The return of Crown Preference – and why this is bad news for both lenders and borrowers.
Back in the Autumn Budget of 2018 the government announced its intention to reinstate the preferential status of HMRC. It estimated that this would raise £180m for the Exchequer. Over the last two years the Insolvency profession has been lobbying the government to reconsider. Regretfully these protests have been ignored.
The Finance Bill 2020 received Royal Assent on 22 July 2020. In Part 4, under Miscellaneous, section 98 provides for HMRC to once again be put in a much better position than everyone else, including the banks and trade suppliers. These changes reverse the position established by the Enterprise Act 2002 which abolished the preferential status of tax debts, and in so doing freed up lending capacity secured against stock. These new rules will apply to all insolvencies commencing after 1 December 2020. HMRC will become what is known as a secondary preferred creditor – ranking behind employee claims for unpaid wages and holiday pay. The difference this time around is that HMRC will be able to claim for all unpaid VAT, PAYE and employees NIC deductions.
So why is this a big thing?
When it comes to lending, a bank or finance company needs security over the borrower’s assets in case of default. This security takes the form of a debenture incorporating fixed and floating charges. The fixed charge will attach to intellectual property such as goodwill and trademarks as well as any big fixed plant. The floating charge attaches to moveable assets such as stock, debtors and moveable kit such as fixtures and machinery.
Currently, once the costs of the insolvency process have been paid, the floating charge holder sits behind the employees and what is catchily known as the ‘prescribed part’. This is a deduction, brought in by the Enterprise Act 2002, which carved out a fund for the benefit of the unsecured creditors. Any lender is predominantly interested in the risks of being repaid – which means a careful understanding of where they will rank in the pecking order following any insolvency.
What are the consequences?
These changes will have a big impact on the ability of a bank or other secured lender to be repaid – and hence on their risk analysis when deciding if, and how much, they are prepared to lend.
Consider a bank providing stock finance. When these changes are introduced, they will have to keep a close eye on the borrowers’ payments to HMRC for VAT and PAYE/NIC. Any arrears will severely impact on how much they might recover. Not only will they want monthly figures, but they will be factoring in the provision required to cover the average liability for VAT and PAYE. Which means they will be unwilling to advance the same level of funding. This will really hurt retailers and manufacturers who will have to find additional external capital to fund their stock purchases. And if that finance is not available, then sales and production will have to be scaled back.
For owner-managed businesses these changes will also increase the likelihood of the lender wanting personal guarantees due to the diminished value of the company’s security.
In addition, another issue will be the 1 December 2020 deadline. Any lender will be thinking about their return both now and after the new changes are introduced. Marginal customers may find that the bank would rather enforce their security now than wait until December when HMRC will rank in front. Especially as, due to Covid-19, by December HMRC are likely to be a very significant creditor.