Predictions for key issues in insolvency in 2021

In this article we identify 4 key themes we expect to be dealing with in 2021:

  • Continuing to deal with a large number of solvent liquidations – MVLs
  • Fraud in relation to Coronavirus Job Retention Scheme and Bounce Back Loans
  • Provision of advice to charities looking to wind up
  • Impact of employee claims when directors’ are assessing their options

Solvent wind-ups at a 20-year high

It has been reported that solvent wind-ups, known as Members’ Voluntary Liquidations (MVLs) were at a 20-year high for the quarter ended 30 September 2020. Shona Campbell, Partner and Head of our Business Recovery and Insolvency team expects this to continue in the short term and the team are still seeing a high number of enquiries. Shona discusses the three key drivers for this increase below.

Potential tax changes

One of the most common reasons we are getting  MVL enquiries at the moment is because of concerns around potential tax changes in the March 2021 budget. MVLs enable business owners to extract the value in their business in a tax-efficient manner. This is because Capital Gains Tax (“CGT”) applies and CGT tax rates are lower than Income Tax rates. The rate payable is often reduced even lower by Business Asset Disposal Relief (”BADR” ) which until recently was known as Entrepreneurs’ Relief.  Where BADR is applicable the taxation rate is only 10% on lifetime gains up to £10m. A recent government review recommended that CGT rates be increased in line with income tax and that the eligibility of BADR be narrowed. You can read more here. The exact nature of CGT and BADR going forward is unknown, all will be revealed at the Budget on 3 March 2021, but a rise in the tax that will be due is expected.

Off-payroll working / IR 35 legislation changes

Another common reason we are currently seeing for implementing a MVL is where a company which was used for IR35/ off-payroll working is no longer required because of upcoming changes to legislation.  Freelance workers have been able to set up their own limited company and charge an employing company for their services via that company. This freelancing occurs widely in the financial services, IT, oil and gas and pharmaceutical industries.  There are detailed rules for the applicability outlined in IR35 and the responsibility for assessing the applicability has rested with the freelancer. Where applicable, no PAYE or NIC is due and payment for services is taxed by way of corporation tax which is generally at a lower rate. It is perceived as being abused in that some arrangements which do not meet the IR35 rules are being treated as such and avoiding payment of taxes. From 6 April 2021 legislation will come in to force which in many circumstances will move the responsibility for assessing the applicability from the freelance worker to the employing company. More info here.

We are seeing employing companies being more prudent in their assessment than the freelancer was and a number of employing companies are implementing blanket policies that they will not operate off-payroll going forward. The outcome is that there are a number of companies that are no longer required. If net assets are over £25,000  then a MVL is probably the most tax-efficient way to close that company down and extract the value.

Early retirements

By “early retirements” we mean “earlier than previously planned”. Business owners who had planned to retire in the next 2-5 years are fatigued, reluctant to fund ongoing losses and reluctant to take on new finance as the pandemic continues. They have taken the decision to wind up now, rather than at a point in the not too distant future.  The proposed changes in tax which have been outlined in the first point above are also key to the decision. It is possible that any tax changes will carve out genuine retirals, for example when the business owners have traded for a number of years and are over a certain age, but there is no certainty. Unfortunately, there is even less certainty around the continued economic impact of the pandemic.

Fraud and insolvency in 2021

Shona Campbell, Head of our Business Recovery and Insolvency team has identified fraud as a key issue in the world of insolvency and business distress for 2021. In this article, she discusses the types of fraud we expect to see in the next 12 months.

Fraud has been around for a long time. The earliest recorded fraud was in 300BC where a Greek merchant received payment in advance for a ship of corn. He planned to sink an empty ship, keep the money he had already been paid and then sell the corn again. Classic frauds like this happen over and over again.

The type of frauds that are prevalent at any particular time depends on the economic and legislative backdrop. The COVID pandemic required the government to get money into the economy quickly.  In the last months of 2020, there was a wide range of grants, loans and funding made available:

  • Bounce Back Loans
  • Coronavirus Job Retention Scheme
  • Small Business Grant Fund 
  • Retail, Hospitality and Leisure Grant Fund 
  • Local Authority Discretionary Grants Fund 

A strategic decision was made by the government to put ease of accessibility and speed of getting money into the economy as the priority.  Accordingly, many of the loans and funding relied on self-certification by applicants with minimal checks by the funding entity. This meant a high risk of schemes taken advantage of by organised crime, opportunistic individuals and business owners under severe pressure.

As Insolvency Practitioners, we regularly deal with fraud as we often discover it whilst carrying out our investigations once appointed or we are appointed because there has been a fraud.

We expect that the most common fraud scenarios that we will come across in the next 12 months will involve Coronavirus Job Retention Scheme (CJRS) and Bounce Back Loans. We will look at each of these in turn.

Coronavirus Job Retention Scheme

CJRS is funding for employees on furlough and is currently running until April 2021. It is a self-certification scheme whereby a business makes the claim and the money will then be paid. There are reported instances of abuse of the scheme such as employers claiming for employees that were working rather than on furlough,  employees no longer in employment, or even fictitious employees. In August, HMRC advised that they had received 8,000 calls to their anonymous fraud tip-off line.

HMRC understand that the scheme was rolled out quickly and that mistakes could have inadvertently be made. There was an amnesty period to 20 October 2020. More recently HMRC have been sending out letters in respect of specific claims requesting that they be checked and confirmed.

If an inadvertent error has been made HMRC should be notified as soon as possible and certainly within 90 days of the receipt of funds. If a known incorrect claim is not brought the attention of HMRC then this is fraud which could result in hefty financial penalties and ultimately a criminal conviction. Under the Finance Act 2020, directors can be held personally liable by HMRC for fraudulent CJRS claims.

Bounce Back Loans

Bounce Back Loans are loans of up to £50,000 for small businesses that are struggling due to the COVID pandemic. The amount is capped at 25% of annual turnover and is 100% guaranteed by the government.

Typically the terms will be as follows:

  • no interest charged or repayments in the first 12 months.
  • after 12 months 2.5% annual interest.
  • the loan can be repaid at any time without penalties.
  • up to 10-year repayment term.

As the speed of rollout was important, there were minimal checks carried out which meant a greater risk of abuse. There are reported instances of eligibility misrepresentation,  use of dormant companies and duplicate applications.  In October, the National Audit Office estimated that over 50% of the Bounce Back Loans would not be repaid, a significant portion of this relating to fraudulent applications. The remainder of bad debt will be credit-related where the business is unable to repay the amount. Although the loan is 100% guaranteed by the government, the government has advised that it expects the lender to pursue the debt fully before recourse to the guarantee will be given. The first repayments will be due in May 2021 and given that some are for 10 years, it will be some time before the actual position is known.

If the loan is not be repaid, it is likely that a business will end up in formal insolvency.

In a formal insolvency, the insolvency practitioner is required to submit a report on the conduct of the directors to the government. The government has written to all Insolvency Practitioners asking them to be mindful of Bounce Back Loan fraud, specifically highlighting where a Bounce Back Loan was obtained, and the proceeds removed by the directors for their personal benefit in close proximity to the company entering into formal insolvency proceedings. The consequences of this are director being disqualified from acting, convicted for fraud and having to repay the full amount. Inability to repay could mean personal bankruptcy.

Providing false information in connection with any application for a COVID-19 support scheme will also have consequences. This could be overstating the turnover of a business in the application or stating that the business was viable “but for” the pandemic.

5 things to think about when considering solvently winding up a charity

Some charities are finding things tough at the moment, particularly charities which were heavily reliant on local authority grants which have been cut, compounded with the challenges of COVID.

Charity trustees are responsible for the safeguarding of charitable funds which are given to a charity to fulfil a charitable purpose.  The trustees should ensure that those funds are used for the purpose for which they were given. Where the future is uncertain with no clarity over longer-term funding, one option which should be kept under regular consideration is an orderly wind up of the charity. Early consideration of this option means that surplus remaining funds can be paid over to another charity that will fulfil the purposes for which the money was given. The alternative may be a less than orderly insolvent wind up that exposes the trustees to personal liability issues.

Charity trustees should be assessing the financial position of the charity regularly. This should include a review of the current financial performance, cash flow going forward and discussion around whether it is appropriate to wind up.

We have been speaking to a number of charities recently in this situation helping them weigh up options. We provide advice around and assist with solvent and insolvent winding ups. Here are 5 key things to look at when considering winding up:

1. What is the asset and liability position?

There may be a decent cash balance in the account and a sizable net asset position. However, this may not be the outcome in a winding up because of the following reasons:

  • The balance sheet does not take account of employee termination costs. If there is a high number of employees with long service, this could be a very large number.
  • If there is a defined benefit pension scheme there could be a significant additional liability triggered by winding up. If there is a defined benefit pension scheme the trustees should take specialist pensions advice on the implications of winding up.  
  • Long term contracts –how many years are left on the lease where a property is rented? Also, check contracts and leased equipment terms and conditions for minimum terms, notice periods and penalties. 
  • Asset values per the accounts may not be what they will actually realise. For example, office furniture is likely to realise very little if it is to be sold but may be included in the balance sheet at a much higher amount. There may be agents fees to be incurred.
  • In addition to agents’ fees, there may be other costs of the winding up. For example legal costs, storage costs. These need to be taken into account.

If all the liabilities cannot be met then this means that the charity is insolvent. There may be personal liability for the trustees and they should speak with an insolvency practitioner immediately.  If there are sufficient funds to meet all liabilities and costs of the winding-up then it is likely to be a solvent winding up. Solvent means that all liabilities will be met.

When a charity is facing uncertainty we recommend that they calculate the costs of redundancy and long term contracts and include this figure in the board papers for consideration by the trustees along with a 13-week cash flow forecast.

When a charity is facing uncertainty we recommend that they calculate the costs of redundancy and long term contracts and include this figure in the board papers for consideration by the trustees along with a 13-week cash flow forecast.

2. What is the legal entity?

There are a number of different types of legal entity that a charity can be e.g. a company limited by guarantee, a trust, a Scottish Charitable Incorporated Organisation (“SCIO”). The constitution should be checked for any conditions or requirements in the constitution regarding winding up.  It may be that the constitution contains certain voting provisions around the winding up or specifies how remaining funds are to be dealt with. There are different ways to solvently wind up the various entities. The trustees may be able to do this themselves but should take advice from an insolvency practitioner (even if solvent) or a lawyer.

3. What will happen with the remaining funds?

Any remaining funds should be transferred to a charity with the same or similar charitable purposes. The trustees may have several potential charities in mind and funds can be split between different charities, if there are restricted funds, then any charity that takes those funds must be fully appraised and confirm in writing the understanding of the requirements around the restrictions. If a charity is unclear on who might be suitable the OSCR register of charities can be searched. For very specific purposes and restrictions, OSCR can provide support and guidance.

OSCR will need to be satisfied with the proposed choice, which leads on to the next key consideration.

4. OSCR Consent

No matter what type of entity a charity is, in Scotland, consent to wind up must be applied for from OSCR before any winding up is commenced. The application needs to be made 42 days in advance of the proposed commencement, so this is an important consideration for timing. OSCR has 28 days to respond and will look at what does the constitution say with regards to the winding-up (point 2 above) and what is happening with any residual funds (will they be used for the same charitable purpose as they were given). If these are both in order and OSCR has no other concerns consent will be granted.

5. Stakeholder considerations

Some specific things to note:

  1. Other regulatory bodies involved – make sure they are notified in accordance with requirements.
  2. Employees – observe contractual or statutory notice periods where appliable.
  3. Check notice periods on leases and contracts and issue formal notice in plenty of time.
  4. Books and records – financial records and charitable records need to be kept for 6 years (for HMRC and OSCR), arrange for back up of computer files, accounting system and storage of paper records.
  5. Consideration to be given to whether there is a need or desire to advise service users, funders, beneficiaries, open funding applications?

What are my employees entitled to if my business enters insolvency?

One of the most common questions business owners who are assessing options when facing financial distress is around their employees.  They are keen to understand the implication of insolvency on their employees where there is insufficient monies to make payment of the unpaid wages, holiday pay, notice pay and redundancy that they are entitled to.  Lynn Barr from the Business Recovery and Insolvency team summarises the position here.

In a formal insolvency when there is no money to make payment of the employees’ statutory entitlements, the Government will step in and make these payments. A formal insolvency means that there must be a liquidator, administrator or receiver appointed to a company or LLP and a trustee in bankruptcy in the case of sole traders and individuals. The Government will not pay out if one of these is not in office. There must be a formal insolvency practitioner in office.

What is an employee entitled to receive?

Employees are entitled to receive unpaid wages, holiday pay, statutory notice pay and statutory redundancy pay. 

Unpaid wages – this is money that should have been paid for work that has been done. It includes overtime, bonuses and commission.

Holiday pay – this is for holidays that had been accrued but had not taken. It is capped at 28 days entitlement.

Notice pay – An employee is entitled to receive notice before being made redundant. Only statutory notice from the government will be paid even if a contract has different notice provisions. The statutory redundancy notice periods are:

  • one week’s notice if employed between one month and 2 years
  • one week’s notice for each year if employed between 2 and 12 years
  • 12 weeks’ notice if employed for 12 years or more

Statutory notice is capped at 12 years. This means that it is likely that different employees with the same job and rates of pay will be entitled to different notice periods.

Redundancy pay – This is due to any employee who has worked for the employer for at least 2 years and the entitlement is:

  • half a week’s pay for each full year the employee was under 22
  • one week’s pay for each full year the employee was 22 or older, but under 41
  • one and half week’s pay for each full year the employee was 41 or older

Length of service is capped at 20 years.

Cap on payments

Payments made by the Government are subject to a weekly limit, which is currently £538.  This means that if an employee earns less than £538 a week they will be entitled to the full amount, however, if an employee earned over £538, the weekly payment will be capped at £538. Any balance of sums due to an employee over and above this would be a claim in the insolvency and is submitted by the employee to the liquidator, administrator or trustee.

An employee can’t claim for unpaid expenses. For example, travel expenses which were incurred personally in carrying out their job which would normally be paid on submission of an expense claim. Again, the employee would need to submit a claim in the insolvency

Subcontractors do not qualify as employees and will not be entitled to any payment for unpaid services from the government. Subcontractors will have to make a claim in the liquidation.

What if the employee was on furlough?

They are still entitled to receive money which is calculated using their usual rate of pay rather than a furlough amount. Any amounts the business has received from HMRC in respect of furlough claims submitted should be paid to the employee as soon as it is received.

How does the employee make a claim?

The Liquidator, Administrator or Trustee will provide the reference number called a “CN” and website link to enable employees to submit their claim to the Insolvency Service.  They cannot make a claim without the CN reference. The application is made online and consists of 2 parts.

The first part is the application for redundancy pay, holiday pay and other sums due including arrears of wages, bonuses and commission.  The Insolvency Service aim to deal with 95% of claims within 6 weeks of receiving the applications. The employee will provide bank details when making the application and monies are paid directly into their bank account.

The second application is for statutory notice pay and cannot be applied for until the statutory notice of period has ended. Once the notice period has ended the employee will be sent a CN reference number and then they can make the claim online for the loss of notice. This will be different for each employee depending on the length of service and because employees are expected to mitigate their loss as much as possible by claiming any unemployment benefit and sickness benefit, they may be entitled to, along with trying to obtain alternative employment.  If employees do not apply for benefits when they lose their job, the notice payment from the government may still make deductions for these, so redundant employees are encouraged to check their benefit entitlements and make sure they apply for those they are entitled to.

Get in touch

Henderson Loggie’s Business Recovery & Insolvency team are happy to answer any questions you have on this topic.