This has been a year of unwanted change for a number of reasons including the return of preferential status of HMRC in insolvencies (‘Crown preference’) with effect from 1 December 2020 via the Finance Act 2020 (‘2020 Act’) that was enacted on 22 July 2020.

The re-introduction of Crown preference is largely considered contrary to the rescue culture, greater access to funding and improved returns to creditors more generally that the Enterprise Act 2002 sought to create.

The new provisions of the 2020 Act (Sections 98 and 99) will now give HMRC secondary preferential status, whereby it will have a preference claim for VAT and certain relevant deductions (which are expected to be unpaid employer PAYE and NIC, student loan repayments and CIS deductions). This means that HMRC will have the lowest category of preferential debt and will come after the other preferential categories, namely contributions to occupational pension schemes, certain wages and salary and other financial compensation deposits/other levies. Presently, there is no limit to the extent of the historic debt given preferential status whether in quantum or time period – whether that changes will depend if any secondary legislation is enacted.

This change has largely been considered by R3, funders and other stakeholders as being extremely detrimental to the finance market and, ultimately, creditors as it impacts the ability to achieve restructurings and rescues. This is all the more heightened given the current COVID-19 operating environment, whereby VAT payments and other arrangements have been deferred, therefore potentially increasing the level of preference claims in insolvencies.

What exactly, then, are the concerns being raised?

  1. Funders/holders of floating charges will now have a lower recovery in insolvency as these HMRC debts will be paid in priority to floating charge holders, particularly taking into account the increase in prescribed part (see below) and the additional priority given to certain moratorium debts under the new moratorium procedure introduced by the Corporate Insolvency and Governance Act 2020. This reduced recovery will undoubtedly have an impact on strategy decisions in distressed cases and the appetite of funders to take a risk approach and provide ongoing support. Similarly, it is expected to impact the appetite of funders to extend lending and to increase pricing – this will, of course, hit the customers.
  2. In addition to the above, the prescribed part has been increased with effect from 6 April 2020 to new floating charges to £800,000, up from £600,000. While this may have been badged as an improvement for creditors, any such improvement may well be lost if the monies are absorbed by the preferential creditors. Further, it simply increases the risk to funders whose floating charge is further cut down by the increase in the prescribed part – this in turn represents a further risk for lenders.
  3. Scotland in particular is likely to see a bigger impact given the lack of ability to rely on fixed charges other than over land/property. While there are movements being made to modernise Scots financing laws to expand the ability to take fixed security over moveable assets, any such change is not anticipated until 2021 at the earliest, therefore this will remain an issue at least for the short to medium term in Scotland.
  4. This change to Crown preference also applies to personal insolvencies – it is simply that there is no floating charge in those circumstances and, therefore, in personal insolvency cases it affects more directly the return to the unsecured creditors, who of course do not have any protection via the prescribed part.

While the return of Crown preference is not what the market was necessarily looking for and many are disappointed, it would appear certain that it will return with effect from 1 December 2020. It may therefore be that any planned insolvencies will take place ahead of 1 December 2020 to minimise the potential impact for the wider creditor pool.

Allana Sweeney is a Senior Associate in Shepherd and Wedderburn’s restructuring and business advisory team. For further advice on this or another related matter, please contact Allana on 0141-566 7215 or at allana.sweeney@shepwedd.com.

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