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Update to lenders on recent changes affecting floating charge realisations

HMRC regaining preferential creditor status

On 1 December 2020, the Crown will regain preferential status for some debts, more than 17 years after the Enterprise Act 2002 was brought into force which abolished it.

The reintroduction was first proposed, without any prior warning, in the Autumn 2018 budget for introduction in April 2020. The rationale was that too often, distressed companies spend the tax they collect from other taxpayers (for example VAT and PAYE deductions for employees) onpropping up an ailing business, leaving HMRC high and dry in the event of insolvency.

Due to the attempts to prorogue Parliament and the General Election last year, the necessary legislation was not passed. However, the measures were since included in the Finance Act 2020 which was enacted on 22 July 2020.  From 1 December 2020 HMRC will have secondary preferential creditor status (behind [other preferential creditors such as employees for certain claims]) in all insolvencies commencing on or after that date, regardless of when the tax liability arose or became due for payment, or when the affected floating charge was created.

This regained (secondary) preferential status will relate only to types of HMRC debt where the business should have simply passed on tax already paid by third parties, namely for:

  • VAT, in uncapped amounts
  • Employee PAYE
  • Employee NICs
  • CIS deductions

HMRC will remain an unsecured creditor for Corporation Tax and Employer NICs.

Increase of the prescribed part

Lenders will be aware that the Insolvency Act 1986 contains a carve out of a proportion of floating charge realisations, ringfencing an amount equal to 50% of the first £10,000 and 20% of the balance, referred to as the ‘prescribed part’.

Prior to 6 April 2020 the maximum value of the prescribed part was £600,000, but that has now increased to £800,000 for floating charges created after this date.

Effect on lenders

The combined effect of these changes is expected to significantly impact the value of floating charge realisations for secured creditors on the insolvency of the borrower.

Fixed charge realisations are unaffected.

The current economic outlook

The UK is now in recession and temporary government measures supporting businesses are currently due to expire on 30 September 2020 (although are capable of extension).

Both the withdrawal of support such as the Coronavirus Job Retention Scheme and the expected resumption of tax collecting by HMRC (including presentation of winding up petitions) will put cash flow pressure on companies. Cash flow is also likely to be affected by the ongoing measures businesses are required to adopt in order to trade, including

  • the expense of acquiring any necessary PPE for staff,
  • the impact on productivity of social distancing policies for employees and contractors , and
  • forced reductions in customer numbers from restaurant diners to private dental patients to gym users.

Such measures affect businesses in a vast array of sectors and are clearly going to be in place for some time.

As a result, many businesses are going to be struggling by Q4 of 2020 / Q1 of 2021. Insolvency practitioners are predicting that high numbers of businesses will go into formal insolvency procedures towards the end of 2020 / start of 2021.

Many companies that do go into a formal insolvency process will have taken advantage of the VAT payment holiday.

This has the potential to affect floating charge holders doubly. Not only will the value of the preferential claim for unpaid VAT will be larger as a result of the VAT payment holiday, but as it is often liabilities to HMRC that cause a company to go into an insolvency process, it is expected that when the deadline for payments of such deferred VAT (31 March 2021, well after the reintroduction of HMRC’s preferential status) is looming, this will be a key trigger point for many corporate insolvencies.

What can lenders do – existing lending?

Lenders considering enforcement action against defaulting debtors, such as appointment of an administrator, should consider whether this can be done before 1 December 2020, as HMRC will not have preferential status in insolvencies beginning before this date.

What can lenders do – new borrowing or re-financing?

With new finance arrangements, lenders will need to carefully consider the assets of borrowers when considering whether and how much to advance. Where a borrower has minimal fixed assets or where the real value of a borrower business is in plant & machinery, stock or debtors, lenders may wish to restrict lending, or consider other options instead of relying on the floating charge. As an example, invoice discounting and factoring arrangements may be more appealing to lenders than a floating charge over trade debtors, or lenders may wish to obtain a personal guarantee from a director as a condition of lending.

Care will also be needed with any borrower refinancing. Any new floating charges which rank equally with or in priority to floating charges which pre-date 6 April 2020 will be subject to the new maximum sum for the prescribed part. This will affect the value of floating charge security with subordinate priority even if the subordinate floating charge was created before 6 April 2020.

In future, lenders may wish to ensure they have rights to access information from the borrower from time to time about its liabilities to HMRC (particularly those debts which will be preferential) , so informed decisions can be made about enforcement. Additional monitoring will come at additional cost, and lenders will be keen to pass that onto borrowers.

For more information on the article above contact Katie Farmer or Amy Gallimore.

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