Will the return of Crown Preference expose Personal Guarantees?

Tue 17 Nov 2020

When the Finance Act received Royal Assent and reintroduced preferential status for certain HMRC debts in insolvencies from 1 December 2020, I do not believe anybody expected us to be living and working in a world changed by a Covid-19 pandemic!

What are the Preferential status changes?

In an insolvency process, asset realisations are paid to creditors in accordance with “the order of priority”, from fixed charge holders (first-ranking) down to company shareholders (lowest ranking).

Under a waterfall flow, funds cascade from one level to the next, only being available to the next, if the level above is paid.

The current order of priority stands as:

Fixed charge holders (eg. Bank lending tied to security of assets)

Preferential creditors (eg. Unpaid wages and holiday pay)

Floating charge holders (eg. Bank lending tied to general types of asset)*

Unsecured creditors (HMRC, suppliers etc)

Shareholders

From 1 December 2020 the order of priority will be:

Fixed charge holders (eg. Bank lending tied to security of assets)

Preferential creditors (eg. Unpaid wages and holiday pay)

HMRC Preferential debts (Held “on trust”)

Floating charge holders (eg. Bank lending tied to general types of asset)*

Unsecured creditors (HMRC, suppliers etc)

Shareholders

* Funds otherwise payable to floating charge creditors may, in certain circumstances, be subject to a deduction of fund of up to £800k (which has also changed earlier this year from £600k to £800k), known as the “Prescribed Part”, which is paid to unsecured creditors. The subject is not specifically covered here.

What will be classed as a HMRC preferential debt (held “on trust”)?

Preferential status will only apply to certain debts which are paid to the Company “on trust” to account to HMRC. The debts are as follows:

• VAT
• PAYE
• Employee National Insurance Contributions
• Student Loan deductions
• Construction Industry Scheme deductions

The following debts will still rank as unsecured creditors:

• Corporation tax
• Employer National Insurance contributions

Crown Preference prior to its removal in 2003

Prior to Crown Preference being abolished by the Enterprise Act 2002, which came into force in 2003, HMRC were able to claim preferential status for tax liabilities ageing prior to the insolvency for up to 12 months for PAYE/NIC and up to 6 months for VAT.

The abolition of Crown Preference was a move taken to reduce the impact for lenders of the abolition of Administrative Receivership.  Administrative Receivership was a process that gave lenders with security over substantially all the assets of a company control over the realisation of assets by appointment of their choice of receiver.  In addition, the introduction of the Prescribed Part by the Act provided a better outcome for unsecured creditors.

What is the impact of the return of Crown Preference from 1 December 2020

• In the event of an insolvency, there is likely to be even less cash available for floating charge holders, unsecured creditors and shareholders, who after November will rank below HMRC preferential debts and fixed charge holders;
• In many cases these stakeholders will have provided funding, trade credit or other support to the Company before these changes and/or any arrears accruing with HMRC;
• The arrears are likely to be much higher than normal due to VAT deferral and Time to Pay schemes allowed by HMRC being a key government support mechanism in supporting businesses during the pandemic;
• The lack of restriction on the level of HMRC arrears which will rank as preferential claims means the value of security held by lenders could vastly reduce overnight;
• The reduction in security is likely to have the knock-on effect that the director’s personal guarantee will need to be called upon for to repay the secured lender’s shortfall.

If you would like to talk to one of our team about the impact of the Crown Preferences changes on your clients, then please feel free to get in touch with Conrad Pearson at Mazars LLP.

Conrad Pearson is an appointment-taking insolvency practitioner and director in our Northern Restructuring Services team, with over 28 years of experience and can be contacted on conrad.pearson@mazars.co.uk / 0161 238 9242.