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Company Top Guns may face HMRC investigation

01 April 2021. Published by James Wickes, Partner and Alison Clarke, Of Counsel

HMRC clamping down on furlough fraud by companies in Danger Zone

The latest statistics show that over 11 million workers have been furloughed in the UK as part of the government's job retention scheme (that equates to 16% of the population or one in six people) and 41% of employers had staff furloughed.  The scheme has so far cost the government over £40 billion and this figure will continue to rise until the end of September this year when the scheme is set to wind down. 

With so much at stake, legislation was introduced as part of the Finance Act (the Act) last year providing HMRC with certain recovery powers.  Under the Act, which came into force last July, HMRC can investigate and claim back falsely obtained employer grants.  Those found guilty of abusing the system will face penalties.  HMRC are cracking down on claims by insolvent companies or companies where there is a "serious possibility" of insolvency.  For companies unable to repay monies obtained under the scheme (clawed back as a tax liability), those responsible for management of the company can be held jointly and severally liable.  This will not only affect directors, officers and senior management but potentially shadow directors and even shareholders.  Given these companies may have few assets, it's likely that HMRC will seek reimbursement from individuals, where recovery may prove more fruitful. 

Individuals engaged in furlough fraud against HMRC, constituting fraud against the government, may also face criminal sanctions.  Directors may also face claims for breach of their statutory duties and disqualification under the Company Directors Disqualification Act 1986. 

According to EY's report on profit warnings, over 60 quoted companies (one in twenty) entered the profit warning "danger zone" by issuing their third (or more) profit warning in a year.  That's double the number for 2019.  Ordinarily, and statistically speaking, one in five of those companies would be placed into administration within one year of the third warning.  However, none have failed.  Thanks to the retention scheme, it has been reported that, in December 2020 half of the UK quoted companies most at risk of insolvency claimed support from the government. 

EY predicts that 11 of the 62 companies in the "danger zone" will enter administration this year.  Given the additional 114 companies which have issued second profit warnings, this may turn out to be a conservative estimate.  In light of these figures, it appears that a number of these companies are vulnerable and being kept artificially afloat by the government.  It is therefore likely that HMRC will launch yet further investigations against directors and other individuals as the year progresses and financial support is lifted causing businesses to fail.   

Comment

While the government's job retention scheme can be used during the administration process, it should only be used when employees are likely to be transferred to another business or when selling the troubled business as a going concern.  Furlough cannot be used once the insolvency process begins.

If the government are propping up a number of these listed firms, the insolvency trends predicted by EY will inevitably lead to greater exposure to directors and officers of those firms.

It is well known that insolvencies are a prime source of D&O claims. Upon an insolvency, management decisions from the point of financial strain up to the commencement of insolvency proceedings are closely scrutinised. Claims and investigations can come from various directions, including: claims by insolvency practitioners (i.e. for breach of fiduciary duty, breach of insolvency law / company law), regulatory investigations/proceedings (i.e. for market abuse or breaches of listing rules), and claims by pension trustees/the Pensions Regulator (i.e. alleging the directors' conduct impacted the pension fund etc).         

If EY's predictions are correct, D&O insurers are likely to see an increase in claims notifications towards Q3/Q4 2021. We will be closely monitoring these insolvency trends and will revisit the topic in Q3 2021, so watch this space.