Secured loans – HMRC to get priority

Secured loan capital – not so secure after all?

In a big blow to secured lenders, the UK government has introduced a change to the law so that debts owed to HMRC would trump any security held in favour of lenders. These changes are forecast to raise revenue in the region of £185 million. HMRC will essentially become a ‘preferential creditor’ for certain tax debts, ranking above both fixed and floating charge holders, and stripping such creditors of the collateral comforts they once relied upon.

Fixed vs floating charges

Typically lenders can register either a fixed or a floating charge depending on the type of borrowing being advanced:

• Fixed charges – borrowing is secured against one or more identified assets. In the event of default, the charge holder has a direct claim on the asset(s). Generally this would apply to property or land (in the form of a mortgage), vehicles or plant and machinery.

• Floating charges – borrowing is secured against liquid assets which can be freely sold, traded and disposed of such as stock. They include current and future assets and essentially ‘float’ over them. It is only if and when the company runs into financial difficulties that the charge ‘crystallises’. From that moment on the company can no longer dispose of assets covered by the charge.

A step back in time?

Many lenders consider the new legislation a backward step. Rewind two decades and HMRC enjoyed a so called ‘Crown Preference’.

Before the Enterprise Act came into force in 2002, Crown Preference meant that HMRC sat above floating charge holders in respect of all unpaid taxes. The new provisions partially reverse the position back in favour of HMRC in respect of certain ‘priority taxes’. That is to say, taxes that a company collects on behalf of HMRC such as VAT, PAYE income tax and employees’ national insurance contributions.

There are no transitional arrangements in place meaning HMRC will stand to benefit in relation to charges created at any time. Furthermore, the new look Crown Preference is not subject to any time limit or financial cap meaning HMRC will also have priority in relation to historic arrears of priority taxes.

Impact on lenders

Previously a lender relying on its floating charge assets need not have worried that HMRC could potentially prejudice their position in the unfortunate event of their borrower’s insolvency. Their floating charge ranked above HMRC in the so called insolvency distribution waterfall.

Instead of HMRC siting side by side with other ordinary, unsecured creditors priority taxes will now be paid to HMRC from the proceeds of floating charge assets before amounts owing to the floating charge holder itself. Secured lenders therefore now run the substantial risk that any unpaid priority taxes could take a significant ‘bite’ out of their recoveries if not obliterate them completely.

Impact on borrowers

It will now be extremely difficult if not impossible for lenders to predict with any accuracy the risk and potential recovery position on lending in the event of insolvency of their borrower(s).

Due to the increased risks to lenders, the harsh reality is that borrowers are likely to find it increasingly challenging to secure traditional forms of funding and, in the event they do, may find that the terms offered are far stricter and that the amounts they can borrow are significantly reduced as lenders scrabble to minimise their exposure.

In particular, we may see the introduction of never before seen strict lender controls and monitoring ensuring that their borrowers pay collected taxes over to HMRC and covenants to that effect becoming a familiar sight in the drafting of loan agreements.

Practical implications

Any decline in appetite to lend may lead, in turn, to a decline in appetite to borrow.
Lenders will no doubt be increasingly keen to ‘lift the corporate veil’ by requiring more personal guarantees to be given by directors of borrowers as back up to their security which many business owners will naturally be reluctant to give. It also seems inevitable that the costs of borrowing generally will rise in line with the increased risk profile faced by lenders.

At a time when economic certainty is already shaken beyond measure, the trickle down effects of this will no doubt further dent confidence and stunt commercial growth. Whilst HMRC may have general support for the measures, given recent government spending on the furlough scheme, grants and bounce back loans, the truth of the matter is that they may be the most likely party to use winding up petitions against those very same companies.

Gannons can help

We specialise in working with SMEs and investors alike to secure investment and funding deals in a number of tax efficient and innovative ways when traditional forms of lending become less obtainable or less attractive . To find out how we can help you please do not hesitate to contact us.

Jennifer Wall

A master at turning what looks to be a tricky problem at the start with lots of dark alley ways into a workable commercial outcome.

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