Where is the line between legitimate company failure and misuse of funds by directors?
A PREDICTION – STARTING Now and well into 2021 we expect to see more Civil and Criminal Law claims against Directors personally from HMRC, from the Insolvency Service and from Liquidators of failed limited company businesses, arising out of Covid Loans and Grants, including Bounce Back Loan Schemes, the Job Retention Scheme and others. These claims – including director disqualification investigations – are already happening and will, we predict, grow in number as insolvencies increase.
This article looks at:
- The basis on which the taking of Covid Loans and Grants can result in claims for repayment, Director Disqualification and even criminal proceedings against the Director personally, where the funds have been misused.
- What the well-advised Director can and should be doing, right now, to be best protected in the event of such claims and reduce the threat of director disqualification.
THE POSITION RIGHT NOW – A REAL LIFE CASE
In a case where NDP’s Insolvency Law solicitors are currently instructed, Liquidators are already pursuing recovery of a total of £250,000 in loans and grants from Directors personally (see below) from:
- Coronavirus grants of £150,000 – made to a now liquidated limited company business pursuant to the Coronavirus Retail, Hospitality and Leisure Grants Fund (‘the Grants’).
- £50,000 loans made to the company under the Bounce Back Loan Scheme (‘the BB Loan’).
- Repayment of £50,000 paid to the company under the Job Retention Scheme (‘JRS’), from Santander.
The key for the director disqualification angle, of course, is whether the directors have misused these taxpayer funded loans and grants
No right thinking person is likely to object to personal recovery action being taken against Directors (and ‘Managers’ (see below)) who have received and then misused Taxpayer funds intended for and paid to help a company stay alive, during the pandemic.
WHICH DIRECTORS ARE LIKELY TO BE ATTACKED & FACE DIRECTOR DISQUALIFICATION OR MORE?
However, what about Directors who caused the Company to take the Loans/Grants but then failed to repay before the Company went into liquidation, but, crucially, where there was no obvious or blatant misuse of the funds? Where is the line between legitimate company failure – ‘I tried but failed to trade through’ – and the Director who becomes personally liable for misconduct?
COMMENT – WHICH THREATS WILL DELINQUENT DIRECTORS FACE?
The only certainty is that Liquidators, HMRC and the Insolvency Service will be looking at every such company failure very closely indeed, with the delinquent Director looking down the barrel of one or more of the following threats:
- Financial recovery proceedings against the Director from the Liquidator and/or HMRC for misuse of Covid loans and grants. HMRC have indicated that it may seek to treat even the smallest of unpaid Loans received as remuneration in the hands of the Directors, being liable to Income Tax.
- Director Disqualification investigations and Director Disqualification proceedings against the Director, under section 6 of the Company Director Disqualification Act 1986, alleging that the Director has engaged in ‘Unfit Conduct’ (the legal test) that requires Director Disqualification proceedings to be threatened against the Director.
- Criminal Law investigations and Criminal proceedings arising from Police, HMRC or Insolvency Service investigations, in respect of the alleged misuse of funds received by the Company, with the possibility of Criminal Confiscation proceedings (i.e. asset recovery) against the convicted Director.
A REAL LIFE EXAMPLE
As stated above, we have recently seen our first such case in August 2020, where a Liquidator is pursuing our Director client personally for recovery of £250,000.
The company went into voluntary liquidation in June 2020, having received the Grants, the JRS funds and the BB Loan soon before then.
- WHAT IS THE BASIS OF THE LIQUIDATOR’S CLAIMS IN THIS CASE? WHAT CAN BE DONE TO DEFEND THE DIRECTORS?
The Liquidator alleges that the Directors have breached their statutory duties owed to the company (owed under sections 171 to 178 of the Companies Act 2006), on the specific facts of this case, by having applied and used company funds to pay off the Director’s personal financial liabilities and to set up the Director’s new trading entity, in anticipation of the failure of the company.
Even a cursory look at the facts of this case, suggests that the Liquidator has been far too eager to shout Misfeasance and breach of statutory duty, without his having first sought explanations from the 2 Directors (that in itself is remarkable). Nonetheless, the claims have been made.
For what it is worth, the 2 Directors deny personal liability to repay the sums to the company/its Liquidator. In our view, the Liquidator has failed to look at or take into account all of the particular facts of this case. Had he done so we believe he would have reached a different conclusion. Our task is to bring these matters to the Liquidator’s attention.
THE WIDER PICTURE RELATING TO COVID GRANTS AND LOANS
Here we look at a few basic principles and make a few predictions:
- The purpose of the Grant/Loan when looked at with the actual use of the funds is a good starting point to decide whether there has been misconduct by the Director. We confidently predict that because a Loan or Grant may not have been used for precisely the purpose for which it was given, that may not on all the facts of the case, amount to a breach of statutory duty by the Director and will not thus create a personal liability for the Director.
- The obligation is on a company to repay the BB Loan, the JRS funds or the Grants made to it. This is a starting point, governed by the terms of the agreements on which the Loans and Grants were made to the company.
- What happens at liquidation? Once the receiving company goes into liquidation, there is no automatic obligation or liability on the Director personally, to repay the Loan/Grant, whether to the maker of the Loan/Grant or to a Liquidator, absent a Personal Guarantee to repay. Every case is different and will turn on its facts.
- The Liquidator may have the opportunity to try and reclaim such monies from the Director, if the Director acted improperly, in using the Loan/Grant. The Liquidator will likely claim using the gateway of section 212 of the Insolvency Act 1986 which (in abridged form) states:
‘212 Summary remedy against delinquent directors, liquidators, etc.
(1) This section applies if in the course of the winding up of a company it appears that a person who:
- is or has been an officer of the company,
- has acted as liquidator or administrative receiver of the company, or
- not being a person falling within paragraph (a) or (b), is or has been concerned, or has taken part, in the promotion, formation or management (our emphasis added) of the company…..
….has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company.’ (our emphasis added)
We can thus see that the persons who are potentially liable to repay are the Directors of the company and personS involved in the management (emphasis added) of the company. ‘Management’ is a term that is very widely construed, as shown by decided case law on this subject.
WHAT REMEDY IS AVAILABLE TO THE LIQUIDATOR?
‘(3) The court may, on the application of the official receiver or the liquidator, or of any creditor or contributory, examine into the conduct of the person falling within subsection (1) and compel him:
- to repay, restore or account for the money or property or any part of it, with interest at such rate as the court thinks just, or
- to contribute such sum to the company’s assets by way of compensation in respect of the misfeasance or breach of fiduciary or other duty as the court thinks just.’
COMMENT – IT IS THE PARTICULAR FACTS OF A CASE THAT REALLY COUNT
A Director who liquidates his/her company without repaying Loans and Grants, without giving serious thought/taking prior legal advice about the position, is potentially running headlong into problems. Cases will turn on their own specific facts.
- SO, WHAT SHOULD THE WELL-ADVISED DIRECTOR DO?
- Get the factual story of the taking of Loans/Grant straight and committed to writing before
- Assuming a creditors voluntary liquidation is envisaged by the Directors, then before taking that step, the Director needs to carefully document, in writing, the full circumstances in which the Loan(s) and Grant(s) were taken, why they were taken and why the funds were applied in the way they were.
- Copies of the Loan and Grant applications (and documents evidencing the permitted purpose of the Loans and Grants) need to be very carefully considered. Were the monies applied as intended and if not, why not? (there is not necessarily a fatal answer here).
- Such an explanation needs to be undertaken by reference to (and be supported by) contemporaneous documents, to include documents that evidence the then financial position of the company and should (where possible) refer to business plans, cashflows and professional advice that may have been obtained in the lead up to liquidation.
- Before formally instructing a Licensed Insolvency Practitioner to liquidate the company, the Director should have before him, a written explanation of the above matters (supported by documents) that the Director/Manager can rely upon in his/her dealings with the Liquidator. The Director’s choice of Liquidator can be particularly important. Not all Liquidators behave in the same way.
- BOOKS AND RECORDS OF THE COMPANY
The Director should be in no doubt that his/her recollection of key events will fade and his/her ability to support the position with documents, may well be lost/diminished, once the Director has complied with his/her statutory obligation to deliver up to the Liquidator, the books and records of the company. Failure to do so is a Criminal law offence by the Director, under the Companies Act 2006 with the applicable sanction of the Director being fined or even imprisoned for breach of this section.
- TAKE LEGAL ADVICE
The Director should seek and obtain legal advice, to assist him/her in the preparation of the above before liquidation.
PREPARE NOW TO AVOID DIRECTOR DISQUALIFICATION AND OTHER PROBLEMS LATER
- Statements from third parties (who may have assisted in Loan/Grant applications, for example Accountants) should be obtained now.
- Copies of papers held by third parties (for example, the Accountant’s files) should be obtained now. Remember that the Liquidator, once appointed, is entitled to delivery up of those papers from the Accountant. Getting copies after the event is a much trickier task.
- The Director should consider taking a mirror image of the company’s IT server before liquidation, to ensure that all emails and other documents are captured. That mirror copy should be deposited with the Director’s Solicitor, so as to attract legal professional privilege. This will prevent that document having to be delivered up to any third party, to include the Police.
This may seem like a draconian step to take, but our experience shows that taking this step now may avoid a heap of angst, time and money spent on fees further down the line.
PROVIDE THE DOCUMENTED AND EVIDENCED STORY TO THE LIQUIDATOR
The Liquidator has a statutory duty to report to the Secretary of State on the conduct of all Directors. The failure of the company to repay Grants and Loans will inevitably be a matter to be reported in most if not all cases.
Providing the Director’s side of the story to the Liquidator at the outset, hopefully ensures the Liquidator understands what has gone before.
CONCLUSION – PREPARE FOR ALL EVENTUALITIES
As with most things, preparation is everything. It is not a foregone conclusion that director disqualification investigations, repayment claims, or even criminal proceedings will ‘succeed’ when a company is liquidated and has not paid back its Covid Loans and Grants. However, following the advice above will help a great deal, as will taking legal advice from our experienced director disqualification and misfeasance solicitors.
The focus of HMRC, the Insolvency Service and Liquidators is very heavily focused now on possible misuse of Covid Grants and Loans by failed companies. If you are, or a company you know is, in this position, the sooner you call us on 0121 200 7040 or contact us, the more we can do to help.