The story of this fashion company going into administration has increased the buzz around the recent changes in Crown Preference rules.
What is the Crown Preference?
As of 1 December 2020, on a UK company’s insolvency, the HM Revenue & Customs (HMRC) is a Preferential Creditor in respect of certain unpaid taxes. HMRC has effectively moved up from seventh to fourth in the ranking ladder of creditors when a company fails, and it’s now ranking ahead of Floating Charge Lenders and Unsecured Creditors.
The new order of preference in insolvencies (commenced on or after 1 December 2020) is:
- Secured Creditors (often fixed charges i.e. mortgages)
- Insolvency costs
- Ordinary Preferential Creditors (primarily limited to certain employee claims)
- Secondary Preferential Creditors (this will include certain HMRC taxes now - VAT, PAYE, Employee NI contributions, student loan contributions and contributions to the construction industry scheme)
- Prescribed Part
- Floating Charge Holders (normally includes finance companies who may have some security on products such as invoice finance)
- Unsecured Creditors (including HMRC for non-Secondary Preference debts)
Is your business operating on credit terms?
This change impacts all companies who trade on credit terms, from sole traders, to SMEs to large corporates. Recoveries for Unsecured Creditors and Secured Creditors with floating charges will be impacted. The chances of recovering debts are weakened for Unsecured Creditors. All this can trigger a in the second half of 2021, when most of the will be gradually withdrawn.
Also, as part of the Covid-19 measures, there has been a value-added tax (VAT) repayment holiday and VAT to be paid is at a record high. Given that VAT is on the list of Crown Preference items (VAT, PAYE, employees NI contributions, student loan collections, construction industry schemes), this is potentially a huge issue for Unsecured Creditors who will be at the bottom of the list.
Imagine Company A has been put into administration with assets available for distribution of £18m (to be shared between outstanding creditors). Company B has a credit of £2m and it is classified as an “Unsecured Creditor”. For simplicity purposes, Company B is the only Unsecured Creditor of Company A.
Ranking of liabilities:
Before 1 December 2020, Company B would receive £1,970,000 (almost the totality of its credit) and after 1 December 2020, Company B would receive £0.
What implications can your business expect?
- Risk profile:
now that the unsecured creditors are lower in the pecking order, it is fundamental for credit managers to collect information about the risk profile of their customers, and frequently update it, as this can evolve quite quickly.
- Credit terms will tighten:
from a client perspective, businesses may find they receive tighter credit terms to pay their suppliers.
from a supplier perspective, tightening credit terms might mean becoming less competitive. It might seem a small issue in the middle of an economic and health crisis, but as the world starts to trade at pre-pandemic levels, competition might become harder.
with less cash flow available, funding business recovery and growth could be more challenging.
borrowing money may become more expensive (and have higher administrative costs).
How can trade credit insurance help you?
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Why Euler Hermes?
Euler Hermes is the global leader in trade credit insurance and a recognized specialist in the areas of surety, collections, structured trade credit and political risk. When the unexpected arrives, our AA credit rating means we have the resources, backed by Allianz to provide compensation to maintain your business.
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