HMRC preferential status and the impact on personal guarantees
The government’s reinstatement of HM Revenue & Customs (HMRC) to the position of a secondary preferential creditor in insolvent liquidations comes at a time when many businesses are being squeezed and cash flow is poor. Lenders may be more inclined to seek personal guarantees before releasing new funding, which could have the effect of slowing or stopping growth as directors hesitate to risk personal assets.
Those creditors holding personal guarantees may also be quicker to request repayment in insolvency. For those who have found the past year to be difficult, the new legislation is unlikely to make things easier.
The new order of debt repayment in insolvency
The Finance Act 2020, which took effect on 1 December 2020, has moved HMRC up the order of priority when it comes to repayment of debts in insolvency. With creditors paid in a strict order during insolvency, this could make a big difference to creditors further down the list as well as influencing the behaviour of lenders.
The monies that HMRC can reclaim in preference to lower placed creditors is VAT, PAYE, employee National Insurance Contributions and Construction Industry Scheme deductions. In respect of other taxes, including corporation tax, HMRC remains an unsecured creditor.
The order in which creditors are repaid is as follows:
- Secured creditors holding a fixed charge
- Preferential creditors such as company employees
- Secondary preferential creditors (HMRC)
- Prescribed part creditors, where a sum is put aside for unsecured creditors
- Secured creditors holding a floating charge
- Unsecured creditors
The effect of the new order on debt recovery
With temporary restrictions on the issuing of winding-up petitions and the extended use of time to pay arrangements, the amount owed to HMRC will in many cases have continued to accrue over the difficult months of the pandemic.
For lenders who hold a floating charge, they are likely to see a substantial reduction in the amount left to repay their loan. They are likely to be relying on a debenture of both fixed and floating charges giving them security over company assets. However, funds recovered against company assets which would normally be applied to their floating charge will now have to be used to repay HMRC first.
Previously, the main class of creditor with a prior claim was employees, which is generally a smaller sum of money. The prescribed money is a percentage of the money owed to all other creditors, usually around 20 per cent, which has traditionally left a substantial sum for lenders holding floating charges. Where HMRC debts are sizeable, this could leave very little for lenders.
The implications for those who have given personal guarantees to lenders could be significant as where lenders have required a floating charge and a personal guarantee, the liability under the personal guarantee could be much higher as the realisations on the floating charge are significantly lower. Lenders will also be nervous about the amount that could be owed to HMRC and with no way to quantify this, they may be quicker to require payment under the guarantee in an insolvency situation.
In any event, if insufficient funds are left to repay loans backed by personal guarantees, they will be called in, with interest, and could result in the loss of a home and even bankruptcy.
Going forward, lenders may be more likely to require personal guarantees and without cap to mitigate the risk of being behind HMRC in the repayment queue. Business owners will be faced with the difficult choice of risking everything or trying to operate without the funding they need. Ideally, borrowers should try and negotiate the lowest cap possible in respect of a personal guarantee.
Lenders may also review the amount they are prepared to lend in light of the risk of accrued HMRC debt. Traditionally, money owed to HMRC has been used to ease cash flow during difficult periods. With HMRC in a stronger position and no way for lenders to quantify the amounts owed, they are likely to be cautious in agreeing to loans.
Where businesses start having cash flow problems, it can also impact those other organisations with whom they trade.
Where a business fails to secure the funding, it needs to expand or deal with temporary complications, profitability and viability could be affected.
While HMRC stands to collect far more from insolvencies, they, along with the wider business community, may stand to lose out as enterprises are hampered. In effect, the liability for losses has been transferred from HMRC to the private sector and is likely to have a dampening effect on growth.
Dealing with financial difficulties
If your business is facing financial hardship or you are concerned about the level of personal guarantee you are being asked to provide to a potential lender, it is recommended that you seek legal advice.
There may be other options available to you and ways in which you can obtain a much-needed breathing space to enable you to put your business back on track.
The idea of having a personal guarantee called in can be extremely stressful. By talking through your options with a professional, you can put a plan of action in place and work out the best way through any difficulties.
Facing the possibility of insolvency does not necessarily mean the end of your enterprise. With help and guidance, it may be possible to restructure or find innovative solutions to allow you to return to profitability.
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If you would like to talk to one of our expert legal team about any queries you may have, 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.