the terms of a proposed CVA, they should seek advice from an insolvency professional at the earliest opportunity.

 

Source
1 75% of creditors present and voting and 50% of creditors excluding connected creditors, present and voting

Challenges to CVAs – Checks and Balances 2021-02-25T00:00:00.0000000 /en-ca/insights/publications/restructuring-advisory/challenges-cvas-checks-balances /-/media/assets/images/publications/featured-images/2021/challenges-cvas-checks-balances.jpg publication {0840D7ED-B8E4-48DD-8F31-7345340BF1D9} {3C558FF3-C774-4BA0-B54F-2D1E71BCCC7A} {58146FCB-D49C-4137-9D98-D47D9F4AF237}

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