The proposal to reinstate Crown preference in insolvency has met resistance from all angles; the insolvency profession, turnaround experts, accountants, lawyers and funders. But despite HMRC’s bold statement in its consultation paper that the re-introduction of Crown preference will have little impact on funders, it is clear following a discussion with lenders that it may well have a far wider impact on existing and new business, business rescue and the economy in general than HMRC believes.

The intention to use Crown preference as a means to recover unpaid taxes for the benefit of the public purse fails on many levels. In fact it is likely to result in a far bigger dent to the Treasury’s pocket through loss of tax elsewhere.

The Government issued a consultation on the proposal in February this year (a copy of which can be accessed here) and comments on the paper are invited by 27 May 2019.

Squire Patton Boggs and R3 hosted a discussion group with representatives from across the restructuring and lending community and other key stakeholder groups. With the Government having largely dismissed the impact of the proposals on lenders, the discussion produced lively and interesting debate.

The proposal

HMRC announced in the Autumn 2018 budget its intention to restore HMRC as a preferential creditor from April 2020 in respect of certain taxes (namely PAYE, VAT and NIC employee contributions).

HMRC has been an unsecured creditor since 2003 when the Enterprise Act abolished its preferential status. The change was introduced as part of a package of reforms designed to support business rescue and encourage enterprise. As well as abolishing Crown preference, the Enterprise Act created the prescribed part and introduced the ability to appoint administrators out of Court.

Since 2003, the UK’s reputation as a place to do business has grown, with many new lenders entering the market. Factors that influence entrepreneurship and drive investment include the UK’s flexible market and fair insolvency regime.

HMRC remains one of the largest creditors in many insolvencies but currently sits behind floating charge holders as an unsecured creditor. Its claim does not therefore dilute the funds available to pay secured lenders.

A significant amount of lending in the UK is inventory based and secured by a floating charge, which gives a business the flexibility to deal with its assets. When assessing the risk of investment, lenders already take into consideration the loss that they would sustain because of the prescribed part by making adequate provision. The prescribed part is a known quantity.

If HMRC receives preferential treatment, what are the expected and real consequences of this to lenders and UK business?

Views of the restructuring and lending community

There were many points of contention and little by way of support from those attending the discussion.

In summary, the proposals are not welcome for their lack of support to enterprise and growth and uncertainty surrounding the implications are already having an impact on lenders and their customers.

We set out below some of the key concerns:

Liquidity issues for borrowers and lending risk to lenders

In order to reflect the lending risk, funders will have to make greater provision to cover the VAT and PAYE payments that will receive preferential treatment. These liabilities could be significant.

All lenders were concerned about how they might calculate the risk and make adequate provision when, for the reasons highlighted below, HMRC’s claims are unquantifiable.

Some lenders indicated that they would apply a 20% reserve across the board but this an educated guess because how can lenders assess the real risk?  HMRC at least has the luxury of greater access to tax information and records.

To protect against this, lenders will have to look to different forms of security and therefore we can expect there to be a greater use of personal guarantees and fixed charges.

The net result is that greater provision means reduced liquidity and reduced funds. The impact on new business, growth and enterprise could be significant and consequently the tax, which HMRC seeks to recover through this measure, will be lost elsewhere.

It is estimated that there is at least £3 billion in floating charge lending to the SME market.   The impact on that market is huge compared to the estimated £185 million return to the Treasury.

A move towards more fixed charge security is also likely to affect the nature of insolvencies seeing a move away from administrations towards liquidations given that administrators cannot deal with fixed charge assets without a lender’s consent.

In addition, in Scotland, taking a fixed charge may not be an option at all because if the lender already has floating charge security, it cannot take a fixed charge.

To protect against the risk, the lending market will have to adapt. All change comes at a monetary and administrative time cost that may need to be passed on to the customer.

Unquantified claims

The proposal does not cap either the time period of HMRC’s claim or the amount. Therefore, unlike the pre-Enterprise Act position where PAYE was capped at 12 months and VAT at 6 months, HMRC’s claim could easily absorb all available funds on insolvency leaving floating charge holders hung out to dry.

HMRC’s claim can also include costs and penalties and given that there is no time restriction on the claim, these could be significant.

HMRC also has power to raise an enquiry into prior year returns. Given the costs of challenge, current practice means that it is rare for an office holder to challenge an enquiry. As an unsecured claim, the cost of challenge versus the return to creditors is rarely justified.

A few voiced concerns about what safeguards there would be to stop HMRC issuing a follower notice or accelerated payment notice if HMRC returns to preferential status.  Such practice would lead to HMRC taking the lion’s share of any recoveries and leaving floating charge holders and unsecured creditors with an empty wallet.

Office-holders will have to review, investigate and defend those claims (if appropriate) given that payment would be treated preferentially, causing additional costs to the insolvency estate and probably lower returns for all creditors.

Realistically how can lenders underwrite a transaction when the tax liabilities are unknown and could be extensive? It is impossible to weigh up risk and benefit.

HMRC already has power under existing legislation to recovery unpaid tax from corporates. Some therefore questioned why they don’t use those powers more effectively.

New business

To manage risk, lenders will have to make larger provisions.   That will also require increased reporting from their customers and additional audits. The increased costs to lenders of monitoring and assessing risk may well need to be passed on to customers making borrowing costs higher. This affects the funds available to support new business.

In addition, it creates distress and causes additional costs for customers who will have to meet the additional reporting and audit requirements.

Impact on existing facilities

The proposals do not suggest a transitional period; as such, existing facilities will also suffer.

When the Enterprise Act came into force, the prescribed part only applied to those floating charges entered into after that date, allowing lenders to plan and make provision for the change.

Without any transitional arrangements, the change will result in existing customers (involuntarily) breaching the terms of their facility agreements. Customers who are “good book” customers could well find themselves moving overnight to the lender’s bad book resulting in more business distress and business failures.


CVAs are flexible because they allow a corporate to compromise its debts to unsecured creditors on whatever terms it can agree with them, provided that those terms are not materially prejudicial. A CVA is a valuable tool in the restructuring tool box. However, a CVA cannot be used to compromise a preferential creditor’s claim.

If HMRC holds preferential status, this will make CVAs a non-viable option in many cases.

Double jeopardy

The prescribed part was introduced to balance the abolition of Crown preference and to create on insolvency, an even distribution of assets amongst creditors but under current proposals, it will not be abolished. In fact, it is due to be increased to £800,000.   This puts a further squeeze on lenders and the level of funding they can offer.

Credit insurance

Credit insurance is a vital finance tool providing assurance and income to businesses.

For the same reasons highlighted by lenders, credit insurers have no way of assessing risk when determining the level of cover they can offer and concerns were raised about the future viability of credit insurance if the proposals are implemented.

The UK economy and competition with Europe and the rest of the World

UK high street retailers are already struggling.

Lenders expect other sectors such as the automotive industry, agriculture, construction and wholesale (where the primary source of funding is against floating charge assets) to be hit hardest by the changes pushing many into distress.

The corporates, which these changes are most likely to impact upon, are those companies within the £10-25 million turnover bracket. If the market is challenged in this way, there is genuine concern that this will have a domino effect, particularly amongst smaller business, causing many to fail.

When battling against the uncertainty and impact of Brexit, the timing of the change could not be worse.

More widely, the UK hopes to improve its standing in the World Bank rankings and has proposed new corporate reforms. These reflect changes that are being made in Europe which will make insolvency regimes in other EU countries more comparable to the UK.

The Government is working to secure the UK’s reputation as a competitive place to do business and retain its reputation of having a fair and flexible insolvency regime but these proposals would have the opposite effect.

Time to pay agreements

HMRC has in our experience, negotiated, agreed and when appropriate extended time to pay arrangements supporting business through difficult trading periods.

Will that willingness to co-operate be lost if there is an easy win on insolvency?

Instead of extending time to pay, HMRC may see insolvency as a preferred option given its preferential status. Where is the incentive to support an ailing business? Arguably, there is none or at least no assurance that there will be. It is, after all, HMRC’s function to collect tax.


Uncertainty over tax liabilities leads to uncertainty over recoveries, greater provisions, and less money being available for customers in both distressed and non-distressed scenarios.

This frustrates enterprise, reduces available finance options for corporates, and affects lenders who are required to take a more cautious approach to lending and look at alternative security. This in turn increases costs which makes borrowing more expensive and discourages investment in the UK. It also adversely effects business rescue by discouraging CVAs and a move away from administration if lenders change their business models and move towards fixed charge security to reflect the risk.

Whilst the proposals are framed around the impact of recoveries on insolvency, their impact is much wider than that.

It was reported that the uncertainty created by the proposed changes is already impacting upon customers.  Combined with the uncertainty of Brexit the proposals put the brakes on the UK economy, with some fearing that the UK may slide into recession again.

The £185 million, which the Treasury hopes to secure by this change, may very well end up costing the UK economy much more if the concerns highlighted above are not taken into consideration.

If HMRC is unwilling to re-consider its position, at the very least there needs to be some mitigation; a cap on amounts (monetary and/or time based); abolishing the prescribed part; increased access to tax information and clear and better channels of communication with HMRC.   Businesses in financial distress don’t have the luxury of time and rescue requires there to be an open, quick and sensible dialogue. HMRC will need to make internal changes to make sure that the proposals do not undermine the UK’s rescue regime.

The future

No one can calculate the true financial impact that this proposal will have but lenders already report that uncertainty is having an impact.

Whilst the rest of Europe looks to make changes to its insolvency processes to implement the EU Restructuring Directive bringing other countries regimes in line with the UK, the UK appears to be taking a step back in time with proposals that are more damaging to business rescue than the position pre-Enterprise Act.

The proposals would, in our view, stifle business rescue entirely and drive lenders away from the UK market which has (at least since the Enterprise Act) been seen as a safe place to do business.

With one lender commenting that the proposals could be a “disaster”, we hope that HMRC will take on board the genuine concerns of the restructuring and lending community when deciding whether and how to implement these proposals.