Has the return of Crown Preference killed off the CVA?

Has the return of Crown Preference killed off the CVA?

February 3, 2022

The Company Voluntary Arrangement (CVA) has long been a useful weapon in the armoury of business rescue experts, with an infinite flexibility designed to allow solutions to be designed to fit the unique situation of every business with temporary or longer-term issues. Not all CVAs succeed, of course, and there has been concern in recent years about its use to discriminate against one particular category of creditor, the landlord.

Crown Preference restored

Now the procedure is under threat from a new and unexpected quarter in one of the clearest examples of the law of unintended consequences. As from December 2020, HMRC regained its preferential status for certain taxes owed to it, such as VAT, PAYE and NI (Crown Debt). They had been demoted to the rank of unsecured creditor alongside suppliers by the Enterprise Act 2002, but now they are back at the front of the queue for distributions in insolvency procedures, such as a CVA. The technical term for their newly enhanced status is Crown Preference.

Implications for CVAs

The outcome of this apparently minor tweak to the insolvency legislation is that in all CVAs, the deal put to creditors will have to provide for Crown Debt to be paid off in full before any other creditors can receive a penny. The only exception will be where HMRC agrees to accept than less than 100p in £.

HMRC approach to CVAs

The official guidance from HMRC on their approach to CVAs is of scant help, at least on this major change to their status and their role in approving proposals. It is dated November 2011, a full nine years before Crown Preference was restored, which itself was over a year ago now.

There is little anecdotal evidence yet of their current attitude to CVAs, although there have been rumours of deals being put to HMRC seeking their agreement to accepting less than 100p and providing for a small distribution to unsecured creditors.

The impact of the pandemic

The government’s well-meant measures to protect businesses badly affected by the Coronavirus crisis has only compounded the Crown Preference problem. By allowing VAT to be deferred and encouraging HMRC to agree time-to-pay arrangements, Crown Debt has escalated well above normal levels for many businesses. This has the effect of swelling the numbers of situations where HMRC may be the only significant beneficiary of a CVA and where it will effectively have the casting vote.

What’s in a CVA now for ordinary unsecured creditors?

In many cases, the simple answer is not a lot, if anything at all. There will be some instances where the debt owed to HMRC is small related to other debts, but in too many cases the question will be why would suppliers or landlords agree to a deal that provides HMRC with a positive outcome, but leaves them with little or nothing? In certain industries, such as recruitment, Crown Debt will always be large and HMRC often the dominant creditor.

Unsecured creditor apathy in CVAs

A CVA has to be approved by 75% by value of creditors who vote. Even before the restoration of Crown Preference, it could be difficult to persuade unsecured creditors to engage with the process by voting. But the greater challenge was to persuade HMRC not to vote against a set of proposals, thereby preventing them from being approved.

Now the situation has been reversed, where HMRC may wish to push through a CVA on terms most advantageous to itself, but which by definition will harm the recovery prospects for unsecured creditors.  Unsecured creditor apathy will now be potentially self-defeating.

Continuation of supply

Even before the restoration of Crown Preference, the government dealt a further blow to unsecured creditors by passing legislation (the Corporate Insolvency and Governance Act), which as from June 2020 forces suppliers to continue to trade with companies undergoing an insolvency process, including CVAs. Suppliers are not allowed to change any term of supply, such as the price, the credit terms or to ask for any guarantees.

As such, it now appears that unpaid suppliers could be forced to continue doing business with a company under a CVA voted through against their wishes by HMRC and under which they may receive little or no repayment against their pre-CVA unpaid debts. Their only upside will be if the business survives to be a profitable trading partner once the CVA is over.

Is there evidence that the CVA is falling into disuse?

Statistics for insolvencies in 2021 have now been released. They show that in the first full year since Crown Preference was restored, only 115 CVAs were approved, equivalent to 0.8% of total corporate insolvencies. This compares to 278 in 2020 and 355 in 2019, both at about 2% of total corporate insolvencies.

However, many other factors were in play during an unprecedented period for insolvencies, with so many creditors banned from enforcing debts. It is too early to be certain that the CVA is dead, or at least only restricted to cases where there is no significant Crown Debt.

Most recently, HMRC have been granting Time to Pay (TTP) deals stretching out for as long as five years, which in its own way could be viewed as HMRC facilitating informal CVA’s. With this option available to cash-strapped businesses, a CVA will inevitably be less relevant.

Is there a pragmatic way forward to save the CVA?

The main issue is why any company would propose a CVA where the objective was to save the business and preserve jobs, if only HMRC was happy and all its suppliers were left disgruntled? Once the CVA is over and suppliers are no longer compelled to trade with the company, what future will the business have?

There are sufficient early rumours of HMRC flexibility in the face of problems at businesses which owe substantial Crown Debt to suggest that sensitively handled negotiation, backed up by credible financial information may produce a satisfactory outcome for all interested parties. That way, businesses can be preserved and jobs can be saved.

Get in touch

If your business is facing problems, a CVA may still be the best way forward even though this is a more complex procedure than ever before. Opus has extensive experience of difficult situations like theses. You can contact us at your nearest local office to arrange a no obligation and confidential call with one of our Partners.