John Kelly, partner in Begbies Traynor and West Midlands president of the Institute of Chartered Accountants in England & Wales, ponders where new rules on saving companies are going all wrong
Despite the growth of turnaround professionals and the Government's stated desire to assist ailing businesses, the insolvency profession's principal rescue tool, the company voluntary arrangement, remains relatively unused.
A CVA is where a company faced with financial difficulties makes a proposal to its creditors to pay its liabilities or a proportion of them over a period of time.
Why is there a problem? The first issue is turnaround professionals.
Overheard at a recent Society of Turnaround Profession-als seminar was the comment "all the insolvency guys are after is a job".
Given STP was founded by the insolvency profession, greater mutual understanding is needed for the future. The two professions, turnaround and insolvency, need to work closer and with respect if the best solutions are to be found.
Many of my colleagues have already given up trying to make CVAs work. They were too difficult, too risky, too likely to fail and there were easier and better alternatives. For a long time I considered such colleagues to be too risk averse and not prepared to go that extra mile.
Recent experiences however have moved me closer to their way of thinking and I believe a change in legislation is the only way to give CVAs a real chance of success.
Time is needed to prepare forecasts, review the business, assess the management, discuss with shareholders, bankers...to determine whether a CVA is suitable.
It takes time and during that time there is no protection to the business from precipitous action from creditors.
Hence many practitioners will not consider a CVA without an administration first. But administration often creates many more difficulties than it solves, and, if the right answer is a CVA, administrations should be avoided.
And of course who tends to be one of the most aggressive creditors? The Crown.
In fairness, sometimes they will give time to consider the options but their response is not consistent and all too often you have to resort to the administration to protect against the Crown distraining.
For any CVA to work, one of the essential ingredients is the bank's co-operation. This varies considerably. Of the big four, two are generally very supportive, one maintains they are and one will seek to take advantage of the situation. Most independent asset based lenders are interestingly nearly always supportive.
So if you have managed to jump these hurdles you are now faced with the creditors meeting to consider your proposals. As a general rule most creditors will support proposals as they are being offered something as opposed to nothing if the company failed. Well-considered proposals will contain forecasts and cash-flows, and will seek to balance the interests of shareholders, management and creditors.
Step in the Crown once again.
They appear to consider the proposals a negotiating document and to some extent it is. However they have a list of over 20 amendments they seek to include in the proposals!
The amendments place the business under far more financial constraint than any other trading business.
They will also seek to extend the proposals to five years or full repayment of the Crown debt. Their argument is five years is better than three as it gives a greater return. But using the same argument seven is better than five etc etc.
If a CVA is going to work it has to balance the interests of the company with the interests of the creditors. For a management team to commit to trading under the restriction of a CVA for five years is asking too much.
In three years or less management can realistically see light at the end of the tunnel and can work to that end. Five years is in my view too long. At five years, management will ask what are the options? A pre-pack asset sale is often the answer and as a result the Crown and other creditors lose out. It comes as no surprise that pre-packs are on the increase.
Pre-packs which have received negative comment from the likes of Jon Moulton of Alchemy, are a process where a sale of assets is agreed just before an insolvency process, which then concludes the sale immediately upon appointment.
Mr Moulton's concerns are based upon the sale not being offered to the open market. The defence is that to do so could jeopardise the sale or produce a reduced outcome.
Wow! So if you have managed to get the proposal agreed by the 75 per cent majority, what hits you next? Ransom payments!
Ever since the infamous Land Rover chassis fiasco - when the insolvent supplier sought to threaten the production of Land Rovers by demanding a significant "ransom" payment to continue supplying chassis - more and more creditors are refusing to supply a company in a CVA unless their old debt is repaid. Such action makes continued trading difficult if not impossible, as there is seldom spare cash to make such payments.
Such demands undermine the very concept of a CVA, which acknowledges a company cannot pay its past creditors in full straight away!
Some of these creditors may have debt insurance. A number of the debt insurers actively encourage their clients to seek ransom payments - not helpful for a recovery.
Next hurdle. The very creditors who supported the proposals at the creditors meeting now refuse any credit terms. Understandable to some extent, but how many companies could survive without at least some credit?
Debt insurers could play a part by properly assessing the proposals and giving some cover to deserving plans - but they don't in my experience.
As a result of this lack of credit, the business may need to raise more finance. Existing banks already have fixed and floating charges and are unlikely to release those charges in favour of new funders.
You overcome all these barriers only to find the principal customer does not understand the CVA procedures and withdraws their support.
Management or the super-visor failed to persuade the customer that a CVA is a restructuring exercise which puts the business on a firmer financial footing.
The CVA fails!
The supervisor thinks there must be a better way! "Next time I will recommend an asset sale - simpler, less barriers, quicker fee!"
If CVAs are ever to stand a chance of surviving, we need a change of attitude from the Crown and some of the banks, and legislation to ensure continued supplies and super priority for new finance.
That's what they have in America!
