On Monday 7th February, Malcolm Niekirk held one of his popular Coffee Break Briefing Webinars.
In the webinar, Malcolm looked at a hot topic - Bounce Back Loans (BBL). Malcolm provided an overview of BBLs, looked at their status as unsecured and discussed some of the misuses and abuses of the loan.
This is the summary from the presentation. If you’d like to watch it back, you can do so below. If not, read on for a summary.
Quick links
- Overview of BBLs & other schemes
- Are BBLs secured or unsecured?
- Could BBLs be caught by a Personal Guarantee?
- Misuses and abuses of the emergency funding arrangements
If you’re interested in this, you might also be interested in our earlier presentation on claims against directors. Here’s a link to it.
An overview of Bounce Back Loans and other emergency funding
There were around 30 or so government backed schemes for coronavirus emergency funding. Most of these are now closed.
Mostly, if they were open for more than a very short time, the rules changed over time to –
- Narrow down the options and make them more restrictive
- In a few cases, to open them up a bit
Some of the schemes were discretionary, others had a defined entitlement, meaning that you would be entitled to the funding if eligible.
Most of them were open, in various ways, to abuse or misuse.
Emergency grant funding
I’ve listed some of the grants and concessions below…
- Furlough
- Coronavirus Statutory Sick Pay Rebate Scheme
- Omicron Hospitality and Leisure Grant
- Christmas Support Payment for wet-led pubs
- VAT concessions; HMRC time to pay
- Local authority discretionary grant schemes
- Business rates relief
- SEISS – Self-employment income support scheme
- Eat out to help out
These were not normally repayable; it was it was it was essentially free money.
Ineligible claimants of COVID grants
You might find a case where the grant was claimed when the company was ineligible.
You might find this with a SEISS when you're dealing with the liquidation of a limited liability partnership. Because, of course, the SEISS was available to members of LLPs, as well as partners in traditional partnerships and self-employed sole traders.
After November 2020, the SEISS scheme was restricted so that:
- Businesses must have been trading, or intending to trade; or
- If they weren’t trading, their profits needed to be significantly reduced from covid
After February 2021, people were eligible only if self-employment was most of their income.
So if you're dealing with an LLP, you might see information that was false when the partners applied for their funding. You might have to report fraud in a case like that.
Examples of loan schemes
These are the main loan schemes that are or have been available, I'll focus mostly on bounce-back loans:
- Recovery Loan Scheme
- Bounce Back Loans (Now with the ‘Pay As You Grow’ option)
- Covid-19 Corporate Financing Facility
- Coronavirus Business Interruption Loan Scheme
- Coronavirus Large Business Interruption Loan Scheme (up to £200m)
- Future fund
Bounce Back Loans
- Introduced early in May 2020
- At a time of uncertainty
- Interest free loan for 12 months (then just 2.5%)
- The maximum loan size was £50,000
- Businesses could borrow up to 25% of their turnover
- The lending was given by banks and financial institutions.
- The loan was 100% guaranteed by the British Business Bank PLC
- A wholly owned subsidiary of the Department for Business, Energy, and Industrial Strategy (DBEIS).
Pay As You Grow
- Introduced September 2021
- Extended the term of repayment from 6 years to 10 years
- Businesses could elect to pay interest only of 3 periods of up to 6 months
- Business could claim a complete payment moratorium for 1 period of up to 6 months
Bounce back loans closed for new applications at the end of March 2021.
Other Bounce Back Loan Criteria
- There were no personal guarantees taken for bounce back loans
- Where bounce bank loans were being provided to unincorporated businesses, enforcement action could not be taken against the personal homes, or main cars of the principal, or the partners,.
The eligibility criteria:
- Had to be a UK company, partnership or sole trader which had been in business on 1 March 2020
- Most income had to be earned from trading activity
- The loan should not be used for personal purposes, but only to provide economic benefit for the business
- Companies were not eligible if they’d already received funding from a scheme for larger business
- Businesses of any size were eligible
Semi-official Bounce Back Loan Guidance
It was legitimate to use a BBL to re-finance existing debt
It was also expressly stated that loans would be legitimate even when their only purpose was to support personal income
The Treasury’s Q&A - April 2021
In a series of short written statements, the Treasury, at that time, confirmed that:
- BBLs could be used to support income
- Loans can’t create profits, but BBLs could be used to fund dividends already earned
- Loans could be used to pay salaries to directors, but BBLs should not be used to increase the rate of pay
Are BBLs secured or unsecured?
The original publicity, when BBLs were announced, strongly suggested that they were unsecured loans.
The emphasis was given on the state guarantee from the British Business Bank and the fact that banks could not take personal security to support the loan.
In actual fact, banks were not prohibited from taking security for BBLs. But normally they didn’t, because:
- They already had a full guarantee from the state – so were unlikely to lose money on the transaction
- It would have been extra work, and therefore, expense for them to take security when lending on a BBL
- And it would also have made them look uncompetitive by comparison with other lending institutions that perhaps would not have been taking security.
Pre-existing security and BBLs
But, consider the situation where a bank had pre-existing security when the bounce back loan was taken out.
Let’s look at an imaginary worked example:
2017 – XYZ Limited borrows from A Bank plc:
- £1m on a term loan (to buy its premises)
- Overdraft facility, with a £50k limit (to smooth cash flow)
A Bank plc has this security for those facilities:
- Mortgage on the land and buildings
- Debenture with floating charges on everything else
2020 – lockdown hits
- XYZ Limited furloughs its employees
- XYX Limited borrows £50k BBL from its existing bankers (A Bank plc)
2022 – XYX Limited ceases trading
At that time, XYX Limited owes a total of £1.1m to A Bank plc:
- £1m term loan +
- £50k overdraft +
- £50k BBL
Let’s say the bank’s security is worth £1.2m
Q: What’s the equity; £150k, or £100k?
The answer to this question might make a big difference to the dividend you can pay to unsecured creditors.
You will need to review the documents. Start with the mortgage deed and the debenture. I expect that both will secure ‘all monies’ due to the bank.
If so, that would allow the bank to extend that security to include the BBL, if agreed with their customer. Imagine instead, the rare alternative, where those documents were written to limit them to securing only the term loan and overdraft. In that case, clearly the BBL would be unsecured.
Assuming the security documents are ‘all monies’ security, you next need to look at the BBL agreement itself (and the bank’s promotional materials and application forms). Suppose that were to say that the BBL is unsecured. That would be the end of the matter; no matter what the security documents say, the BBL will be unsecured.
It's unlikely that the BBL agreement will say that the BBL is unsecured. And so, next you will need to look at the company’s older banking agreements, particularly the term loan agreement and overdraft facility letters. Look to see if they limit how the bank can use its security. Probably they won’t say anything helpful, either way.
It’s quite likely that there will be nothing in writing to say, conclusively, whether the BBL is secured. The bank will have two advantages in the negotiations:
- Until their secured debt is agreed, and paid, they are likely to refuse to release their security. This means you will not be able to sell the security until you and they have reached an agreement.
- The ‘all monies’ clause in the mortgage deed and debenture. You will need to persuade the bank that those do not automatically mean the BBL is secured by those documents.
This is a problem that can arise only in cases where:
- the company was already a customer of the bank from which it borrowed the BBL; and
- the bank was already holding security over the company’s assets (which might even be for old facilities, no longer used).
In cases where the BBL was borrowed from a bank that was not already holding security (and didn’t take new security, then or later), this cannot be a problem.
Will Bounce Back loans be caught by a personal guarantee?
Let's have a look at whether they might be caught by a personal guarantee despite the fact that they are supposed to be unsecured loans.
So, let's look at another similar scenario here…
2018 – PQR Limited borrows from T Bank plc:
- £500k on a term loan (to buy its premises)
- Overdraft facility, with a £50k limit (to smooth cash flow)
- Mortgage on the land and buildings; debenture with floating charges on everything else
- Personal Guarantees from directors, limited to £200k
2020 – lockdown hits
- The company furloughs its employees
- Borrows £50k BBL from T Bank plc (treat it as secured)
2022 – ceases trading
- The company owes £600k to T Bank plc (£500k term loan + £50k overdraft + £50k BBL)
- Security value £500k
The company owes £600,000 to its bank; the bank holds security that's worth £500k. That leaves a £100k shortfall to the bank
How much of that will the directors have to pay on their personal guarantee?
The directors’ view
They'll say:
- There's half a million pounds coming in from the proceeds of sale. That should repay the mortgage the company took out to buy the building in the first place.
- That leaves:
- the guaranteed overdraft of £50k and
- the bounce back loan (that they did not guarantee)
The directors will say that they owe £50,000 on the personal guarantee.
The bank’s view
The Bank may say:
- Half a million pounds of realisations is coming to us under our security.
Taking the previous example (where the bank could claim that the bounce-back was covered by its security), the bank could say:
‘Under our terms of business, we have the right to allocate realisations to whichever account we see fit, in whichever order of priority we see fit.'
‘We are therefore going to use the first £50,000 of realisations to repay the bounce-back loan.'
‘The next £450,000 will repay most of the term loan.'
‘And then, the company will be left owing the overdraft of £50,000 (which is personally guaranteed) and the £50,000 shortfall on the term loan (which is also personally guaranteed).'
‘So that means that the directors owe the bank £100,000 on their personal guarantee.'
That's a legitimate way for the bank to use its terms of business and its security to ensure that all of its shortfall ends guaranteed by the directors rather than guaranteed by the British Business Bank.
I wonder if the British Business Bank might be encouraging the banks to maximise their own recoveries (and so minimise their need to call on the state guarantee)?
The misuse and abuse of Bounce Back Loans
The final thing to look at is the creative uses of bounce-back loans and their misuse and abuse.
The Treasury guidance (described earlier), seems not entirely consistent with the guidance from the Insolvency service (in ‘Dear IP’ for example).
In ‘Dear IP’ (Section 48 in Chapter 29), listed indicators of abuse include:
- Minimal creditors, e.g. only a BBL, bank overdraft and HMRC
- Funds not used for the benefit of the business
- Funds used with no intention to trade or repay
- Knowingly insolvent before the application
- Applications made soon before the formal insolvency
Other examples of abuse that should be reported include applications that are ineligible (which I won’t go through in any detail)
I personally tend to draw a line between misuse and abuse:
Misuse, I think is where there is no actual dishonesty involved. But it's misfeasance - it's where directors haven't complied with their statutory duties.
And abuse is the other side of the line, and that is deliberately dishonest behaviour, where the money was never intended to be used for legitimate purposes.
Examples of abuse:
- Companies making multiple BBL applications
- Fake accounts filed at Companies House
- Funds that were misappropriated – never used for the company’ trading expenses
Examples of misuse:
- Replacing directors’ cars
- Building/improving home offices
- Repaying DLAs
- Refinancing loans (removing personal guarantees)
Normally you might consider that to be the wrong side of the line but do consider the official advice that was given at the time which may muddy the water.
How should directors have used Bounce Back Loans?
Under normal company law principles, before applying for a BBL a director should:
- Consider the company’s financial needs
- Decide how the company will use the BBL to fund those
- Project how the funding will benefit the company’s business and how it will be paid back
- Record this information
After drawing down the BBL a director should:
- Measure events against projections
- Record – with reasons – decisions to change the plan
Remember – many companies applied for BBLs – many perhaps didn’t have rigorous corporate governance to start with. Remember also how difficult business planning was, in the second quarter of 2020 in particular.
What you’re likely to see
- Inadequate records kept by the company
- Sketchy justifications for using the funds in ways that benefitted directors
Legal Issues
Under the Companies Act, particularly Section 172, the duties that directors have is to act in good faith, to promote the success of the business. That is measured financially by reference to the interests, either of shareholders, or of creditors.
You will find yourself asking directors to explain just what they did, and why they thought that promoted the success of the business.
As always, when you're looking at bringing any sort of legal action, there are three questions you need to ask before you start.
1. Can the money be recovered?
- Does the director still have it?
- Are you sure you know they have it?
2. Have you got funding for litigation?
- Will the results be proportionate to the costs?
- Particularly if the claim is significantly less than £50k
3. Have you got a case?
- Legally, does the case fit a statutory claim?
- How are you going to prove each part of it?
- Have you got the evidence you need?
An example
You might be looking at a business whose financial history is not that great. There may have been losses funded by the directors in the last year or two before lockdown.
The directors could then have drawn a £50,000 bounce-back loan, £35,000 of which they used to repay the directors’ loan account. That was money that they had put into the business – in cash – to pay its trading losses over the last couple of years or so.
The balance of the bounce back loan, the £15,000, may have kept the business alive for about another year or so.
After that perhaps the directors decided that, having been repaid the finance they'd put into the business already, they didn't want to put in any new working capital. The company is still making a loss.
So a CVL is almost inevitable.
This might be a case where there is a bounce-back loan and HMRC is the only other creditor. It looks like it's possibly the wrong side of the line.
But, you might find, looking at it in more detail, it's not quite as black and white as that. A case like this might be difficult to run, even though it does look at first blush very much like it's a preference.
Thank you for reading this rather long summary! Hopefully it's helped you out a bit and given you a better understanding of Bounce Back Loans!
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