Crown preference background

The Finance Act 2020 has restored preferential status in an insolvency as from December 2020 to Crown debts, such as unpaid VAT and PAYE.  This reverses a change made way back in 2003 by the Enterprise Act, which was intended to placate banks for losing their ability to take control of struggling borrowers by appointing their own Receivers.  It may seem like a simple re-ordering of the creditor recovery cascade, but the reality is a swamp of unintended consequences, none of which will be good for UK business.

The timing of this change is unfortunate, coming into force as a number of government measures designed to help companies survive the crisis Covid-19 will be coming to an end. In particular, the deferral of VAT payments and generous time to pay arrangements for PAYE will have left businesses with bloated debts to HMRC.

The losers

The new regime promotes those debts above all other unsecured creditors and the claims of lenders under the floating charge element of their security, which typically comes from funds raised by disposing of inventory and chattel assets, such as any vehicles and equipment not subject to finance elsewhere.

This creates two obvious losers – ordinary suppliers and the clearing banks, whose support and credit indulgence are the backbone of working capital finance in the UK, particularly for SMEs. There is also a third potential loser, arguably even more important than the others in keeping British businesses adequately funded. This is the trade credit insurance community, who stand behind suppliers’ risk.

The consequences

It is likely that all of these key stakeholders will look much more carefully at what this seemingly simple change in favour of HMRC means for their recovery prospects when a customer or borrower goes bust and will then restrict their facilities accordingly. This can only mean less working capital for businesses. Anecdotal evidence suggests that the banks are already looking to reduce their exposure to sectors most likely to run up major HMRC liabilities.

The higher prescribed part

The lenders’ view of risk will also be impacted by another change brought in by the Finance Act, which increases the ‘Prescribed Part’, the ring-fenced element of asset recoveries in an insolvency earmarked for unsecured creditors, from £600,000 to £800,000. Cynics might suggest that this is academic if the newly-preferred HMRC snaffles all the asset recoveries, but it will be a factor in determining lenders’ appetite to lend

Will CVAs still work?

Another consequence of HMRC’s elevation to preferred status may be to make business rescue through the Company Voluntary Arrangement (CVA) route more difficult. A little known quirk of the CVA procedure is that it cannot be used to compromise debts owed to preferential creditors. Crown debts can be a significant part of the liabilities of an embattled business and will be especially so early next year as government support ebbs away, leaving companies to fend for themselves in the post-pandemic impaired economy.  If HMRC cannot be made to accept a financial haircut, some otherwise viable businesses may not survive.

Conclusions

It seems that this apparently innocent largesse granted to HMRC by the government may end up reducing both suppliers’ credit limits and lenders’ lending appetite just when recovery prospects most demand that business survivors need help. Has Whitehall somehow lost sight of the law of unintended consequences in the midst of the crisis, or does it not grasped the impact of its internal indulgence? The government is thought to have estimated that it would recover an extra £185m a year from the change, which is surely small change set against the damage to the economy it may cause.