Anthony Milnes discusses some of the key issues advisers should be aware of when talking to clients.
Many companies took advantage of much-needed government funding during the early stages of the pandemic – especially the bounce back loan (BBL) scheme – but with businesses continuing to struggle as we come out of lockdown they can cause concerns for business owners.
Bounce back loans – some background
The bounce back loan scheme provided quick access to funds to help companies survive the effects of lockdown on their business and hopefully avoid a potential insolvency procedure – particularly in the short term.
With no repayments required or interest charged for 12 months, a subsequently low interest rate of 2.5% and duration of repayments which can now be spread over 10 years, it is clear why many SMEs took them. But as things return to a ‘new normal’ many business owners need to assess the long term effects on their finances.
Due to the unprecedented demand for BBLs at the height of the pandemic, limited checks were carried out by the banks and directors simply had to self-declare that the company was eligible. Most business owners took these loans for genuine reasons – but there is anecdotal evidence of directors that abused the scheme.
With loan repayments starting to become due, the furlough scheme having ended in September and an imminent return of creditors’ ability to issue Winding Up Petitions – we are talking to more and more accountants and their clients about the challenges businesses are facing and what their options are – as well as their duties as directors – should a business fail.
Acting in best interest
As a general piece of advice – and not directly related to the pandemic or bounce back loans – directors should always act in the best interests of the company and its shareholders, but where a company appears to be unable to pay its debts then directors’ duties shift to acting in the best interests of the creditors of the company.
If it appears that a company is unable to repay its debts, then directors should seek professional advice from an Insolvency Practitioner as soon as possible – the sooner a problem is identified then the greater the range of options is likely to be.
Where these debts include a bounce back loan, directors should not panic, provided (as has always been the case) that the directors’ conduct is not likely to be challenged eg. they have not acted fraudulently in obtaining the loan or misappropriated the funds in any other way.
Fraud and Bounce Back Loans
As has been the case over many years of corporate insolvency – the vast majority of directors of failed businesses tried their hardest to make it a success and attempted to run the company in a proper manner. In these cases, it is unlikely that their conduct would have been questioned by an IP or the Insolvency Service.
But there has always been a minority whose conduct has not been good enough – ranging from, for example, preferring one creditor over another – right through to wholescale fraud.
With an increasing number of directors seeking advice about a struggling business and what they should or should not have used the bounce back loan for, here’s a bit of guidance:
When is it fraud?
Examples of fraudulent cases would commonly include where more than one bounce back loan was obtained for a company (not including a topping up of a bounce back loan from the same lender) and where the directors knew that the company would be entering an insolvency procedure when the bounce back loan was applied for.
It may also be considered fraud where the directors overstated the company’s turnover in order to receive a larger loan than it was entitled to and where the bounce back monies were not used for the benefit of the company.
The guidance provided by the Insolvency Service is that a 25% tolerance is allowable for directors of a company when they were stating its turnover, so if a company had a turnover of £160k during 2019 and the directors had estimated the turnover to be £200k and obtained a £50k bounce back loan, then this is within the tolerance and therefore, in isolation, will not be reported as fraud.
Although the bounce back loans were to be used for the benefit of the company, it is recognised that directors still require an income and where the wages paid and/or dividends drawn were not excessive and were in line with wages/dividends drawn prior to the pandemic, then this would not ordinarily be considered a fraudulent use of funds. However, directors should be mindful that where dividends have been drawn and the company did not have the available reserves, then these may constitute illegal dividends which would need to be repaid should the company fail.
Director’s Responsibilities
If a company fails, then transactions made which were not in the best interests of the company (or creditors when the company is insolvent) can result in claims against the directors for misfeasance resulting in personal liability and potential disqualification from acting as a director.
Directors should not prefer a creditor, ie. pay one creditor ahead of the other particularly where this benefits themselves or a connected party. This includes repaying themselves or connected party loans ahead of other creditors or repaying loans where the directors or a connected party has provided a personal guarantee. Such transactions are known as preferences and can be overturned by an Insolvency Practitioner if the company enters an insolvency procedure and could result in an adverse conduct report for directors which could lead to disqualification. Bounce back loan funds should not be used to repay existing loans which are subject to a personal guarantee, with the intention of reducing the directors’ personal liability, as this may constitute a preference and can be overturned on the failure of a company.
The suspension on wrongful trading action ended on 30 June 2021 and therefore directors should ensure that they do not continue to trade at the detriment to creditors if it appears unlikely that the company can avoid an insolvency procedure. Directors can be held personally liable for the debts of the company from the point where they should have ceased to trade.
Whilst a company may have funds remaining from a bounce back loan, if directors conclude that the company is unlikely to avoid insolvency then the financial position of the company should be preserved from this point, the bounce back loan funds should not be used and professional advice should be sought as soon as possible.
Summary
Directors being concerned about their conduct and their obligations when they see a business beginning to fail is an age-old problem. And, while the majority of directors have nothing to worry about in terms of whether their actions were detrimental to the company and its creditors in the event of an insolvency, there have always been those whose standards are not high enough.
The events of the last 18 months and the necessary government schemes like BBLs has not changed that, although the ease with which such funding could be accessed and the desperate times that business owners have found themselves in may have increased the chances of directors acting inappropriately.
As things return to normal but businesses face further challenges ahead then directors are going to find themselves trying to solve problems which may, in some cases, lead to an insolvency of the business.
Our advice to people in that situation is always to talk to your advisers and an IP as soon as possible as the sooner a problem is spotted then the greater the chance of remaining in control and maximising the number of positive options.
For further information or to discuss any of the above, please do not hesitate to get in touch with Ant on Anthony.milnes@leonardcurtis.co.uk or contact your local team.