It is very often the case that when directors of an insolvent company come to us for initial advice on the options available, the fact that there is an overdrawn director loan account [DLA] is disclosed.
Loans v Remuneration
When businesses are in distress, directors frequently take loans from the company rather than salary or bonuses because of the need to pay tax and national insurance to HM Revenue & Customs on such remuneration. Given the financial and cash-flow pressures most companies experience in the run-up to a formal insolvency procedure, such a course of action is understandable, but does lead to uncomfortable conversations with directors.
The overdraw DLA represents an asset of the company, a debtor which a liquidator, administrator, supervisor of a Company Voluntary Arrangement [CVA], will seek to recover.
The problems faced by a director with an overdrawn DLA of over £10,000 are further compounded by the fact that the loan is treated as a benefit in kind which must be disclosed in the director’s Self-Assessment Tax Return with a resultant tax and interest charge to be paid personally.
Director loans are legal
Overdrawn DLAs are no longer illegal as the general prohibition was removed in the Companies Act 2006. There is, however, now the rule requiring that any such loans [over £10,000] should be approved by the shareholders, prior to the making of such a loan. This compliance is something we rarely see in practice.
Unlawful Dividends
Again, as part of our conversation with directors, questions regarding unlawful dividends arise when reviewing overdrawn DLAs. Legislation requires that sums utilised for dividends are restricted to the amount of distributable reserves available at the point at which the dividend is declared.
Often, director-shareholders of close companies simply pay themselves “dividends” each month disregarding the fact that such distributions are in excess of distributable reserves. It is frequently the fact that the error only comes to light at year end when the external accountant, on his annual carries out an inspection of the books of account. Accordingly, in the case of a director-shareholder, the unlawful dividend amount is effectively added back to the DLA.
The directors’ problems do not end there. Directors may find themselves personally liable if they authorise unlawful dividends that cannot be recovered from other shareholders who also receive payment. If the monies are not repaid, directors could be held personally liable due to a breach of their fiduciary and statutory duties relating to the conduct of business and obligation to preserve assets.
And if that was not bad enough, there may well be Anti-Money Laundering implications surrounding illegal dividends which could be construed as a suspicious activity that a liquidator or administrator should report to the National Crime Agency.
Offset of overdrawn DLA
Many owner-managed businesses consist of a husband and wife and sometimes one is owed money by the company and the other owes money. In order to offset the balances, the parties must enter into a formal written agreement, before such offsetting occurs. Again, this is something very rarely seen in practice.
Joint and Several liability of directors
“A director is not the agent of his co-directors and the other officers of the company are not the agents of the directors. Accordingly, the mere fact that a particular director or other officer of the company is liable to the company for a breach of duty is not enough of itself to render the remaining directors liable as well.”
(Gore-Browne on Companies)
The general rule as stated above should give directors some comfort when it comes to the situation where certain directors have overdrawn DLAs whereas other directors do not. But beware! As we know, all cases turn on their particular facts, but the concepts of culpable inaction and/or failure to supervise could be successfully argued against directors who allowed other directors to build up large overdrawn loan accounts without taking any action to stop this occurring. Such directors could find themselves personally liable for company debts as a result of negligence in office.
Director Disqualification
In all insolvent liquidations and administrations, the acting Insolvency Practitioner will complete an online questionnaire submitted to The Insolvency Service which is the body which will decide whether or not to take action to have directors disqualified from acting as a director or being involved in the management of a company’s affairs for any period between 2-15 years.
As you can imagine, one of the questions posed related to overdrawn DLAs. Rather like a red-rag to a bull, an overdrawn DLA immediately brings into question the conduct of directors in the lead up to insolvency.
Attitude of Liquidators and Administrators
Some Insolvency Practitioners will take a very aggressive line when dealing with overdrawn DLAs. Spurred on by disaffected creditors, such practitioners can move quickly to the threat and implementation of legal action to recover the debt.
Most liquidators and administrators will, in a reasonable manner, seek a negotiated settlement with the director concerned. Ideally, such debts will be paid withing 6 months, but it is not unusual for such repayment periods to extend to 2-3 years, with the Insolvency Practitioner securing the indebtedness on the director’s matrimonial home or other freehold property.
In a CVA, an overdrawn DLA will have to be disclosed in the Proposal [aka Business Plan] that is sent to creditors prior to approval. In our experience, creditors will require any overdrawn DLAs to be repaid to the company withing 3 months of the acceptance of the CVA. Failure to comply with this requirement would lead to early failure of the CVA.
In conclusion
Overdrawn DLAs are a fact of corporate life. An early acceptance by the director that monies are owed to the company and will have to be repaid should, in a formal insolvency procedure, lead to a reasonable conversation and negotiated settlement with the Insolvency Practitioner acting in his capacity as liquidator or administrator of the company
Early professional advice should be sought from a Licensed Insolvency Practitioner to ensure that all relevant options are considered and the correct course of action taken.
