HomeFWJ TakeawayBanks & financial institutionsClient take-onHMRC as a secondary preferential creditor: implications for asset based lenders – part 2

In our blog posted on 16 September 2019, we warned that the government was introducing legislation to make HMRC a secondary preferential creditor in insolvency proceedings for certain tax debts paid by employees and customers (“Crown Preference”). The new rules were originally anticipated to come into force on 6 April 2020 but, due to the coronavirus pandemic, the commencement date was deferred until 1 December 2020.

The new rules rank HMRC as a preferential creditor in the insolvency of a company or LLP above floating charge holders and unsecured creditors for the relevant taxes paid to insolvent businesses by their customers and employees through a deduction by the business. The relevant taxes are VAT, PAYE, employee NICs and Construction Industry Scheme deductions.

HMRC’s preferential claim ranks after fixed charge holders, expenses of the insolvency process and ordinary preferential creditors but in priority to floating charge holders.

Although HMRC’s secondary preferential claim will only begin to apply in relation to insolvency processes commenced on or after 1 December 2020, the claim is not subject to any upper limit and it will have priority over all floating charges, even if the charges are created prior to this date. It is conceivable that in some insolvencies HMRC’s preferential claim could absorb all floating charge realisations.

HMRC remains an unsecured creditor in respect of taxes it collects directly from taxpayers, including Corporation Tax and Employer NICs.

The change to the rules has exacerbated the position of floating charge holders as, since 6 April 2020, the ring-fenced deduction from floating charge realisations payable to unsecured creditors, known as the “prescribed part”, was increased from £600,000 to £800,000. This increase in the prescribed part applies to all floating charges created on or after 6 April 2020 and also to those floating charges created before that date if there is a floating charge created after that date which ranks equally or in priority to the earlier floating charge.

What does this mean for asset based lenders?

Receivables financiers who structure their funding to SMEs as an outright purchase of debts are not impacted by the new rules (to the extent that funding is predicated solely on the value of the purchased debts and not floating charge recoveries) as their title to the purchased debts is not affected by the change in priorities.

Similarly, lenders who take fixed charges over a borrower’s assets will continue to have priority in relation to fixed charge realisations in the event of a borrower’s insolvency.

  • However, this new legislation will increase the risks for lenders providing funding using floating charges as security as it reduces the realisations available in insolvency under the lender’s floating charge.
  • In addition, lenders may find it difficult to estimate accurately provisions for HMRC’s preferential claim when calculating funding availability and assessing their exit strategies.
  • Regular audits and accurate asset valuations will become increasingly important in calculating availability and reserves in order to avoid over funding.

The changes may have adverse implications for borrowers at a time when many borrowers are already facing financial distress due to the coronavirus pandemic, as lenders may restrict funding if advances under asset based lending facilities are linked to the value of floating charge assets and there is a decrease in the net realisable value of such assets.

Operational covenants in asset based lending agreements may be breached because the floating charge asset pool is diminished, particularly where facilities are fully drawn when the legislation comes into force.

Inevitably, when borrowers are operating under financial constraints and suffering cash-flow issues, there is an increased likelihood of information being out of date or inaccurate and fraud, so lenders need to be vigilant and attentive to such possibilities.

The reduction in prospective recoveries and consequent risk of unsecured shortfalls may also make guarantees, entered into by both directors of the borrower and companies in the same group as the borrower as part of a “security package”, more valuable from a lender’s perspective.

When does the legislation take effect?

1 December 2020. The new rules will apply to lending facilities entered into prior to this date as there are no transitional provisions.

How should asset based lenders prepare for the change?

Asset based lenders should review their availability calculations and forms of Borrowing Base Certificates to reflect the new priorities.

It is possible that ABL Facility Agreements will need to be amended to accommodate the impact of the changes and the application of revised controls and processes.

Lenders should also consider how to monitor the level of secondary preferential debt owed by their borrowers to HMRC through reporting obligations and audits, whether reserves and Net Orderly Liquidation Value calculations in inventory appraisals need to be adjusted and whether their pricing of relevant facilities is affected.

If a lender has taken “fixed” security over an asset and there is a risk that such security could be re-characterised as “floating”, it is advisable to procure professional advice to determine the true nature of the security and its impact on potential realisations.

Lenders should also establish whether a borrower has opted to defer VAT payments until March 2022 under the interim Coronavirus measures, as unpaid VAT will have preferential status.

It is probable that some CVAs will be less viable due to HMRC’s preferential status as a CVA cannot compromise a preferential creditor’s claim.


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