Almost 20 years ago the Government decided to abolish Crown Preference bringing it into step with other western jurisdictions such as Germany and Australia. It was considered at the time "inequitable" to elevate the public purse above ordinary unsecured creditors for whom the impact was potentially far greater.
Astonishingly, in the midst of a global pandemic and a looming "No Deal" Brexit, absent a dramatic last minute "U-turn" by the Government (let's face it, it wouldn’t be the first !), Crown Preference will return with effect from December 1st 2020.
HMRC enjoyed Crown preference until it was abolished by the Enterprise Act 2002. Designed to promote a rescue culture, to encourage "responsible risk taking" and to provide a boost for the economy the Enterprise Act, and the changes it introduced, improved the position of secured and unsecured creditors on an insolvency and as a consequence increased liquidity and confidence across the lending market.
But back in 2018, Philip Hammond, the Chancellor rather inexplicably indicated the intention of the Government to reverse the position and to reintroduce Crown preference. Out of step with International trends, and contrary to the views of UNCITRAL (who firmly believe that public interests should not be given precedence over private rights). The move was justifiably lambasted by the UK Insolvency profession who unanimously concluded that this was a really bad idea, running contrary to the UK’s established business rescue culture.
Nevertheless, and despite fierce opposition, The Finance Act 2020 quietly passed through parliament and into legislation in July of this year. This means that in any administration or liquidation commenced after 1 December 2020, HMRC will enjoy preferential status in respect of uncapped VAT, PAYE and employee NICs as a second tier preferential debt (behind employees). One of the many consequences of the Covid-19 pandemic is the huge build-up of HMRC arrears that many companies are carrying, meaning the impact of the new legislation, will be much more significant than could ever have been imagined. This will come at the expense of the floating charge holder (if any) or the unsecured creditors.
Tax reserves, increased use of assignments and covenants which require tax compliance have all been suggested as ways in which lenders might respond, however, the most logical way for lenders to mitigate their exposure to the effects of the return of Crown preference, is simple – reduce their exposure to floating charge lending and impose tighter controls on borrowers. That will inevitably reduce liquidity in the market and increase the cost of borrowing (which is generally priced on risk) at a time when businesses desperately need cash to help them bounce back and kick-start the UK economy once more. It has been estimated by UK Finance that the reintroduction of Crown preference will remove some £1 billion of floating charge finance from the pool of money available to companies.
So, whilst the comprehensive raft of support measures introduced by the Government to combat the pandemic, widespread HMRC forbearance and the temporary suspension of creditor rights has done much to "flatten the curve" of potential insolvencies, the reintroduction of Crown preference is likely to be counterproductive (not least because it was only ever expected to yield just £185m per year), undermining many of these essential support measures at a time when the UK’s economy can ill afford anymore instability and disruption.
Here's hoping for (another) dramatic last minute U-Turn then...