HMRC’s Preferential Creditor Status and Preference Payments to Creditors

Directors Beware! Do you know what HMRC’s preferential creditor status means for you in insolvency? And why making preference payments to creditors when insolvency looms could be a major issue?

On 1st December 2020, HMRC ‘s status as a preferential creditor was reinstated for formal insolvency proceedings, after some 17 years when the last changes were made back in 2003. Unfortunately for many people this change has gone unnoticed and could lead to some nasty surprises further down the line. Insolvency Practitioners can help.

What does it really mean for directors? In particular, what effect will it have on directors’ Personal Guarantees – and indeed whether the small print in any finance agreement includes personal liability within any warranty and indemnity clauses – if the company becomes insolvent? This of course also applies to guarantors who are not directors.

In this article, our Licensed Insolvency Practitioners point out some of the potential pitfalls. It is vital for directors to know what is in their current finance agreements, or in those they are about to sign, as personal liability if the business becomes insolvent could be in the Terms & Conditions. We conclude by reminding directors that making payments to creditors that prove to be preferred, could lead to personal liability and/or director disqualification.

What is HMRC’s Preferential Creditor Status?

Prior to 1st December 2020 (since after the Enterprise Act, 2002 which came into force in 2003), HMRC did not have preferential status when businesses become insolvent. However, from 1st December 2020, all that changed and their preferential status was restored for most outstanding taxes, namely PAYE/ NI, and VAT. As a result, now, when a company becomes insolvent and fails to pay its creditors , assets must first be used to pay preferential creditors, including HMRC. However, the issues do not stop there.

The impact on personal liability and Personal Guarantees – are directors or guarantors fully aware?

The change of HMRC’s creditor status will also have an impact where a director has provided a Personal Guarantee to a lender (either secured or unsecured), or there are personal liability warranties and indemnities in the terms and conditions, and their company is at risk of insolvency.

It may seem surprising but, more often than not, people forget they have given guarantees in the first place. So, before you go any further check. In an insolvency, a creditor with a Personal Guarantee and/or warranties and indemnities will demand repayment from the company first and if all or a balance remains unpaid then a claim will be made on the guarantor personally. However, when a company is at such a point, the impact of HMRC’s new preferential status will likely have an impact on the amounts available to the lenders. In a liquidation when such lenders have floating charge status, there is likely to be a diminished balance available to them which could result in an increased chance that claims will be made against the guarantors.

The Impact on lending decisions

For lenders and funders who are reliant on floating charges to recover lending in the event of insolvency, the security cover position becomes more tenuous because of HMRC’s preferential status. This could now mean that HMRC would rank ahead of the lender, which could have a negative impact on lending decisions. This is not good news for businesses, coming at a time when cash flow is tight, and many will be carrying higher than normal levels of Crown debt due to the impact of Covid-19.

Directors should check their Ts and Cs

As Insolvency Practitioners, much of our time is put into saving businesses and turning them around, and so avoiding insolvency. This may include helping and advising businesses who are threatened because of the change in HMRC’s status, especially where personal guarantees and personal liability is involved.

Our Licensed Insolvency Practitioners are here to explain what this change means on a practical level, work through the financial outcomes with directors and advise on what needs to be done if insolvency looks likely. As a starting point, check your Ts and Cs to see if they include clauses on Personal Liability.

What About Preferred Payments to Creditors?

When a company enters Insolvency whether it is liquidated, or enters administration, the conduct of its directors or those who control the business in the lead-up to insolvency must be scrutinised by the Insolvency Practitioners appointed to see if they have acted wrongfully or unlawfully. A major area of scrutiny is that of preferred payments. This is because directors must ensure that creditors within each class are treated equally as far as repayments/losses are concerned. Preferred payments can involve payments to connected parties such as family members; prioritising lenders where a Personal Guarantee exists (to avoid personal liability); or simply a payment to maintain a good business relationship.

Directors could face personal liability for some or all of the company’s debts if a preference is found to have been made. If the preferred payment was made when the company was insolvent, or caused it to become insolvent, it could also lead to disqualification as a director for a period of up to 15 years.

Talk to our Insolvency Practitioners about Crown Preference and Preferential Payments

To find out more about preferences in insolvency, and to ensure you, or a client, are acting legally as a company director, talk to our Licensed Insolvency Practitioners for help and advice. We can advise on whether your actions could lead to legal action being taken against you and what steps you can take to avoid such an outcome.

There are always options available, but the sooner you, or your clients, to talk to us, the more we can do to help. The initial discussion is FREE of charge. Contact us at any of our offices:

Also, K&W Recovery, trading as Antony Batty and Company, Thames Valley: