Alan Munro, Insolvency Law expert at Wright, Johnston & Mackenzie LLP, talks us through the reckoning of pandemic scheme fraud and the web of insolvency fraud loophole.

As the pandemic’s aftershocks reverberate through the financial ecosystem, insolvency law specialists are bracing for an overwhelming influx of fraud-based legal cases.

The pandemic, by its nature, required the government to provide fast and extensive support to keep businesses and individuals afloat. When schemes are created and implemented at such a pace, they’re unlikely to be completely airtight from exploitative or fraudulent behaviour.

The dark underbelly of financial fraud cases is coming to light. Over 450 directors were disqualified in 2022–2023 alone by the Insolvency Service for abuse of the pandemic financial support schemes, with the average disqualification length being seven years and four months, and this shows no sign of slowing.

While the whirlwind of economic challenges caused by the pandemic has mostly passed and the dust settles, we can start to see the real damage of what has been left behind. Personal insolvency cases are overwhelmingly voluntary, meaning that the debtor initiates the process, but during the worst of the pandemic, there was a moratorium on creditor petitions, meaning that debtors weren’t being actively chased by creditors. That ended in October 2021, and we can see the effect of this down the line with an explosion in creditor petitions – soaring by 283% from 2022-23 Q1 to 2023-24 Q1.

Most colleagues and peers in our field talk of creditors showing considerable forbearance in dealing with debtors, but we cannot ignore the fact that compulsory court-ordered liquidations were by up 133% over the same quarter – most of which will likely be directly or indirectly due to creditor pressure.

It will be interesting to see how many companies winding down voluntarily will have pandemic-related funding skeletons in the closet. Bounce Back Loans, Eat Out to Help Out, furlough – all of them came with their own issues that could be exploited as the unprecedented nature of the pandemic overwhelmed the legal framework. The rushed nature of their implementation made it difficult to conduct thorough checks on applicants, creating loopholes for fraudulent claims.

The first conviction for COVID scheme fraud by HM Revenue and Customs (HMRC) was in March this year, with Mr Mohammed Ikram being jailed for over £430,000 worth of Eat Out to Help Out fraud.

Another notable example was the case of Khalid Iqbal Bhatti, who claimed Bounce Back Loans for 12 companies that were not financially entitled to the loans. At £50,000 per company, Mr Bhatti has left the taxpayer £600,000 out of pocket, which has resulted in Mr Bhatti being disqualified from directorship of any UK organisation for 13 years.

These cases are all too common. Many knew that the government schemes were open to vast fraudulent activity, but trusted that the systems in place would bring the money back into the public pot.

The rampant amount of fraud is, unfortunately, putting even more sustained pressure on a court system already at capacity as it continues to play catch up from the pandemic. The same is true for the HMRC fraud investigations teams faces the double whammy of underfunding and an ever-increasing caseload. In October last year HMRC estimated that the total value of error and fraud was about £4.5bn, or roughly 4.5% of total expenditure on these schemes.

The Taxpayer Protection Taskforce that was established to tackle this issue in 2021 was asked to begin winding down in March 2023 as it did not recover anything close to what was expected.

Despite all this, my colleagues and peers hope this period shatters the illusion that limited liability shields directors from personal responsibility in the event of financial wrongdoing – accidental or otherwise. Intentionally or negligently engaging in fraudulent activities can result in disqualification, fines, and often more extensive legal action.

Transparency, compliance, due diligence, and proactive professional advice are how you avoid the worst of the troubled waters.

We have by no means heard the last of this issue and I suspect that in the months, and even years, to come, we’ll see more and more businesses seeking guidance through the treacherous waters of insolvency.