A director’s loan account arises where a director removes more money from his or her company than they introduced.
Until the director repays the amount overdrawn, this will appear as a loan on the company’s balance sheet.
Making use of a director’s loan account is common practice in owner managed businesses and is generally not a problem if a proper record of transactions is maintained, and the balance can be affordably repaid.
However, the loan account becomes problematic where the amount overdrawn is significant and the company is in financial distress.
Directors who are shareholders are often remunerated with a small salary which is supported by a balance of dividends, but dividends cannot be paid if the company is loss-making and there are no distributable reserves available.
When a company enters an insolvency procedure such as Liquidation or Administration, the Insolvency Practitioner has a statutory duty to realise the company’s assets, including any overdrawn director’s loan, in order to return funds to creditors.
The Insolvency Practitioner will therefore be required to establish the director’s financial position and take all reasonable steps to ensure that the balance is repaid. This may necessitate legal action, including personal bankruptcy, if acceptable settlement proposals cannot be agreed. The implications for directors personally can therefore be severe.
In addition, in certain insolvency proceedings the Insolvency Practitioner has a statutory duty to investigate the director’s conduct for the purpose of reporting to the Insolvency Service. This will encompass a review of transactions between the company and its directors.
Not only are these transactions subject to scrutiny, to establish if any claims can be brought against the director(s) for any form of malpractice, if it is considered that the drawing of funds or assets has significantly contributed to the demise of the company, then the director could face disqualification.
Early remuneration planning is key, not only for corporate and personal tax reasons, but to protect a director’s personal position in the event of insolvency.
If your company is in financial difficulty and you are concerned about the implications for you personally, please contact a member of our team to arrange an initial free, no obligation meeting to discuss the issue.
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