Whilst the corporate insolvency market continues to be fairly quiet, the number of queries surrounding the risks to directors following the use of various government backed initiatives is on the rise.
From March/April 2020 the future of many businesses, even those which were flourishing, was brought into question as a result of the COVID-19 pandemic. In response the government launched various initiatives to help businesses and protect the economy.
Many businesses opted to claim furlough payments to protect their employees while they could not work, and/or take out a bounce back loans (or similar) to help the business get back on track.
Back in April we reported in a blog that many accountants and advisors considered their clients to fall into one of 3 camps, reflecting the impact on them as a result of the pandemic.
1. Cash rich or 'business as usual' so there would be no material impact;
2. Good businesses that were '50-50' as to whether they would be able to get back on track following lock down, despite the available government backed loans and grants; or
3. Businesses that were already trading 'on the edge' before COVID19, but are waiting to see what happens.
Directors in the 2nd or 3rd group are now concerned for the future of the businesses and what implications may exist if they have benefited from government back initiatives. In this blog we focus on two key queries we have received:
1. The company received furlough monies from HMRC. Will this cause me an issue if I place the company into an insolvency process?
2. We decided to take out a bounce back loan but I can’t see how we’re ever going to be able to repay it. Is that an issue?
It has been widely publicised that HMRC are cracking down on companies who “may have made a mistake” in their claims. Recent reports suggest that over 3,000 employers have been contacted so far with HMRC understandably showing less concern to businesses that have made innocent errors, and more so to those who may be found guilty of lodging fraudulent claims. The chief executive of HMRC has stated his belief that 5-10% of furlough claims may have been made in error (innocently or not).
Will the insolvency effect this? No, is the short answer.
Whilst we suspect that the misuse of furlough funds will be something looked at in greater detail in the coming months, and relevant case law will follow, there is not much to go on at present other than the legal interpretation on the strict purpose stipulated within the provisions of the Coronavirus Job Retention Scheme. It is argued by many that the furlough funds received from HMRC are effectively held on trust by the employer to be paid over to the employees. If the funds are not used for this purposes, HMRC are likely to ask for repayment.
As for the directors, the misuse (or inappropriate claim) of furlough monies on a fraudulent level is likely to result in action against them by HMRC. In the event of insolvency, the insolvency practitioner will need to assess the actions of the directors to determine if they have acted appropriately. If not, it is possible that the insolvency practitioner may also have a claim against the directors, most likely under the misfeasance provisions, and action will be taken accordingly.
It is therefore of great importance that all directors are advised of the strict use of furlough monies. If the company appears to be insolvent and the directors are unsure on how to utilise funds held, they should liaise with an insolvency practitioner at the earliest opportunity to protect themselves.
If furlough monies have been claimed correctly, and used to pay on to the employees and discharge relevant tax liabilities, there is nothing to worry about. If they have been used in any other way, talk to us urgently.
Bounce Back Loans
With many businesses reopening their doors earlier this year following the lock down, cash injection was vital to assist with working capital restraints. A bounce back loan seemed to have been the perfect option for these businesses, with the 100% government backing and flexible repayment terms they were more attractive than any other loan facility on the market.
Whilst there are no obvious restrictions attached to bounce back loans, they were designed to help businesses ‘bounce back’. But what about those businesses that have simply not been able to ‘bounce back’? Will the use of the loan be scrutinised in the event of insolvency?
In very brief terms, if the bounce back loan has been used to cover everyday business expenditure there should be no risk for the directors in the event of insolvency. An acceptable use of the funds could include ongoing wages, purchase of goods, payments on account to suppliers, purchase of assets etc. So, if payments have genuinely been used for business expenditure, and there was a genuine belief at the time that the company had a chance to ‘bounce back’, directors should have no risks associated with their decision to take out the facility.
There has, however, been a recent trend of enquiries regarding the drawing of dividends by shareholders from the loan monies, or just a general use to cover living expenses with there being no reasonable prospect of a business ‘bounce back’ when the loan was taken out. The enquiries come from smaller director-owned businesses who many believe were 'left behind' when the government announced their support packages back in March/April. Whilst we remain sympathetic to the impact lock down has had on smaller director-owned businesses, typically remunerated by way of a basic salary with a dividend top up for tax efficiency, these scenarios could present an issue in the event of insolvency.
We all know that dividends may only be declared from distributable reserves. If there were no distributable reserves to declare a dividend, the insolvency practitioner is obliged to demand repayment. Also, and regardless of the above position, the insolvency practitioner must form an opinion as to whether the use of the funds by the directors, for dividends or otherwise, was appropriate given the financial state of the company at the time. This is never an easy task, but if it becomes evident that directors have taken out bounce back loans with little if any prospect of repayment, an action against the directors may be necessary.
How to manage the risks
If any of the scenarios detailed within the blog appear to relate to your company, or perhaps a client, we would strongly urge you to contact us for some free, confidential and no obligation advice. We will work with you to clearly understand the options for the company, as well as the potential risks that may exist for the directors.
If you would like some further information, please contact us. We are here to help.