Joint Stakeholder letter voices serious concerns about the return of the Crown Preference in April 2020
Margaret Linn previously wrote about the draft clause for the Finance Bill 2019-20 in July about the reintroduction in Crown preference in insolvencies.
In the article, Margaret highlighted that there will be an estimated additional return of £185 million to the government via HMRC but two consequences would be less money available for other creditors and a negative impact on the availability of borrowing for businesses. These consequences are providing “serious concerns” to a number of bodies who have written jointly to the Chancellor to express them. These bodies include professional accountancy bodies ICAS, ICAEW and ACCA, The British Property Federation, the Chartered Institute of Credit Management and the Alternative Credit Council.
What is a Crown Preference?
Not all creditors rank equally in insolvency. There are two classes of creditor, secured and unsecured. For unsecured creditors, certain debts already hold a preferential status, which means they are paid before the general body of non-preferential unsecured creditors.
Currently, certain elements of claims from employees and the redundancy payments service are the only debts which typically qualify for preferential status (subject to statutory caps). HMRC meanwhile currently ranks alongside all other unsecured creditors but this change will see it climb the ladder and sit behind the other preferential creditors. The Crown, being HMRC, is to be given preferential status which means that it will rank ahead of unsecured creditors.
In simple terms, an unsecured creditor will have less chance of receiving money back against a debt they are owed in an insolvency process.
Haven’t we been here before?
Preferential status for HMRC is not something new. In fact, when speaking with directors and creditors it is often a misconception that HMRC will be paid ahead of the general body of creditors. It was actually withdrawn in 2003 as part of the Enterprise Act 2002. That Act was all about business rescue and the revamped “Administration” process which was to assist as rescuing companies as going concerns. That Act also introduced the “prescribed part” which would ring-fence a portion of floating charge realisations for the unsecured creditors including HMRC, a quid pro quo for the abolishment of the then Crown preference.
The Governments rational is about increased revenue recoveries, estimated at £185 million. The Government policy objective states that:
“Taxes paid by employees and customers do not always go to funding public services if the business temporarily holding that money goes into insolvency before passing the tax on to HMRC. Instead, they often go towards paying off debts to other creditors.
This measure will amend insolvency legislation to move HMRC up the creditor hierarchy for the distribution of assets in the event of insolvency by making HMRC a secondary preferential creditor in respect of certain tax debts held by a business on behalf of their customers and employees. This change will enable more of those taxes paid in good faith to fund public services as intended.”
Not only is HMRC going back to old ways, but Crown Preference Mark 2 gives even wider scope to claim debt preferentially. This is because the reincarnated version doesn’t include any restrictions on the age of the debt as it once did.
What are the “serious concerns”?
Essentially, it is thought that the £185m of tax recoveries will be outweighed by the wider costs of the change.
Firstly, secured lenders are going to see the value of their security weakened, specifically any monies loaned under a floating charge. This is because preferential creditors are paid in priority to debts caught under a floating charge too. While the thought of the banks losing a bit of money won’t cause too many people sleepless nights, the consequence of this could be felt by directors personally and SMEs (small and medium-sized enterprises) generally.
The major banks may well reconsider their lending criteria and this could create issues for SMEs. These businesses are already facing the prospect of having to source funding from secondary lenders, who are likely to charge a higher premium. For a business which is already struggling, higher costs of finance are unlikely to help buck that trend.
Where there is insufficient asset security, it is not uncommon for lenders to obtain personal guarantees in addition to the security they hold over a business’s assets. If fewer assets are available for the lender under their floating charge then we could see more personal guarantees being requested and subsequently called upon, which makes it an even more daunting time to be a director. This won’t encourage entrepreneurs into business.
In summary, it will make floating charge lending riskier for a lender, which will restrict access to finance which will mean it is harder to rescue businesses and therefore more business failures.
Secondly, there will be less money available for unsecured creditors such as trade creditors, pension schemes and consumers. This impacts everyone.
It is currently going to happen in April 2020. The letter urges a rethink or at least capping the amount of the preference. We shall continue to watch with interest.
Get in touch
If you have any questions about any of the issues raised in this article, please get in touch with a member of or Business Recovery and Insolvency team.