The beginning of December saw the return of preferential creditor status for unpaid PAYE, NIC and VAT owed to HMRC when a company goes into an insolvency procedure such as a CVA (company voluntary arrangement), administration or liquidation.
Whilst the payment over to HMRC of tax deducted by a business is clearly essential to financing the running of Government, the clear losers from this measure will be the trade creditors of a company that has gone into an insolvency procedure, given that the improving of HMRC’s position will come at their direct expense as there will be less (if anything) remaining in the pot with which to pay their claims.
The reintroduction of HMRC preference comes at a time when, in response to the COVID-19 measures enacted by the Government, many companies have (quite legitimately) deferred the payment of VAT ordinarily due this year until the end of March 2021 (or even later if opted-in to the phasing scheme). Together with amounts subject to Time to Pay (TTP) arrangements between HMRC and many companies, in the last 12 months the amounts owed by companies to HMRC – which are now subject to its preferential status if those companies enter into an insolvency procedure – are now tens of billions higher than they were at the beginning of 2020 prior to the pandemic.
The consequence of this measure is that trade creditors will inevitably recover less – and in more cases nothing at all – from the formal insolvency of a customer than what they would have expected to recover had HMRC preference not returned.
In the case of a potential CVA, at worst the inability to offer the unsecured creditors any return at all may scupper prospects for its approval (after all, why would a creditor vote in favour of something that offers them nothing at all?) leaving administration or even liquidation as the only realistic alternatives. Whilst CVAs have their critics, research has demonstrated that the average returns to creditors from a CVA are still vastly superior to those in an administration or liquidation.
Furthermore – and unlike a floating charge which to be valid against an administrator, liquidator or creditors must be registered at Companies House and is publicly searchable – there is no system for a TTP arrangement between HMRC and a company to be registered and disclosable to others. There is therefore opacity to a company’s creditors (as well as those who may be considering whether to trade with and extend credit to it) as to the extent of its liabilities to HMRC that will now rank as preferential to their own claims in the event of a formal insolvency of that company.
So what action should be taken by businesses in response to the return of HMRC preference?
There are a number of possible mitigating actions which may be used individually or in combination.
1. Do due diligence on your customer before beginning to trade, including by consulting with a credit reference agency.
2. If trading with a new customer, consider asking for a personal guarantee of payment from its directors and/or principal shareholders. A solicitor can assist with drafting a guarantee and avoiding common pitfalls frequently encountered.
3. Avoid giving credit and require cash up front or on delivery before supplying the goods and/or services. Frequently difficult in practice, but you should ask yourself what the consequences would be for your own business if your customer didn’t pay and became insolvent.
4. Where credit is given, review and tighten up on your terms and conditions and make sure that it is yours (and not your customer’s) that prevail. Pay particular attention that the period of credit allowed is not exceeded (and put your customer on stop if that is not the case) and – where goods are supplied – that you have an effective reservation of title (RoT) provision. Again, a solicitor can assist with drafting terms and conditions.
5. Also, with the new restrictions on termination on insolvency provisions having been introduced in June 2020 (with temporary exemptions for small company suppliers), pay particular attention to pre-insolvency grounds for termination of the contract (e.g. – breaches by the customer occurring prior to its administration) and be prepared to actually enforce them.
6. Take account of the risk of customer default and bad debt in your pricing. If the outcome for creditors on customer insolvency is inevitably going to be worse as a result of the return of HMRC preference, the increased risk should (where possible) e reflected in the contractual price. Of course, in a competitive market (where competitors may not have factored in such risks in their pricing) it may be difficult to charge a risk premium.
Above all, businesses need to consider the likely effect of them and their customers of the return of HMRC preference (particularly in the midst of the COVID-19 pandemic), ranging from the increased risk of extending credit to lower (if any) recoveries from insolvent customers, and take action to mitigate such effects.
Now is the appropriate time to look afresh at your trading relationship with your customers and, in particular, to the risks attached to extending credit to them. Consulting with a solicitor experienced in restructuring and insolvency is an invaluable part of assessing the risk and devising a strategy suitable for your own business.
For further information contact Neil Harrold at email@example.com.