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Up until the early 2000s HMRC were a preferential creditor in cases of insolvency. When this changed in 2003 it was frankly a relief to many insolvency practitioners because it meant some good news for small businesses. In essence, it meant more money was likely to come the way of SMEs in the event of the insolvency of a customer. On 1 December 2020 though, all that will change and HMRC will once again adopt preferential status when it comes to insolvency. It is often the case these changes have unforeseen effects and this one is no different. High level decisions like this are similar to pebbles thrown into a still pond. They may only seem to be a small disturbance but it’s all about size. That tiny ripple is a huge wave to some.
The first, and most obvious, effect of the change is that HMRC will now take their cut for monies owed for VAT, PAYE and National Insurance, before the other creditors get a look in. As usual the first round of insolvency payments will go to those affected by the closure in the most personal way. Employee salaries, holiday pay, pensions contributions and similar will still be considered in the first round of payments, these will be described as first preferential creditors. Then these new secondary preferential creditors will swoop in for their cut.
Most insolvencies have an element of debt to the Government. In truth it is common that directors will not make payments to HMRC, instead ensuring payments are made to employees and trade suppliers when cash flow becomes difficult. While this may be understandable because these payments seem more instantly urgent, over time these HMRC debts build up. We find many directors take advice from us because of this debt build up and it can be a major factor in insolvency. The practical upshot of this then is fairly straightforward. If a business goes under owing you and HMRC money you are less likely to get a payment towards your outstanding debt.
Put yourself in the position of a lender at the moment and you immediately see that many are already looking at two potentially difficult recovery scenarios in relation to the government response to the Covid-19 epidemic. Basically, the banking system is strained right now to say the least. Opinions vary on how large it will be, but there does seem to be very high likelihood of defaults on bounce back loans on a pretty huge scale. While these are guaranteed by the government, it does potentially mean a lot of money missing from the pot and a lot of administrative logistical burden on the financial institutions. As well as that issue, applications for loans and other forms of funding will potentially be coming from businesses that have survived the pandemic on the support loans. Which means they will be applying with that prior debt already in the books. Add that to dropping down the list of creditors if a business does go insolvent and you have to ask the question ‘will the lenders become increasingly cautious about lending money to SMEs’? We think the answer is bound to be a yes. Caution is highly likely to be the watchword for future loan and other funding decisions.
The chances of a very cautious supply chain when it comes to payment terms are very high in the coming months. As well as the continuing economic fallout of the pandemic, there is still the uncertainty of Brexit with at best an expected short term knock effect on the export/import market to consider. When it comes to the post Covid-19 economy we have to accept that best case, we are looking at difficult times, worst case, we could be looking at an extended period of recession. This means either businesses will be stricter about credit control, terms and conditions and cashflow (which is what we recommend right now) or a few may go the opposite way to encourage buyers with better payment terms. Sadly, the latter could well result in cashflow problems and cash, as we often say, is king when it comes to insolvency. One part of the market offering less flexible payment and another part offering extended terms to get quick orders on the books is a worrying situation because, right in the middle of that are a lot of SMEs who could lose out.
So, this small change could be quite impactful on the wider market. With less money available, more cautious suppliers and lenders and an already difficult market where there is potentially stalled stock flow (see our article for more on this) adding to the problem.
As always, we are here to help if you do find yourself in a difficult position but we strongly suggest you keep an close eye on any potential debt.
Our article on the current impact of stock on the supply chain can be found here.
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