Crown preference – The impact on insolvencies and business rescue
Unfortunately we’re not talking Netflix recommendations here, although some may say that would make for a much more interesting article… Crown preference relates to how business debts are treated on insolvency, which has implications for business rescue at most (if not all) levels of the market, from struggling businesses to lenders.
As of 1st December 2020 the status known as ‘crown preference’ has been re-introduced, giving preferential treatment to HMRC debts in an insolvency situation. Having previously (post 2003) ranked near the bottom of the insolvency payout waterfall, HMRC was in the same position as everybody else (without security) when it came to recovering debts owed by an insolvent company. However, as a result of crown preference, HMRC debts such as VAT and National Insurance will now be higher in the queue for a payout, ranking just behind secured creditors and preferential creditors, and ahead of those with floating charges.
What does that mean for businesses?
Businesses can expect a much more stringent approach from lenders, who will want a more detailed review of a company’s tax liabilities before advancing any lending (and on an ongoing basis), given the possibility of reduced returns if the company falls into insolvency.
Lenders will also be looking to reduce their risk by asking for fixed charges over company property and/or personal guarantees from directors, which will allow a lender to recover the money from a director’s personal funds, side-stepping the company’s separate legal personality.
For businesses already in financial difficulty access to lending (especially at a commercially viable rate) will be that much harder, as lenders will be reluctant to lend to a business without sufficient uncharged fixed assets, or assets substantially more than its existing debt – neither of these will be readily abundant in a company already feeling the strain of the current climate. Ultimately this is set to lead to more insolvencies as businesses struggle to stay afloat.
What does that mean for lenders?
As you would expect, this will put lenders in an uncomfortable position. For those who have previously taken comfort from a floating charge, the security of that will be significantly eroded by the re-introduction of crown preference. This is further exacerbated by the deferred VAT payments, which has allowed businesses to roll over VAT liabilities until March 2021 – such VAT payments will now take preference on an insolvency.
UK Finance suggests the return of crown preference will reduce the lending pool available for floating charge finance by around £1 billion – bad news for companies at a time where cash really is king.
Is there a silver lining?
It is somewhat difficult to put a positive spin on a re-introduction that is set to have wide reaching effects. Perhaps one view is that the measures will force directors to consider and review carefully the financial position of the company even more so than previously, as no doubt lenders will require regular financial updates. This will arm directors with early knowledge of any worrying signs in the business, allowing early action and advice to be taken with a view to business recovery.
For advice please contact Stephen Rome, Director of Dispute Resolution on 0121 726 8782 or srome@thursfields.co.uk
