Following a wave of recent prosecutions in relation to cash fraudulently obtained through the various Covid-19 support schemes, we consider the criminal and civil ramifications on a legitimate business which has received cash from someone who has been prosecuted and offer some helpful tips to reduce the risk of your business inadvertently laundering the proceeds of crime. 

How big is the problem? 

According to the most recent policy paper tackling error and fraud in the Covid-19 support schemes, published in October 2022, it is estimated that between £3.2 billion and £6.4 billion of taxpayers’ money was obtained either in error or by deception during the Covid-19 pandemic. To the end of March 2022, HMRC confirmed that they have recovered around £726 million of funds, around 20% of the estimated money obtained in error or by fraud.  

All law enforcement bodies, have the powers to investigate Covid-19 frauds. However, the Taxpayer Protection Taskforce (‘TPT’), which was set up by Rishi Sunak to recoup fraudulently obtained funds during the pandemic, is being wound down by HMRC from March 2023.  

What could the impact be on a legitimate business?

In June 2022, Abdul Zagroba was the first person to successfully be prosecuted under new powers obtained by the Insolvency Service for fraudulently obtaining a bounce back loan. He was the sole director of Amigo Pizza, which at the time was already going through the process of being dissolved. In interview, Mr Zagroba told the Insolvency Service that he had no intention of using the bounce back loan for the business and had arranged for £14,000 in cash to be given to his family abroad, using the remaining £6,000 to buy a car and insurance. He was convicted of offences under the Fraud Act 2006 and the Companies Act 2006, receiving a 2-year custodial sentence and was disqualified as a director for 7 years.  

But what does the case of Zagroba mean for legitimate businesses - businesses who legitimately received loans under the various Covid-19 support schemes or didn’t apply for a loan at all?  In the case of Zagroba what is the impact on the unsuspecting dealership that he purchased his car from and the provider from which he purchased his insurance? 

The Criminal Perspective

The Proceeds of Crime Act 2002 (‘POCA’) is the UK’s primary Anti-Money Laundering (‘AML’) regulation. The explanatory note defines money laundering as “the process by which the proceeds of crime are converted into assets which appear to have a legitimate origin”.  

Perpetrators can be broken down into two categories:  

• Those who commit and then launder the proceeds of crime.  In this case, Mr Zagroba fraudulently obtained £20,000 of taxpayers’ money. This was fraudulent as he had indicated to HMRC that the money was necessary to keep Amigo Pizza operational, but instead it was used as personal expenditure. 
• The second category are those whose only involvement is to launder the proceeds of crime committed by others.

Sections 327 to 329 of POCA set out the primary money laundering offences and in each case, it is necessary to show that the person knows or suspects that the property in question is criminal property (ie the proceeds of crime). In this case, only if the car dealership or insurance company knew or suspected that Mr Zagroba’s source of funds to purchase a car was from a bounce back loan would they potentially face money laundering charges.  

Businesses should be aware that the threshold for suspicion is low. Defined in the Court of Appeal decision in R v Da Silva (2006) (EWCA Crim 1654) a person ‘must think there is a possibility, which is more than fanciful, that the relevant facts exist’.  

Any cash intermingled with fraudulently obtained funds is tainted and therefore also the proceeds of crime. If you become aware that a business with which you trade is suspected to have financially gained from committing a criminal offence, such as fraudulently obtaining a bounce back loan or has been convicted of doing so, you may have inadvertently accepted or be about to accept the proceeds of crime. Swapping tainted cash for a legitimate service means that your business would be committing one of the principal money laundering offences.  

The Money Laundering Regulations 2017 and 2019 (‘the Regulations’) set out additional obligations on private sector firms working in areas of higher money laundering risk, such as solicitors, and, since expansion of the Regulations in 2019, letting agents and crypto asset exchange providers amongst others. The aim of the Regulations is to stop criminals using professional services to launder money by requiring professionals to take a risk-based approach to business transactions. Any type of professional service defined within the Regulations is a business within the regulated sector and bound by the Regulations. Even if your business is not in the regulated sector, it is best practice to follow the spirit of the Regulations.  

Under the Regulations, businesses in the regulated sector are required to put adequate procedures in place to identify their clients and monitor how they use their services. 

Under Section 330 POCA, individuals in the regulated sector commit an offence if they fail to make a disclosure in cases where they have knowledge or suspicion, or reasonable grounds for suspicion, that another person is engaged in money laundering. The trigger for reporting is low and any business, even when the suspicion is slight should consider if it is appropriate to submit a Suspicious Activity Report (“SAR”) to the National Crime Agency (‘NCA’). A SAR can be submitted by anyone. They do not have to be in the regulated sector.  

On the submission of a SAR it is possible to apply to the NCA for a defence against money laundering (‘DAML’). The DAML may be requested by those who submit SARs and dealing with the suspected criminal property.  

In practice, if a business either regulated or not, identifies that one of their trader/counterparties is being investigated, faces or has faced criminal proceedings and they have paid cash into your business then you and your business are at risk of committing one of the principal money laundering offences.    

The Civil Perspective

A substantial proportion of businesses which utilised bounce back loans during the Covid-19 pandemic were Small and Medium Enterprises (‘SMEs’). These companies often operate on tight margins. The extraordinary effect of Covid-19 on businesses affected these smaller entities in a disproportionate way when compared with large business who had financial reserves available to them.

Given the tight trading margins, SMEs often build up close relationships with their counterparties. Business relationships will build over months/ years and the goodwill between the parties will be invaluable. However, when a company is nearing insolvency, this personal goodwill between the parties can break down, even if the underlying intention was well-meaning.

If a company verging on insolvency has received extra cash from a bounce back loan, the directors will quite often want to pay off their suppliers with these funds – and indeed there is no criticism for doing so. However, if a company is not paying its debts, then there is a risk creditor’s will take enforcement action which will cause the company to enter into insolvency. However, the risk arises when the directors choose to use cash to pay one creditor, at the expense of others.

On a practical level, it is not uncommon after the event for directors to say that when they received funds in the run up to insolvency, they want to “see their supplier right”, years of trading together will have created a personal relationship, and many directors find that they feel guilty if they suspect their trading partner will be out of pocket if the company enters insolvency. However, when paying this supplier with the new funds other creditors are left unpaid. 

Whilst paying their supplier might be well meaning on a personal level, it offends the underlying pari passu principle in insolvency that all creditors should be treated equally. Therefore, a liquidator may look to reclaim these funds as a preference.  

So if you are a supplier what should you do? One of the critical deciding points for a preference claim is whether the payment was made with the necessary desire to prefer. If a payment is made to ‘see you right’ or ‘help out’ to make sure you are paid in full before any insolvency, the transaction could be vulnerable. However, if there is some other reason for the payment – such as enforcement action would have been taken if the payment wasn’t made, then the necessary desire to prefer is likely to be absent.

Similarly, in the case of Zagroba, if you are the car showroom, there is no cause for concern from a preference perspective – the monies paid to you were part of a transaction; there was no desire to prefer. 

If you think you might have received a preferential payment, one point to consider is when was this payment made? Insolvency law prescribes a fairly short period for transactions that can be challenged (so no need to start scrolling through years of payments). The ‘look-back period’ for unconnected parties is six months from the date of insolvency. However, if a party is connected with the company, then the look-back period is significantly longer – two years.

But what is a connected person or company? There are entire books dedicated to this question and so what we say now will inevitably be brief. However, as a rule of thumb, if you are a close family member or a company that is part of the same wider corporate group, you are likely to be connected. In which case, a liquidator can review transactions that took place for two years in the run up to insolvency. So for Mr Zagroba, the payments to family members would certainly be vulnerable.

How to reduce the risk

Put adequate procedures in place to identify your customers and monitor how they use your services.  Adequate procedures could include:

• Implementing systems, policies, controls and procedures to address money laundering and terrorist financing risks and apply them.  
• Conduct a money laundering and terrorist risk assessment.  
• Provide training to staff. 
• Make sure you keep records and that data protection systems, policies and procedures are in place.
• Adopt appropriate internal controls. 
• Undertake due diligence checks, enhanced and simplified due diligence if necessary.  
• Comply with requirements relating to politically-exposed people. 

With increased insolvencies post Covid-19, check the status of the trading partners you are working with and if you find that they are entering into liquidation, take advice on transactions which may be vulnerable to challenge by a liquidator/ administrators.