Whether you manage clients or your own accounts, knowing what constitutes misappropriation of funds is key to avoiding negative consequences down the line.
Below we explore the topic; the definition of funds misappropriation, its forms, legislation, and consequences that can result.
What is misappropriation of funds?
Misappropriation of company funds is a form of financial or ‘white collar’ crime. It involves the unauthorised use or theft of money or other assets. It is the using of funds that were intended for a different, specific use.
The funds may belong to an individual, company or organisation such as the UK government.
Funds misappropriation can include anything from a director using company funds for personal gain (such as to buy a new property), to an employee siphoning cash from an organisation’s accounts.
It is a serious offence which can result in unemployment, fines, director disqualification or even a prison sentence.
Types of misappropriation of funds
Six types of misappropriation of funds include:
- Embezzlement: Probably one of the most well known, embezzlement involves the theft or exploitation of money entrusted to someone for safekeeping or management. For example, a bookkeeper who steals company funds from their employer’s bank account.
- Fraud: Deliberately deceiving others in order to gain access to funds that would not otherwise be available. This can take many forms, including identity theft, false invoices, and falsifying financial statements.
- Insider trading: Obtaining confidential or non-public information, such as a trade secret, to make unfairly advantageous trades on the stock market.
- Money laundering: The process of hiding profits from illegal activity by making them appear legitimate. Money laundering often involves moving funds through multiple bank accounts, or countries, to conceal how the money was obtained.
- Tax fraud: Deliberately providing false information to HM Revenue & Customs in order to pay less tax. This includes failing to declare income, overstating expenses or claiming false tax credits.
- Director self-dealing: When a director uses company funds to repay a loan which they have personally guaranteed, thus lessening their personal exposure to repaying the debt in the event that the company cannot pay that liability. This can be referred to as self-dealing or simply a conflict of interest.
A real example of misappropriation of funds
Here at Mercury Corporate Recovery Solutions, a common scenario we encounter is a director selling assets at a price that’s much less than their market value, in order to pay off a loan for which they have personally guaranteed.
For example, if your company van is worth £30,000 but the company has a debt of £10,000 which you have personally guaranteed, you may be tempted to sell the van for £10,000. You then use this company money to pay the loan, meaning you have eliminated your liability under your personal guarantee.
It would also be regarded as a transaction at an undervalue, which is a specific breach of the Insolvency Act.
Should your company go into liquidation, the liquidator has a statutory duty to investigate the causes of the company’s failure and identify any transactions which should be reversed so funds can be recovered for the company’s creditors. You can be ordered to pay this money back to the company even if the transaction took place up to 2 years in retrospect.
Selling assets at less their market value, and subsequently taking money out of the company in financial difficulty, is not in the best interests of the company and is therefore a breach of your fiduciary duty as a director.
As explained in the previous section, this can be considered ‘self-dealing’ or a ‘conflict of interest’.
Depending on the specific circumstances, such actions could also be considered fraudulent and therefore illegal. Directors who engage in such activities may be subject to civil or criminal penalties, including fines and in serious cases of fraud, imprisonment.
Embezzlement vs misappropriation of funds
Embezzlement involves the theft or unauthorised use of company or public funds, entrusted to someone for safekeeping or management.
Whereas misappropriation involves the misuse or theft of funds, or other assets, that were intended for a specific purpose, but were used for a different purpose instead.
The misappropriation of funds includes embezzlement, fraud, insider trading, money laundering, tax fraud and other crimes.
To summarise; while the misappropriation of funds is an umbrella term which describes several types of financial misconduct, embezzlement is just one way in which a person can misappropriate money.
Who is most likely to commit misappropriation of funds?
Anyone who has access to funds or assets can potentially misappropriate them, but employees, directors and people in positions of authority are often the ones who we most often encounter committing such offenses.
What are the consequences of misappropriation of funds?
In the UK, fund misappropriations can be prosecuted under various criminal offences, such as theft, fraud, and false accounting.
Consequences for the perpetrator can vary depending on the severity of the offence, but they can include criminal charges, fines, loss of employment, and damage to reputation. In the context of misappropriation in the lead up to the insolvency of a company, consequences can include director disqualification and civil recovery action to repay the funds as detailed above.
The extent of the penalty will depend on the specific offence committed and the circumstances of the case.
The specific UK laws to note:
- Theft Act 1968
- The Company Directors Disqualification Act 1986
- The Insolvency Act 1986
- Fraud Act 2006
- Companies Act 2006
- Proceeds of Crime Act 2002
How can misappropriation of funds be prevented?
Preventative measures can include having strong internal controls, conducting audits, establishing strict policies and procedures, and providing employee training on ethical behaviour and fraud prevention.
Directors particularly have a duty to act in the best interests of the company and to follow the code of director conduct as set out in the Companies Act 2006. Education and training is paramount when it comes to financial conduct. Knowing what does and doesn’t constitute misappropriation is the best way to prevent it happening in your company. Ignorance of these duties and responsibilities is no defence in law.
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If you or your client’s company is in financial distress, seeking help early ensures you have the greatest number of options available to you.
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