Bad news for businesses: Crown Preference is back

01 December 2020

Giving his spending review speech last week, Chancellor Rishi Sunak had a hugely difficult balancing act to manage. As he noted, "Our health emergency is not yet over ... And our economic emergency has only just begun."

Despite the low level of corporate insolvencies since the onset of the pandemic, as a result of the Government's support for businesses and individuals and due to the temporary suspension of a range of enforcement actions and on issuing winding-up petitions, most economic commentators agree that next year will be very difficult for many companies, and tax rises are very likely to be part of the overall response to the pandemic.

The reintroduction of Crown Preference on 1 December was not mentioned by Sunak in his speech, despite - on its face - appearing to be a mechanism by which the Government will increase its tax take. Perhaps the relatively modest amount which the Government predicts will be gained by the policy - up to £185 million per year - meant it did not merit a shout-out.

However, as we have repeatedly pointed out - most recently in the Daily Telegraph and the Times - the Government's forecasts for how much it will gain by leapfrogging ahead of other unsecured creditors do not take into account the damage that the policy will cause to businesses of all kinds.

Hampering growth prospects and stymieing rescue attempts

Now, as Crown Preference makes its unwelcome return, it is worth reiterating that the policy's impact will be felt in many different ways. With qualifying tax debts to HMRC placed above holders of floating charges (that is, loans secured against 'changeable' types of security, such as stock, or work in progress), this type of finance will become less available, both to growing companies which would like to use it to expand their operations, and to distressed companies for whom it can act as a lifeline during a rescue attempt.

The insidious twin effects of a contraction of the pool of floating charge finance will be fewer successful rescues of ailing firms, and less funding available to growing enterprises - effects which will be very difficult to measure, but which will nevertheless have a concrete impact on the economic recovery of UK plc.

The damage to growing businesses could be substantial. One R3 member gives the example of a small, successful and ambitious food producer whose product requires a substantial time to mature, and to be ready for sale; the producer was looking for extra funding in order to expand its maturation facilities, to be secured against the food product in question on a floating charge basis. The company was on the verge of agreeing a multimillion-pound floating charge finance facility with a lender - but, overnight, the facility on offer was greatly reduced following the announcement in the October 2018 Budget that Crown Preference was to be brought in.

With floating charge lenders facing the prospect of far greater losses in the case of insolvency, as they will rank behind qualifying tax debts, it is not surprising that finance providers will become more reluctant to extend funds; their own risk management and forecasting protocols will demand a more conservative funding approach, with smaller advances at a generally higher cost. As with the food producer, whose expansion plans were set back by a reduction in the available funding, the cumulative damage to the UK's economic output could be enormous - but difficult to quantify directly.

A reduction in successful Company Voluntary Arrangements (CVAs) could be another unintended consequence of Crown Preference. HMRC will now rank as a preferential creditor, and its approval will be required in order for CVA proposals to pass. HMRC is unlikely to grant its approval unless the CVA proposes to pay qualifying tax debts in full. This will reduce the funds available for all other unsecured creditors, meaning that their approval in turn for the CVA proposals will be harder to secure. In addition, with less cash at hand for the company, the prospects of a successful outcome for the CVA will be lower, as it will have less money to invest in its business, or to have in reserve for unexpected situations. This matters for other creditors, especially suppliers and customers, and for the overall economy: R3's 2018 report found that CVAs are an important business rescue tool, and that even when they do not meet their objectives, they still often provide a better outcome for creditors than the alternatives (i.e. administration or liquidation).

Yet another consequence disregarded by the Government's assessment of the policy's impact is that of an overall reduction in returns to unsecured creditors. R3 research from 2018 found that over a quarter (26%) of UK companies had suffered a hit to their finances following the insolvency of a customer, supplier or debtor in the last six months, showing yet again how the economy is interconnected; a large insolvency will cause a wave of financial pain to its suppliers, customers, and staff, and sometimes the damage is enough to cause other companies to enter an insolvency process as well, as indicated by an R3 member survey in 2016.

A bleak outlook

The lockdowns in various parts of the UK are gradually easing, with England due to come out of lockdown tomorrow (2 December). However, there are still strict measures in place in many parts of the UK, and companies which rely on the festive period to make up a hearty share of their annual takings may find themselves facing a less than cheery Christmas, with limits on capacity and household mingling in the hospitality trade as one obvious example. Add in the uncertainty around the final shape of Brexit, just a month away, and the new year looks set to hold tough challenges for many business owners.

Our campaign to get the Government to reconsider its Crown Preference policy will continue, but - sadly - many growing companies will have their wings clipped by a reduction in available finance, while numerous potentially viable businesses will not be saved. Given this, the decision to forge ahead with the policy, just when UK businesses will be crying out for funding and when rescue attempts are likely to be increasing, seems incredibly short-sighted.