The Preference Trap?

Jamie CochranePBC Logo

My most recent blog on the Chancellor’s support schemes  (available here) included comments on the Bounce Back Loan scheme.  One question I have received following that blog focussed on how using the funds from the loan to pay off debts personally guaranteed by the director would be treated (as the Bounce Back Loan scheme does not involve any personal guarantee) and I thought I would take the opportunity to explain the situation.

 

The Insolvency Act 1986 states “a company gives a preference to a person if that person is one of the company’s creditors or a surety or guarantor for any of the company’s debts or liabilities and the company does anything…..[which puts] that person which, in the event of the company going into insolvent liquidation, will be better than the position he would have been if that thing had not been done”.

 

So let’s unpick that legal jargon for a moment by revisiting the scenario.  The director was a guarantor for a company debt.  The company did something which put the director in a better position – by paying off the debt which had been guaranteed and removing the potential for the creditor to call on the guarantee.

 

However, that is not the whole situation.  The liquidator has to prove three things:

 

  1. The transaction took place at a relevant time. As the director is a connected party, the transaction must have taken place in the two years prior to the liquidation.

 

  1. The company must have had the desire to prefer the individual who received the preferential treatment. As the director is a connected party, this desire is presumed (but can be rebutted by the director).

 

  1. The company was insolvent at the time of the transaction or as a result of the transaction. Clearly, this fact is subjective on the facts of each individual case.

 

Let’s return to our scenario.  Could the company have taken out a bounce back loan to repay other business borrowing (whether or not guaranteed) to take advantage of the low interest rates on the Bounce Back Loan versus their existing borrowing?  Therefore, the director may argue that the desire was not there as they were seeking to improve the cash-flow of the business, but that argument would be stronger if contemporaneous notes (something I strongly advise) were made explaining the thinking behind the transactions, particularly as such transactions may be challenged several years later.

 

As previously stated, each scenario will depend on its own facts.  Should you be worried about your position or you have another insolvency-related issue then please contact me at PBC Business Recovery & Insolvency on (01604) 212150 (Northampton office) or (01234) 834886 (Bedford office). Alternatively, you may send an email to jamiecochrane@pbcbusinessrecovery.co.uk or access our website at www.pbcbusinessrecovery.co.uk

 

Am I Liable or Not?

Can a director be held personally liable for company debt?

The knee-jerk response to the above is, “No, that is what limited liability means.”  Indeed, the only obvious exceptions would be where a director has given a personal guarantee or, when a director is the named contracting party, which does happen occasionally, especially where leasehold property is concerned.

In a recent press release by the Insolvency Service two directors received custodial sentences and a Proceeds of Crime Receiver appointed to recover monies from the estate of both directors for the benefit of the company creditors.  This should be considered as the worst-case scenario in terms of penalties for errant directors, but it should also be considered a warning to those who feel they are “Above the law”.

There is a worrying upward trend in directors acting in a manner where they believe they can beat the system and fall short of meeting their duties as required by the Companies Act.  Both the Official Receiver and insolvency practitioners are being asked by creditors to investigate the conduct of directors and to seek restoration (compensation) by “Lifting the corporate veil” and demanding directors contribute towards the company losses.  Some of the principal areas of focus include unlawful dividends, debt avoidance and adverse loan accounts, where a director has (what HMRC describe as) taken disguised remuneration.

What is probably more disturbing is the “Blame culture” as an increasing number of directors are seeking to point the finger of culpability toward their professional advisors by suggesting a defence of merely following independent advice.  This is seeing advisors being caught up in litigation or demands to deliver up their client files, or both.  It is a trend that advisors have probably noticed but what can be done to minimise the risk?

On 13 May PBC are holding a free to attend seminar at the Kettering Park Hotel where Gary Pettit and myself will be discussing the issues that are generally leading to personal liability and what professional advisors ought to consider.  Should you be interested then please contact Lisa Parker on lisaparker@pbcbusinessrecovery.co.uk in order to book one of the limited spaces available.

 

A Business Adviser? Come to our free seminar on Personal Liability

To be held at Kettering Park Hotel on May 13th.

Looking at the hot topics that could affect you and your clients including

  • Re-use of prohibitive name
  • HMRC hot potatoes
  • Dividends
  • The Warning Signs

Plus we are looking to cover topics arising from The Budget

RSVP: lisaparker@pbcbusinessrecovery.co.uk

 

DUE TO THE COVID-19 CRISIS THE SEMINAR HAS BEEN POSTPONED AND WILL BE REVISITED IN SEPTEMBER DEPENDING UPON GOVERNMENT GUIDELINES

Tax efficient or tax avoidance?

As a director you are probably advised to pay yourself a nominal salary with the balance of your remuneration package being paid by way of dividend.  This is perfectly sensible.  It reduces the tax burden and improves cash flow.  However, what happens if you draw dividends when there are insufficient reserves?

There has been a long-running debate on whether dividends are unlawful when there are insufficient reserves to cover them.  Some commentators (like me) always took the view if a director followed independent and professional advice and the payment of dividends was a tax-efficient way of paying remuneration then it should be fine.  Indeed, in recent years court decisions on various matters (such as wrongful trading or malpractice) have generally looked at the position and adopted the view if a person took independent advice and followed it then they have done what any reasonable diligent person is expected to do, irrespective of whether that advice is flawed.

The above approach was continued in a case that was brought before the court where a sole director had drawn some £23,000 in dividends over a financial year.  The company went into liquidation with a deficiency in excess of £173,000.  It was recognised the director took independent advice and acknowledged if there were insufficient reserves then he would have to adjust his remuneration back to salary and account to HMRC for the PAYE/NIC as appropriate.  The court adopted a practical, common sense opinion and the claim against the director was dismissed.  The Applicant (who had “Purchased” the action from the liquidator) appealed.

In Global Corporate –v- Hale [2017] EWHC(Ch) the appeal over-turned the earlier decision, saying,

“If it looks like a dividend and sounds like a dividend, it is a dividend.”

The court of appeal added further clarification in order to clear the waters muddied by the High Court by reaffirming:

  1. Companies must have sufficient reserves to pay dividends at the time they pay them, whether or not they intend to rectify any deficiency at the end of a tax year;
  2. Quantum meruitwill not act as a defence or set off to claims made by companies against their directors;

 

Personally, this decision does not sit well.  After all, in some cases directors may have been taking dividends when something that could not have been reasonably envisaged extinguishes the reserves, automatically making those dividends unlawful.  That, to me, is using the benefit of hindsight, something the courts have frowned heavily upon in the past, making the Global decision a little contradictory.  I am sure there will be some that disagree with me on this but is that not what freedom of opinion is all about?

Should you have an insolvency-related issue or a corporate dispute then please contact Gary Pettit at PBC Business Recovery & Insolvency on (01604) 212150 (Northampton office) or (01234) 834886 (Bedford office). Alternatively, you may send an email to garypettit@pbcbusinessrecovery.co.uk or access our website at www.pbcbusinessrecovery.co.uk

HMRC to be a preferential creditor once again

 

The 2018 Budget has seen the announcement that HMRC will regain their preferential creditor status, a position which they lost in 2002 under the Enterprise Act. Since then they have ranked alongside unsecured creditors (such as suppliers, landlords etc).

Chancellor Philip Hammond, speaking in Parliament said, “We will make HMRC a preferred creditor in business insolvencies…to ensure that tax which has been collected on behalf of HMRC, is actually paid to HMRC”.

Further detail announced by HM Treasury states, “Taxes paid by employees and customers do not always go to funding public services if the business temporarily holding them goes into insolvency before passing them on to HMRC. Instead, they often go towards paying off the company’s debts to other creditors.  From 6 April 2020, the government will change the rules so that when a business enters insolvency, more of the taxes paid in good faith by its employees and customers but held in trust by the business go to fund public services as intended, rather than being distributed to other creditors such as financial institutions”.

It is understood HMRC will become a “secondary preferential creditor”, ranking after current preferential creditors, which includes the Redundancy Payments Service and employees for certain elements of their employment rights. HMRC will only become preferential for debts collected by the company on behalf of HMRC, such as VAT, PAYE and employee’s NI contributions but will remain unsecured for Corporation Tax and employers’ NI contributions.

The Government believe this measure will result in an extra £185 million in taxes being recovered each year. However the policy will have other consequences such as:

  • Banks and other lenders may be unwilling to support companies, or charge higher interest rates on lending, as their risk will increase.
  • Other unsecured creditors, including small businesses, landlords, pension funds, suppliers and employees will see the amount they receive reduced.

The full release from HM Treasury is available here:

The budget also included confirmation of proposals whereby directors could be held liable for debts due to HMRC where there is a risk that the company may deliberately enter insolvency. Following Royal Assent of the Finance Bill 2019-20, directors and other persons involved in tax avoidance, evasion or phoenixism could be jointly and severally liable for company tax liabilities in certain cases.

Restoration of Company Results in Dividend to Creditors

PBC are pleased to report that a dividend of 66.40 pence in the pound was paid to unsecured creditors in a liquidation that, at first, appeared to have no distributable assets.

The company was placed into creditors’ voluntary liquidation in June 2012 and following closure of the liquidation the company was dissolved. PBC were subsequently approached to restore the company to the register and act as liquidators to realise a refund of fees from the company’s former bankers.

With the assistance of Katie Summers, a partner at Howes Percival LLP, a successful application was made to restore the company to enable the fees to be recovered and subsequently a payment to be made to creditors.

PBC CONFIRM DIVIDEND PAID FROM AN IVA

PBC are pleased to announce a first and final dividend to creditors from an individual voluntary arrangement (IVA).

The debtor’s proposals for an IVA were approved in November 2017 and comprised a lump sum following the sale of an investment property. The arrangement included the removal of a second charge against the dwelling property, with the creditor in question submitting a claim in the IVA.

Joint Supervisor, Gary Pettit said, “It is pleasing to see this dividend paid to creditors and the IVA nearing a successful completion. The IVA has successfully dealt with the debtor’s financial difficulties, which were not helped by the debt management plan he was previously using”.

For more information on IVAs, please see this video.

Are Members’ Voluntary Liquidations (MVLs) under attack again?

A couple of years ago, the Finance Act 2016 introduced a new anti-avoidance rule which targeted MVLs to counter ‘phoenixism’ – starting a new business soon after winding up the previous one. This was to stop what was seen as an abuse of Entrepreneurs’ Relief.

More recently we have seen HMRC now demand statutory interest on tax liabilities from the date of the solvent liquidation even though, in the case of Corporation Tax, these tax liabilities are not technically due until 9 months later.

The latest attack is that HMRC are running a test case to challenge the approach of distributing overdrawn directors’ loan accounts in specie and reclassify the distribution as income, rather than capital, and therefore claim more tax.

It has been common practice to distribute overdrawn directors’ loan accounts in specie to save the directors having to repay the loans back to the liquidator and then wait for a distribution back to them as shareholders.  In the vast majority of cases the director and shareholder are the same person or husband and wife.

It is also our experience when the Company is brought to an end that directors will dip into Company funds before appointing a liquidator, thereby leading to an overdrawn director’s loan account.

We have spoken to both tax advisors and compliance firms within the insolvency world and currently what is certain is that there is uncertainty. However what is certain is that Schedule 11 of the Finance (No 2) Act 2017 seems to put an end to the approach going forward where the loan is not repaid before 5 April 2019.

As always as with any MVL it is now more important than ever to meet with your accountant and an insolvency practitioner before you bring the Company to a close to avoid any of the common pitfalls.

As always, PBC offers free initial meetings which are confidential and impartial.

The New Rules – 12 months on

The 6th April will mark the first anniversary of The Insolvency (England & Wales) Rules 2016, (commonly referred to as the “New Rules”). Doesn’t time fly?  So, we thought the anniversary was an opportunity to reflect and comment on the major changes introduced by the New Rules.

The right to opt out of receiving future correspondence – this has been used by about 5% of creditors, typically where there will be no return to creditors or where the creditor decides to write the debt off and does not want to keep being reminded of the bad debt every 12 months. This appears to be a well thought out change to the legislation and one which is well understood by creditors, particularly when you bear in mind that any notice of intended dividend must still be sent to these creditors, giving them the chance to opt back in when appropriate.

The right for an IP to post all documents online, having given notice to creditors they will do so – this rule change has not really been tested. The proof of how well creditors understand this change will come in the next few months as the second report since the New Rules is uploaded with no notice to creditors. The rule has been brought in to cut down on the copying and postage costs associated with each report to improve returns to creditors, but will that cost be replaced by phone calls with creditors asking for updates? Time will tell.

The abolition of physical meetings and the new decision procedures – this is probably the most fundamental change and is explained in detail in our blog here. Put simply, physical meetings can only be requisitioned by creditors (under a set criteria) and creditors’ views are now sought by virtual meetings, correspondence, electronic voting or deemed consent. We have had two instances where creditors have asked for physical meetings and, in both occasions, it was probably unnecessary (indeed in one the physical meeting was adjourned and nobody attended the adjourned meeting). Some good points of this rule change include the removal of final meetings (which nobody ever attended and were a waste of time and money) and the increased flexibility the New Rules now offer meaning two different cases, say a “Burial” liquidation of a company with minimal assets and a large complex company can be administered differently rather than applying a “one size fits all” approach which was excessive in many cases.

Standard Forms now longer exist – in their place have come a prescribed list of information in a set order (sounds like a form doesn’t it!) Despite the abolition of prescribed forms, Companies House have issued new forms for their purpose, which must be used when filing. The real purpose of this rule we suspect has not yet been met yet; at PBC we believe the purpose here is to allow online filing of the information at some point in the future.

The formation of creditors’ committee has changed – previously creditors had to vote for both the formation of a committee and its members at the same time. If the former happened but the minimum of three members were not forthcoming, then the committee was not formed. Now the New Rules mean that creditors can vote for the formation of a committee but not its members. If this happens, the IP then has to seek nominations for the minimum number of members and only then if there are insufficient members does the committee not form. At PBC we have seen this occur on several occasions, probably because of the creditors not understanding what a vote in favour of a committee means.

The New Rules have introduced many changes which are too numerous to list but these are, in our view, the major changes affecting creditors. It is also interesting to note The Association of Business Recovery Professionals, the industry’s trade body, took nearly ten months to update the standard terms it issues which form part of IVAs and are yet, at the time of writing, to update their Creditor Insolvency Guide website!

So in summary, are the New Rules good or bad? In theory our short experience is they are, in the main, a positive move forward.  However, it is a question that cannot be fully answered until they are tested in court over the next year or so.

PBC ANNOUNCE DIVIDEND TO CREDITORS IN LIQUIDATION

PBC are pleased to declare a dividend of 26.82 pence in the pound to the unsecured creditors of Silver Sovereign Limited.

The company’s major asset was an adverse directors’ loan of approximately £57,000. This has been recovered in full which has allowed a payment to creditors to be made.

Joint liquidator, Gavin Bates, said, “Whilst it has taken some time to collect the payments from the directors in respect of their loan, the approach taken has resulted in a significant return to creditors. It is always good to make payments to creditors”.