Case Study: Are CVAs effective for large retail companies

Late 2017 and 2018 has proven an extremely difficult year for large high street retailers. Toys R Us, Maplin, New Look and now Carpetright have entered into insolvency procedures. In this article, we take a look at how effective company voluntary arrangements (CVA) are in the context of large high street retailers.


Can CVAs aid in business recovery for large retail companies

As mentioned above, we are discussing the CVA procedure and the practicalities for retail companies. Do they help preserve the brand? Or do they simply draw out the length of time before the retailer becomes another high street casualty, entering administration with no hope of finding a buyer?

Why the increase in high street casualties?

There are many reasons cited by these large retailers for having to turn to formal insolvency procedures, including:

  • Increasing rental costs for the large units.
  • Increases in business rates.
  • The knock on effect from the weaker pound resulting from Brexit.
  • Reduced footfall due to shoppers not specifically travelling to stores out of town.
  • Reduced footfall as a result of shoppers going online.

 

The impact of increased online sales can be seen in the chart below. It explores the comparison between the change in the value of retail sales against the previous year from online/postal order stores against the non-food retail stores.

CVAs case study

While there has generally been growth in the value of sales in retail units over the past 2 years, the increases in the value of online and postal order sales has been strong and consistent – evidenced in the chart.

With online retailers often operating from a single enormous warehouse and office unit, store retailers have to manage a portfolio of large retail properties across the country. Often, this sees companies facing increasing leasing and business rate costs. At the same time, they must compete on pricing with the much cheaper online only retailers. This has culminated in the current situation retailers are finding themselves in, as seen in the number of CVAs.

When is a CVA appropriate?

Company voluntary arrangements make up the smallest number of formal insolvency procedures entered into by businesses. The chart below sets out the insolvency figures for 2017. CVA’s make up only 2% of total corporate insolvencies.

CVA chart

Generally speaking, it is rare for a company voluntary arrangement to be best advice for a company in financial difficulties. A CVA may be the best advice for a company in each of the following circumstances:

  • The company is struggling only with historic debts and is able to meet its day-to-day expenses.
  • There has been, or is going to be, a significant material change in the trading of the company, allowing it to return to profitable trading.
  • To facilitate a restructuring agreement with some of the resulting costs, ie lease termination etc. being included in the CVA.
  • To wind down the company, eventually to dissolution, without facing the liquidation of a company or otherwise.

 

The latter option is rarely used, due to the significant increased cost. There is also the risk of further losses to creditors if the CVA fails, over actually going into liquidation. It will often only be used if there is to be a significant personal contribution from the director to deal with an overdrawn loan account or similar issues.

As a CVA requires 75% of voting creditors to approve the proposals, canvassing creditor opinion, where possible, before putting forward formal proposals is essential. If all faith has been lost with major creditors, they will often outright reject a CVA, leaving the company facing terminal insolvency. A CVA can also not be used as a “sticking plaster” to prolong the inevitable. The insolvency procedure should not be put forward if there has been no substantive change in the business.

If there is a serious risk of a winding up petition submitted at a later date, this can be highly detrimental for employees rights in future dealings with the Redundancy Payments Office:

  • The date of insolvency will be treated as the date of the CVA, rather than the date of the subsequent insolvency.
  • If contracts are renegotiated, this will be the basis of their calculations.

 

Any entitlements arising after the date of the CVA would, therefore, not be paid by the redundancy payments office. If a pay cut has been taken and, only a couple of months later the company is wound up, they would be paid based on the the reduced level. Consequently, this can leave employees seriously out of pocket. Subsequently, the board may face complaint and reputational issues for not taking the correct action immediately.

Are CVAs appropriate for large unit retailers?

Going back the the statistics in the first section of this article, there is no real evidence of a significant increase in growth for large store based retailers. This rules a CVA out on the grounds that the business is only dealing with problems from its historic debts. Subsequently, this leaves the situation that either the business has recently restructured, or will be restructuring using the CVA as a means to deal with this.

In reality, unless there is a material change in how retailers operate, they must become creative to compete with online only retailers:

  • Narrow down to a strong niche market, rather than trying to over diversify.
  • Sell your product so customers want it, now rather than waiting for shipping.
  • Create an innovative customer experience to make customers enjoy coming to your store.
  • Use social media to turn customers into fans of your business and write content to make them look forward to your posts.

 
It is worth remembering that once online retailers get to a certain size, they are not quite so focused on the customer experience. It’s hard to find anyone who does not have a story about poor service from their delivery drivers. Hitting these niches, therefore, can allow in-store retailers to compete on the same platform as online only stores, as well as with their own unique customer service experiences. If a previously struggling high street retailer can take steps to increase the number of customers  and sales value, whilst cutting down on costs, then a CVA may be a viable option.

Current cases

Based on the above, there is a lot to be done before a high street retailer can viably propose a CVA. Essentially, they need to innovate and potentially reinvent the business, with limited funds and increased creditor pressure.

Looking first at the Toys R Us CVA, this failed as soon as the first VAT quarter fell due. The CVA was a last ditch attempt to rescue the business, without a serious attempt to change the nature of the business. Some cost savings were attempted, but there was no serious attempt to change the structure of the business. The same one it had been operating under for the last 30 years. Therefore, a CVA was not deemed appropriate in this instance, particularly evidenced by how quickly it failed. As such, the Toys R Us administration came about, and they should have entered company administration immediately.

Moving on to the New Look CVA, approved by creditors last month. The company is now bound to make payments for the next 3 years in order to settle its debts. New Look will be looking to close 10% of its UK stores, along with making 6% of its staff redundant in an attempt to reduce costs, at the least profitable stores. The company is also attempting to generate additional sales via e-commerce, realign its pricing in the increasingly competitive market, and narrow its range to more of a niche. These are all steps in the right direction. With these changes, there is the possibility of the CVA being appropriate, thus avoiding the same mistakes in the Toys R Us administration case. However, only time will tell.

Finally, looking at the prospect CVA for Carpetright, the board has suggested they intend to raise funds via investment. They will also close a number of unprofitable stores and re-brand the remaining stores to attempt to save the business, whilst proposing a CVA. Unfortunately, many will be unwilling to invest money in the failing company after announcing they are looking to propose a CVA. They appear to be a similar story to Toys R Us, operating on the same model and seeking to simply polish the failing company. They do sight the reasons for failure as the previous management opening an excessive number of stores. However, in these circumstances, company administration may be more appropriate, with the “investors” conducting a buyout through a pre-packaged deal.

Conclusion

Out of the 3 recent high profile retail CVA announcements, only one set of circumstances actually lends itself to a CVA as opposed to company administration. It can be appealing to keep the company going for as long as possible, but is it a breach of fiduciary duties to propose a CVA, with no real chance of successful implementation. This is particularly pertinent when the arrangement fails on the due date of the first VAT quarter. If you are considering a CVA for your retail business, you can contact our business rescue experts for some honest and straightforward advice as to the best option for your circumstances.

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