Lenders have an enormous challenge ahead to parse out legitimate loan defaults from a spiralling number of instances of fraud among the taxpayer-backed coronavirus loan schemes.
Fraud risk was identified as high in the design of the schemes, particularly under the bounce back loan scheme (BBLS), with the speed of access to funds prioritised over due diligence. For example, under BBLS, credit and affordability checks were omitted, and borrowers were allowed to self-certify loan application documents.
This scheme design ensured far greater demand than anticipated by the Treasury, with £47.4bn of loans across 1.6 million facilities approved under BBLS, according to data from the British Business Bank.
The government does not have definitive data on how much loan demand resulted from opportunistic company directors capitalising on the availability of finance with no credit and affordability checks. However, much of the suspected fraud is concentrated among ‘micro’ borrowers, defined as companies with a turnover of less than £632,000 per annum and 10 employees or fewer.
Accredited lenders are responsible for fraud management and are required to conduct stringent counter-fraud due diligence, supported by post-scheme implementation coordination between fraud prevention services, fraud bureaux, HMRC and lenders.
One alarming indicator of potential fraud has been the huge spike in the number of companies that applied to be struck off the Companies House register in the first quarter of 2021. According to Companies House data, strike-offs increased by 25 per cent year-on-year to 34,191 in the first three months of 2021. It raised alarm bells that unscrupulous company directors were registering a new company to secure a government-backed loan, supported by fraudulent documentation.
However, lenders do have specific powers to support loan recoveries from insolvent borrowers. For example, lenders can object to borrowers’ voluntary strike-off applications by filing a simple form with the Registrar of Companies, where an insolvency event occurs, and can exercise a “right of offset” over any credit balances held by insolvent borrowers (which provides authority to directly take money from a borrowers’ bank account).
In voluntary liquidations, lenders can use their voting power to ensure an insolvency practitioner of their choice is appointed to carry out an investigation into the conduct of the borrower and its directors in the lead-up to insolvency.
In cases of suspected fraud, lenders can apply through the courts to issue a winding up petition; this is typically reserved as a last resort after a borrower has repeatedly failed to repay debts and has ceased communication. To support fraudulent debt clawbacks, the government granted new powers to the Insolvency Service in May to investigate directors of dissolved companies and identify companies that have remained dormant since receiving a coronavirus loan.
The government provided a 100 per cent guarantee to BBLS lenders, but this does not remove the lenders’ duty to take reasonable steps to recover money from defaulting borrowers. Accredited lenders are expected to exhaust recovery options before turning to the Treasury for compensation on defaulted loans.
How easy the recovery process will be depends on how the loan proceeds were deployed, how they interact with existing balance sheet loans and whether borrowers undertook a corporate restructuring after receiving loan payments.
To its credit, the government moved quickly to support UK businesses that suffered cash flow difficulties after national lockdown measures were introduced. The government’s rapid response protected viable businesses and saved jobs, but the expeditious roll-out has ensured a messy loan recovery clean-up process that may take years.
If you would like to speak to one of our team about your Covid loans and discuss your options, please contact Sorca McGeown at firstname.lastname@example.org or Gary Shankland at gshankland@ btgadvisory.com.