Using A Company Loan – What Are The Ramifications In The Event Of Insolvency

In the ordinary course of trade, it is not uncommon for a company to obtain a loan. This could be to help get up and running, invest in new assets or assist with working capital constraints.

A loan can come from any source, with the most common sources being:

• A bank or other finance provider
• A director’s loan account; or
• An intercompany or connected party

How Is A Loan Treated In A CVL?

When a company enters creditors voluntary liquidation (CVL), or any other insolvency process, the loan provider is treated as a creditor.

In a CVL, creditors rank differently for dividend purposes pursuant to the security they hold, if any. For more information on this, please read our article – ‘Who Gets Paid First in a Voluntary Liquidation?’

In broad terms, unless the loan provider has been granted security over a company’s assets they will rank as an unsecured creditor in the CVL alongside other creditors. For a more detailed overview of how a director’s loan account is dealt with in a CVL, please click here.

How Should A Company Loan Be Used?

Whenever a company takes out a loan, the directors should specify what it is to be used for and make this clear to the loan provider. If the company approaches the bank for a loan, for example, they may also insist on some form of security to protect themselves in the event of non-repayment. This could be in the form of a charge over assets or a personal guarantee from the director(s), or both.

In all eventualities, the loan must be used for genuine businesses purposes.

The incorrect use of company loans has been flagged as a hot topic in recent months with a surge of companies benefitting from Bounce Back Loans or CBILS (coronavirus business interruption loan scheme). For many directors, how such loans were used probably does not seem like a big deal. It is a commercial loan after all, and probably at a lower interest rate than anything else on the market.

But what about if the company subsequently enters a creditors voluntary liquidation or another insolvency process?

How Not To Use A Company Loan (In The Context Of A Pending CVL)

When a company enters liquidation (whether a compulsory or voluntary liquidation) or an Administration, the Insolvency Practitioner has a duty to review the financial affairs and transactions of the company for the period leading up to the insolvency.

The purpose of this is twofold; (1) to review the conduct of the directors in order to complete an independent report to the disqualification unit of the Insolvency Service, and (2) to identify any claim the Liquidator (or Administrator) may have against the directors pursuant to insolvency legislation.

For any party not familiar with insolvency legislation, the general rule of thumb when entering a CVL, for example, is ‘if you haven’t done anything wrong, there is nothing for you to worry about’. Such areas of wrongdoing often include:

• Disposing of assets at an undervalue;
• Preferring one or more parties over the general body of creditors;
• Continuing to trade when the company was insolvent; or
• Not acting in accordance with the director’s fiduciary duty or without reasonable care.

When contemplating the above, the Insolvency Practitioner is obliged to review how any funds received by a company in respect of a loan have been utilised. This is emphasised perhaps more so with Bounce Back Loans or CBILS (below £250,000) where no personal guarantee or other security was obtained from the directors.

Here are a few examples of how the use of company loan funds may be frowned upon in a CVL scenario which could result in a personal liability from the directors to repay:

• Using a loan from an external source to repay a director’s loan account – This puts the director in a better position than they would have been had the transaction not occurred, and most probably be challenged as a preference or misfeasance.
• Using to loan to purchase a personal asset, such as a car – this sounds like common sense, right? But surprisingly it is common. The purpose of a Bounce Back Loan or CBILS was to assist the company in getting through the pandemic. Using it for personal assets clearly does not meet this criterion, not to mention the personal tax implications depending on how the funds were extracted from the business; was it a dividend or a director’s loan account withdrawal?
• Using a Bounce Back Loan or CBILS to pay off another loan – on the surface, this seems harmless. Perhaps the other loan had a higher interest rate so it makes commercial sense. Or maybe it was from a friend or connected company and you would have rather been indebted to the bank instead. If a company then enters CVL, things are unfortunately not that simple. The overriding issue here is that the transaction has put that loan provider (the bank) and the government (who provided a guarantee to the bank) in a worse position. It could be argued that they have been unfairly treated and there may be ramifications. This will have to be considered on a case by case basis and always worth a conversation with an Insolvency Practitioner if you are concerned.
• Using a Bounce Back Loan or CBILS to pay off a secured loan – in a similar vein, the company may already have a loan or finance facility that is secured by a personal guarantee. Using a Bounce Back Loan or CBILS to pay these off clearly puts that director in a better position and is likely to be challenged.
• Not using the funds for genuine business purposes – every company has a purpose. If it can be demonstrated that the loan funds were used during the course of trade in an attempt to achieve that purpose, no problem. This could be wages, payment to trade suppliers, tax bills purchasing stock etc. But if the funds were used, let’s say, to take a punt on the stock exchange that is clearly not for a business purpose and the directors could be penalised.
• Provision of loans to other parties – As stated previously, any loan obtained by a company must be used for the purpose of its business. Using those funds to then loan to another party, a friend or connected company perhaps, would not be acceptable and the directors may be held personally liable to repay the funds to the company (in liquidation) if the other party is unable to repay.

This is not an exhaustive list but gives some common issues encountered.

How Can My Liquidation Help?

If your company is in financial difficulty and has benefitted from a loan facility from any source, please contact us for some free, confidential and no-obligation advice.

At My Liquidation, we regularly advise company directors, not only in respect of the most appropriate procedure to undertake but also what the likely ramifications could be if there has been any wrongdoing. This provides directors with a clear indication as to what the issues are and how to resolve them and provides creditors with the comfort that the Insolvency Practitioner is protecting their interests.