Dilemma for Insolvency Practitioners

A couple of weeks into the coronavirus lockdown the Government announced the Bounce Back Loan Scheme to help businesses’ through the crisis. Under this scheme loans of between £2k and up to 25% of a business’ turnover, up to a maximum of £50k could be obtained from a bank, which were 100% guaranteed by the Government.

The eligibility criteria was very wide. The scheme applied to most UK based businesses established before 1 March 2020, where the business has been adversely impacted by the coronavirus.

On the face of it this is a very generous scheme, with a low rate of interest and no repayments for the first 12 months. It is a matter of fact as to whether or not the business is UK based and the date it was established. Seemingly the only area of contention is likely to be whether or not the business has been adversely impacted by coronavirus. That is going to be a judgement call, but in the current economic circumstances, unless you were manufacturing/selling PPE it is not difficult to see how most businesses could claim to have been “adversely impacted”

What then is the issue for borrowers under the scheme?

We have recently become aware of instances where existing lenders have made it clear that they would have no objection to the Bounce Back Loan being used to repay part, or all, of an existing secured loan. Similarly we have heard from directors considering taking the Government guaranteed loan, to pay outstanding Corporation Tax/VAT and existing secured loans, that they have personally guaranteed.

In the event that the business continues and repays the Bounce Back Loan then there is no issue. However problems could arise where a company goes into liquidation and the Bounce Back Loan is not repaid. Many directors and indeed some advisers we have spoken to are under the misapprehension that because the Government have guaranteed the loan that will be the end of it. That may not be correct where a company becomes insolvent and goes into a formal insolvency procedure.

In all liquidations and administrations, the duly appointed Insolvency Practitioner will carry out an investigation into the demise of the company, in particular looking at what monies have been received from the bank and how those funds have been spent. They are looking for ways in which the directors have personally benefited, with a view to challenging certain transactions and recovering money for the insolvent company. An obvious and absurd example might be if a director used  a £50k loan to buy a watch. Most people would see that that was a misuse of the company’s monies for the directors personal benefit and expect that it is something that could be overturned.

Matters become more interesting when the loan is used to repay existing borrowing. The director might argue that little has changed. One lender has in effect been substituted for another. However what if the director had guaranteed the prior loan. By using the Bounce Back Loan to repay the prior loan, the director has put themselves in a better position than they otherwise would have been in as they have not guaranteed the Bounce Back loan. They have improved their position. In Insolvency parlance, they have Preferred themselves. Liquidators and administrators have specific statutory remedies to allow them to bring actions against the directors in such a situation.

Directors and their advisers need to give consideration as to what the Bounce Back Loan is used for. We expect that many recipient’s of the various Government schemes will, through no fault of their own, fail. Where this happens be aware that an Insolvency practitioner, as part of their functions, will be looking back to see what you borrowed, what you utilised the funds for and to see that you did not benefit at the expense of your other creditors. The vast majority will have used the funds as intended, to try and keep their business going.