With the ramifications of the coronavirus pandemic impacting the UK economy in a number of ways, the UK government has introduced several extraordinary measures designed to support UK businesses and to keep the economy as far away from recession as possible during these unprecedented times. Whether this has been from the introduction of the furlough scheme to the more recent ‘Eat Out to Help Out’ initiative, it is evident that the impact of Covid-19 has meant that the government’s reaction and budgetary strategy to the pandemic is unsurprisingly under the microscopic eye more so than ever before.
One of the more conspicuous schemes which attracted headlines was related to the deferral of VAT payments which would have normally been due between March and June this year. Those payments can now be deferred until the end of the 2020/21 tax year and this will have certainly aided businesses to manage their cash flow by providing them with, what is effectively an interest-free loan facility. Despite the government's best efforts to ease the burden on businesses affected by the pandemic, and despite praise from several business figures, there remains criticism from businesses up and down the country of the government’s overall strategy in helping businesses stay afloat.
It is surprising in light of this that the government is still pressing ahead with the reintroduction of the Crown Preference legislation which had originally been abolished back in 2003. The return of the scheme was initially announced in the 2018 Autumn Budget by the then Chancellor of the Exchequer Phillip Hammond, and it was met with scepticism by a plethora of business figures, none more so than from the CEO of R3 (the trade association for insolvency practitioners), with the worry that HMRC’s return up the rankings on the creditor's ladder could potentially reverse the status quo that has been encouraging business rescue since 2002. Nonetheless, reintroducing a scheme which at the time had demoted HMRC as a preferential creditor as a result of The Enterprise Act 2002 for the purposes of improving enterprise and encouraging a rescue culture amongst failing companies certainly appears to be even more controversial in the current climate following the impact of Covid-19 on the economy.
One of the issues regarding the reintroduction of the modified Crown Preference legislation is the impact it will have on lenders, especially when it comes to recoveries in insolvencies. Under the Crown Preference legislation, if a company enters insolvency and the lender has security in place over a company’s assets, HMRC will take precedence over other preferential creditors and thus jump the queue and have an entitlement to any assets that would otherwise be secured under a lender’s floating charge.
Consequently, one of the major problems that lenders will face is the greater associated risk when lending to companies. To compensate for this, lenders may have little choice but to increase the costs associated with lending to offset that risk. Naturally, companies will either be deterred or reluctant to engage in borrowing, especially if directors are required to offer personal guarantees. If companies are put off in any way from borrowing money, this could restrict any growth within the business and ultimately impact on its survival.
We are therefore likely to see lenders lend less whilst also witnessing a reduction in the assumed valuation of assets subject to floating charge in any loan agreement. There is also the possibility of an increased compliance burden as businesses may need to regularly report their tax positions and liabilities to lenders in order that lenders can assess HMRC’s preferential claim on company assets.
For many unsecured creditors, the reality is that many of them receive very little anyway, but with the re-emergence of this legislation, the chances of recovering any monies from a business are significantly reduced. Nonetheless, several business groups have also expressed scepticism, with many suggesting that the return of Crown Preference could have disastrous consequences on the wider economy, especially for smaller businesses.
Regarding the foreseeable future, there is no doubt that several UK businesses will make use of the option to defer VAT payments until next year, and should those businesses then enter insolvency, the Crown Preference legislation would entitle HMRC to be positioned ahead of other creditors such as banks and finance lenders who are generally secured creditors. The result of this will mean that VAT deferrals made under the Covid-19 crisis measures will give rise to an increase in sums due to HMRC. Furthermore, lenders will be facing a major problem as the protection they thought they had based on their security is going to be reduced due to the newly reinstated Crown Preference and to the increase in the prescribed part.
Critics regarding the reintroduction of Crown Preference have jumped on the controversy surrounding its comeback by declaring that the government simply wants to collect taxes due and payable from insolvent companies, whilst others have claimed that there is a desire by the government to fill the ‘black hole’ of funding UK public services, as well as a desire to build a ‘war-chest’ for Brexit-related funding needs. The Chancellor has tried to depict a positive stance on the matter by way of reassurance by declaring that unsecured creditors will be mostly unaffected by the proposed change as they currently recover only 4 percent of debts owed on average from insolvent companies. At the same time though, it is understandable why smaller businesses do not share the Chancellor’s optimism, given their cash-flow constraints and exposure to bad debts from suppliers and counterparties.
A question that is on many people’s lips is that is this merely a money-grabbing strategy by the government? The Insolvency Rules 2016 rightly sought greater engagement from ordinary unsecured creditors in insolvency procedures. With the reduction in dividends to unsecured creditors as a result of HMRC preferential claims, the result is that this is likely to lead to creditors being further disinclined from engaging in the insolvency process.
With the Crown Preference due to come into effect from 1 December 2020, and with the legislation only applicable to insolvencies which will commence from that date irrespective of the date of when the tax debts were incurred or the date of the qualifying floating charge, it is hoped that between now and then, there is some serious reflection on what some of the consequences could be.