Update on the rules concerning the changes to Crown Preference

15 Jul 2021

In our February 2021 newsletter we reported on the re-introduction of “Crown Preference” which came into effect for companies going into liquidation or administration from 1 December 2020.  As corporate insolvencies remain low (owing to the continuing high levels of government support for business), a clear picture of how the partial reintroduction of Crown Preference is likely to impact on businesses, and on lender practices, has yet to emerge. 

As we noted in our last newsletter, the changes effect corporate insolvencies which commenced on or after 1 December 2020.  They only apply to certain HMRC debts, namely VAT, PAYE income tax, employee National Insurance contributions, construction industry scheme deductions, and student loan repayments.  In respect of these debts, HMRC will rank ahead of floating charge holders and unsecured creditors in the statutory order of payment, although it will still rank behind fixed charge holders and ordinary preferential creditors, such as employees.  The changed do not apply to taxes owed by businesses themselves, such as Corporation Tax and employer National Insurance contributions.  In respect of these HMRC continues to rank alongside other unsecured creditors.

The changes are likely to have particular impact on lenders holding floating charges, with the value of their security being significantly reduced.  These problems will have been exacerbated by the VAT deferrals granted to companies as part of the government’s Covid response.  This will have inflated a company’s VAT debt to the detriment of floating charge holders and unsecured creditors.

It is also expected that, in many cases, companies will have more difficulty in obtaining consent for a CVA.  As preferential debts cannot be compromised without the preferential creditor’s consent, and given HMRC’s patchy record of supporting CVAs, it is likely to be harder for companies to obtain approval for a CVA which seeks to compromise the HMRC debt.  If HMRC hold out for payment in full, there may not be enough left in the pot for a company to propose a CVA that is acceptable to unsecured creditors.

As a consequence, the re-introduction of Crown Preference, although only partial, is likely to result in changes to lender practices.  They are likely to increase their pricing when taking a floating charge.  They may require other sources of security, such as directors guarantees or financial collateral.  Alternatively, lenders holding a floating charge may consider holding reserves of tax or making it compulsory for borrowers to hold tax reserves.  In addition, they may carry out ongoing diligence to ensure that borrowers comply with their tax obligations.

As we touched on previously, where possible, lenders are likely to want to enhance their security by seeking a fixed charge in place of a floating charge.  Alternatively, lenders may explore whether a borrower’s existing credit facilities (overdrafts or loans) can be refinanced through invoice discounting, the effect of which is to transfer floating charge assets from being charged in favour of the lender to being owned by the lender.  

These are, of course, just a few examples of the steps which lenders may consider to improve their position and ensure that their lending remains viable.

For further information please contact Oliver Jackson by email or by phone on 01293 558 552. 

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