Hot on the heels of our April 2020 article on the proposed reintroduction of the Crown preference, Parliament has recently approved legislation that will increase the ring-fenced amount available to unsecured creditors on an insolvency of a company from £600,000 to £800,000.
What is this ring-fenced amount and why is it increasing?
When a company enters into an insolvency process its assets are realised and distributed in the order of priority described in our Crown preference article. Unsecured creditors are pretty much at the bottom of this waterfall, sitting just above the insolvent company’s shareholders. This means that if there are insufficient funds in the insolvent estate to pay creditors in full they are likely to receive only a percentage of the sums due to them or, worse still, nothing at all. This is where the ring-fenced amount (known as the “Prescribed Part”) comes in.
The Prescribed Part is a specific monetary amount set aside for the unsecured creditors out of the floating charge realisations; it ranks above, and is paid out before, the balance of the floating charge recoveries. The Prescribed Part was introduced in 2003 and capped at a maximum of £600,000; that cap is increasing to £800,000 to adjust it in line with inflation.
Impact of the increase
An increase in the Prescribed Part is good news for unsecured creditors obviously, as it should increase their percentage recovery of the money they are owed.
The opposite applies to floating charge holders as their ‘pot of cash’ will diminish; but in view of that the increase in the Prescribed Part will only apply to floating charges which are created on or after 6 April 2020 where the insolvent company’s net assets exceed £2,985,000. The existing £600,000 cap will apply in all other circumstances. The Prescribed Part does not apply at all to floating charges created before 15 September 2003. Nor does it apply to a charge created or arising under a financial collateral arrangement.
It also worth remembering that a floating charge holder can, prior to receiving a distribution out of the insolvency in realisation of its security, surrender that security and participate in a share of the Prescribed Part if it concludes that there is some benefit in doing so. For example, if a junior floating charge holder realises that enforcement proceeds on a given deal are insufficient to repay the senior qualifying floating charge holder in full, its security is effectively commercially worthless and therefore will do better by surrendering it to participate in a share of the Prescribed Part. Although this would undoubtedly impact recoveries for the other unsecured creditors and hence arguably undermine the rationale for the Prescribed Part, it is worth bearing in mind for any secured creditor as an option.
What could this mean for future lending?
Funders entering into new transactions post-6 April 2020 should bear in mind that their pot of floating charge realisations will be reduced by a further £200,000 where the insolvent company’s net assets exceed £2,985,000. As a consequence, funders should consider whether the “value” of their fixed security will plug that gap and/or if other collateral is available to fill that void.
Tim Carter, co-head of Restructuring & Insolvency at Stevens & Bolton comments: “Approximately 25% of floating charge realisations are used to settle government creditors (e.g. HMRC) as the government’s explanatory memo (regarding the increase in the Prescribed Part) notes. Therefore although HMRC will be set certainly to benefit, so will the other unsecured creditors. For funders, the increase may make them a little more circumspect in their lending decisions if the borrower has little in the way of fixed charge assets. This scenario though is relatively uncommon – in most cases funders have multiple “recovery avenues” in a corporate insolvency including via fixed charge security and/or corporate and personal guarantees, together with other forms of credit support. So whilst of theoretical relevance, my thinking is that increasing the Prescribed Part cap for new floating charge realisations of insolvent estates worth more than £2,985,000 is unlikely to reduce the availability of credit or make it more expensive in and of itself.”