Farming is one of the very few sectors where the majority of businesses still operate as traditional partnerships, often without the benefit of a partnership agreement. The options available if a farm becomes insolvent, and the consequences of insolvency, are therefore much more complex than in the case of limited companies or individuals.
In this article I will provide an overview of partnership voluntary arrangements which provide an alternative to winding up/bankruptcy and enable the farm to continue trading.
Traditional Partnerships V Limited Liability Partnerships
When two or more people conduct a business together, the law assumes that they are in a traditional partnership. All partners share the profits of the business but are also responsible for the debts. Farmers may formalise their partnership in a written agreement that stipulates, for example, how profits and liabilities are to be dealt with, and how the partnership will come to end. But, with or without an agreement, individual partners in a traditional partnership are personally liable for the debts of the partnership.
Since the enactment of the Limited Liability Partnerships Act 2000 in April 2001, many traditional partnerships converted to LLPs to take advantage of the benefits of limited liability equivalent to those applicable to limited companies. The process of setting up an LLP is straightforward, and farmers are strongly advised to obtain professional advice on pursuing this structure for their business.
Consequences of insolvency for a partnership
If a farm business that is not registered as an LLP is unable to pay its debts, rules relating to partnerships and individuals will apply because it is not always obvious which assets belong to individual partners and which belong to the partnership business. A creditor can present a winding up petition against a partnership as well as bankruptcy petitions against individual partners. This may lead to the closure of the partnership business, the sale of all the assets of the partnership and (where bankruptcy petitions are also presented) the sale of all the assets of the individual partners. Such a situation will be devastating, not just for the farm business, but often for many members of farming families.
The effects of insolvency on farms structured as LLPs are usually limited to the assets and debts within the business and should therefore afford some protection to family and individual assets. However, as many farming businesses are extensions of farming family life, the potential personal consequences may nevertheless be far-reaching.
For any farm in financial distress, liquidation or bankruptcy are not inevitable. There are several options farmers may explore with professional advisers. If the farmers want to continue to trade in order to overcome their financial difficulties, a Partnership Voluntary Arrangement (PVA) may be a good option to explore.
Partnership voluntary arrangement (PVA) – enabling a farm to continue to trade
A PVA is a formal insolvency process under insolvency law that needs to be implemented under the supervision of an insolvency practitioner. It allows a farm business to reach a payment agreement with creditors for unsecured debts. This will typically involve an offer to pay either a reduced sum to creditors over an agreed period of time or to pay the debts in full over an extended period of time using agreed contributions paid into the PVA or the sale of certain assets.
In essence therefore a PVA is a mechanism for dealing with historic debt in circumstances where there is a core business that is capable of trading profitably into the future. At the same time, funds are paid into the PVA to “compromise” or reduce the historic debt. Identifying those areas that are and are not profitable is critical, and difficult decisions may have to be taken as to which parts of the business will continue to trade going forward. The part of the farm business that continues to trade will need to be able to demonstrate to creditors that it will be able to pay its post-PVA creditors as these debts fall due, as well as maintaining contributions into the PVA.
The PVA process
Curiously the law does not require a partnership to demonstrate that it is insolvent for it to enter a PVA. But since creditors are being asked to compromise their debts, they will usually expect to see evidence of inability to pay the debts in full in the ordinary course of business.
A licensed insolvency practitioner (IP) must be engaged to assist in drafting the PVA Proposals. The Proposals cannot affect the rights of secured creditors to enforce their security without their consent. It is therefore important that when drafting the Proposals regard is had to the need to service any secured debt. Entering a PVA may amount to an “Event of Default” as defined in security documents which might enable a secured creditor to appoint a Receiver over the secured assets. It is therefore crucial to liaise with secured creditors when drafting the Proposals even though their rights can’t be adversely affected by the Proposals.
The Proposals must then be circulated amongst the partners in the farming business and the creditors of the business for approval. The Proposals will be approved by the partners if the majority of the partners in value vote in favour. This means it is necessary to take into account each partner’s share of the partnership capital to determine this value.
The Proposals will be approved by creditors if at least 75% in value of creditors vote in favour unless those voting against make up more than 50% of unconnected creditors. Connected creditors include partners and their relatives. The voting rules are therefore designed to ensure that the PVA will only be approved if a majority of unconnected unsecured creditors vote in favour. Notice must be given to all known creditors (including secured creditors) and a failure to do so could lead to the PVA being set aside by the court. Secured creditors are only entitled to vote in respect of any unsecured shortfall.
Creditors are entitled to propose modifications to the proposals. Typically, HMRC will insist that all post PVA tax returns are filed on time and all post PVA tax is paid on the due dates. If the partners agree to the proposed modifications, creditors will be invited to vote on them. Provided the requisite voting majorities are achieved the PVA will then bind all creditors and all the partners in the farming business.
Important consequences of a PVA
It is common for the financial affairs of the individual partners to become inextricably bound up with the affairs of a farming partnership. For example, partners may have borrowed in their personal names to fund the farming business. Significantly, once a PVA is approved, creditors will be unable to seek recourse against the assets of individual partners of the business. This will provide some relief for the farming family involved.
Once the Proposals have been approved, the IP must file a report at court, and he or she becomes the Supervisor of the partnership. The main role of the Supervisor is to receive the agreed funds from the partnership, monitor the performance of other obligations under the PVA and to pay a dividend to creditors. The Supervisor’s fees will come out of the PVA funds ahead of any dividend. If any of the terms of the PVA are breached, the Supervisor usually has the power and sometimes an obligation to petition for the winding up of the partnership and the bankruptcy of the partners.
When does a PVA end?
The terms of the Proposals will determine when the PVA comes to an end. Typically, the PVA comes to an end when it has been fully implemented in accordance with the terms of the Proposals. However, it may end early either because the terms have been breached or the terms have been implemented ahead of time. When the PVA ends, the Supervisor must send a report to all creditors within 28 days and file a copy of his report at court.
If the PVA ends because there has been a breach, creditors are no longer bound by the terms of the Proposals and are free to take enforcement action against the assets of the partnership and/or the assets of the individual partners. However, credit would have to be given for any dividends received in the PVA prior to termination. But, where the PVA ends because its terms have been fully implemented, creditors are not able to take enforcement action to recover any shortfall between the sums owed and the dividends received, and the farm may continue trading unfettered.
There is help for farms in financial distress
Farming partnerships differ from partnerships in other sectors as many farming businesses have been trading for several generations, and families often feel a responsibility to preserve the business for future generations. Farming families may also fear reputational damage associated with bankruptcy in close knit rural communities. A Partnership Voluntary Arrangement may provide a solution that enables a farm business and farming partners to avoid liquidation, and to continue trading. Insolvency professionals are available to help any farm in financial distress to explore the best options for the business and all partners involved. Please do get in touch.