Changes to the Insolvency Act: Preferential Debts

Pursuant to section 175 of the Insolvency Act 1986 (the “Act”), when a company is wound up, certain unsecured creditors are given ‘preferential’ status in priority to all other debts in the distribution of the realisations of the insolvent company’s assets.

Ordinary preferential debts rank equally among themselves and are, in accordance with section 386 of the Act, paid after the expenses of the winding up and must be paid in full unless there are insufficient assets, in which case these are paid in equal proportions.  Ordinary preferential debts are the debts of the insolvent company owed in relation to (amongst others):

  1. Contributions to occupational and state pension schemes;
  2. Wages and salaries of employed for work undertaken in the 4 months’ prior to the date of the company’s insolvency (and limited to £800 per person); and
  3. Holiday pay to employees whose contracts have been terminated (whether or not termination takes place prior to or after the date of the company’s insolvency).

The Banks and Building Societies (Depositor Preference and Priorities) Order 2014 introduced secondary preferential debts which rank equally among themselves after the ordinary preferential debts have been paid and shall be, in accordance with section 386 of the Act, paid in full, unless there are insufficient assets, in which case these are paid in equal proportions.  Secondary preferential debts consist of certain deposits owed to depositors that are not protected by the Financial Services Compensation Scheme.

With the implementation of the Enterprise Act 2002 (as amended by the Enterprise Act 2002 (Commencement No. 4 and Transitional Provisions and Savings) Order 2003), debts due from insolvent companies to HM Revenue and Customs ceased to hold ‘preferential’ status; these having previously been specifically referred to in Schedule 6 to the Act as categories of preferential debts.

However, on 11 July 2019, the Government confirmed in the draft legislation for the Finance Bill 2019-2020 (the “Bill”) that it intends to give debts due to HMRC secondary preferential debts status.  It is intended by the Bill for ‘certain HMRC debts’ to be contained in paragraph 15D to Schedule 6 of the Act.  ‘Certain HMRC debts’ will include VAT and ‘relevant deductions’ which we understand will include PAYE, Employee NICs and Construction Industry Scheme Deductions.

Consequently, as secondary preferential debts, VAT liabilities and other relevant deductions will be paid in advance of creditors who hold floating charges and other non-preferential debts rather than ranking equally with any other unsecured creditors of the insolvent company.  The outcome of this will certainly affect companies and the economy generally.  For the more money which is paid back to HMRC from the realised assets of an insolvent company in advance of other creditors, the less money which will then be available to those creditors.

It should be noted that HMRC will remain an unsecured creditor in relation to liabilities of a company in liquidation which relate to, amongst other things, Income Tax, Capital Gains Tax, Corporation Tax and Employer National Insurance Contributions.

If you would like to discuss anything relating to this article, please contact Paul Green at [email protected]