Coronavirus Business Recovery
HMRC’s New Preferential Creditor Status may harm business rescue efforts
If you are the Director of an SME company fighting to recover from the effects of the pandemic, there is an awful lot going on at the moment for you to contend with. The next 6 months are critical to survival and many SME companies will be reliant on the continued support of their existing funders to maintain and continue with current lending arrangements during this difficult time.
However, the Finance Bill 2020 which received Royal Assent on 22 July, is set to change the dynamics between an SME company and its funders. HMRC are pressing ahead with plans announced before the virus hit to re-instate their preferential status as creditors in formal insolvency proceedings. This will come into effect for all formal insolvencies from 1 December 2020.
For funders reliant on floating charges to recover lending to an SME Company, this will change the security cover position and impact on lending decisions.
This also comes at a time when many businesses will be carrying higher than normal levels of Crown debt due to the impact of the Coronavirus.
For Directors of SME companies who have personally guaranteed borrowings with secured lenders and whose companies are at risk of insolvency, the exposure to personal guarantees could change significantly from November to December this year.
Where are we now?
Funders to SME companies will rely on the security granted by both the SME company and quite often, the personal guarantees of the business owners to recover their lending in the event of a default. This has provided a degree of comfort and encourages lenders to continue with funding facilities, albeit with an increased sense of caution at the moment.
The floating charge element of this security means the funder currently has an elevated entitlement to recoveries in a formal insolvency, second only to the preferential creditors which are claims for unpaid wages and holiday pay by the workforce, subject to statutory limits. Whilst a funder is also required to sacrifice some of its entitlement under the prescribed part rules (a ring fenced fund that goes to the unsecured creditors) in most cases, the funder will receive the lion’s share of available funds.
So what is about to change?
From 1 December 2020, the claims of HMRC for all taxes collected by a company on behalf of the Crown (output VAT, employees PAYE and NI deductions etc) will rank as a secondary preferential claim. There is no time limit on the period of when the tax was collected by the company and due to be paid over to HMRC. These claims will rank ahead of any entitlement to realisations in a formal insolvency otherwise payable to the holder of a floating charge.
How could this affect SME companies?
Firstly, the timing of the change adds another dynamic to the situation faced by many SME companies. Under the emergency Coronavirus measures many such Companies will have taken the opportunity to defer their VAT quarter from earlier this year until March 2021. Many Companies will also have entered additional “Time To Pay” arrangements for VAT and PAYE, the combined impact of which means many SME Companies will be carrying higher than normal levels of Crown debt.
Funders will be alert to this and will want to monitor their own lending exposure more often and in more detail. Directors of SME Companies can expect a greater level of security and interaction from their lenders and perhaps a little less forbearance going forwards.
For Directors who have personally guaranteed the borrowings of their SME Companies, there is a heightened risk of those guarantees being called in the event of a formal insolvency which commences after December 2020. The prospects of a funder recovering funds from the Company under its floating charge will be considerably diluted or even eliminated completely if the claims of HMRC soak up all of the realisations available.
Advice for Directors
Many Directors will be working hard to preserve and protect their SME Companies and these new measures will make that challenge even harder. The Partners and Team at Poppleton and Appleby are here to explain what these changes might mean on a practical level and work through the financial outcomes and illustrate how things might change from December if there were to be an insolvency event.
Please contact us if you, or a client, would be interested in an initial chat about any insolvency problem.