Changes in UK Insolvency Law and Their Impact on CVAs
The insolvency landscape in the United Kingdom has undergone significant changes in recent years, primarily influenced by economic challenges such as Brexit, the COVID-19 pandemic, and the evolving needs of businesses navigating financial distress. Among the tools available to struggling businesses, the Creditors’ Voluntary Arrangement (CVA) stands out as a popular mechanism for restructuring debt and avoiding liquidation. However, changes in insolvency law have introduced new considerations for businesses, creditors, and insolvency practitioners when engaging with CVAs.
This article explores the recent changes in UK insolvency law and their specific implications for CVAs, shedding light on how these developments may influence the decisions of stakeholders involved in this process.
Understanding Creditors’ Voluntary Arrangement (CVA)
Before diving into the legal changes, it’s important to revisit what CVAs are and how they function. A Creditors’ Voluntary Arrangement (CVA) is a legally binding agreement between a financially distressed company and its creditors. The company proposes a plan to repay part or all of its debts over an agreed period, typically ranging from three to five years. The process is overseen by an insolvency practitioner who acts as a nominee and later as a supervisor once the arrangement is approved.
For the CVA to take effect, at least 75% of creditors (by debt value) must agree to the proposal. CVAs are often preferred because they allow companies to continue trading while avoiding more drastic measures such as administration or liquidation.
Key Changes in UK Insolvency Law
Several notable legislative and regulatory changes in recent years have impacted CVAs. Below are some of the most significant developments:
1. Corporate Insolvency and Governance Act 2020 (CIGA)
The Corporate Insolvency and Governance Act 2020 was introduced to address challenges faced by businesses during the COVID-19 pandemic. While the Act primarily introduced measures to mitigate the impact of the pandemic, some provisions have long-term implications for insolvency proceedings, including CVAs:
- Moratorium on Debt Recovery Actions:
The Act introduced a new moratorium process, providing companies in financial distress with breathing space to restructure without creditor actions such as winding-up petitions. While this moratorium operates separately from CVAs, it can serve as a precursor, giving companies time to develop and propose a CVA plan. - Suspension of Wrongful Trading Provisions:
To protect directors of distressed companies, the wrongful trading rules were temporarily suspended during the pandemic. This change encouraged directors to pursue restructuring options, including CVAs, without fear of personal liability if their efforts to save the business ultimately failed. - Virtual Meetings and Digital Communication:
The Act modernised how meetings with creditors are conducted, allowing virtual meetings and electronic voting. This change has streamlined the CVA approval process, making it easier for creditors to participate.
2. Changes to Preferential Creditors’ Rights
The reinstatement of HMRC (Her Majesty’s Revenue and Customs) as a secondary preferential creditor in December 2020 has had a profound impact on insolvency proceedings. Previously, HMRC ranked alongside unsecured creditors in CVA and liquidation processes. Now, HMRC holds priority over floating charge holders and unsecured creditors for certain tax debts, including VAT and PAYE.
This change has affected CVAs in the following ways:
- Reduced Funds for Unsecured Creditors:
With HMRC claiming a larger share of recoveries, unsecured creditors are likely to receive smaller distributions under a CVA, potentially making them less inclined to approve proposals. - Stricter HMRC Scrutiny:
HMRC’s elevated status has led to more stringent reviews of CVA proposals, particularly where significant tax liabilities are involved. Businesses must now ensure that CVA terms are realistic and adequately address HMRC’s concerns to secure approval.
3. Increased Focus on Fair Treatment of Creditors
Courts have increasingly scrutinised CVAs to ensure fairness among creditor groups. High-profile legal challenges to CVAs, such as those involving large retail chains, have highlighted the importance of equal treatment for all creditors. The rise in litigation has influenced the drafting and negotiation of CVA proposals in several ways:
- Landlords and the “Unfair Prejudice” Argument:
Landlords often claim they are disproportionately affected by CVAs, particularly when rent reductions or lease modifications are proposed. Courts now expect CVA proposals to balance the interests of landlords with those of other creditors. - Transparency and Justification of Terms:
Insolvency practitioners are under pressure to ensure CVA proposals clearly outline how different creditor groups are treated and justify any variations.
4. Small Business Restructuring Reforms
In 2022, the UK government introduced the Small Business Restructuring Scheme (SBRS), an alternative to traditional CVAs for smaller companies. This streamlined process is designed for businesses with liabilities below a certain threshold and offers a simpler, less costly route to restructuring. Key features include:
- Reduced Insolvency Practitioner Involvement:
Unlike CVAs, where an insolvency practitioner plays a central role, the SBRS allows businesses more control over the process. - Expedited Approval Process:
The SBRS accelerates creditor approval timelines, making it more accessible to small businesses in urgent financial distress.
While the SBRS competes with CVAs in some respects, it also highlights the need for CVAs to remain flexible and cost-effective for businesses of all sizes.
Impacts on Creditors’ Voluntary Arrangements
The aforementioned changes in insolvency law have had both positive and negative effects on CVAs, shaping how they are proposed, negotiated, and executed.
1. Greater Accessibility for Businesses
The introduction of moratoriums and digital processes has made it easier for businesses to explore CVAs as a viable option. The flexibility provided by virtual meetings and remote voting has streamlined decision-making, encouraging more companies to consider CVAs over other insolvency routes.
2. Increased Complexity in Creditor Negotiations
The reinstatement of HMRC as a preferential creditor and the heightened scrutiny on creditor fairness have added complexity to CVA negotiations. Businesses must now carefully balance the demands of HMRC, landlords, and unsecured creditors while ensuring the proposal meets legal and ethical standards.
3. Challenges for Landlords
Retail and hospitality businesses often rely on CVAs to renegotiate leases and reduce overhead costs. However, landlords’ growing resistance to CVAs and their willingness to challenge proposals in court have made it more difficult for struggling companies to secure creditor approval.
4. Competition from Alternative Restructuring Tools
The availability of new restructuring tools, such as the SBRS, has introduced competition for CVAs, particularly among small businesses. This shift may lead to fewer CVAs being proposed, as businesses opt for faster and less costly alternatives.
5. Enhanced Creditor Protections
Changes in insolvency law have empowered creditors to hold businesses more accountable during the CVA process. The emphasis on transparency and fairness ensures creditors are better protected, but it also places additional demands on companies to present robust and well-justified proposals.
Looking Ahead: The Future of CVAs in the UK
As UK businesses continue to face economic challenges, CVAs remain a valuable tool for restructuring and recovery. However, their role in the insolvency landscape is likely to evolve further due to ongoing legislative changes, economic trends, and shifts in creditor behaviour. Key areas to watch include:
Further Regulatory Updates:
The UK government may introduce additional reforms to streamline insolvency procedures or address specific concerns raised by creditors and businesses.
Impact of Rising Interest Rates and Inflation:
Economic pressures such as higher interest rates and inflation may lead to an increase in CVAs as businesses struggle to manage debt.
Digital Transformation of Insolvency Processes:
The continued adoption of digital tools and platforms could make CVAs even more accessible and efficient for businesses and creditors.
Conclusion
Recent changes in UK insolvency law have had a profound impact on Creditors’ Voluntary Arrangements, influencing how they are proposed, negotiated, and approved. While these changes offer new opportunities for businesses to restructure, they also introduce challenges, particularly in balancing the interests of different creditor groups and navigating stricter legal scrutiny.
For businesses considering a CVA, understanding these legal developments and seeking expert advice is crucial to achieving a successful outcome. Likewise, creditors must stay informed about their rights and responsibilities to make well-informed decisions during the CVA process.
As the UK insolvency landscape continues to evolve, CVAs will remain a critical tool for fostering business recovery and financial stability.
For more information on Creditors’ Voluntary Arrangement (CVA) contact Blake-Turner LLP.