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The taxman’s preference on insolvency returns to England and Wales: things that art lenders should know (and borrowers too)

Finance Act 2020 reintroduces Crown preference in an insolvency – in respect of some taxes

Following Royal Assent in the summer of 2020, the Finance Act 2020 will become effective on 1 December 2020. Among other things, the Act will reintroduce the preferential position of HMRC over creditors holding floating charges and unsecured creditors. Pursuant to section 98 of the Act, the taxman will enjoy privileged treatment in relation to select taxes, pushing, for example, lenders holding floating charges over assets further down the order of priority upon insolvency of the borrower.

The new Act has not avoided controversy, particularly because it could undermine lenders’ confidence at a time when – as a result of the pandemic – access to credit has become existentially important for many businesses. In this article, we consider what this legislative change might mean for businesses that lend and borrow against art in England and Wales.

Details of the changes

If a business is unable to pay its debts, it may face insolvency proceedings. As part of that process, an insolvency practitioner is appointed to distribute any remaining assets owned by the business. Creditors may include employees entitled to unpaid wages, lenders claiming outstanding amounts on loans or, indeed, HMRC seeking to collect taxes due by the insolvent business. Some creditors, notably lenders holding fixed and floating charges have been afforded privileged treatment on a business’s insolvency, tapping into any available assets before unsecured creditors such as trading partners claiming unpaid invoices. For almost 20 years now, HMRC has also ranked as an ordinary, unsecured creditor, following the removal of its preferential status by the Enterprise Act 2002.

The Finance Act 2020 will reshuffle the order of priority, putting the taxman before secured creditors holding floating charges – in respect of a range of taxes, namely VAT, PAYE income tax and employees’ national insurance contributions. HMRC’s preferential status will not apply to taxes that it collects directly such as corporation tax and employer’s national insurance contributions. As of December 2020, under the new regime, HMRC will be paid out of proceeds of assets subject to a floating charge before the holder of that charge. Importantly, there is no cap on the amounts claimed by HMRC in respect of the relevant taxes. Lenders holding floating charges may, accordingly, find themselves in a situation where proceeds of assets subject to their charges are not sufficient to cover in full both the relevant taxes owed to HMRC and outstanding amounts on loans secured by the floating charge.

Key concerns arising from HMRC’s priority over floating charges

Taking a fixed charge instead? Not always a solution

What is the difference between fixed and floating charges? From a practical and commercial point of view, what matters to lenders is the level of comfort and strength of rights that a particular charge would give them over an asset should the borrower become insolvent. In an insolvency, secured creditors holding fixed charges collect ahead of those holding floating charges. It follows, naturally, that lenders will attempt to take a fixed charge over assets wherever possible. Indeed, taking a fixed charge as opposed to a floating charge would appear to be a simple solution to the legislative change introduced by the Finance Act. And it may well be that many lenders will be able to overcome the new hurdle by doing just that. In some cases, however, taking a fixed charge may not be possible or it may not solve the lender’s problem. For example, assets may already be subject to existing fixed charges held by another lender. In other situations, it may not be possible to take a fixed charge over assets because of the nature of those assets. A good example is a gallery’s trading stock: in simple terms, the borrower retains control over the stock in the course of its trade as it buys and sells. That is why the lender’s charge only “floats” over the business’s inventory. A very substantial part of the market for commercial lending in the United Kingdom is currently secured by way of floating charges.

Chilling effect on access to finance

The new order of priority could dissuade lenders from providing credit in situations where, under today’s rules, they would be willing to lend. In other words, the new rules will affect the borrower’s creditworthiness in the eyes of a lender. As many businesses struggle to survive amidst the pandemic, the timing is less than ideal. A recent debate in Parliament, for example, highlighted the irreconcilable contradiction between the Government’s efforts to help businesses in the current climate and the provisions in the Finance Act elevating HMRC’s status – at the expense of businesses.[i]

Even if lenders do not refuse to provide credit altogether, the new legislation could force them to lend on stricter terms. The balance in commercial loan agreements may now tip more heavily in favour of lenders who might insist on more onerous conditions precedent, representations and warranties and restrictive covenants.

Retrospective application to floating charges created before December 2020

Another shortcoming of the Finance Act 2020 is that it will apply retrospectively, i.e. HMRC will rank ahead of holders of floating charges in any insolvency that arises on or after 1 December 2020, even if those floating charges were created prior to that date.[ii] The legal and commercial concerns are clear: a piece of legislation will interfere with lenders’ rights in respect of existing loan agreements. It remains to be seen whether or not lenders will try to take steps to improve their position in relation to outstanding loans. They may, for example, seek to renegotiate terms with borrowers. Worse still, creditors may now press for insolvency proceedings before December 2020 to secure better ranking.

Application to art finance

If lenders continue to take possession of art as they do today in the UK

Art finance in the United Kingdom is characterised by lenders’ insistence on taking possession of the art before releasing funds to borrowers. At present, England and Wales, as well as other parts of the United Kingdom, lack appropriate mechanisms that would facilitate non-possessory lending against art. The archaic Bills of Sale Acts which, in theory, allow such non-possessory lending, are not fit for purpose. Accordingly, if an art business or, for example, a private collector seeks to borrow against a work of art, a lender will typically agree to extend credit only as long as it as able to take possession of the art.

Paradoxically, the old-fashioned lending practices based on possession that are prevalent in the art market could prove advantageous in light of the changes brought about by the Finance Act 2020. By taking possession art lenders effectively ensure that the type of charge they hold is fixed rather than floating, as the art is under their full control. It would appear, then, that if lenders continue to take possession of art, the art market would avoid the problems brought about by the Finance Act.

That said, art finance based on possessory security interests is undesirable because it is impractical and more expensive. More importantly, it hurts British art finance that lags behind the United States, a much larger market where non-possessory lending against art is the norm.

Art businesses constituted as limited companies, as opposed to individuals, can, in principle, borrow against art without giving up possession because lenders can protect their security interest by publicly recording it at Companies House. Such charges, however, are often created as floating charges. While there are other reasons why lenders may prefer to take possession of art, the preferential status of HMRC will only cement the current market practice whereby borrowers have no choice but to hand the art over to lenders.

The case of galleries and dealers

Galleries and dealers are more likely to be hit by HMRC’s privileged standing. They typically borrow against their trading stock, and lenders may take a floating charge over stock as it fluctuates and changes. Like borrowers in other sectors, galleries and dealers could now find access to debt finance more difficult as a result of the incoming legislative changes. Lenders could now require possession of part of the stock to create a fixed charge. Alternatively, lenders may seek to restrict borrowers’ commercial freedom by imposing various restrictions or tighter conditions.

Related developments

Lenders and borrowers, including art market professionals, should consider the changes brought about by the Finance Act 2020 in conjunction with a related legislative development from earlier this year: in April 2020, the Insolvency Act 1986 (Prescribed Part) (Amendment) Order 2020 was amended to increase the amount due to the “prescribed part” from £600,000 to £800,000. The prescribed part essentially consists of unsecured creditors who, but for the “prescribed” amount, would recover very little or nothing at all on a business’s insolvency. Crucially, the prescribed part is, first, paid out of floating charges and, second, distributed to unsecured creditors, i.e. before the holders of the floating charges are paid. The increase, therefore, disadvantages holders of floating charges. HMRC’s elevated status will disadvantage them further still…


The Government estimates that HMRC’s enhanced status as a preferential creditor should bring an additional annual revenue of approximately £185 million to the Crown. Considering the many concerns that the Finance Act raises, however, it remains to be seen whether this additional income stream will materialise or whether the Act will, in fact, have greater stifling effects on access to finance in the United Kingdom.

For the art market, 2020 has been a turbulent year. We previously discussed many of the developments that have challenged art market professionals in 2020, including the United Kingdom’s adoption of Money Laundering and Terrorist Financing (Amendment) Regulations 2019, transposing the European Union’s Fifth Anti-Money Laundering Directive, and the impact of the pandemic on transactions in the art market.  By making access to finance less attractive for the art dealing community, the Government is not helping.

By Samuel Milucky

[i] See remarks made by Lord Palmer, HL Deb 9 June 2020, vol 803, col 1698. Many other members of the House of Lords also expressed grave concerns. For the full debate, see cols 1673-1732.

[ii] In the said debate, Baroness Burt also urged the Government not to introduce retrospective effect into the Finance Act, ibid col 1691.