Published on 28 January 2011 by Tony Groom
It is not being much talked about in the marketplace but it is becoming increasingly common for HM Revenue and Customs (HMRC) to reject Company Voluntary Arrangements (CVA) that would previously have been accepted.
For a business in difficulties a CVA can be used to improve cash flow quickly in order to keep trading while paying off its debts in a manageable way. It is a legally binding agreement between an insolvent company and its creditors to repay some, or all, of its historic debts out of future profits, over a period of time.
In the past HMRC has appeared to be a great supporter of CVAs, but recently they have been rejecting a number of CVA proposals that they would have approved in the past.
While there are no published statistics on the numbers of liquidations resulting from failed CVAs, historically a large percentage have failed. Statistics only measure the number of formal procedures including CVAs and liquidations, but they do not identify the numbers of liquidations that have resulted from either rejected CVA proposals or failed CVAs post approval. However, among business rescue advisers and insolvency practitioners it is believed that the failure rate of CVAs post approval is somewhere between 60% and 70%.
HMRC website guidelines to case officers indicate that they should attempt to get arrears repaid within 12 months with longer periods being the exception. This may explain why HMRC is now rejecting more proposals because its objective is to maximise early repayment contributions for clearing VAT and PAYE arrears rather than accepting those that propose a realistic repayment schedule with lower early repayments.
From the viewpoint of the business in difficulty a low level of contributions in the early period of a CVA allows it to get back on its feet in the short term while refocusing the business on survival and increasing profits, thus enabling it to pay higher contributions later in the CVA. This increases the chances of the business being able to maintain its payments throughout the CVA period and reducing the risk of failure. High repayments required in the early stages will mean it cannot do this.
In contract a CVA that allows for paying the same level of contributions over its full lifetime can impose a burden on the company during the early period. Therefore business rescue advisers helping a company to construct a CVA proposal as part of a turnaround process would often propose a lower level of contributions during the early period, increasing them as the company became healthier. Many turnaround specialists believed that this strategy improves the chances of a CVA succeeding post approval.
However, many CVAs are drafted by insolvency practitioners with a view to the proposal being approved, and as a result many of those being approved today are offering significant contributions to creditors, some exceeding 100p in the £.
While the greater contribution improves the chances of a CVA proposal being approved by creditors, the lack of realism about a company’s ability to achieve the commitments is the reason for such a high failure rate post approval.
The emphasis for anyone drafting a CVA proposal must, therefore, be focused on realism, on it being achievable, with supporting evidence of how this will be done, and not on getting it approved regardless of whether the business is going to be able to stick to it.
This balancing act between maximising contributions for the benefit of creditors while at the same time being realistic so that it survives and pays the contributions is key to persuading HMRC to support a CVA proposal.
Since they often have the casting vote needed to approve the CVA proposal, it is imperative to include detailed forecasts in the CVA proposal to help make the argument. Having these prepared with the assistance of turnaround specialists will help demonstrate that contributions are both maximised and that the forecast is realistic.