Crown preference and the impact on lenders and business owners
Published: 06/12/2019 By Andrew BaileyIt was a surprise to many in the insolvency profession that the government is seeking to re-introduce crown preference in April 2020. In summary it means that in any insolvency scenario you will see the HMRC debt jump ahead of not just other unsecured creditors, like trade suppliers, but also lenders in respect of any floating charge security that the bank may have.
For those of us who recall the crown preference previously we saw it abolished in 2003 in conjunction with other measures that sought to even the playing field when it came to secured and unsecured creditors receiving money in insolvency scenarios. For a trade supplier you may consider this entirely reasonable and ask why should HMRC have priority to anyone else when a business fails given the resources available to them? The abolition of crown preference last time was regarded as “more equitable”.
The announcement of the re-introduction of crown preference (albeit with some amendments to the pre-2003 version) is not exactly a very exciting headline and frankly to those outside the insolvency profession you wonder if it has any relevance at all? Is it just another attempted cash grab by the government for the sake of headlines but generally unlikely to have much impact? Alternatively is this a policy that could result in repercussions that may have not been envisaged when it was first contemplated?
For many in the insolvency profession it is considered that the latter question will be more applicable and the impact upon lenders and business owners should not be underestimated. We have considered some examples below.
- If a lender has security in place over a company’s assets, the introduction of crown preference is going to have a significant impact. If the company enters an insolvency procedure then HMRC will jump up the queue and will be entitled to any proceeds that would otherwise be secured under a lender’s floating charge. If a lender is secured on assets like stock/inventory and other items that are generally traded in the ordinary course of business then any realisations from these sources will go to HMRC prior to the lender receiving any funds. From a lender’s perspective there will be much more comfort in lending on assets where they can secure their lending easily (ie. fixed charge security on plant, machinery and book debts) and restrict lending on anything else. Lenders will take care to restrict lending for existing facilities and it is likely that clients will see their facilities reduce in size to reflect that the bank do not want to be exposed too much when lending on these other items like stock. We may see changes to how personal guarantees are used and they may become more common and potentially increase to reduce the risk to the lender.
- For those lenders that do not rely upon security and offer unsecured loans then there is an even greater risk. In the event of an insolvency they will rank below HMRC and the only likely return is if they have personal guarantees in place. It is needless to say that whilst these types of loans will not disappear it is likely that the level of lending could decrease and more due diligence is undertaken on the business and the individual before any funds are released to businesses.
- If you are a business owner then how do you cope with your lender restricting the amount of funds that you can borrow? When you rely on your lender for cashflow purposes then you will need to consider, in advance of April 2020, how you are going to accommodate these changes in your business. This will be of particular importance to those businesses who borrow money from a lender on the basis of their main asset being stock/inventory for example.
- If you are a trade supplier, do you need to revisit your credit terms with clients? In an insolvency scenario the unsecured creditors, including trade suppliers, have effectively fallen further down the ranking when it comes to receiving a distribution from a business failure. For many unsecured creditors the view may be taken that often they receive little in return in any event. However, what is certain is that the chance of recovering any monies from a business are even less likely now.
- Surely the options of turning around a business whilst in a distressed state is now even more unlikely. As soon as it becomes apparent that a business is rumoured to be distressed you are likely to see facilities reduced and credit terms squeezed as third parties seek to protect their position.
Interestingly, the introduction of this legislation goes against international trends and respected guides by UNCITRAL and the World Bank that have recommended not having priority debts in insolvency.
Also, is the introduction of crown preference actually not addressing the fundamental problem in that HMRC are not effective enough at collecting taxes? I hear of HMRC seeking to change the culture of tax payers and taking a carrot approach as opposed to the stick. However, it is reasonable to question whether any additional taxes raised through this legislation is going to be lost elsewhere as a consequence of the impacts felt elsewhere by lenders and businesses.
It will be interesting to see what imaginative solutions may be produced to potentially mitigate the impact of this legislation. Will we see new ways of demonstrating “control” over particular categories of assets to demonstrate that the lenders have more control over previously categorized floating charge assets. Maybe we will see more regular use of group structures with assets being held in separate entities from the trading part of the business? To what extent will lenders need to take a more hands on approach to monitor HMRC liabilities of their clients?
Let’s see what the early months of 2020 bring but I suspect that this legislation will be getting more attention as the implementation date comes closer.