HMRC proves clear willingness to fight for preferential ranking
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In 2003 His Majesty’s Revenue and Customs (HMRC) lost the Crown Preference. Under this, it had enjoyed preferential status for unpaid taxes in the statutory order of priority in insolvency. While the introduction of the ‘prescribed part’ – set out in Section 176A of the Insolvency Act 1986 – was intended to mitigate this, HMRC spent nearly 20 years as an ordinary unsecured creditor in the insolvency distribution waterfall. Then, in 2020, it regained preferential status for certain taxes under the Finance Act 2020, once again ranking ahead of floating charge holders and ordinary unsecured creditors on insolvency.
However, 2020 also saw the introduction of the restructuring plan under Part 26A of the Companies Act 2006 via the Corporate Insolvency and Governance Act 2020. This new tool includes a cross-class cram-down mechanism, allowing one or more dissenting classes of creditors (or shareholders) to be “crammed down” by one or more consenting classes. In 2022, this mechanism was deployed for the first time against HMRC in Houst, with the plan successfully departing from the insolvency order of priority in the apportionment of the restructuring surplus (ie, the dividends available under the plan that would not be available in the relevant alternative) (Houst Ltd, Re  EWHC 1765 (Ch).
In Houst, HMRC’s newfound secondary preferential status looked vulnerable. There have been three attempted cram-downs of HMRC since, with it successfully challenging two of them. It is clear from these cases that HMRC is willing to defend its preferential ranking. A look at the facts underlying each of these attempts, however, confirms that cramming down HMRC is possible in the right circumstances.
In Houst, the relevant alternative for the purposes of the plan was a pre-pack administration. In this scenario, there would have only been two ‘in-the-money’ classes: HMRC and a bank holding a fixed and floating charge over the company’s assets. Although the bank would have had priority over HMRC in terms of assets secured by the fixed charge, HMRC would have had priority with respect to the company’s remaining assets. This meant that HMRC was likely to receive a higher dividend than the bank in the relevant alternative. However, under the plan, the bank received a higher dividend, representing a clear departure from the statutory order of priority.
HMRC accordingly voted against the plan and made clear in an email to the judge that it was “not willing to compromise” on its secondary preferential status. While the court explored the possibility that the company could have crammed down the bank instead of HMRC, it ultimately sanctioned the plan on the grounds that HMRC would still be better off under the plan than in the relevant alternative. HMRC was also a sophisticated creditor but had chosen not to attend the hearing to oppose the plan or present any evidence against its sanction.
Following Houst, HMRC understood that defending its preferential status required more active engagement in proceedings. In Nasmyth, the court found that the company had proved to the civil standard that the relevant alternative for the purposes of the plan was an insolvent administration and that HMRC would be better off under the plan (Nasmyth Group Ltd, Re  EWHC 988 (Ch)). However, HMRC leaned on the court’s exercise of discretion in sanctioning the plan and argued that it did not reflect a fair distribution of the restructuring surplus.
The court was satisfied that it “should exercise caution in relation to HMRC debts”. It found that it would be unfair to sanction the plan due to the size of the debt (including group-wide liabilities), HMRC’s secondary preferential status and its share in the restructuring surplus, which was “both tiny by comparison with [the senior secured creditor] and in absolute terms”. Crucially, the success of the plan was contingent on HMRC agreeing time-to-pay (TTP) arrangements with the company after the plan had been sanctioned, but the company had not treated HMRC as a critical creditor and instead used the plan as an opportunity to “put pressure on HMRC to agree new TTP terms”.
In GAS, the court was not satisfied that the company had discharged the evidential burden to show that HMRC would be no worse off under the plan than in the relevant alternative (Great Annual Savings Co Ltd, Re  EWHC 1141 (Ch)). Although HMRC had not filed its own expert valuation evidence, it was still entitled to challenge the factual basis of the independent valuation, and much of this was reliant on unscrutinised figures given by the company in this case.
Even if the evidential burden had been discharged, the court concluded that it would decline to exercise its discretion to sanction the plan, as it was not satisfied that the division of the restructuring surplus was fair to HMRC. While the purpose of the plan was to stabilise the company, this was to be achieved via the writing down of (primarily HMRC’s) existing debts, rather than injecting new capital. Further, the plan’s benefits did not appear to be tied to existing rights (ie, non-critical creditors were taking no new risk but were set to recover more p/£ than HMRC). The division was also found to be a departure from the order of priority in the relevant alternative without satisfactory justification.
In Nasmyth and GAS, the courts recognised HMRC’s “critical public function” in the exercise of their discretion to not sanction the proposed restructuring plans. However, in Prezzo, HMRC’s preferential debts were compromised notwithstanding their dissent, showing that it is still possible to cram down HMRC, even when it actively opposes a plan (Prezzo Investco Ltd, Re  EWHC 1679 (Ch)).
Nonetheless, key differences in the fact pattern between Prezzo, Nasmyth and GAS explain the contrast in outcome. In Prezzo, HMRC received “most, if not all, of the ‘restructuring surplus’”, and although the shareholders remained whole (marking a departure from the statutory order of priority), they were also the secured creditors and injected new capital into the company under the plan. Moreover, unlike in Nasmyth and GAS, the company did not have a chequered history of unpaid HMRC debts; payment to HMRC under the plan was to be immediate and guaranteed by the secured loan noteholders and shareholders. While the court was “astute” to the possibility of the restructuring plan becoming “an instrument of abuse” for unpaid tax bills, it did not think that that was the case here.
An onward battle
Houst may have emboldened companies and their stakeholders to think that the restructuring plan is a useful tool for compromising HMRC. However, through Nasmyth, GAS and Prezzo, HMRC demonstrated its willingness to defend its ranking as secondary preferential creditor. The key message emerging from these cases is that the courts recognise the special status afforded to HMRC under the statutory insolvency waterfall. Companies should ensure that any compromise of HMRC under a plan is fair, particularly where there will be a departure from the statutory order of priority in the relevant alternative. From a practical standpoint, companies should engage proactively with HMRC prior to proposing a plan to try to satisfy its concerns.
Ultimately, HMRC may well continue its fight by pushing for statutory amendments to the restructuring plan, such that their consent is required for any compromise of its rights as a secondary preferential creditor (as is the case in company voluntary arrangements).