CVAs: draining the swamp

How do you improve the image of company voluntary arrangements? Start by reforming the voting rules, explains Mathew Ditchburn. A recent research paper commissioned by the Insolvency Service concluded that property owners were “broadly” treated equitably in company voluntary arrangements. Needless to say, the property industry did not share this assessment, with Melanie Leech, chief executive of the British Property Federation, pointing out: “Almost all CVAs analysed impacted property owners, almost double the number of cases that affected trade creditors. It is no wonder property owners have felt singled out.” The authors of the paper suggested ways in which the use of CVAs could be improved. They recommended executive summaries, standardised tables and post-CVA balance sheets to help navigate “extremely lengthy and legalistic” CVA proposals, and proposed that company directors be required to consult with the BPF on behalf of its property owner members. Nobody would argue with this, but does it really address the fundamental problems, as property owners see them? What is wrong with CVAs? There are many complaints about CVAs and the way they treat those who supply commercial property to impecunious occupiers – like writing off arrears, reducing future rents, compromising dilapidations, terminating leases, linking rent to turnover or rewriting lease terms. As well as feeling singled out for harsh treatment, property owners often suspect compromises in a CVA cut more deeply than necessary and are being used opportunistically to improve the balance sheet.  At its heart, such controversy stems from the way that CVAs are voted on. It is a single class process, where all creditors vote together on the proposal regardless of how and, indeed, whether they are affected, meaning that an unimpaired majority is able to bind an impaired minority.  In Lazari Properties 2 Ltd and others v New Look Retailers Ltd and others [2021] EWHC 1209 (Ch); [2021] PLSCS 96 for example, the vote was carried by the company’s senior secured note holders even though they were entirely unaffected by the CVA itself. In such a scenario, conflicts of interest are bound to arise: the more onerous the terms imposed on the minority, the better the outcome will be for other creditors. How did this happen? In a scheme of arrangement, by contrast, separate meetings of each different class of creditors must vote in favour of the proposal for it to be approved. The same is true of the new restructuring plan procedure, subject to the court’s ability to impose a “cross-class cram down”. In 1982, the Cork committee reported on modernising UK insolvency law and highlighted perceived difficulties with the “long and involved” scheme of arrangement procedure. They recommended a new voluntary arrangement process “where the scheme is a simple one involving a composition… for the general body of creditors which can be formulated and presented speedily”. This, it was said, “will prove of value to small companies urgently seeking a straightforward composition”.  This is not how CVAs have turned out. The process, coming into effect as part of the Insolvency Act 1986, has been deployed in some of the largest, most valuable and most complex restructurings of recent times, involving large numbers of different creditors, often receiving wildly divergent treatment.  What can be done about it? The judge in New Look found that: “There would be strong grounds to conclude it was unfairly prejudicial where a CVA, which compromises the claims of a sub-group of creditors, is achieved only because of the votes of a large swathe of creditors who are unaffected by the CVA, even if there was an objective justification for those creditors being unaffected by the CVA.” This was quite radical: never before had it been suggested that a class-based approach be taken with CVAs. How exactly it will be applied remains to be seen. Either it will be decided by the courts in due course or, perhaps better, a rule against vote swamping should be codified in statute to provide the industry with greater certainty. A limited form of protection is already built into the Insolvency (England and Wales) Rules 2016. Rule 15.34 requires 75% by value to vote in favour of a CVA for it to be approved. To avoid this being achieved by parties connected to the company, 50% of unconnected creditors must vote in favour. It would not take much to include an additional voting threshold condition that 50% by value of substantially impaired creditors also vote in favour.  Would this go far enough? The judge observed in New Look that, when determining whether unfair prejudice exists, it is important not only to consider whether the statutory majority was achieved by unimpaired creditors but also by “differently treated creditors”. Taken to its logical conclusion, 50% by value of creditors in each class should have to vote in favour for a CVA to be approved. This should not be difficult to apply, based on the familiar test in Sovereign Life Assurance Company v Dodd [1892] 2 QB 573 that a class is made up of those creditors whose rights were “not so dissimilar as to make it impossible for them to consult together with a view to their common interest”. If all creditors are impaired to a similar extent, or if 50% of impaired property owners must vote in favour of a CVA for it to be approved, then the effect on CVA terms is likely to be transformational. Mathew Ditchburn is a partner and head of real estate disputes at Hogan Lovells Photo by Malcolm Schuyl/Flpa/imageBROKER/Shutterstock (5317393a)