Posted 25/08/2020 by Justin Lavery
The loan must be used in a way which will provide an economic benefit to the business. This could include boosting working capital and improving general cash flow. The loan can be used to pay salaries; however, it cannot be used to increase them, nor can it be used to pay dividends unless there is adequate profit showing on the balance sheet.
Understanding Preference Payments
The loan can also be used to refinance existing borrowing, although caution needs to be exercised if you are planning on doing this. Take for example a company which has a significant amount of existing debt which is owed to a variety of creditors. Some of this debt is personally guaranteed, the rest is unsecured.
In this example, if the director chooses to pay off only that debt which is personally guaranteed – and therefore that for which he or she would be personally liable for if the company was to be liquidated – leaving unsecured creditors unpaid, then this is likely to be seen as an act of misfeasance through the making of a ‘preference.’
Suspension of wrongful trading
Wrongful trading provisions have been temporarily suspended; however, this is not a get-out-of-jail free card for directors thinking of making a preference payment to minimise their future personal liability.
The current relaxation of wrongful trading rules allows directors to continue trading even if their company is financially distressed and at risk of insolvency, without the threat of becoming personally liable for the business’s debts. The aim is that this should reduce the number of companies heading into liquidation, instead giving viable businesses the chance to trade through the current challenging climate and recover once ‘normal’ trading conditions return.
However, while wrongful trading rules may have been momentarily suspended, this does not include the rules surrounding preference payments or misfeasance, both of which still apply. This means that directors could face possible personal liability for repayment of a Bounce Back Loan should this not be used in accordance with the declarations made during the application process, or if directors utilise this borrowing to clear personally guaranteed debt at the expense of other creditors, thereby creating a preference.
If you are considering taking out a Bounce Back Loan, particularly if you are intending to use these funds to pay back existing borrowing, it is important to take advice from a licensed insolvency practitioner beforehand to remove the risk of inadvertently falling foul of the rules surrounding preference payments.
Back to Blog