The Improper use of Customers’ Deposits

This is a ‘red flag’ offence at Insolvency. Our Insolvency Practitioners explain why and look at some examples.

When a company becomes insolvent and Insolvency Practitioners are appointed, there are many things they must investigate, not least because at this point there is a shift towards representing the creditors, as detailed in The Insolvency Act 1986 and the Company Directors Disqualification Act 1986. If directors in an insolvency have failed in certain areas of Administrative, Fiduciary, Trading Duties and/ or Financial Duties, the result can lead to a full investigation, which may lead to insolvency claims against them, and/ or director disqualification. One of the failings we have seen repeatedly is the improper use of customers’ deposits, which is a red flag offence in insolvency.

In this article, our team of Insolvency Practitioners look at why this is the case and use some examples to illustrate the point in cases the Insolvency Service has investigated and pursued.

What is Improper use of Customers’ Deposits?

This occurs when a business takes a deposit from a customer for goods or services yet to be delivered. It secures the order, with the customer (who at this stage is, in effect a creditor of the business) expecting to pay the balance on receipt of the goods. But what happens to the deposit whilst the customer is waiting for delivery?

In the case of Solicitors, for example, the answer is simple. They must have (as stipulated by the Solicitors’ Regulation Authority) a client account where client deposits are held. In this way, deposits are ring fenced and cannot be used for any other purpose, such as for improving cash flow or paying other creditors.

This is, however, not always the case with other businesses where deposits typically go into the main bank account (or are required to be placed in a recognised scheme as specific legislation requires) and can very easily end up getting used for general cashflow purposes. That should not be a problem if the business is solvent and trading is profitable. The problem arises, of course, if/when a company is approaching or enters insolvency before the goods have been delivered and the customer loses their deposit.

If the customers’ deposits have been used improperly, this a serious breach of a directors’ duties, especially if the deposit was taken with the company knowing it had little or no chance of delivering the goods.

We now look at two case of improper use of Customer Deposits from the Insolvency Service’s archives.

5-year ban for property boss after abusing client’s funds

In this case, an estate agent was disqualified from managing companies for 5 years after she failed to safeguard £28,000 worth of tenants’ deposits and rent destined for landlords.

The agency was placed into liquidation in August 2018 after encountering difficult trading conditions, and an Insolvency Service investigation followed which found that the director had failed to comply with legislation requiring all tenants’ deposits to be placed in a recognised scheme.

After the company entered into liquidation, investigators discovered the company had no record of 11 tenants’ deposits totalling £12,000 that had been received between March and August 2018, while tenants’ deposits received between April 2017 and August 2018, totalling £20,000, had not been paid into a government-backed statutory deposit protection scheme.

The company had also collected just over £7,000 of rent from tenants between March and August 2018. This should have been paid over to the tenants’ landlords but had instead been spent in the general running costs of the business.

As a result, the director was banned from being a director for 5 years. As the Insolvency Service pointed out:

“A fundamental part of the director’s role was being responsible for safeguarding money on behalf of the tenants and landlords, something they failed to do prior to the company falling into liquidation.”

Director of Window Installation Company banned by Insolvency Service

In this case, the director of a window installation company was banned from being a director for seven years after taking deposits from customers with no reasonable prospect of being able to deliver the goods.

The director signed a disqualification undertaking after an Insolvency Service investigation revealed he had taken deposits from 78 customers totalling £85,552 between January 2016 and 1 July 2016, for goods and services that his company then failed to supply.

Commenting on the disqualification, the, Official Receiver at the Insolvency Service, said:

“The director caused the company to take deposits from customers when the company was insolvent and without a reasonable expectation that services would be provided. The company failed to provide services to these customers and losses were incurred as a result.”

How Can Insolvency Practitioners Help?

Once a company enters liquidation, Insolvency Practitioners are legally bound to report any Directors’ duties failings they find to the Insolvency Service. However, if companies are in financial distress, but not yet insolvent, one of the things we can help them with is make sure that they are fulfilling their duties as directors.

Directors need to make the right decisions when facing insolvency, especially in relation to their duties as directors and these decisions need to be properly recorded. Here at Antony Batty & Company, our team of Licensed Insolvency Practitioners and Business Recovery and Restructuring Specialists can help Directors to ensure they fulfil their duties with practical measures and advice that can create a framework for managing a company in difficulty.

This advice can help to ensure that the Directors can avoid criticism at a later stage, if insolvency is the outcome, reducing the risk of a director disqualification investigation. Such advice can also be crucial in directors keeping control of the decision-making process, helping to prevent HMRC, banks, landlords or creditors influencing the outcome.

Contact us or call us on any of the numbers below for help and advice on insolvency and the possible issues regarding the duties and responsibilities of directors, including director disqualification. The initial discussion is FREE.

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