A Successful Bounce Back Loan Doesn’t Always Pay Dividends….

The Bounce Back Loan Scheme (“BBLS”) offers six-year loans, with a payment holiday for the first 12 months in most cases. Usually, the loans have been lent without the normal viability checks and the Government itself estimates that nearly two thirds of the loans may never be repaid, costing the Treasury £26 billion.  No wonder then that the use of BBL loan monies is coming under intense scrutiny if a business subsequently becomes insolvent.

The BBLS provided many companies with the opportunity of an immediate injection of cash to fill the financial cavity resulting from the effects of the Coronavirus lockdowns. Many owner-managed companies took advantage of the scheme during the spring of 2020 and in the extraordinary circumstances of the first lockdown, few directors can be criticised for having avoided hard questions that stem from the receipt of the loan and the way in which it was applied by their company. A year later the questions about how the funds have been used, particularly if BBL monies have been used to pay a business owner through dividends, often cannot be avoided.

Warning!  Hazard Ahead!

Most owner-managers depend on income from their companies.  As Directors, these business owners can use the money from BBLS to meet the cost of salaries, including their own, as these are a legitimate business expense and usually covered by a contract for the Directors services.  There are however many hazards, even during ordinary times, surrounding the extraction of the income where business owners extract income as dividends paid to themselves as Shareholders.

Those hazards are now accentuated by the extraordinary situation caused by the pandemic.  Many Directors will extract funds on a monthly basis and at the year end, declare a dividend to cover the accumulated overdrawn loan account.  In view of the uncertain and unprecedented times in which business owners find themselves, reliance on the “usual” profits that have been historically achieved may prove ill-founded if the business is suffering financially.  If the profit is not achieved, those monthly payments will stay as an overdrawn loan account, exposing the business owner personally until dividends can once again be paid.

The Dividend Dilemma….

Care should be taken before declaring and paying dividends during the pandemic, particularly where the payment is utilising some or all of the funds obtained under the BBLS.  In a time of uncertainty and confusion, it is worth taking time to step back and consider the rules and implications surrounding the payment of dividends.

In view of the uncertain and unprecedented times in which business owners find themselves, reliance on the “usual” profits that have been achieved historically may prove to be ill-founded. If the business is suffering a sudden financial downturn due to the pandemic and there are no profits to declare at the end of year, any dividend paid might be challenged.  If the profit is not achieved, those monthly payments will stay as an overdrawn loan account, exposing the business owner personally until dividends can once again be paid.

Dividends and BBLS During Covid -19

We have put together a brief guide to help you advise your clients and to discuss the implications of dividend payments, particularly if there is an ongoing risk to the solvency of a business. Hindsight is of course a wonderful thing but that is exactly the stance any liquidator will take if a company becomes insolvent and its financial affairs come under a liquidator’s microscope.

When considering such payments with their professional advisers, business owners should bear in mind the following principles:-

• It is a fundamental principle that a company’s money is its own and cash advanced under the BBLS is no different – after all, it is the company which has the responsibility to repay the loan. Directors owe a statutory duty to promote the success of their company which means that if they make a payment improperly, they can be required to repay personally, even if they are not the recipient.
• Whilst there is nothing preventing a company in receipt of cash from a BBLS loan declaring and paying a dividend to shareholders, the economic circumstances in which the BBLS has been introduced mean that the purposes to which the loans are applied will be subject to increased scrutiny.
• In most private companies the power to declare dividends to shareholders is exercisable by the directors or by the shareholders by ordinary resolution, although the amount of the dividend cannot exceed the amount recommended by the directors.
• The requirements concerning declaring and paying dividends are comprehensively set out in Part 23 of the Companies Act 2006 (“the 2006 Act”). A company may only pay dividends out of profits, and whether a company has sufficient profits can only be determined by reference to the last annual accounts or interim accounts.
• Any payment to shareholders which does not comply with Part 23 of the 2006 Act cannot be a lawful dividend, is an improper exercise of the company’s powers, and any director responsible can be personally liable to make repayment (if they received a payment as a shareholder) or compensate the company personally, even if they were not the recipient of the funds.
• Even if a payment to shareholders can be shown to have been by way of a lawful dividend within the statutory code, payment of the dividend might be a preference under section 239 of the Insolvency Act 1986. A Liquidator might obtain a court order requiring the recipient to repay.
• Further, directors’ duties include a common law duty to have regard to creditors’ interests. That duty arises when the directors know or should know that their company is or will probably become insolvent. Payment of even a regular dividend at such a time would be a breach of that duty making the directors personally liable to repay.
• Directors can borrow from their company if the company’s memorandum and articles of association permits. However, the company will be liable to pay additional tax if the debt is not repaid and there will be an impact on the directors’ personal tax as the loan will be considered a benefit in kind. A Liquidator will be entitled to seek re-payment in any event.
• Once a Liquidator has proven that a particular payment has been made it will be for the directors to prove that the payment was made for proper company purposes and the Liquidator will be given the benefit of the doubt. Directors must be ready to justify payments they cause their company to make. A contemporaneous record of the purpose of payments and the directors’ reasons for agreeing to make them will help.

Proceed With Caution

Given the current unprecedented circumstances being faced by Directors, now is the time to consider carefully the basis on which they are remunerated. Directors should seek advice from their professional advisers if they intend using money advanced under the BBLS to maintain their income. They should also seek assistance if they are concerned about the viability of their business to ensure that they follow correct procedures where there is a potential that their business might fail.

Our team at Poppleton & Appleby is on hand to support you and your clients in these specialist areas.  Should you wish to discuss any client matters or simply chat around the issues we have raised here, feel free to contact Andy, Matt or any of the team at Poppleton & Appleby.