26 November 2020

The Return of Crown Preference on 1 December, 2020

The return of Crown Preference on 1 December, 2020 has widely united the restructuring community against the new measures. Whilst the rationale that the Treasury should have priority for sums received by a debtor on its behalf is logical, the effect is not. The additional sums estimated to be generated by the Treasury are small (estimated to be £185 million each year). However, lenders’ confidence to lend against floating charge assets will be diminished and unsecured creditors in an insolvency will receive less (if anything), reducing the amount of cash in the economy and potentially causing financial distress for counter-parties.

What is Crown Preference?

Crown Preference is a term used to describe the elevated ranking of HMRC in UK insolvencies. Rather than being in the pool of ordinary unsecured creditors, HMRC previously held preferential creditor status for the purpose of certain unpaid taxes. This meant that certain HMRC debts would be repaid ahead of those creditors with the benefit of floating charge security. Almost 20 years ago, as part of the Enterprise Act reforms in September 2003, the UK Government abolished Crown Preference and re-designated HMRC as an ordinary unsecured creditor. However, the UK Government has now decided to reinstate Crown Preference.

What is the extent of the HMRC preference?

The new elevated status of HMRC is in respect of taxes which the insolvent company collected or deducted from or on behalf of third parties, i.e., VAT, PAYE, employee NICs and Construction Industry Scheme Deductions. There is, currently, no limit on the amount which is to be preferred, nor is there a limit on the lookback period in which the debts became due for payment to HMRC. HMRC will, however, retain its ordinary unsecured creditor status in respect of other taxes, such as corporation tax and employer NICs.

How does this differ from the Crown’s previous preferential status?

Previously, Crown Preference applied in respect of similar liabilities. However, the extent of the preferred liabilities was limited in time. Prior to the Enterprise Act reforms, the Inland Revenue (as it was called) could only claim preferentially for 12 months’ outstanding PAYE and NIC, and HM Customs & Excise could only claim preferentially for six months’ outstanding VAT.

Why is it important?

HMRC is often the largest unsecured creditor in a company’s insolvency. The return of Crown Preference will reduce the likely recovery for creditors with floating charge security and unsecured creditors. Additionally, in response, secured lenders will approach floating charge assets for the purpose of providing finance to UK businesses with increased caution. This will limit the sums which lenders are prepared to lend and thereby reduce liquidity in the market. Also, borrower covenants are likely to be introduced or tightened in order to monitor and regulate the borrower’s compliance with its tax payment obligations. Lending which is secured against floating charge assets is regularly utilised in a restructure or in connection with a business rescue. The return of Crown Preference is likely to reduce the financing options available to distressed companies.

This comes at a time when businesses will have built up significant arrears with HMRC as a result of the COVID-19 pandemic and, also, as Brexit looms. 

When will it come into effect?

It will be effective in respect of administrations or liquidations which commence on or after 1 December, 2020.