Who gets paid when it all goes wrong
Crown Preference is back, a change snuck in while no one was really looking that has a major effect on how insolvencies will proceed
No one (except “bad people”) plans for the outset for their company to go bankrupt, but the formal processes of insolvency are extremely important to the way in which groups are restructured, how problems are resolved, and to cleanly end a company when it is no longer needed.
Working with some excellent Insolvency Practitioners, we have used insolvency as a tool many times to ensure that the right things are transferred and the rest is dealt with properly. Some examples:
turning a £400k write off into a £2M gain for a property investor trapped behind “deadlocked directors”
ensuring that the real value of a software product was seen to include the liabilities of perfecting and maintaining it (thus getting some valuable IP out of a dead company for £1)
freeing a valuable trading company from a complex web of unprofitable subsidiaries that were draining its cash
removing litigation risk from a manufacturer who had long ceased to maintain a product
For years, the Crown has ranked alongside other unsecured creditors, but Dishy Rishi wants his money more than his predecessors and has bought back “Crown Preference” as of 1 December 2020
That would have dramatically affected the outcome of a couple of those scenarios
What has happened?
In the Finance Act 2020, the Treasury drafted the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 (the Regulations)
The Regulations make provision for certain debts owed to Her Majesty’s Revenue and Customs (HMRC) to be included in a category of preferential debt and ensure that more of the taxes paid by employees and customers will be recovered rather than be distributed to other creditors.
Now, in the distribution of assets in the insolvency of a UK corporate entity, HMRC will now rank in priority to a floating charge holder, unsecured creditors and pension funds in respect of:
Value-added tax (VAT)
Pay-as-you-earn tax (PAYE)
Employee national insurance contributions (NICs)
Construction industry scheme (CIS) deductions
(The Regulations should not affect taxes collected directly from a company such as employer NICs and corporation tax, which will remain unsecured claims in the respective insolvency processes.)
What does this all mean
It means you need to think a lot more carefully now about using insolvency to restructure or close a business, and take advice in time to action to plan at least a year beforehand.
Lenders and unsecured creditors face the possibility of seeing reduced returns if a company becomes insolvent, they may become less willing to lend
You need to think hard about the extent of any deferred VAT payments due between March and June 2020 which could be deferred to March 2021, which will now take on priority status.
Lenders may move away from floating charges towards the security of a fixed charge or personal guarantees from directors or their family members wherever possible to provide them with comfort.
For corporates, this means reduced liquidity and available funds.
For directors and their family members, this means more exposure to personal liability.
Lenders will want extensive DD on the company’s tax position of a borrower prior to the advance of funds and on an ongoing basis. Borrowers will have to be more transparent in divulging their tax position to a lender and keeping accurate accounts of their tax liabilities.
Asset-based lenders who use security on floating charged assets to provide working capital will suffer particular hardship in already difficult trading conditions. Floating charges will no longer provide a useful source of funding to help businesses in rescue situations, with HMRC debts likely to use up any realisable funds.
Conclusion
This is a complex area, and getting help across taxation, accounting, insolvency and restructuring will be essential now.
You know who to call