HMRC restored to secondary preferential for creditors: How does this impact secured lending?

The Finance Act 2020 (‘the Act’) which received royal assent in July 2020 has returned HMRC to the position of secondary preferential creditor in insolvent liquidations. This change will come into effect on 1 December 2020 and will mean that certain debts owed by a business to HMRC will now be paid in preference to floating charges (held typically by financial institutions), and unsecured creditors.

While this may not appear to make much difference to an insolvent organisation, the impact on the wider business community and the economy could be far-reaching.

Which debts owed to HMRC have become preferential?

The Act states that HMRC can claim as a preferential creditor for VAT, PAYE Income Tax, Employee National Insurance Contributions and Construction Industry Scheme deductions, although not corporation tax.

How much can HMRC claim?

There is no limit on the claim in respect of either time or amount claimed. The fact that no cap has been imposed has caused concern. HMRC has the power to make enquiries into previous years’ returns and figures. The expense of challenging enquiries means that insolvency practitioners may be reluctant to do so. HMRC can also add costs and penalties to their bill, meaning a substantial sum could be demanded.

HMRC is one of the largest creditors in many insolvencies and these payments could constitute a significant part of available funds.

It also remains to be seen whether HMRC will be less likely to grant Time To Pay agreements to struggling businesses if they feel that any debt owed to them is now more recoverable.

Why has the ranking of these debts changed?

In proposing the legislation, the government explained that it views the debts as taxes paid by employees and customers and held by a business on behalf of HMRC. As such, it stated that they should be protected in insolvency and recovered to the public purse.

Who will HMRC’s debts rank ahead of?

Money owed to HMRC in respect of the above debts will now be payable ahead of floating charges, many of which are held by banks and other institutional lenders, and other non-preferential unsecured creditors.

The current list in order of payments is as follows:

· Fixed charge holders

· Liquidators’ fees and expenses

· Preferred creditors, to include employees, HMRC and the Financial Services Compensation Scheme

· Floating charge holders

· Unsecured creditors

· Interest on unsecured debts that has accrued post-liquidation

· Shareholders

The impact on unsecured creditors

Prior to the Act’s implementation, HMRC was an unsecured creditor. Now that it has moved up the list, far fewer funds will be left for unsecured creditors to share and there is a substantial risk that they will receive nothing in the event of an insolvency.

It may also rule out the use of Company Voluntary Arrangements (CVA) in many circumstances. A CVA allows unsecured creditors to agree terms such as staged payment with an insolvent business to try and recover part of the debt. If there is too little money left to make this viable, the loss of the CVA option could not only impact unsecured creditors but make restructuring or company rescue far less likely.

The impact on floating charge holders and the knock-on effect

Banks and financial institutions that hold a floating charge now run the risk of recovering significantly less from an insolvent business. A major problem for them in managing this risk is its unquantifiable nature. Without access to tax records and other information, there is no way for them to know the amount that businesses may end up owing to HMRC.

Currently, net orderly liquidation value can be calculated to a degree of accuracy by taking inventory of assets such as plant and machinery and lenders use these figures to work out viable lending terms.

To deal with this unknowable threat in a way that protects their assets floating charge holders will no doubt review their lending strategy and pricing. They may also increase the amount of information they need from businesses, both before funds are lent and during the time of any loan. In particular, they may request information about HMRC arrears and changes in tax affairs and introduce more audit procedures.

In considering whether to lend and the terms of any funding, those seeking floating charges are likely to be considerably more nervous going forward. This could be compounded by the current economic situation, the likelihood of more difficulties before things stabilise and the continuing presence of Brexit fallout.

New businesses and those needing financial help through a difficult time may be particularly affected by a reluctance to lend. Company rescues are likely to be far harder to arrange, with lenders looking to avoid risk and fewer funds available to offer to unsecured creditors by way of a CVA.

Directors are likely to face requests for personal guarantees. The risk of losing personal assets will no doubt limit their appetite for borrowing and may limit the amount others are able to borrow, further slowing economic growth.

The knock-on effect could potentially be huge and cost the Treasury far more in lost taxes than the gain from funds recovered by HMRC from those facing insolvency.

Coming at a time when the economy is under almost unprecedented pressure and businesses are struggling to survive, the measure has the potential to cause substantial damage.

Facing the future

For business owners looking to deal with the changes in legislation, the most they can do at this stage is to ensure the best possible financial health for their organisation. Good record keeping will be essential should lenders start demanding to see more tax documentation and as well as ensuring HMRC have no cause to raise enquiries going back years.

At Lincoln & Rowe we understand the importance of helping our clients keep their business running smoothly. We are able to act on your behalf if you are involved in insolvency or liquidation, and can assist on your options if your business is financially damaged because of Covid-19. 

We have wide-ranging experience in commercial law and were named as the ‘Commercial Disputes Specialists of the Year” in the Corporate Livewire Innovation & Excellence Awards 2020 as well as ‘Boutique Litigation Law Firm of the Year’ in both the 2019 and 2020 Global Awards by ACQ5. Partner, Dipesh Dosani, was named Commercial Litigation Lawyer of the Year in 2019 and 2020 in the ACQ5 Law Awards. 

If you would like to talk to one of our expert legal team about any queries you may have regarding insolvency or liquidation, contact the author, Dipesh Dosani, or call the team today on 020 3968 6030 and we’ll be happy to help.

The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact a legal advisor.