CVA Case Study Logistics and Distribution Company

9 March 2011

Welcome to the first of our detailed case studies. Many people ask about CVAs and how they can be used to terminate contracts. Here is a great example from early 2008.

Key Deal Points Exited two warehouses, consolidated business into one remaining unit with rental ratchet, removed staff, terminated onerous contract with customer.

Approached by our client via the internet. Cashflow crisis caused by rapid over expansion and failure to fill all of the 3 warehouses with profitable work. Three properties needed rationalising and one of the largest customers (a Japanese multinational) had promised more space/sales would be forthcoming. It did not and the loss making contract was a running sore.

Losses approached £900,000 in y/e 2007 and the investors and directors could not provide any more funds.
Big 4 bank had increased loans on the back of PGs and it was nervous that it would lose £800k in administration. Too many people, not enough work/revenue and four problem contracts.

We reviewed the position and the boards options/plans and suggested the following KSA action plan at our first meet with board.....

• Close two sites and terminate leases
• Consolidate all activity into the largest site which was half empty
• Reduce headcount by 20%
• Remove fixed costs of £600,000
• Terminate contract with loss making customer
• Broker deal with remaining (quoted on FTSE) landlord who had £900,000 of rent arrears on a lease paying £1.1m pa rent
• Freeze bank loans with interest only payments for 12 months
• Write off directors loans
• Compound the rent, tax and trade creditors
• Guide the board through the above process

We suggested that a company voluntary arrangement would pull the plan together. See Company Voluntary Arrangements.

It was vital to present a cogent plan that would allow the business to survive and create the conditions where the bank, factor, HP and lease companies and remaining landlord could support a workable deal. Administration would have caused problems that were seen to be insurmountable. So we used CVA as the catalyst and deal enabler.

We approached the large FTSE landlord and asked for a deal that would see the arrears compounded in CVA and asked whether they would they also accept weekly rent payments for now. As they say you dont ask you dont get!

Whilst they thought about it we ensured that every week a cheque was taken to the landlord. They rejected the initial proposals but a deal was struck with the CVA that ensured the large landlord agreed to the consolidation.

In effect a new lease was negotiated whereby the company would pay rent at increasing levels each year over the 5 years of the CVA deal.

This allied to dividends that would be paid to the landlord in the CVA would pay off the arrears. Why is this not a preference under section 239 insolvency Act 1986 we were asked?

The plan required the company to consolidate into one large property. Without this it was a stillborn deal and liquidation was the likely outcome. If that landlord would not support then the deal was not going to happen. Their lawyers and advisors made sure that a good deal was extracted. It was not a preference because there was no desire to create a preference only a desire to continue occupying the property on a commercially structured deal that allowed the company to trade.

This rent deal was agreed against a backdrop of the landlord being acquired by a foreign company! So time slipped by rapidly while we waited for the landlords internal and external lawyers to agree which eventually they did.

That then allowed us to approach the large Japanese customer and tell them their contract was being terminated. Given that technically the customer was a debtor NOT a creditor, their lawyers argued that the CVA could not terminate the supply contract and our client MUST continue to provide the loss making service!

We argued that if our client entered insolvency the contract would be terminated anyway AND there would probably be a claim in liquidation by this customer. Secondly the fact that the customers lawyers had complained about some non-deliveries and said that the customer was reserving a claim to damages made it a creditor of our client and covered by the CVA! The lawyers then argued that the contract for warehousing was in fact a lease under the Landlord and Tenants Act! We again used our lawyers to argue that this was not the case the relationship was that of a supplier and customer. However by agreeing that a lease had existed and it was being terminated by the CVA they would agree to leave.

After 5 weeks a form of words was agreed, the customer agreed that the lease/supply contract would be terminated by the CVA and they agreed to exit the property on the day the CVA was approved. This meant that we could re-sell the space to more profitable customers.

That just left the easy bit of getting by now a very complex CVA approved!
Oh, and the deal had now taken 3 months longer than planned. The bank asked an external top 6 firm of accountants to give its opinion of the deal structure and the request for 12 months of loan capital payment deferment. This request was backed up by very detailed 5 year forecasts. The insolvency team put in by the bank said we agree its a good workable plan BUT only if the CVA was approved.

So once again this review process caused a delay but we thought we could now pull the deal off.
The proposals were taking shape but creditors were becoming restless!

Then notice was served on the client that one of its other major customers needed more space and could they take on one of the unwanted properties. This was a bit of luck and speeded up the process, given that this new client was a Scandinavian blue chip the landlord was quite happy that our client was leaving and being replaced by a better covenant. By way of bringing us back down to earth a winding up petition was issued by a creditor!

We managed to prevent this being advertised and the creditor agreed to read the CVA and subsequently voted in favour of the deal.

Then we discovered a hole in the companys forecasts this required reworking the numbers many times to ensure that the plan would work. At times the demands of the quoted landlord, the loss of some smaller sales pitches and the problems of getting the deal pulled together were very challenging for client and KSA alike.

In this dark time another new customer was landed that was delivering rates 35% higher than the Japanese (exiting) customer. So we pressed on.

Finally, a deal was agreed with the major landlord after their own acquisition had gone final. They wanted the problem solved pronto and we finally pulled the numbers together.

Meanwhile, HMRC had seen their debt rise sharply and they were concerned about the CVA. A small tax investigation had been ongoing for some months. So they rejected the CVA until their questions were answered. At the first CVA creditors meeting the nominee decided to adjourn to allow these answers to be provided the client. They were and HMRC Voluntary Arrangement Service then voted in favour of the CVA 14 days later. Allied to the £900,000 landlord vote the deal was approved.

The CVA deal says unsecured creditors will receive 28p in £1 over 5 years if the company is modestly profitable. If it is more profitable it will pay a higher dividend.

The message here is a CVA can be a hugely powerful tool to enable major structural changes in a distressed business. We would argue its the ONLY tool that can do ALL of this and allow the company to trade on.

• Terminate leases of properties, landlords are generally not aware of this power.
• Kill of onerous customer contracts, using our techniques we argued that such a contract MUST be killed off if the company is to survive.
• Remove fixed and overhead costs rapidly, with NIL cash cost and no consultation. 
• Encourage creditors to accept a compounding or face the prospect of seeing a zero return. 
• Build a flexible deal with a willing landlord that sees them get paid 100% over time with all other creditors ratifying the deal.

This case took some 5 months to conclude and whilst no new case law was created the advisors including Keith Steven of KSA Company Rescue (turnaround advisors), Eric Walls of Marlor Walls (the nominee and now supervisor of the CVA) and Sean Upson of former Masseys LLP (now Stewarts LLP) all believe some interesting new ground was broken.

The CVA was used effectively to save a viable business which would otherwise have gone into liquidation with large losses for the bank, tax and VAT and landlords in particular. There would have been a deficiency of £5.3m in terminal insolvency.

We will be happy to answer any questions on this case study either email Keith Steven or call 0800 9700 539.

Sean Upson is available on 020 7822 8187 or at supson@stewartslaw.com. Stewarts Law website can be found here: http://www.stewartslaw.com/

Categories: CVA