As the longer-term economic impacts of the Covid-19 pandemic are becoming apparent, it is unsurprising that a significant number of directors took advantage of the Covid-19 support which was offered to keep struggling businesses afloat during the pandemic.
However, there is now a rising number of instances where directors have been found to have fraudulently obtained or misused Covid-19 support funds.
As detailed in our article the Government pre-empted that there could be some abuse of the Covid-19 financial support measures. In anticipation of potential abuses, the Secretary of State (and in turn the Insolvency Service) was granted strengthened powers of investigation by the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021, to tackle the risk of abuse during a time when directors had access to substantial, unsecured Government-backed lending in the form of measures such as the Bounce Back Loan scheme.
The first directors disqualified under the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021 in August of 2022 were all involved in securing bounce back loans, before taking steps to dissolve their companies to avoid repaying the loans under the bounce back scheme.
Director disqualifications are being reported in the press more and more frequently. It is prudent for directors to be aware of the process and the impact of disqualification and what behaviours might prompt the Insolvency Service to conduct further investigations.
Misuse of Covid-19 support funds
Bounce Back Loans (BBLS)
Director disqualification is at the forefront of many business owners' minds at the moment. The Times reported earlier in the year that up to £17bn of the £47bn spent by the Government on bounce back loans will never be paid back. Approximately £4.9bn of the funds that will never be recovered are suspected to have been lost to fraud.
There has been a significant increase in disqualification orders and undertakings being sought against directors in cases where misuse or abuse of bounce back loans has been found. One in three of the directors disqualified in the first quarter of 2022 had misused bounce back loans.
The Insolvency Service has made it very clear that they will be actively pursuing directors suspected of bounce back loan fraud. Dave Elliott, Chief Investigator at the Insolvency Service recently said in a case where the director in question received a 10-year disqualification order “disqualification should act as a deterrent to others who think they can profit by obtaining taxpayer-backed loans to which they are not entitled.”
But disqualification is not the only risk to directors. A director who knowingly provides false information to secure a BBL before making off with the money or winding up the company could find themselves the subject of a criminal investigation and subsequently charged with the following fraud offences:
- false accounting
- fraud by false representation
- fraud by failing to disclose information
- fraud by abuse of position
- conspiracy to defraud
- money laundering
Where there is suspicion that an individual has committed one of the above offences, the Police or National Crime Agency (NCA) may seek a warrant to search premises for material relevant to their investigation. If an individual is arrested, investigators have the power to search a person or premises in order to seize evidence relating the alleged offending behaviour. If Court Proceedings subsequently arise it would likely take between six to 12 months for the matter to be heard in the Crown Court. The aforementioned offences attract a varying range of sentences and punishments including; fines, imprisonment, compensation, confiscation orders and director’s disqualification.
Coronavirus Business Interruption Loan Scheme (CBILS)
CBILS was a Government scheme introduced by Chancellor Rishi Sunak in March 2020 and led to £20bn being lent across 80,000 separate facilities. There are two common misconceptions with CBILS loans; firstly the loans are debts and not grants and secondly, the loan is advanced by banks and is therefore not Government money.
CBILS loans are of varying duration but importantly the first year of the loan is interest free and the fees for arranging a loan are paid for by the Government. CBILS loans were attractive because the banks could not seek any form of security for the first £250,000 lent. Furthermore, a Government guarantee is in place for up to 80% of the sums lent (or £50,000 depending on which sum is the greater).
The purpose of CBILS was to replace lost turnover and borrowing for companies during the pandemic. However this scheme, like many of the other Covid-19 support schemes, appears to have been subject to widespread abuse. The intention was that the CBILS loan could be used by companies to pay fixed costs that the business could do nothing about. This was to stop businesses going immediately into insolvency from the outset of the pandemic when the future of many businesses was unknown with future prospects almost impossible to predict.
However, there are a number of cases where directors appear to have diverted the money to maintain their lifestyle or in some cases to buy luxury personal items.
As we see businesses start to default on these CBILS loans it is expected that we will see a significant wave of insolvency litigation brought by liquidators (on behalf of creditors including banks), and the Insolvency Service is likely to adopt a similar attitude towards disqualification as they have already shown in relation to BBLS.
The furlough scheme
During the pandemic Mr Sunak also introduced the furlough scheme, officially called the Coronavirus Job Retention Scheme (CJRS), which allowed employers to keep their employees on the payroll even if they had no or limited work to do because of the pandemic.
The employer could then apply to the Government for a grant to cover up to 80% of their employee’s wages /the statutory cap depending on which was greater. According to gov.uk, the Government protected nearly 12 million jobs throughout the pandemic, having funded £70bn into CJRS.
However, as has often been the case during Covid-19, the CJRS was a hotbed for opportunistic fraud. HM Revenue & Customs (HMRC) estimate that furlough fraud amounted to approximately £5.28bn in 2020/2021. A survey by Crossland Employment Solicitors in 2020 found that 34% of employees were asked by their boss to work whilst they were placed on furlough.
These employers claimed for salaries of their employees under the CJRS, despite the fact that those employees were still working (and therefore producing revenue for the company). HMRC stated that abuse of the CJRS by organised crime totalled approximately £0.18bn, fraud by error totalled approximately £1.4bn, with opportunistic fraud from employers constituting almost two thirds of the total fraud lost as part of the CJRS at £3.7bn.
As with BBL fraud, directors found to have fraudulently claimed under the CJRS could see themselves facing disqualification and potentially criminal proceedings.
Directors of insolvent companies
Directors of insolvent companies are not automatically disqualified (though bankrupt individuals are).
If a company’s solvency is a concern directors can take steps to ensure that they act reasonably and in accordance with their duties to the company. As soon as a director is aware that the company is in financial difficulty the director should raise their concerns with other directors and professional advisors.
Where directors have acted reasonably and properly (and have maintained evidence of their conduct), any investigation should be resolved fairly promptly - though in some cases directors will need to defend their position.
It is clear that there has been a push to investigate instances of Covid-19 support fraud in particular and company directors should be aware that disqualification investigations may be commenced by the Secretary of State under the Company Directors Disqualification Act 1986 (CDDA) in a broad range of circumstances, either alongside or without separate claims by a liquidator of the company to recover monies.
If a company is placed into compulsory liquidation, voluntary liquidation, or administration the office holder (the liquidator or the administrator) will consider how the directors acted and what decisions they made in the period before the company became insolvent.
The office holder will report to the Insolvency Service, which acts on behalf of the Secretary of State/Government. The office holder must identify if the behaviour of any of the directors appears to warrant further investigation and potentially disqualification proceedings.
In an insolvency context that might include:
- drawing excessive salaries at a time when the company was insolvent
- continuing to trade when the company was insolvent
- taking credit when there was no reasonable prospect of other creditors being paid
- failure to respond or comply with a liquidator's requests
- failing to pay HMRC debts (as a matter of public policy)
- misuse of Covid-19 support measures
Based on the information it receives from the office holder, the Insolvency Service will then decide whether it is in the public interest to investigate further and, ultimately, whether or not to seek a disqualification order.
Other circumstances leading to director disqualification
The court can also make a disqualification order against any director who is convicted of an indictable offence in connection with the promotion, formation, management, and liquidation or striking off of a company (s2 CDDA). The order may be made after a conviction for a wide range of offences including theft and insider dealing.
A director found to have been persistently in default in relation to the filing of accounts and returns to Companies House can also be disqualified (s3 CDDA) as can a director whose conduct was found to make the director unfit to be concerned in the management of a company following a company’s insolvency or dissolution (s6 CDDA).
Process of disqualification
If the Secretary of State decides that it is in the public interest to seek a disqualification order, the director will be contacted to seek an explanation of their conduct and to provide further information if required.
Under s1A of the CDDA, the Secretary of State may accept a voluntary disqualification ‘undertaking’ from a director as an alternative to initiating disqualification proceedings. The advantage of agreeing an undertaking is that the process is significantly quicker, and the director will not need to pay the costs of going to court. A disqualification undertaking has the same force and effect as a court order. The undertaking usually requires the director to acknowledge unfit conduct, which can have a significant impact if later seeking permission (see below). There is often scope to negotiate and agree the terms of an undertaking, so as to manage the impact on directors.
If an undertaking is not appropriate or cannot be agreed the Secretary of State will commence court proceedings against a director and formal notice of the disqualification proceedings will be served on the director.
Where an application for a disqualification order is made to the court, the court must make a disqualification order if it is satisfied that the director’s conduct makes them unfit to be concerned in the management of a company. The whole process is about protecting the public at large and preventing directors from repeating the ‘unfit’ conduct.
If applying to court for a disqualification order, the Insolvency Service will also seek to recover their legal costs.
Impact of disqualification
If a disqualification order or undertaking is made the individual will be disqualified, for a period of 2-15 years, from:
- being a director of a company
- acting as receiver of a company's property
- being concerned in or taking part in the promotion, formation, or management of a company
- acting as an insolvency practitioner
In addition to the above additional restrictions are placed on disqualified individuals within certain professions such as charities, schools, the police, social care bodies, solicitors, barristers and accountants.
Criminal consequences for failure to comply
Disqualification proceedings are a civil, rather than criminal process; however, if a person acts in contravention of a disqualification order they could be sentenced to up to two years imprisonment, a fine or both (s13 CDDA).
Permission to act while disqualified
Under s17 of the CDDA, it is possible to apply to the court for permission to act as a director or to take part in the promotion, formation, or management of a (specific) company, while subject to a disqualification order or undertaking.
In order to obtain permission, the individual must satisfy the court that there is a need for them to be a director of the company in question and that if permission is granted the public will be protected. The court may impose additional safeguards and conditions on the individual in order to adequately protect the public. The terms of an undertaking at this stage could be crucial in determining what safeguards are appropriate.
The impact of being disqualified from acting as a director and the consequences of failing to comply with a disqualification order or undertaking can be very serious. It is possible to defend disqualification proceedings if there are mitigating circumstances or material inaccuracies. However, any defence should be brought to the Secretary of State’s attention as soon as possible.
While there is currently a focus on ensuring that directors who improperly obtained or made use of Covid-19 support are pursued for any misconduct, all directors should be mindful that they must act in accordance with their duties, and that they do not act in an unfit manner.
Even companies who haven’t felt the impact of Covid-19 can enter into financial difficulty, especially during the current economic climate. Directors should take early advice if they have concerns regarding their company’s solvency or their conduct prior to their company being dissolved.
Russell-Cooke’s insolvency, fraud and criminal litigation departments regularly tackle these issues and are well-placed to support clients that are the subject of an investigation for Covid-19 fraud/facing director disqualification proceedings.