The return of Crown preference – Will the Government get their way?

18th Oct 2019
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In 2018, the Government announced plans to introduce new legislation in the 2019-20 Finance Bill.  The legislation intends that, in the case of an insolvency process, HMRC will become a secondary preferential creditor for certain debts; essentially VAT, PAYE, Employees’ NIC and CIS deductions – there is to be no cap on the age limit of these debts.  It was also due to include interest and penalties although this was subsequently removed after consultation.  It is intended that, in respect of these debts, HMRC will rank after costs of the insolvency, primary preferential creditors (including some employee claims) and any fixed charge security, but will rank ahead of floating charge security.  The legislation is due to come into effect on 6 April 2020.

Many stakeholders, including the insolvency profession, through its professional body R3, saw this as a backward step, and were highly vocal during the consultation process which closed on 27 May 2019.

In July 2019, the Government published the draft legislation along with additional guidance, leading to further comment and well-publicised criticism, especially from R3.

On 3 September 2019, R3 wrote to the Chancellor of the Exchequer, expressing serious concerns over the proposed legislation and requesting that a further review is undertaken before the changes become law in April 2020.

While it is clear that additional revenue for the UK Government in the event of an insolvency situation is attractive, the concern is that the proposed changes risk inflicting greater damage on the wider economy, with potentially serious implications for both business owners and funders.  The key concerns are as follows:

  • The proposed changes contradict the previous culture of business rescue introduced by previous Governments
  • Because HMRC will rank ahead of the holders of floating charges, a common form of security (including the growing number of alternative lenders), those funders will find themselves in a less-secure position in the event of an insolvency.  There are a number of possible knock-on effects:
    • Funders may be less willing to lend if their risk of loss increases;
    • Funding costs may increase as compensation for increased risk;
    • Business owners’ ability to access new finance may become restricted;
    • This could lead to good businesses being unable to grow, or be adequately financed – clearly bad for the UK economy;
    • It could lead to struggling businesses, becoming unable to access much-needed additional funds, thus forcing them to fail and enter an insolvency process.
  • Existing lending may be reduced or could fall into default if covenants have to be recalculated to take account of a diluted security position which may also lead to currently healthy businesses entering insolvency.
  • While there would be a greater return to HMRC from an insolvency process, the trade-off is that unsecured creditors and pension funds will receive less.  This could also have a number of implications:
    • The reduction in returns from insolvencies could lead to increased numbers of business failures – clearly bad for the UK economy;
    • The risk of lower returns may mean that unsecured creditors are less likely to support rescue packages that, ordinarily, would be supported – again, leading to greater levels of business failure.

There are also some serious risks for lenders if the value of their available security is diluted and, whilst banks need to lend money in order to make money, it is perfectly understandable that it could become harder for business owners to access that capital. 

If new funding is harder to come by, then that cannot be welcome news for the owners of UK businesses.

R3 have asked for a full review of the proposed legislation but, as a minimum, have asked that the following changes are made to the legislation as drafted:

  • Introduce a cap on the age of tax debts that can be included in HMRC’s preferential claim;
  • For the legislation to only affect bank security taken out after 6 April 2020 i.e. for the order of priority of existing floating charge security to be unchanged.

This is going to be a game-changer for UK business, the funding community and the insolvency profession if the Government get their way – the question is will they be successful or will the legislation be watered down to a level that allows HMRC to improve their position without potentially causing widespread damage to the UK economy?