Responding to financial risk and mitigating exposure when a bank fails

Many start-ups and tech businesses with deposited funds in or loans from Silicon Valley Bank would have experienced a very anxious time as the bank was on the brink of failure. Thankfully, the start-up and tech communities quickly lobbied the government and they ensured the unthinkable scenario was averted, which could otherwise have cost a significant number of jobs and businesses. HSBC ultimately announced its purchase of SVB UK and the Bank of England confirmed that all depositors’ money with the bank was safe and secure as a result.

While a successful outcome was achieved and businesses banking with SVB were unaffected as a result, we know that many business owners were concerned about their position had this not been the case.

Contemplating what you might be able to do in similar circumstances and/or how to protect your business and employees from the worst-case scenario, below we address some of the frequently asked questions.

Who can claim compensation when a bank fails?

In general, individuals and corporates can claim compensation under the FSCS. In the case of deposits, large companies are also able to claim compensation, although some exclusions may apply. By default, corporates may be able to claim, with certain exclusions such as credit institutions, investment firms, insurance undertakings and reinsurance undertakings, collective investment schemes, pension schemes.

As a lender, are we still liable to pay interest, fees or other charges owed to a failing bank?

Yes, liabilities owed to a failed bank will continue to be owed, for example under a loan facility agreement with the bank as lender.

How much compensation can be claimed when a bank fails?

The maximum compensation sum payable for the aggregate eligible deposits of each depositor is £85,000, and this could go up to £170,000 for a joint account (the amount calculated will be divided equally among joint account holders). There is also protection for individuals in exceptional circumstances under temporary high balance rules. As an exception, the maximum compensation sum payable for a FSCS Temporary High Balance (THB) is £1,000,000, apart from compensation payable for a THB arising from a payment in connection with personal injury or incapacity where no limit applies.

What is the process for an FSCS payment and do we need to submit a claim?

The FSCS has stated on its website that 'if your bank, building society or credit union has failed, you don’t need to make a claim. We’ll return your money automatically, up to our compensation limit.' In most cases, for deposits, FSCS aims to pay compensation within seven days of a bank, building society or credit union failing. More complex claims may take up to 15 working days.

If I need to inject cash into my business, what routes are there?

Simple Agreements for Future Equity (SAFEs) and Convertible Loan Notes are relatively quick and easy ways to raise funding, since no equity changes hands at the outset. These deals provide immediate cash, with shares being issued at a future funding round at a discount from the price offered to new investors. Expect to pay interest at around 8% on a three-year note, and negotiate to repay loans by mutual agreement (should this be possible prior to maturity of the note).

What about emergency funding from finance houses?

A more conventional approach to cash flow issues is to turn to emergency funding. Currently, finance houses are offering cash in around seven days on a six-month term and with no guarantee required. Interest rates are hovering at 2%. Consider outfits such as Liquidity Group, Muse and Uncapped. To meet payroll obligations, Capchase is offering a specialist finance. Be wary though – borrowing during a cash crunch could negatively affect your ability to attract investors in future funding rounds.

If our company needs to turn to alternative financial assistance, are there any data protection pitfalls I should be mindful of?

When a bank is rumoured or reported to be failing, there is often a barrage of offers of help, assistance and support out there for those potentially affected by the news. These offers can involve large amounts of personal and commercially sensitive information being collected to assess viability, usually via some sort of platform or website. Applicants should take time to carefully read privacy notices and terms and conditions to understand whether those organisations follow UK GDPR compliant practices, eg do they intend to share the information with third parties, and if so, whom? Be wary of organisations that are asking for information which isn’t relevant to the purpose of processing as ‘data minimisation’ is a fundamental principle of UK GDPR. This means that personal data should be ‘adequate, relevant and limited to what is necessary’, any organisations that use the offer of help to prise more information than is necessary out of people should be treated with caution.

What should we do if we are unable to pay our employees because we can’t access our bank deposits?

Employees and workers will almost always have a contractual right to be paid on a certain date of the month or week. If your company fails to pay on time, then you are at risk of Employment Tribunal claims and also your employees getting nervous and jumping ship. An important point to consider is whether this is a short-term cash flow issue, or a longer-term problem which means you are unlikely to be able to regularly pay your employees moving forward.

If it is a short-term issue, consider whether there are any steps you can take to pay your employees before any other parties (eg creditors), which may feel like a balancing act between your employees and everything else. If you believe that the delay in payment could be a matter of days, discuss this with your workforce. As most employees will have their own personal financial commitments, it is important that you are upfront with people as early as possible so they can manage any missed payments. You will need to strike the balance between informing your employees of the late payment while reassuring them that it is not going to be a recurring issue.

If our financial difficulties are prolonged, what happens if we are forced to make redundancies?

If your company’s financial situation goes beyond a cash flow blip and you’re unable to retain your current workforce, you need to think carefully before moving straight to redundancies as this can have a detrimental effect on morale. You may be able to consider options such as offering sabbaticals, reduced hours, a recruitment freeze, less reliance on agency workers / consultants and potentially short-term lay off, if you have the contractual right to do so. It may well be that none of those options will work for your business, but it is important to at least consider alternatives before moving straight to redundancy. For more information on this, see our guide to offering alternatives to redundancies.

If you ultimately reach the point where redundancies are sadly necessary, the key points for employers to get right in a redundancy situation include genuine consultation, fair selection criteria applied in a fair manner and consideration of suitable alternative employment. Putting in the time at the outset allows for the process to go as smoothly as possible.

You’ll also need to keep in mind that just because an employee has less than two years’ service, it does not mean that they are without rights. All employees are entitled to protection from unlawful discrimination from day one of their employment and a discriminatory practice does not need to be intentional and may not be obvious until after the event.

It is important to get advice at the outset and whilst redundancies are never pleasant, the key is in the planning in terms of any redundancy process. You will need to strike the balance between genuine consultation and not prolonging the agony for those employees at risk of redundancy. Bear in mind that following any redundancies, you will need to work hard on employee morale to ensure that those employees remaining don’t feel like ‘they’re next’ as you may end up retaining your best employees during the redundancy process, however you risk losing them in the future because they feel unsettled or insecure in their role.

If you are proposing to dismiss as redundant 20 or more employees within a 90 day period, you need to consider your collective consultation obligations.

If things worsen and redundancies won’t achieve your objectives or you are unable to afford paying your employees what they are owed, you may need to consider more formal options such as insolvency (see section above). If an employer is insolvent, the National Insurance Fund (NIF) guarantees a basic minimum payment of certain debts owed to employees by their employers including, for example, capped arrears of pay, statutory notice pay and statutory redundancy pay, provided certain conditions are met. This guarantee applies irrespective of the type of insolvency procedure or whether the debt is unsecured or preferential. Employees requesting payment from the NIF can make a claim online and are usually provided this information by the relevant Insolvency Practitioner.

What should I do if I’m unable to pay my suppliers on time due to my bank failing?

If you have problems accessing money in your bank account and you are unable to meet your contractual obligations to another party, then you should speak to the other party straight away, informing them what is happening with your bank. You should also look to negotiate more time to pay them if necessary.

The Practice Direction on Pre-action conduct emphasises that litigation should be seen as a last resort, so it is unlikely that the other party will start court proceedings against you straight away. Instead, you and the other party will be expected to focus on compromise, to address what is likely to be a temporary financial disruption.

What should I do if a banking issue means our company is unable to pay our landlord?

If your company is unable to pay your landlord due to lack of access to bank deposits, it is important that you are transparent with your landlord and inform them that you may struggle to pay your rent on time. Having an open conversation with your landlord early on will prevent you from going into arrears.

If your landlord is unaware of your situation and you miss a payment deadline, they will have the right to take legal action against you and in some circumstances seize goods to the value of the outstanding debt.

The most important thing is not to panic; if you can put together a reasonable proposal and communicate early and consistently, most landlords will be understanding.

If my company is left unable to make payments to creditors and this is not just a short-term blip, what are the options available to us?

There are various options available to a company that is facing financial difficulties. The important point is to address potential problems as early as possible. This opens up the options for you and provides far more opportunity to recover your company. If left too late, your options are often significantly reduced, and sadly it can mean there’s no way back for the business.

If initial negotiations with creditors have broken down, then it may be time to consider more formal options. This doesn’t have to mean insolvency. There are methods of continuing a company and restructuring and agreeing a way forward with your creditors that don’t have to mean the end of your business, but they might give you the space to recover and turn the situation around. For example, you may be able to agree a Scheme of Arrangement, or a Company Voluntary Arrangement with your creditors. Both are ways of formally structuring an agreement with your creditors to allow you to move on without constant fear of insolvency action being taken against your company.

If your creditors aren’t cooperative, then you should consider options such as putting the company into administration. This again will give you some breathing space to assess the situation and turn it around, or if not, to rescue the viable parts of the business before closing down the remainder. More permanent solutions would be to look at putting the company into liquidation. 

If the worst case scenario happens and you need to put the company into liquidation, it is important that this happens before more creditors are prejudiced, as this can lead to ramifications personally for the directors.

The earlier you speak to our insolvency solicitors, the better. We can work with you and an insolvency practitioner to look at the best solution for your business if you are facing financial uncertainty.

As a company director, can I be personally liable if my company goes into formal insolvency?

The starting point in all company matters is that a company is considered a separate legal entity, and the directors and shareholders are only liable for debt to the extent of their own shareholding. However, in certain situations, a director can face personal financial liabilities for the debts of the company that has gone into liquidation or administration, eg if a director is found guilty of some form of misconduct while acting as a director of a company that has had to enter formal insolvency. The main reason for this is the protection of creditors – both by ensuring money comes back into the company for their benefit, and it also acts as a deterrent effect to prevent directors from breaching their duties and hiding behind the corporate entity.

For insolvent companies specifically, insolvency legislation sets out several ways in which a director might be personally liable for the debts of the company. These include, but are not limited to, the following:

• Wrongful trading – trading when the company should have known there was no reasonable prospect of turning the business around, therefore increasing the detriment to creditors when they should have ceased trading.
• Transactions at undervalue – moving assets or money out of the company and not obtaining reasonable value into the company in return.
• Preferential payments – repaying certain creditors in preference to others. Often repaying the directors or family members for example.
• Fraudulent trading - this is the same as wrongful trading, but more seriously doing this as a deliberate policy.

If found guilty of any of the above, or of the many other potential offences under the insolvency or companies legislation, a director may have to repay to the company the sums lost so that these can be used to repay creditors. They may also be disqualified as a director for a period of between two and 15 years, depending on the seriousness of the misconduct. There are many others potential pitfalls and reasons why directors might be held personally liable for matters in an insolvent company.

If you believe that your business is facing significant financial difficulties, it is vital that you take legal advice on your duties as early as possible to avoid potential personal liability as a director, and to protect your creditors from any further prejudice.

Further information and assistance

With these FAQs, we’ve covered some of the questions you may be asking if your bank should fail and you’d be left without access to your company’s deposits and cash flow. We have a library of other advice and guides you may find useful in our Knowledge Hub, including a few of the topics listed below:

• Finance and investment – including corporate loans and what happens to lending in insolvency
• Insolvency and corporate recovery
• Dealing with redundancies and reorganisations

Please do get in touch with us if you have any other questions as we are here to support and guide any business through difficult times. We can also help review any existing arrangements with your current bank to help you understand any likely exposure and/or to discuss any future arrangements you plan to enter into.