We have recently been asked about the approach an IP might take when dealing with the directors of a company that is considering an insolvency solution, but has received one or more of the Government's Covid-19 support packages. This article explores some ideas, mainly dealing with corporate insolvency procedures, although we briefly consider the situation in a solvent MVL near the end. We cannot cover every detailed requirement in one article and we have not considered the position in personal insolvencies, but this should provide a reasonable airing for some of the key issues.
There are basically three types of Covid-19 finance that might be offered to an IP as funding for an insolvency procedure at this time: grants; furlough payments; and loans. We will also consider deferred VAT, as funds created by deferring payment on a VAT quarter might also leave cash in a business to fund an insolvency procedure.
Grant funding is available in two forms. Under the Small Business Grant Fund (SBGF) all eligible businesses in England in receipt of either Small Business Rates Relief (SBRR) or Rural Rates Relief (RRR) in the business rates system will be eligible for a payment of £10,000. Under the Retail, Hospitality and Leisure Grant the local authority will automatically pay between £10,000 and £25,000 per property based on the rateable value of the business property. Under both schemes the business had to be in occupation of the rateable property as at 11 March and should not have been an “undertaking in difficulty on 31 December 2019”.
An ‘undertaking in difficulty’ is defined by the EU General Block Exemption Regulation (GBER) (2014) as an undertaking in which at least one of the following circumstances occurs:
a. In the case of a limited liability company (other than an SME that has been in existence for less than three years), where more than half of its subscribed share capital has disappeared as a result of accumulated losses. This is the case when deduction of accumulated losses from reserves (and all other elements generally considered as part of the own funds of the company) leads to a negative cumulative amount that exceeds half of the subscribed share capital.
b. In the case of a company where at least some members have unlimited liability for the debt of the company (other than an SME that has been in existence for less than three years), where more than half of its capital as shown in the company accounts has disappeared as a result of accumulated losses.
c. Where the undertaking is subject to collective insolvency proceedings or fulfils the criteria under its domestic law for being placed in collective insolvency proceedings at the request of its creditors.
d. Where the undertaking has received rescue aid and has not yet reimbursed the loan or terminated the guarantee, or has received restructuring aid and is still subject to a restructuring plan. e. In the case of an undertaking that is not an SME, where, for the past two years: 1) The undertaking’s book debt to equity ratio has been greater than 7.5 and 2) The undertaking’s earnings before interest, tax, depreciation and amortization (EBITDA) interest coverage ratio has been below 1.0.
While the situation would be different for a company considering an MVL, it appears likely that many businesses seeking a formal insolvency solution triggered by the Covid-19 restrictions may have been in financial difficulty for some time. One factor that an IP will have to consider when approached by such a business is whether the funds were correctly obtained by the business. If the business was already in trouble in December 2019, but the directors have declared that it was not, the grant may have been obtained fraudulently, making the funds proceeds of crime and subject to the Anti Money Laundering legislation. You would have to report your findings without tipping off the directors, and if you take the appointment you would need permission under the Money Laundering framework in order to use the funds, and that would apply in respect of your fees irrespective of whether they were paid by the company pre-appointment, or out of assets realised and with the approval of creditors post appointment.
It is, however, quite possible in the extreme circumstances of the current crisis, that a perfectly viable business has suffered such a catastrophic failure that it cannot continue. If you are approached by such a business, which received the grant funding, but it simply was not enough, so that the directors now want to liquidate the company, then it becomes a more subjective decision. Normally, an IP’s work is funded by money that someone else has lost. It is a harsh reality that the money that pays for insolvency proceedings had to come from somewhere and the unsecured creditors usually bear the brunt of the cost. On one hand, it could be argued that unused grant funding is the same as any other money left in a company that is being placed into an insolvency process that is available to pay the costs. If the funding was correctly given to the company, which was not in distress at the time, but subsequently found that the changes in the economy made continued survival impossible, the remaining funding is available to fund the insolvency. There is a morally charged argument that the surplus funds should be returned to the national coffers for the greater good, but quite apart from the fact that there is no procedure for such an approach (a grant can be refused, but we cannot find any provision for returning some of the funds once granted), it would simply leave the company as a zombie and the directors with no closure. It might also have a knock-on effect on employees, suppliers, and others. On balance, in order for the insolvency process to work, the grant funds must be available to the potential office holder for fees and, potentially, for distribution to the creditors in the normal order of priority.
The second form of available funding is furlough payments, or to give them their correct name, the Coronavirus Job Retention Scheme (CJRS). The scheme pays 80% of the salary of any employees who are “furloughed”. An employee is furloughed if there is evidence of an agreement between the employee and the employer that from a set date the employee will not do any work because of the coronavirus, for a period of at least three weeks. There are various complicating factors, such as the fact that the company can even furlough its directors and that staff that were made redundant or who left recently can be re-employed and furloughed to give them access to funds released under the scheme. It is up to the employer whether they pay the employee just the 80%, or their full salary before claiming the 80% back. The scheme has two main aims. One is to help companies retain staff that can be used when the restrictions are lifted and the company can operate again, thereby reducing the long term economic damage of the shut-down. The other is effective a social benefit, in that it keeps at least some income in the hands of the individual, reducing their claim on other benefits in the welfare system. There is no condition in CJRS that the company must continue. Although intended partly to allow the company to continue, CJRS just reimburses money that has usually already been paid out to employees. Without the scheme the company would fail more quickly and the employee would get nothing.
There are already administrations running where employees, and CJRS, are important factors. There is case law in respect of the administration of Carluccios about the adoption of employee contracts when employees are furloughed and there are likely to be further rulings as other major retailers use something like a light touch administration to manage their transition into a post-Covid-19 economy. Those cases are already using CJRS monies to an extent and we have less difficulty with that than we might with the grant funding mentioned earlier. With CJRS, the company has generally already paid out the salaries and is reclaiming money already paid. If that money is held and used to start an insolvency process for the business, the employees have benefitted as expected and, even if the business may not survive long term, the original public policy objective of softening the blow has been at least partly achieved. From the IP’s perspective, he is simply working with a slightly lower “pot” than he would have done if the company had first entered an insolvency process without paying employees under the CJRS. Even under CJRS, there are situations where it might be problematic to use the funds that have been made available in the insolvency. Although CJRS payments are usually made after the employer has paid the employees, it is likely that we will see cases where a claim was made with the intention of paying the employees from the funds, but those payments were never made. If you are an IP approached by a director in those circumstances, you will be in a similar position to the one above where you are aware of a fraudulent grant application. It will be a matter for the relevant authorities to decide in due course whether the money was obtained fraudulently, but you will have to report your findings without tipping off the directors, and if you take the appointment you would need permission under the Money Laundering framework in order to use the funds.
The third category of payments is where a loan has been obtained under one of the Government’s loan guarantee schemes. The Coronavirus Business Interruption Loan Scheme (CBILS) allows banks to make loans of up to £5m with the government covering the first year’s interest payments and any fees under a Business Interruption Payment and then guaranteeing 80% of the loan. The Coronavirus Large Business Interruption Loan Scheme (CLBILS) allows banks to make much larger loans, with the Government guaranteeing 80% of the loan. There are suggestions that the government may guarantee a higher percentage of the loan under one or both schemes soon, but for the purposes of this article, that should not make a lot of difference. The main relevant factor for these schemes is that the banks will only loan the money to viable businesses. Some commentators suggest that the banks are being too cautious in their assessment of what is viable, or may be asking for too much information before making a decision. It is possible that you may be approached by a company that has just received loan funding, but it seems more likely that potential insolvencies that include this type of funding will become more common in a few months, when the economy is starting to recover, in whatever format, and businesses are looking to restructure their whole operation, which will include any CBILS or CLBILS. It is likely that any money available to fund the insolvency process is likely to be funded, at least in part, by money derived from CBILS or CLBILS.
As mentioned above in respect of grant funding, it is a harsh reality that the money that pays for insolvency proceedings had to come from somewhere and the unsecured creditors usually bear the brunt of the cost. Here it is easier to argue that unused loan funding is the same as any money left in company that is being placed into an insolvency process that is available to pay the costs. If the funding was correctly given to the company, which was viable at the time, based on an honest application, but the company subsequently found that the changes in the economy made continued survival in the same format impossible, the remaining funding is available to fund the insolvency. The moral argument that applied to grant funding is less likely to apply here, as the money was lent on commercial terms, albeit Government backed. The CBILS also required that the lending was unsecured, making it clear that any shortfall would rank alongside the other unsecured creditors. Refusing to use the remaining loan funds to cover the costs of the procedure would simply leave the company as a zombie and the directors with no closure. It might also have a knock-on effect on employees, suppliers, and others.
One area where an IP is likely to have to be particularly careful is where the evidence suggests that the original application for the loan might have been fraudulent. As pressure from the Government increases on the banks to make loans without delay, it is possible that some loans may be granted after reduced due diligence. It may, therefore, be possible for directors to apply for loans without evidence to support their claim that the company is viable. There may also be companies that fail immediately after making a loan application, despite the application setting out why they were viable. Each case will turn on its facts and we anticipate some difficult decisions will have to be made in due course. For example, is it reasonable for any company to claim that it is viable at present, when the global economy is so uncertain? If it is reasonable to make assumptions about the future global or national economy and a company’s viability within it, it is likely to be difficult to show that a director was fraudulent in applying for loan funding, even if the company is found not to be viable shortly afterwards. With the seemingly ever-changing messages about restrictions and government support, it will be very hard to show fraudulent intent in most cases. Despite that, if you are an IP approached by a director in those circumstances, you will be in a similar position to those above where you are aware of a fraudulent funding application. It will be a matter for the relevant authorities to decide in due course whether the money was obtained fraudulently, but you will have to report your findings without tipping off the directors, and if you take the appointment you would need permission under the Money Laundering framework in order to use the funds.
We have also considered the position in respect of deferred VAT. Unlike the other forms of finance above, where cash is provided by government, supported by underlying requirements or an application, deferred VAT has been made available to all, without pre-conditions. HMRC is simply allowing companies not to pay their next VAT liability when it falls due, and to repay it by 31 March 2021 instead, when they anticipate the economy will be in some form of recovery phase. There is no need to apply or even inform HMRC. The business simply has to stop its VAT payment and there is no requirement to show that the business is viable, or even that the payment is being withheld because of coronavirus related reasons. If an IP is approached by a company that wants to fund an insolvency process by holding back its current VAT payment, we cannot see any commercial or legal reason why an IP should refuse the appointment. There may, however, be an ethical threat in taking the appointment, in that the IP will be paid from the proceeds of the retained VAT, but will also have to report on the director’s conduct, and deliberately not paying the VAT to fund the insolvency process might comprise an area of misconduct. There may be other factors that the IP has to take into account, but it would be important for the IP to identify that threat, recognise the underlying significance of it, and take steps to address it. That would probably require the IP to disclose the misconduct issue to the director and make it clear that it will be mentioned in his report, which could result in disqualification proceedings or an undertaking. It also might require the IP to notify HMRC and seek their approval to take the appointment, despite the threats. We are not convinced that the decision to take the deferral and place the company into an insolvency process would be misconduct in the current economic crisis, but the IP would need to consider the threat when contemplating the appointment.
Before we arrive at a conclusion, it is worth mentioning MVLs, where the company is wound up as a solvent entity, which results in the company’s remaining capital being divided between the members, with certain tax benefits. In those, there is a stronger moral argument that funding designed to support a trading business or reimburse the company for trading expenses during the coronavirus restrictions should not be diverted into the pockets of the shareholders. As ever, when morality and insolvency legislation meet, there are inconsistencies and compromises. We have already been asked about one case where a successful company was to be sold and received grant funding before the sale fell through. Between the residual grant money and some other assets the company could still enter an MVL, but the money to be paid to the members would now be part-funded by the grant, instead of a business sale. In that particular case, it would be easier to accept the use of the MVL funds to reimburse the members for some of the sale money lost as a direct result of the virus restrictions, although there will still be some that say that the grant should be returned and only any non-Covid funds should be distributed. Unfortunately, there are likely to be less appropriate candidates for an MVL, and each case will have to be considered on its own merits.
One other factor in all this is the Court of public opinion. If the local authority becomes aware of the MVL of a company that received a grant and that the grant was distributed to the members, both the members and you, for organising it, might be tried and convicted in the Court of public opinion for “misusing” public funds and pressurised into returning the grant. If the local press becomes aware of it then it could ramp up the bad publicity for your firm, even if what you did was entirely legal, as the public perception may be that it was a dodgy deal. The same could also apply, albeit to a lesser extent, if it was an insolvent liquidation and the grant funds were used to meet your costs.
In conclusion, as long as any funding has been obtained lawfully, if there is still some of it left when an IP is asked to apply an insolvency process, it is likely that the IP will be able to use the funds to cover the costs of the process. In the same way that the Government is currently providing funding to give the economy a chance of surviving the shocks caused by the virus, any funds that fail to secure the survival of an individual entity will generally be available to fund its insolvency. Insolvency and business recovery procedures are necessary to the operation of any economy and they have to be paid for. Whatever the source of the funds, IPs can expect to face increased scrutiny for the foreseeable future, to avoid any suggestion that they are profiteering from the anticipated economic downturn. Indeed, it may be necessary to develop a low-cost one-size-fits-all insolvency procedure for failures up to a certain size, to enable routine corporate failures to be processed in volumes for a set price, with limited statutory compliance and reporting to offset the reduced cost. But that would be a whole new Blog article…
