For some directors the option to write off debt is just not acceptable to them, it goes against their moral stance, with the view that, “as I have incurred the debt I must pay it back in full”. Whilst this may be considered as the honourable thing to do, the end result could actually be that creditors get nothing as without being able to write off debt the result could be that cash flow gets so tight that the company receives a winding up petition and ultimately a winding up order.
So could a Company Voluntary Arrangement (CVA) to write off debt help?
I was recently asked to help the directors of a company which had HMRC chasing and creditors taking action, with some issuing County Court Judgements (CCJs) against the company. The company had been trading successfully for two generations and had never faced financial issues of this magnitude. The directors simply did not know what to do or that they had an option to write off debt. Around twelve months before, an issue with faulty goods from a major supplier left the company with customers demanding refunds and for the work to be re-completed. Whilst the issue was with the goods and not the workmanship of the company, the directors knew that they would have to re-do the work and offer refunds to keep the goodwill of the company intact. Over the course of a number of weeks, the work was completed and compensation payments made to customers where appropriate. The company commenced legal action against the supplier, which is still ongoing…
This is just one example of issues that can occur, which are out of the control of the directors and no fault of their own; in this case the company lost cash through both refunds and legal action, but also had to turn away new customers whilst the issues were resolved. As the money lost in the month needs to be replaced, the cash flow tightens and creditor payments start to slip. With not enough money to go around, creditors invariably increase and start charging interest, debt collection fees and eventually put the company on stop. Having to buy goods upfront from new suppliers harms the cash further and the financial position worsens, particularly when debts are then put on credit cards or are funded by expensive unauthorised overdrafts.
The underlying business in so many cases is profitable, but unable to succeed due to the historical issues and continually playing catch up, in some cases the interest and bank charges are more than the company can pay off each month, so the underlying debt is simply increasing. What the company needs is to freeze the position, write off debt, and move forward. This is where the CVA works. The CVA will ring-fence all of the debts of the company, and importantly can freeze interest. But what is a CVA?
Cash flow is king and sometimes you need to write off debt to save the business
The company works out a detailed cash flow taking in to account the current necessary expenditure, including the directors being able to draw a salary, which in some cases will be a something that has not happened for some time. This will then leave a surplus each month which can be paid into the pot for creditors, over a period of up to five years. In a lot of cases this will not pay creditors back in full, but it will at least give them some return. In most cases, when the alternative is to wind the company up, sell the assets at auction and then pay chargeholders first, the unsecured creditors will be left with very little, if anything.
By choosing to write off debt the company is able to continue to trade, to offer employment, to pay taxes and to buy new supplies, therefore being a customer for the suppliers in the future. There are many advantages to a CVA; but ultimately the creditors get money going forward for new supplies, and a percentage of the debt it was owed already, which they would have had to written off in full most likely without the CVA.
Provided that the underlying business is profitable, that the issues faced historically by the company are identifiable and rectifiable then a CVA can be used as an effective recovery and turnaround tool. Writing off debt and saving the company as a going concern, as well as achieving the best result for creditors. Whilst some may not like the idea of choosing to write off debt, the alternative would be far worse.
The earlier the CVA can be proposed the better, as goodwill remains with creditors. Even at a point where a petition has been issued, we have still been successful in implementing a CVA. It is never too late to write off debt and turn around the fortunes of a company.