Directors be Vigilant! Understanding a Directors Loan Account and your Liabilities

Overdrawn Directors Loan Accounts and Illegal Dividends. If your company is liquidated it can lead to Liquidators’ Claims and even Director Disqualification

The Insolvency Service’s figures for Q2 2022 for England and Wales show there were 5,629 company insolvencies in April-June, up 13% on the last quarter, and 81% more than a year ago – the highest level for 60 years. Of these, 4,908 were Creditors Voluntary Liquidations. Vulnerable companies, and their Directors, need to be aware of the pitfalls of liquidating their companies. In this article we look at two, related, key areas that Directors must seek to avoid at liquidation – overdrawn Directors Loan Accounts and the payment of Illegal Dividends.

Overdrawn Directors Loan Account

We are seeing an increase in enquiries from struggling companies where overdrawn Directors’ Loan Accounts are an issue. Anecdotally, it is commonly accepted in the Insolvency profession that between 75% and 80% of business insolvency cases involve overdrawn director loan accounts.

An overdrawn Directors Loan Account happens when there is a balance owed from the Director to the company at liquidation. Once a Liquidator is appointed, the Liquidator is obliged to recover any such amount that is owed by the directors, which is treated as a debt that is owed to the company. Such Liquidators’ Claims are usually paid personally by Directors. When disputed, cases can and do end up in Court, and if the Director loses, they typically end up paying legal costs as well as the claim – sums which can be hugely expensive.

The rules as they stand stipulate that in the time-period leading up to insolvency and a Creditors’ Voluntary Liquidation, the focus switches away from Directors towards Creditors. So, declaring a dividend in the lead up to liquidation, as an attempt to cancel or reduce an overdrawn Directors Loan Account, for example, is no solution at all.

Illegal Dividends

Dividends are only payable from profits, and yet we regularly see Directors paying Dividends as insolvency approaches and even when insolvent.

Liquidators can, and do, seek to reclaim such Dividends from the Directors personally, because such Dividends are illegal. Financial recovery action is part of a Liquidator’s remit.

The on-going financial effects of the Covid-19 pandemic, as well as the current inflationary pressures, are likely to be prevalent here because sums that directors typically take out of the company to pay for non-business personal expenses are charged to the Directors Loan Account. Then, in order to redress the resulting overdrawn position, a Dividend is declared to repay the sums due before the company’s Accounts are finalised. However, if the profits are not there to allow for the Dividend, then any such Dividend will be illegal and will be investigated at liquidation. Clearly, with many businesses suffering right now, it is likely we will see an increase in such investigations.

Under these circumstances, more directors are likely to face financial recovery action at liquidation.

What can directors do?

Antony Batty comments:

“As Insolvency Practitioners and recovery and turnaround specialists, our first aim is always to see if we can rescue distressed businesses. The earlier we are called in by businesses, or by their accountants, concerned about impending insolvency, the more we can do to help.”

Indeed, research by R3, the insolvency industry body shows that in more than 40% of cases where Insolvency Practitioners are instructed, liquidation is avoided, using processes such as Company Administrations and Company Voluntary Arrangements.

Antony Batty continues:

“Where liquidation is the only available option, it is vital that businesses and directors are well advised by their accountants and referred to us at an early stage, so that they do not fall into the traps of overdrawn directors’ loan accounts and paying illegal dividends that can end up with expensive, time consuming and stressful consequences.”

If you are concerned about the financial position of your company and are facing insolvency, please contact us or contact one of our offices:

Also, K&W Recovery, trading as Antony Batty and Company, Thames Valley:

Our Insolvency Practitioners will take you through your options step by step and will advise you of the best one to take under the prevailing circumstances.