• The unknown consequences of Crown Preference

The unknown consequences of Crown Preference

27 November 2020

Crown Preference, where HMRC have preferential status in insolvencies (removed in 2003 by the Enterprise Act 2002) will be restored from 1 December 2020. This will include all amounts collected on behalf of HMRC but unpaid before that date, including any COVID-19-related deferrals and existing Time to Pay arrangements. As an involuntary creditor, HMRC estimates the current annual loss to the Treasury through insolvency as c£185m. However, the reinstatement of Crown Preference is likely to create some adverse conditions for business and may render rescue lending less flexible.

HMRC’s revised status coincides with other pressures, including the Finance Act 2020 increase in the Prescribed Part (the amount set aside for unsecured creditors). Restructuring options in the Corporate Insolvency and Governance Act 2020 may also affect how lenders respond in distressed situations. 

What could be the impact on lenders?

Lenders are still open for business, but will be exposed to increased credit risk where lending is not fully covered by fixed charge security. To redress the balance, Lenders may seek additional personal guarantees and/or increased security to mitigate this impact, and adjust prices accordingly. They will seek to reduce floating charge exposure and maximise fixed charge lending. Inventory-based lending will be particularly affected as ABLs seek higher reserves to mitigate against any loss in an insolvency.

Lenders are likely to take a robust position around new or extended lending, and funding for growth at renewal may be unavailable, or at least harder to obtain where leverage against existing fixed charge security is high.  Supplier credit terms could be affected, where unsecured suppliers perceive a lower recovery in the event of insolvency, and these terms may become stricter if credit insurance is harder to obtain.

For some years, mainstream lenders have ensured their exposure is minimised through fixed charge securities.  The impact will therefore be greater for those secondary lenders.

It is those lenders reliant on floating charges that are likely to be much more proactive in wanting to understand the build-up of any debt arrears to HMRC, bearing in mind that the debts accumulated prior to 1 December 2020 will be captured by the preference.

What will the change mean for business owners?

Directors with personal guarantees may find that in the event of insolvency, there will be reduced assets available for secured debt repayment. This could result in a larger shortfall to the secured creditors and potentially much higher personal exposure if personal guarantees have been given.

Funding for growth or recovery could be stifled, and renewal of loans may prove more expensive. Administrative costs are also likely to increase as reporting requirements become more onerous.

CVAs are likely to be more challenging. HMRC may be less supportive of Time to Pay/business rescues and may be more likely to put companies into insolvency processes. It is possible that the HMRC will be more aggressive with non-payers (although this could be politically problematic). The flip side is that HMRC may actually become more passive and support a greater number of TTPs on the basis that recovery will be more certain as a consequence of its new status.

Unsecured creditors (potentially small businesses, such as suppliers, contractors and customers) will be pushed farther down the payment waterfall, which will erode further their chance of recovery, adding an extra layer of risk for all suppliers.

Understanding the consequences of the reinstatement

Crown Preference will undoubtedly have consequences. We recommend director’s consider the potential impact on their businesses and take advice in order to understand what these changes may mean for them.

To discuss anything you have read in the article or to give you room to make the right strategic decisions for your business, please get in touch with one of our local experts who will be happy to help.