With the current issues facing the economy and the almost certain rise in corporate insolvencies to come next year, the reintroduction of Crown preference seems to have come at an entirely inappropriate time.
In all insolvencies commencing from 1 December 2020 HMRC will be a preferential creditor in its claims for PAYE, employee NIC, CIS deductions and VAT and will now rank ahead of floating charge holders and the prescribed part, the pot of up to £800,000 set aside for unsecured creditors to share.
Crown preference was previously abolished in 2003 by the Enterprise Act, as part of the push towards creating a business rescue culture. However, this time around, Crown preference is back with a bang! There is no restriction on the age or size of the debts eligible for Crown preference, although HMRC will remain an unsecured creditor for corporation tax and other direct taxes.
The change was introduced pre-COVID and reflected the fact that HMRC was often being used by businesses as an involuntary lender. The world has, however, changed and HMRC has deferred many VAT and other tax payments under time to pay arrangements as part of their coronavirus response. In the circumstances restoring Crown preference does appear to be counterintuitive.
The risk that there could be a reduced or even no return to floating charge holders and other unsecured creditors could make a devastating impact the business rescue culture the Government is trying to achieve. It could prevent rescues in some cases and there is a real risk that reducing the returns to unsecured creditors will, in turn, cause a train of insolvencies. At a time when there is real economic instability and the Government have invested heavily over the past 12 months to keep businesses afloat, it seems entirely counterintuitive to have introduced a measure that could see an increase in corporate and personal insolvencies.
The reintroduction of Crown preference is also likely to make obtaining finance much more difficult. With the security of a floating charge now diminished lenders are likely to seek more extensive fixed charges or personal guarantees to secure their lending. Businesses that do not readily have suitable assets available to offer as security may face difficulties in obtaining finance and progressing their business.
Another area of interest will be CVAs. A CVA cannot affect the rights of preferential creditors without their consent. HMRC are likely to be a creditor in the majority of CVA scenarios and it is unlikely that HMRC will agree unless the preferential debt is paid in full. CVAs will face a tough balancing act of keeping HMRC happy whilst ensuring there is still enough money in the pot for unsecured creditors to ensure those creditors engage with the CVA process.
The reintroduction of Crown preference is a decisive step back from trying to achieve a rescue culture for businesses. With the current issues facing the economy and the almost certain rise in corporate insolvencies. it remains to be seen is exactly how much damage will be caused to Businesses.
R3 and restructuring professionals continue to lobby for the position to be reversed, but for now at least, HMRC is back in the driving seat.
If you are looking for advice and support on how Crown preference may affect you or your business, we’re here to help – get in touch.