What a time it is to be an insolvency lawyer and to be alive! The prescribed part may be increased, a BEIS consultation paper on Insolvency and Corporate Governance, an HMRC consultation paper on Tax Abuse and Insolvency and new Scottish Insolvency Rules. And as if all of that is not exciting enough, Crown preference is coming back. I barely know where to start.
Normally at Christmas I ask for book tokens (if you are buying gift cards or vouchers this year make sure you purchase on credit card please in case of retailer insolvency) but who needs books when there is so much quality legislative material to study. I wonder if there is an audiobook version of The Insolvency (Scotland) (Company Voluntary Arrangements and Administration) Rules 2018?
It would have been easy to forget that the mundane process of making normal law in the United Kingdom has actually been continuing behind the scenes while Brexit has dominated the foreground. But apparently the world does continue to turn whether we are in the EU, or are out of the EU, if one part of the UK is more in the EU than the rest is, or if we remain subject to parts of the EU rules for an indefinite period but are otherwise free to make our own legislative and policy errors.
I am not sure that there is any particular reason why all these reforms and reviews are happening now. It has probably been just some routine Christmastime alignment of the stars. I do wonder however to what extent these different initiatives and proposals are properly joined up. I am going to look at two of the current issues in this article.
Re-introduction of Crown preference
With effect from April 2020, HMRC will once again rank as a preferential creditor in the insolvency of a taxpayer. The preference will not extend to all tax liabilities but rather will be in respect only of tax that the insolvent company has collected from third parties and which the company therefore holds on behalf of HMRC. Included in this category would be VAT, PAYE and employee NIC. This bit is important for this article - the tax involved has been collected by the company on behalf of HMRC. Tax owed by a company on its own account (e.g. corporation tax) would remain as an ordinary unsecured claim in the insolvency. In its previous existence, Crown preference attached to all tax.
The implications of the change have been commented on widely - R3 for example has recommended that the Government has a "rethink" and worries that the proposal could "undermine…recent work to improve and strengthen the UK's insolvency framework". R3's principal concern seems to be the effect that Crown preference will have on floating charge creditors and unsecured creditors "and by extension business rescue and funding".
I am not sure that I share R3's concerns.
Both floating charge creditors and unsecured creditors will undoubtedly be worse off. That is not in dispute. Where I differ from R3 is in connection with their belief that worsening the position of creditors (floating charge or unsecured) makes business rescue harder than it already is.
In particular I do not see any necessary correlation between the level of return for ordinary creditors and successful "business rescue". Of course the phrase "business rescue" covers a multitude of structures and approaches so it is very dangerous to generalise but in my experience, the outcome for unsecured creditors rarely dictates or determines the success of any "rescue". Naturally, where the rescue is being effected through a CVA, the financial outcome for ordinary creditors will be important but in a CVA, the outcome for creditors will not primarily be determined by the extent of preferential debt. Where the rescue is being carried out in some other way, the ordinary creditors do not seem to me to have the ability to intervene in any meaningful way.
Even with floating charge creditors, I do not really see R3's point insofar as it relates to rescue. I can easily accept that an increase in preferential claims means a reduction in floating charge recoveries and I can see that that might impact on the willingness of lenders generally to lend - but that is not a "rescue-specific" concern. (As it happens over the last decade in Scotland we have seen something akin to the effect of Crown preference because of the re-invigoration of landlord's hypothec - think of it as "Landlord preference". Has anyone seriously suggested that landlord's hypothec is a barrier to business rescue?)
Perhaps the best example of where R3 may have a point is where distressed funding is sought. Any lender at that point of course has one eye (probably both eyes) on the outcome in insolvency and should be factoring in the effect of anything that will impact on the return out of insolvency. For a lender, the problem with Crown preference is likely to be that the amount involved is unpredictable and can mount very quickly.
R3 suggests that a weakening of the floating charge position may "force" lenders to take fixed security over fixed assets instead, because lending secured by fixed securities will "trump all other creditors …..so more secured lending means less money back for everyone [else]". And "everyone" in this context will include HMRC (even post April 2020).
I struggle with this analysis - probably not least because I am a lawyer working in Scotland. Up here, fixed securities are pretty limited. All we really ever see are securities over land and buildings and sometimes some assignations of rights (such as debts). Fixed securities over goods or other tangible assets are virtually unknown in commerce here because the lender needs to take possession of the asset. So the idea that a weaker floating charge recovery would lead to wholesale taking of fixed securities to the detriment of the other creditors is simply not tenable. In any case, my experience is that if anything can be secured, it will already have been secured.
I know less about English law of course but if memory serves, where we in Scotland grant a floating a charge, in England what will be granted is a debenture containing fixed and floating charges. Again - if it is available for security - it is probably already secured.
But even if a company in distress does happen to have assets that are available for security, any lender of last resort would already be looking to take that security even though there is no current Crown preference.
So I do struggle with R3's contention that the re-introduction of Crown preference will mean that lenders now will tie up any available assets in fixed securities in a way that they have not been doing hitherto and that will mean "less money back" for the rest in an insolvency.
Having said all that, there definitely is something in the suggestion that a lender of last resort will have to take into account the impact that Crown preference will have. But what they will do, will not necessarily be to lend less. These lenders are in the business of lending to companies in precarious positions - that is what they do. If the level of unpaid tax in a company will impact radically upon their outcome then they can take steps to constantly monitor and review the exposure in that area and perhaps take assurances (or indeed guarantees) from the directors regarding that exposure.
Tax abuse and insolvency
And that takes me nicely to the HMRC consultation paper (April 2018) on Tax Abuse and Insolvency. (Personally I think it would have been better entitled "Insolvency Abuse and Tax" but what do I know?) This paper contained a number of ideas/proposals aimed at attempting to dissuade directors from exploiting the insolvency regimes to avoid or evade tax liabilities. The Summary of Responses to the consultation paper was published in early November 2018 and can be used to give some indication of what the Government is thinking.
The consultation asked for comments in respect of two particular approaches to tackling the problem: (i) joint and several liability; and (ii) the transfer of liabilities. It was suggested that in tackling these behaviours, the Government would "not undermine other creditors' rights to payment of their liabilities". One can see that neither (i) nor (ii) would impact upon the rights of other creditors of the insolvent taxpayer. Those approaches would of course have the effect of impacting upon the rights of the creditors of those entities who are jointly and severally liable or to whom the liabilities are transferred and there seems no logical reason (in fact one might argue that there is even less reason) why those creditors should be disadvantaged in this way in order to avoid harming the creditors of the primary tax debtor.
In this regard, there is a statement in the Responses from a respondent that: "care should be taken to ensure that the principles of insolvency as a collective remedy are also respected". As noted above, HMRC have stated "[the Government] will not undermine other creditors' rights to payment of their liabilities". Given what is happening with Crown preference, one can only assume that the words "at least until April 2020 at which point we will re-introduce Crown preference" were inadvertently missed off the end of that statement.
The Responses make it clear that the Government is of the view that it would be appropriate to render certain persons (e.g. directors and related parties) jointly and severally liable for tax, but only where there has been tax avoidance, evasion or repeated non-payment of tax. No doubt there will be plenty future court-based excitement to be had in determining what constitutes "avoidance, evasion or repeated non-payment of tax" for this purpose.
But now think about this issue in light of the Crown preference position. Remember that Crown preference is not to attach to all tax liability - rather it will only catch those particular taxes that the company has collected on behalf of HMRC.
A simple distinction can be drawn between:-
(i) a company not having enough money to pay its debts (including tax); and
(ii) a company being unable to account for money that it held on behalf of another party (e.g. the sums that will become the Crown preference debt) because the company has used that money for its own purposes.
The latter situation has similarities with the position where assets are subject to a trust (for the avoidance of doubt however as matters currently stand, this is not actually a situation to which trust law would apply).
As noted above, the Government is considering rendering directors/relevant parties jointly and severally liable for unpaid tax where there has been "avoidance, evasion or repeated non-payment of tax". A simple failure to account for the kind of tax to which Crown preference will attach would not necessarily fall within the "avoidance, evasion or repeated non-payment of tax" provision. Accordingly, even under the revamped legislation a director would probably not be on the hook for that particular tax liability (unless there has been "avoidance, evasion or repeated non-payment").
Given that there has obviously been a willingness to embrace the idea of rendering others liable for a company's tax liability, one wonders whether there was any consideration given to the idea of rendering directors liable for any failure to account for those "Crown preference" liabilities. Personal liability is a great thing for focussing the mind and it is not difficult to imagine that the prospect of incurring personal liability would mean that directors would be more minded to ensure that the money collected in this fashion was actually passed on. This in turn would mean that HMRC's position was improved.
It may be argued that whether an improvement in HMRC position is achieved by way of Crown preference or because of potential personal liability might drive a change in behaviours, the outcome will be the same for other creditors: there will simply be less in the pot for them in an insolvency. That is probably true, but in the latter case it will be because the debtor company will have accounted to HMRC for sums that it held only on behalf of HMRC, rather than incorporating those sums into its own assets and cashflow.
HMRC is of course an involuntary creditor. It cannot turn off the credit tap like other creditors can choose to do by refusing further supplies. In many respects HMRC is in a particularly difficult position as a creditor and the money we are talking about here never truly belonged to the company in the first place. That being so, arguably other creditors should not consider that they have any right to participate in those funds at all. Consider the trust analogy in this context. If the funds in question were subject to a valid trust, the other creditors could not participate in recovery from those funds. In addition, any dissipation of trust funds by trustees would give rise to personal liability for breach of trust.
The HMRC consultation was primarily aimed at preventing the deliberate avoidance of liability for tax through the use of insolvency. Other than a desire to increase the tax take, I am not sure what policy considerations underpin bringing back Crown preference.
However since both things were being looked at simultaneously, perhaps the sensible thing to have done would have been to look at the wider issue of improving director behaviour as regards accounting for tax.
Huge numbers of companies in the UK routinely use the tax that they have collected as an informal overdraft to assist their cashflow. There is little HMRC can currently do to prevent that while it is actually happening. The directors of those companies know that they should not do it, but they continue to do it, and if the company fails then, as matters stand, the culpability of the directors in using someone else's money in this fashion is not properly addressed because the directors are rarely held to account for their (mis)conduct.
Personal liability for directors in this area would not come at the cost of prejudice to the interests of other creditors of the company. On the other hand, in any insolvency of a director, the interests of the creditors of that director will be affected because of an increase in claims in that insolvent estate. However one may seek to justify that outcome on the policy basis that the financial position of the director will very often be closely tied to the company's position. Indeed, for the vast majority of companies the directors are also the shareholders, and so the financial well-being of the company and the financial interest of the directors largely coincide. As a result we might even see better corporate financial disciplines evolving and that could only be to the benefit of all creditors.