Due diligence considerations in relation to the Government’s CBILS and BBLS

As a result of the global Covid-19 pandemic, the British Government introduced state backed loan facilities schemes. The schemes are intended to provide support via much needed cash injections into SMEs, in an attempt to alleviate the financial burden afflicting many industries in the UK. Two loan schemes have been introduced to assist small and micro businesses:

(1) the Coronavirus Business Interruption Loan Scheme (CBILS), which is intended to assist SMEs suffering from a downturn in trading and depressed revenue streams. Such loans to SMEs are for between £50,000 to £5m; and

(2) the Bounce Back Loan Scheme (BBLS), announced on 27 April 2020, is intended to aid micro businesses suffering from financial burden and disruptions to their cashflow as a result of the pandemic. These loans provide debt finance to the businesses applying and vary between £2,000 to £50,000.

These schemes have been significantly expanded from their initial roll out back in April 2020 and are now offered by over 100 accredited lenders and account for over £63bn in lending. The Government has also implemented a range of initiatives including Coronavirus Grants and Additional Restrictions Grants to assist companies forced to close as a result of national lockdowns.

With regards to CBILS and BBLS, the Government will pay the first 12 months interest due on the loans via business interruption payments. After which, the principle amount of the loan and any interest will be payable by the borrower. The interest rate on a BBLS loan is capped to 2.5% per annum. However, interest rates payable on a CBILS loan are set by the lender on a case by case basis.

Both schemes offer guidance on the structuring of the loans. BBLS loans are offered exclusively in the form of term loans. However, CBILS loans can be arranged as term loans, overdrafts, invoice finance and asset finance, making them more flexible to meet the applicant’s requirements. As part of the structuring guidance, both schemes have prescribed eligibility criteria that an applicant must satisfy in order to make a successful application. BBLS require a borrower to self-declare that:

a) its trade has been impacted by COVID-19;
b) it was not a business (or part of any wider group) in difficulty at or before 31 December 2019;
c) it is engaged in trading in the UK;
d) it was established before 1 March 2020;
e) it (and any wider group of which it is part) is not using other interruption loan schemes;
f) it (and any wider group of which it is part) is not subject to bankruptcy or liquidation proceedings;
g) it (together with any group of which it is a part) derives more than 50% of its income from its trading activity; and
h) it is not in a restricted sector.

This is not an exhaustive list of criteria and applications are largely at the discretion of the individual lender. However, the above list does highlight a number of considerations that a business needs to make when applying for a loan under the BBLS.

Turning to the CBILS, the criteria that a business must satisfy are:

a) be a UK based business;
b) have an annual turnover of £45m or less;
c) provide a borrowings proposal setting out how the money is to be used and set out the impacts of the pandemic on trading, for the lender’s consideration;
d) self-certify that it has been adversely impacted by the pandemic; and
e) not be a ‘undertaking in difficulty’ (where applying for more than £30,000).

An ‘undertaking in difficulty’ is defined as a business that:

a) has losses greater than 50% of its subscribed share capital, being inclusive of any share premium (capital for unlimited companies);
b) has entered into insolvency or bankruptcy proceedings;
c) has been in receipt of prior rescue funding that remains unpaid; and
d) has received restructuring aid and is still undergoing restructuring or subject to a restructuring plan.

Guidance in relation to an ‘undertaking in difficulty’ changed on 25 September 2020 and removed a condition for the business to have been in financial hardship on or before 31 December 2019. Accordingly, a business may restructure its debt so that it is no longer ‘in difficulty’ and become eligible to apply.

In relation to both schemes, a borrower may only apply for a loan under one of the schemes and is not eligible to apply for another loan under the other scheme while such sums remain outstanding (unless doing so includes the refinancing of a current CBILS/ BBLS loan). Where the business involves a number of linked entities, only one entity may apply for a loan under the schemes.

Further, the borrower is required to provide the lender with details of the amount applied for, what the loan is to be used for and the period over which repayments are to be made (term of the loan). Currently the maximum term must fall within the 6-year tender period for the schemes. However, the Chancellor has recently announced plans to extend the period to a maximum of 10 years. Although it remains to be seen to what extent, if any, this will be implemented.

For smaller amounts of borrowings under the schemes, many lenders implemented automated systems to approve loan applications and issue the relevant funds. This was in large due to the short period of time between the Government announcing the schemes and the loan applications going live. This created several issues for lenders as there was not enough time for them to adequately vet applications or implement internal policies and procedures for the purposes of monitoring and administering scheme loans.

This has ultimately resulted in a proportion of applications being approved that did not satisfy the eligibility criteria. The structuring of both schemes puts the onus on the lender to review and vet the applications it receives and, where appropriate, seek to recover the sums loaned back from the borrower.

It should be noted that the speed at which the schemes were implemented, coupled with the use of automated application and approval systems made the process susceptible to inaccurate and fraudulent applications. Lenders have begun to retrospectively review and scrutinise applications and it is anticipated that such applications will be the focus of recovery action and prosecutions over the coming months and years.

Where an application is deemed to be incorrect, fraudulent or otherwise invalid, lenders will be left with three options, let the loan stand and continue to recover payments and interest, clawback the misappropriated funds or, where the funds have been dissipated, take action to attempt to recover sums from the borrowers immediately.

As lenders are beginning to retrospectively review and assess applications in more detail, it is inevitable that some businesses will be subject to recovery attempts. It is therefore important that buyers take the time and commit the necessary resources to carrying out effective due diligence of CBILS and BBLS in future transactions.

In order to identify any potential exposure of a target in relation to a scheme loan, a buyer may wish to consider raising enquiries in relation to the following:

a) was a loan applied for under any schemes?
b) has the group recently undertaken a restructuring relating to an application?
c) for what purpose was the loan applied for?
d) how have the funds been used?
e) are copies of the application and supporting paperwork available for inspection?
f) has the lender raised any queries with the sellers regarding the application?

When carrying out due diligence in this area, it is important to not treat any one company or entity in isolation. As previously mentioned, group companies are not individually eligible under the schemes as they are considered linked entities and so only one group company will be eligible to apply at any one time.

To highlight this point, consider a situation where a seller has recently undertaken a restructuring of their company group so that the group companies are seemingly no longer directly linked (parent and subsidiary) and instead present as two separate entities.

In such a scenario it is crucial to identify whether separate applications have been made by the entities involved as, upon closer inspection, a lender may ultimately determine that the restructuring exercise was undertaken for dishonest or fraudulent purposes and pursue recovery of the loans from the borrowers (one of which being the target). The lender will be entitled to recover both of the loans as both payments will be in breach of the lending terms and eligibility criteria.

Where there is a question as to whether the loan has been legitimately acquired, the buyer may wish to consider having the seller seek confirmation from the lender that the loan is not in breach of the eligibility criteria or subject to further investigation.

Alternatively, a buyer may consider incorporating an indemnity against any losses arising from potential future recovery attempts by a lender. The implications of a misappropriated scheme loan may also have wider reaching impacts on other aspects of the business such as its ability to secure future lending or impact upon its ability to meet its immediate and short-term financial commitments.