Finance Bill v the Rescue Buy OutPrint publication
Draft legislation for the Finance Bill 2019/20 includes provisions which could significantly impact senior management leading a buy-out from an insolvent employer, making business rescue potentially more difficult and complicated.
In large complex restructurings and insolvencies, it is not uncommon for non-core or subsidiary businesses to be sold off separately by the ailing group, or the administrators appointed over companies in the group, to management frequently supported by private equity finance. Indeed, in many such cases, it is private equity that leads the deal, relying on existing management to provide continuity in the business and hence preserve value. This can be done in an off-market deal, but frequently will be the result of an intensive marketing effort on the part of the selling group and its advisors and/or the administrator concerned.
Some of these deals will involve the sale of the shares in the relevant subsidiary or subsidiaries to a new company formed for the purpose (Newco). However many (and almost all disposals by administrators) will involve a sale of the relevant subsidiaries’ assets and businesses to Newco, leaving control of the subsidiaries themselves (including their tax affairs) to the selling group and/or the administrator.
Draft legislation for the Finance Bill 2019/20 which is expected to come into force shortly, now the new Government is in place, includes provisions which would enable HM Revenue & Customs (HMRC) to make the senior management of companies involved in such transactions jointly and severally liable for a company’s tax liabilities, if there is a risk that the company may enter insolvency. The new provisions will empower HMRC to issue joint liability notices (JLNs) to individuals when certain conditions are met, as well as to companies which have been involved with repeated insolvency or non-payment of tax.
Where a JLN is given, the individual and the company are made jointly and severally liable for the unpaid tax, unless the company no longer exists, in which case the individual is wholly responsible for the debt.
The draft legislation specifically provides that where:
- During the 5 year period prior to the notice, the person was a director, shadow director or participator to at least two companies which have become subject to an insolvency procedure and which had outstanding amounts due to HMRC, or had failed to submit a relevant return or other document it was required to submit, or a relevant claim, declaration or application for approval made by the company had not been determined when they did so (the old companies);
- The person is a director, shadow director, participator, concerned (directly or indirectly) or takes part in the active management of another company (the new company) during that period, carrying on a trade similar to at least two of the old companies;
- At least one of the old companies has a debt of at least £10,000 outstanding to HMRC when the notice is issued and that sum represents at least 50 per cent. of the total amount due to creditors; and
- The notice is issued within two years of HMRC becoming aware of the facts sufficient to conclude that the conditions above were met.
In those circumstances, the relevant individual served with the notice will be jointly and severally liable with the new company for: (i) any unpaid tax liability of the new company; (ii) any tax liability of the new company that arises during the period of 5 years beginning with that day; and (iii) while the notice continues to have effect. If there is any liability of an old company that is unpaid on the day on which an individual is given a notice, the individual is also jointly and severally liable with that company and any other individual given a notice for that liability.
There is, crucially, an appeal mechanism against a JLN. HMRC can be required to undertake a review of its decision to issue a JLN, as would happen in any ordinary tax appeal. The new provisions also give a recipient of a JLN the ability to dispute its quantum, even in circumstances where the company that holds the primary liability no longer exists. However, even if there were time to do so (rescue transactions, frequently need to complete within a very tight timeframe) there is no proposed clearance procedure allowing parties to proceed safe in the knowledge that HMRC has confirmed, in advance, that no JLN will be issued.
The new rules are stated to take effect from the date of royal assent of the Finance Bill 2019/20.
The stated aim of this change in the law is to discourage “phoenixism”. However, on the face of the proposed legislation, as presently drafted, it could have very wide implications for business rescue and those engaged in providing the necessary funding across the whole spectrum. Most providers of finance to a buy-out, whether private equity or debt funders, would prefer to transact where existing management remains involved. Experience would suggest that, generally speaking, management buy-ins are more likely to fail and are therefore inherently more risky, than management buy-outs. It would seem to follow, therefore, that if private equity funding is to play a role in corporate rescue, existing management’s continued involvement is paramount.
In many corporate groups, the operational management of subsidiary companies (including those with a finance function) will have little or no control, or indeed knowledge, of their company’s tax affairs. That is a head office matter, for which most subsidiary managers (including at director level) would consider they have no responsibility. Instead, they have focussed their attention on the operations and performance of the subsidiaries for which they are responsible, running businesses which are successful in their own right and which find themselves in an insolvency process through no fault of their own. It is those management teams that third party finance is looking to support. However, should this legislation become law, any individuals involved in the senior management of two or more subsidiaries in a larger group, could clearly face a real personal financial risk, should they decide to try to save their part of the business by leading a management buy-out out of corporate distress. By leading such a buy-out they could make themselves personally liable for all of their previous companies’ unpaid tax, as well as any unpaid tax in their new MBO vehicle for the next five years.
The one saving grace of the proposed legislation is that the tax liability has to represent 50 per cent or more of the amount owing to all creditors. This would suggest that the intention of the legislators is to target blatant tax evasion. However, where companies are part of the same VAT tax group, quite small companies can find themselves jointly and severally liable for the whole of the group’s VAT, which could be a significant proportion of their creditors. As a consequence, the new rules would seem to catch transactions the purpose of which is not linked to tax evasion.
The great advantage of English insolvency procedures over many other systems is the flexibility it brings to business rescue. Many jobs are saved, and other stakeholders’ positions preserved, where businesses are sold as part of the restructuring process. With the amount of funding presently available to do deals, private equity clearly has a part to play in this, if only to keep up the value of businesses which might otherwise find themselves in the hands of a competitor at a knockdown price. For the reasons given above, third party funders will only get involved where there is a committed, incentivised management team to support. Management will not want to be involved where to do so could leave them unduly exposed to their old companies’ failure.
It may be possible to remove or mitigate this risk, by acquiring the shares in the relevant subsidiaries themselves, by comprehensive and expensive tax due diligence, such that the wider MBO team can get comfortable that the old companies’ tax liability is sufficiently low, or by providing for (and funding) any possible JLN in the Newco financing structure. However, it seems clear that, unless there are significant changes made to the current drafting before it becomes law, these provisions could be another nail in the coffin of our once-prized rescue culture. They will need care and skill to navigate around.