Posted: 13 Apr, 2021
On 8th April TMA UK hosted an insightful webinar where a group of expert panellists discussed the impact of Crown preference restoration on inventory funding and the implications for businesses funded by working capital facilities reliant on floating charge security, including overdrafts, cash flow loans and inventory funding lines.
We thank Kroll for sponsoring this session and the panellists for sharing their expertise. If you missed it, or would like to watch it again, you can find the recording here.
Stuart Tait, Partner, Gateley Legal
Dan Edgar, Director of Inventory Appraisals, European Valuations
Tom Weedall, Head of UK Originations, Wells Fargo Capital
Annabel Todd, Regional Business Development Director, BREAL Zeta CF
A brief history of Crown preference
After an introduction by Mike Parsons, Chair of the TMA UK’s North West Board, Mike handed over to Stuart, who moderated the webinar and began by giving a brief overview of Crown preference.
Under the Finance Act 2020, HMRC regained its status as a secondary preferential creditor in insolvency processes that commenced on or after 1st December 2020. Now, HMRC ranks ahead of floating charge secured creditors in respect of creditor claims of unpaid VAT, PAYE and Employee’s National Insurance Contributions. Whilst HMRC’s claims rank below preferential employee claims, they erode floating charge asset realisations that previously would have been available to secured creditors holding a floating charge.
HMRC last enjoyed preferential creditor status pre-2003, when the Enterprise Act 2002 removed it on 15th September 2003. It was removed because the Enterprise Act was aimed at promoting a rescue culture and deemed Crown preference to be inconsistent with this aim.
How did ABLs approach Crown preference pre-2003?
Turning to the panellists, Stuart asked Dan how asset-based lenders (ABLs) approached Crown preference pre-2003. Before 2003, Dan said that for the larger deals ABLs dealt with Crown preference by simply reserving for potential outstanding liabilities with HMRC and were able to lend against inventory. He said that asset-based lending was actually growing very quickly as a preferred method of lending and Crown preference didn’t seem to hinder that growth.
How significant is the impact of Crown preference restoration on the ABL market?
As part of the team that took an active role in lobbying the government on the negative impact that Crown preference would have on lending, Tom has a better understanding than most of the expected impact. His team estimated that the impact would be significant, and that the reinstatement of Crown preference could amount to around £1billion of liquidity impact. Compared to the benefit to HMRC of around £200million, Tom said it seriously contradicts the loan schemes the Government has supported throughout Covid and doesn’t align with their aim to support businesses. Tom is, however, confident that lenders will rise to the challenge and will come up with creative and flexible ways to continue to lend to businesses.
What impact do the Government’s pandemic measures have in relation to Crown preference?
Answering this question, Annabel said that the last 12 months have been extraordinary, and the Government’s support has undoubtedly provided a lifeline for many businesses. But like Tom, she also thinks restoring Crown preference is contradictory to many of the Government’s pandemic measures. One such contradiction is the ability for businesses to have deferred their tax position which, on an ordinary ABL structure, would increase how much asset-based lenders would need to reserve and might make it difficult for some to lend
How are lenders reserving for HMRC as preferential creditors?
According to Dan lenders used to take a fairly standard approach to reserving for HMRC. They would take one quarter of VAT and one month of PAYE & NI. But what Covid has very clearly shown is that this standard approach does not work for all businesses. Many are seasonal and so is their VAT. For these businesses, just taking the prior quarter’s VAT is not a good estimation and Dan said that more and more lenders are coming to the realisation that they need to look at projected sales to better estimate how much will need to be reserved.
How have institutions approached lending and the return of Crown preference?
In general, Tom said that institutions are approaching asset-based lending with lots of flexibility, particularly where borrowers are profitable with a good amount of headroom. He said the Crown preference liability only becomes a concern for lenders when borrowers get close to insolvency. Businesses that are less profitable with less room for error understandably present a less attractive borrowing position which will not be helped by Crown preference. But Tom is optimistic that the market will always find a way to make the deal work, and that lenders will be able to work out creative ways of helping these businesses. Creative ways could include lending against another asset class, taking a view on a short-term unsecured structure, phasing the build-up of additional reserves, or even lending into a stockco outside of the group. Annabel agreed, saying that at BREAL, they are taking the approach of looking at every situation individually and thinks that more lenders will take this approach now that Crown preference has been restored.
Will lenders really be able to support businesses coming out of the recession?
When asked by Stuart whether she thinks lenders will be able to support businesses through the Covid recession, Annabel was positive. Coming out of this pandemic, she said there will have to be lots of balance sheet restructurings and businesses will need good advisors. She said alternative lenders are showing that they are willing to lend but she has yet to see how much appetite there will be from the big banks. Ultimately, Annabel said that lenders want to support strong businesses with strong management teams, and while many businesses have struggled due to Covid, there are still a lot of businesses with solid foundations out there.
What degree of monitoring are lenders undertaking in terms of their collateral base?
Answering this question, Dan said that as you would expect, healthy companies are not being heavily monitored but those closer to insolvency are. As a company gets closer to insolvency, he said they often get called in to start monitoring monthly, weekly and even daily, looking at flash sales reports, daily stock levels, and making sure that the balance sheet and borrowing base are up to date so the lender knowns their position. In terms of how this relates to Crown preference, Dan said that monthly sales reports are being used to try and anticipate what next quarter’s VAT levels will be, rather than simply relying on historical data. By keeping on top of the data, he said that lenders can forecast with reasonable certainty what the liabilities going forward will be.
Is Crown preference the end of inventory funding?
To close the webinar, Stuart asked each of the panellists whether they think Crown preference will be the end of inventory funding. Annabel responded with a resounding no, saying that it makes lending more challenging but that lenders are creative and will always find a way. Tom agreed but is concerned that in the lower end of the SME market, the value of inventory funding could be wiped out by the additional reserves if a more creative structure can’t be found. While he said there are already lots of alternative structures to consider, many of them are untested and lenders are nervous about being the first. Dan’s take is much the same as Annabel and Tom’s, but he also thinks that the timing of Crown preference restoration, when arrears have never been higher, is not helpful. However, over time he thinks that positions will return to a more normalised basis and he is confident that the industry will find a healthy norm as they did pre-2003.
Overall, the clear consensus from all of the panellists seems to be that while Crown preference presents challenges to lending, inventory funding is far from a thing of the past and has an ongoing role in assisting UK corporates.
Thank you to Kroll, Stuart, Mike and all the panellists that shared their thoughts on this key topic. We hope you found this session useful and can join our next webinar in partnership with Lambert Smith Hampton ‘Asset Advisory Update – Focus on Corporate Recovery Assets & Property’ on 20th April. Register here.
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