Many directors of UK Limited companies believe the corporate veil protects them from any personal liability.
This is true to some extent, but when a company enters a formal insolvency, the veil can be lifted and directors can be fined, disqualified, and civilly sued if found to have committed misconduct. They can also face criminal proceedings for extreme misconduct, although this is rare.
The Insolvency Practitioner appointed in a Liquidation or Administration has a statutory duty to investigate what caused the company’s demise and whether the directors have committed any misconduct under The Insolvency Act 1986.
Until 2020, there were 5 typical misconduct claims that we would investigate. The most common act of misconduct is an illegal preference — i.e. directors preferring one creditor over another (such as paying a loan back to themselves or a family member, or paying a creditor they have given a personal guarantee to, for example).
Now we have a sixth claim to investigate — the misuse of Covid-related funds.
We have a duty to check whether furlough payments, grants, statutory sick pay, eat out to help out schemes, or Bounce Back Loan applications were fraudulently applied for, or the monies misappropriated.
Having been in the insolvency industry for 20 years, I’ve seen my fair share of claims against directors. I prefer to discuss the investigation implications with the directors upfront, so we can discover whether there’s an issue that may come back to bite them. Lately, when directors call me for advice on their struggling company, most red flags are raised in connection with Bounce Back Loans (BBLs).
Bounce Back Loans And Their Benefits
By way of a reminder, BBLs were offered to small businesses, and allowed them to borrow up to £50,000 from the government under 6-year repayment terms. The loans were 100% government guaranteed, and for the first 12 months no repayment was required, and no interest was payable.
In 2021, the government announced its ‘pay as you grow’ scheme, which allowed companies to either extend the term from 6 to 10 years, take a one-off payment holiday of up to 6 months, or make interest-only payments for 6 months.
Because these BBLs were government-backed, directors did not have to give personal guarantees, meaning that if the company enters liquidation or administration and the loan has not been fully repaid, the bank’s debt will rank as an unsecured creditor and will effectively die with the company.
However, directors can still be held personally liable if they’ve committed misuse of these funds.
Delving Into The Directors’ Conduct
Firstly, we will investigate whether any directors committed fraud in respect of the initial application for the loan by verifying that the company met the criteria to take out the loan in the first place.
For example, we’ll check if the company was already in difficulty on the 31st of December 2019, and if it was indeed adversely affected due to the pandemic.
Next, we’ll investigate what the funds were used for. The terms stipulated that the loan must
‘provide an economic benefit to the business’ and ‘not be used for personal use.‘
If we determine that there has been misuse of the funds, or that misleading information was provided in the application process, then we will report that information to the Insolvency Services.
As regards to ‘personal use’, the Insolvency Services later determined that if directors withdrew some or all of the loan personally, it might have been reasonable if it was to cover their living costs if they had no other means of getting income – like for example, in cases where these were director-shareholders who couldn’t claim for furlough funds because they weren’t paid a wage and their income had previously derived from dividends.
The Insolvency Services have got the power to then either disqualify the directors or begin civil proceedings against them.
We must advise the services when we find directors who have provided false information in connection with any Covid scheme application, or where we find that directors removed BBL proceeds for their personal benefit.
Insolvency Practitioners can also pursue the directors under section 212 of the Insolvency Act for misfeasance, and this can run in addition to, or alongside, the actions taken by the Insolvency Services.
In addition, if the directors have drawn these funds out of the company, they will usually be classed as a director’s loan account. This effectively means the company ‘loaned’ the money to the directors, and that they’re responsible to repay it – so we will ask the directors to make the repayment.
Dissolved But Not Disappeared
Some directors will try to avoid their company entering a formal insolvency procedure and attempt to have it dissolved without first winding it up.
In the past, a dissolved company would have to be reinstated in order for a director to be investigated and pursued; however, in February 2022 the Insolvency Services were granted powers to investigate the conduct of directors of dissolved companies without needing to reinstate the company first.
They also have the power to disqualify directors and issue compensation orders against them; this is a mammoth task, and I am interested to see how they will resource these investigations.
I understand they are initially focussing on dissolved companies where BBLs were not repaid. The National Audit Office estimates that of the 1.5milion BBLs made (amounting to £47billion of payments), 37% of them (worth an eye-watering £17billion) will not be repaid. In addition, it is estimated that 11% of the loans – totalling £4.9billion – were fraudulent.
Help And Advice
If you’re a director and you’re worried about the state of your business, you should seek advice from a licensed Insolvency Practitioner. Most of them are very friendly and approachable and will initially advise you for free.