Mar 24
This is article 5 from a series of 10 written by Jonathan Mortimer, a Dispute Resolution Partner at Raworths. The guide is written from the viewpoint of where things may become contentious and involve legal proceedings. It presents a snapshot of the some of the legal issues which impact upon directors. It is not a substitute for taking specific legal advice on a particular set of circumstances.
A director’s loan account tracks the amount a company owes to a director or a director owes to the business. As long as the constitution of the company provides for it and there are no preferred terms, a director can loan money to a company to assist the objectives of the business.
Such loans are usually trouble free as long as the company can afford to repay the loan at some point in the future. Indeed, they are usually tax neutral and repayable on demand. However, loans made by the company to its directors can be much more problematic.
Ordinarily, the director should only be remunerated by payment of a salary or a dividend. Other draw down payments can be made to directors during the course of a financial year that do not immediately fall into either category and instead lead to an overdrawn director’s loan account. Such loans can be legitimate but ordinarily require the approval of the shareholders.
Where directors tend to go wrong is that they confuse their own money with company money – particularly in small businesses. They start to put through what is questionable personal expenditure which finds its way onto the loan account and as the years go by the amount owed to the company spirals out of control.
If the company fails, the director does not realise that the director’s loan is technically an asset of the company. As a result, any liquidator or administrator is obliged to hunt down the assets and seek repayment of the loan from the director who is probably financially embarrassed as a result of the company having gone down in any event.
Many directors have been pursued into bankruptcy by insolvency practitioners on the back of their inability to repay the loan. It is also important to note that a runaway director’s loan account is likely to have adverse consequences in respect of tax for both the director and the company. Some directors attempt to avoid all these consequences by writing off the loan.
The writing off of the loan is rarely legitimate and will further expose the director to potential claims from the company itself, shareholders, any appointed liquidator and will probably spark a tax investigation.
A guide for directors: What you should know before accepting the appointment.
Links to other articles in the full series can be found here when they are published:
Jonathan Mortimer has significant experience dealing with contentious company matters including the issues covered in this guide. Jonathan can be contacted by email at jonathan.mortimer@raworths.co.uk or telephone 01423 566 666
Published on 25 March 2024
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