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Is the writing on the wall for floating charge lending?

HMRC regaining preferential creditor status may mean the end of the line for floating charge lending, as Mark Davies explores below.

Preferential status

Following the implementation of the Finance Act 2020, HMRC will once again become a preferential creditor in insolvencies that commence on or after 1 December 2020, ranking second only to employees and the Financial Services Compensation Scheme. The Act restricts HMRC’s preferential status to outstanding taxes paid by a company’s employees and customers via PAYE, VAT, employee NICs and Construction Industry Scheme (CIS) deductions which the company ought to have passed through to the Revenue. Unpaid corporation tax and employer NICs remain outside the scope of the preferential treatment, but the change is nonetheless significant for floating chargeholders.

Many UK companies have taken advantage of the VAT payment holiday scheme, one of many measures introduced to ease the financial impact of Covid-19. VAT arrears may therefore be at high levels. Whilst some of the government’s schemes designed to help businesses combat the effects of the pandemic have been extended again, it is just a matter of time before that support will be withdrawn. These factors, combined with the resumption of HMRC tax collection, could see a rise in corporate insolvencies in the New Year. Lenders may therefore need to look to their security.

Floating charges

It has become common practice for banks and other lenders to take a debenture from a corporate borrower, when providing any form of facility for over £5,000 or more. Debentures are a cheap form of security: most lenders have their own form, and may not require external advisors to assist in taking them. A debenture contains fixed and floating charges: provided the floating charge is a qualifying charge for the purposes of paragraph 14 of Schedule B1 to the Insolvency Act 1986 (i.e. it is over the whole or substantially the whole of the company’s assets and undertaking), the lender can appoint an administrator following default under the lending. The administrator’s job is usually to collect in the assets and to realise them for the company’s creditors, who will be paid out in their order of ranking: (1) fixed chargeholders, (2) preferential creditors, (3) the prescribed part*, (4) floating chargeholders and lastly (5) unsecured creditors.

Floating charge assets

Floating charge assets are typically assets that are not suited to fixed charge security, such as moveable or fluctuating assets (stock and raw materials, plant and machinery (to the extent that these are not fixed to buildings or owned by third parties under finance agreements), receivables, cash at bank etc.) and intangible assets (goodwill, IP rights, licenses etc.) Prior to the Finance Act, a lender holding floating charge security over such assets could expect to receive the bulk of the net sale proceeds from their realisation, only losing out to any ordinary preferential creditors (essentially employees). Now, HMRC will take the next cut, ahead of the floating chargeholder. HMRC is often one of the most significant creditors in any corporate insolvency, and now with the added possibility of accrued VAT arrears discussed earlier, lPs are predicting HMRC’s slice of the pie will be substantial, meaning recoveries for floating chargeholders will be significantly impacted.

Floating charge lending

The impact of all this may force lenders to view the security value of floating charge assets in a different light. That in turn may impact on the willingness of lenders to advance loans against the perceived value of stock and inventory (something that has become more and more commonplace in the asset backed lending market, often as a bolt-on facility to an invoice discounting line). We might also see more focus by lenders on trying to take fixed charge security, wherever possible, instead of simply taking a debenture (for instance, attempting to take fixed charge security over plant and machinery which may involve greater restrictions on how the borrower can use those assets).

Fixed charge security is invariably more expensive to put in place, and will often involve external lawyers, as title due diligence is usually required and there may be additional steps needed to protect the fixed nature of the security (e.g. registrations, service of notice to third parties, fixing of plaques to charged assets etc.). Not all assets are capable of being secured by way of fixed charge: assets such as cash, stock and raw materials are by their nature often fluctuating and can become mixed in with other similar assets, which defeats the scope of a fixed charge. Such assets may now be viewed as having little or no security value, given the new limitations on floating charge realisations.

Summary

This change to the scope of preferential creditors is unlikely to mean that we see a drop-off in the use by lenders of the debenture as a security instrument. It remains one of the most useful and cheap forms of security available under English law. It does however mean that the value a lender will place on a debenture will now be less than pre-December 2020, and that could impact on the amount and availability of certain facilities, including overdrafts, on offer to borrowers. Facilities that traditionally relied on the perceived value of floating charge assets, such as stock, inventory and cashflow, will be affected the most, particularly as trying to assert an enforceable fixed charge over such assets can be tantamount to impossible. Whether this will mean we see a reduction in the availability of such facilities remains to be seen.

If our dedicated team can assist you with any issues or queries arising from this article, talk to the team today by calling 01482 325242 or email enquiries@andrewjackson.co.uk.

*Under section 176A of the Insolvency Act 1986 and the Insolvency Act 1986 (Prescribed Part) Order 2003, the prescribed part is the part of the proceeds from realising floating charge assets which must be set aside and made available to satisfy unsecured debts. The prescribed part is calculated as a percentage of the value of the company’s property which is subject to a floating charge namely, 50% of the first £10,000 of net floating charge realisations plus 20% of anything thereafter, subject to a maximum prescribed part of £800,000 where the first ranking floating charge was created on or after 6 April 2020 (£600,000 if created before then).

 

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