Many directors only discover they have an overdrawn Directors’ Loan Account when their accountant raises it or when the company starts to struggle financially. What felt like informal drawings or temporary withdrawals can quickly turn into a personal debt that must be repaid, especially if the company enters Liquidation or Administration. At Antony Batty & Company, we see this issue in a significant proportion of our SME insolvency cases, and most directors are unaware of the consequences until it is too late.
Elaine Wilkins, Director at our Bournemouth office comments:
“A significant number of directors we talk to remain unaware that if they enter liquidation an overdrawn directors’ loan account is company money that has to be repaid. I would strongly suggest regular dialogue with the company’s accountant to ensure a director loan can always be repaid when it falls due and remains at a level they can afford to repay.”
This article explains why Overdrawn Directors’ Loan Accounts remain a common issue, how recent case law illustrates the risks and how we work with directors to resolve these matters fairly and transparently.
What a Directors’ Loan Account is and why it matters
A Directors’ Loan Account records all money taken from the company that is not salary, dividends or reimbursed expenses. It also records any personal funds paid into the business.
When the account is overdrawn, the director owes money to the company. In a solvent business, accountants often clear the balance at year end through dividends, provided there are sufficient distributable profits.
Once a company enters a formal insolvency process, the position changes. The overdrawn balance becomes a book debt owed to the company. As Liquidators, we have a statutory duty to recover that debt for the benefit of creditors, a debt for which the director is personally liable.
Take a look at our video for more details.
Do I have to repay my Overdrawn Directors’ Loan Account if the company goes into liquidation?
Yes. In insolvency, the overdrawn balance becomes repayable in full. This is often the point at which directors realise that drawings they viewed as informal have created a significant personal liability.
A recent High Court case that shows how directors get into difficulty
A 2024 High Court judgment, Manolete Partners PLC v Karim and others [2024] EWHC 2053 (Ch), provides a clear illustration of how the courts approach unlawful dividends and personal use of company funds.
In that case:
- the directors of Evershine Travel Ltd were found to have used company funds for personal expenditure
- payments labelled as dividends were held to be unlawful because the statutory accounts were unreliable and there were no distributable profits
- the court ordered the directors to repay substantial sums to the company’s assignee
The judgment confirms that the court will look behind statutory accounts where necessary and will not accept retrospective attempts to reclassify personal spending as dividends. Although every case turns on its facts, the principles applied are long established and remain highly relevant to directors whose loan accounts are overdrawn.
Why do so many directors fall foul of their loan accounts?
Across the insolvency profession, and in our own casework, several themes recur:
Misunderstanding drawings versus dividends
Professional bodies such as ICAEW and ACCA regularly highlight that many SME directors do not fully understand the distinction between drawings, salary and dividends. Drawings are not income. If they are not supported by profits and proper documentation, they cannot be treated as dividends.
The Section 455 tax charge – what it means and why directors misunderstand it
A common source of confusion is the Section 455 Corporation Tax charge on overdrawn Directors’ Loan Accounts. If the loan is still outstanding nine months after the company’s year end, the company must pay tax at 33.75 percent of the balance. This is not a penalty. It is a temporary tax charge that is refunded when the loan is repaid.
We are aware that accountants warn directors about this regularly, but the message is often misunderstood. Directors sometimes hear “your accountant will sort it at year end” when the accountant is actually saying “if you do not clear this balance, the company will face a significant tax charge.” If the company later becomes insolvent, the Section 455 payment does not reduce the amount the director owes. The loan remains repayable in full.
This is one of the reasons why early advice is important. A loan that could have been cleared through salary, dividends or repayment can become a substantial personal liability if the company’s financial position deteriorates.
What happens if I take drawings without profits?
Many small companies operate informally. Directors often take money out of the business as needed, assuming their accountant will adjust the figures at year end. When the company becomes insolvent, these drawings are reclassified as loans and become repayable. Again, we see a lot of this. If brought in early enough, we can tell directors to only draw what the company can afford.
Poor record keeping
Insolvency Service enforcement reports consistently show that inadequate accounting records are a common feature of director misconduct cases. Where records are incomplete, the Liquidator must reconstruct the account using available information. In the absence of clear evidence, withdrawals are treated as loans.
Unlawful dividends
Dividends can only be paid from distributable profits. If profits are insufficient, the dividend is unlawful under the Companies Act 2006. In insolvency, unlawful dividends are routinely challenged and the director may be required to repay them.
The impact of Sequana
The Supreme Court’s decision in BTI 2014 LLC v Sequana SA confirmed that directors’ duties shift towards creditors when insolvency is probable. Continued drawings during financial distress can therefore give rise to personal liability. Sequana is now settled law and forms part of the framework within which directors’ conduct is assessed.
Can a Liquidator make me repay money I took from the company?
Yes. Drawings, personal spending and undocumented withdrawals are treated as loans and must be repaid in full in liquidation.
What happens to an overdrawn Directors’ Loan Account in insolvency?
When appointed, the Liquidator must:
- review the company’s accounting records
- reconstruct the Directors’ Loan Account where necessary
- identify undocumented or misclassified withdrawals
- assess whether dividends were lawful
- determine the balance owed
- seek repayment or negotiate a settlement
Directors are often surprised at how the balance increases once unlawful dividends, personal expenses and undocumented withdrawals are correctly accounted for.
What if I cannot afford to repay my Overdrawn Directors’ Loan Account?
Our approach is based on transparency, co-operation and fairness. Every case is different and we recognise that directors rarely set out to create a problem.
A clear review
We work with directors and their accountants to establish the correct balance. This includes identifying any legitimate business expenses or funds introduced that may reduce the amount owed.
A practical settlement – how do we work with directors to resolve their loan accounts?
If the director cannot repay the balance immediately, we will consider the possibility of a settlement based on their financial circumstances, on a case by case basis. This may involve a lump sum, instalments or a negotiated compromise.
Full disclosure
Co-operation is essential. Providing records promptly and engaging constructively helps avoid escalation and reduces the risk of director disqualification.
Why early advice makes a difference
Directors often contact us only when cash flow has deteriorated significantly. By that point, options are limited and the DLA may already be substantial.
If your accountant has raised concerns about an overdrawn directors’ loan account, or if the company is struggling to meet its liabilities, early advice can prevent a manageable issue becoming a serious personal liability.
Talk to us if you are worried about an overdrawn Directors’ Loan Account
In the majority of SME insolvency cases we handle, the Directors’ Loan Account is a key issue. Many directors are unaware that their drawings have created a personal debt and most are relieved to have the position explained clearly and without judgment.
We have helped hundreds of directors understand their responsibilities, negotiate settlements and avoid unnecessary legal action. If you are unsure about your position, please contact us, we are here to help with a confidential, free of charge initial discussion.
Frequently asked questions about Overdrawn Directors’ Loan Accounts
What is a Directors’ Loan Account?
It is a record of money taken from the company that is not salary, dividends or expenses, and of any personal funds paid into the business.
Do I have to repay my Overdrawn Directors’ Loan Account if the company goes into liquidation?
Yes. In insolvency, an overdrawn Directors’ Loan Account becomes a debt owed to the company and the Liquidator must seek repayment.
What happens if I cannot afford to repay my Directors’ Loan Account?
A settlement can often be negotiated based on your financial circumstances. This may involve instalments or a lump sum.
Can a Liquidator make me repay money I took from the company?
Yes. Drawings, personal spending and undocumented withdrawals are treated as loans and must be repaid.
What is the Section 455 tax charge?
If a Directors’ Loan Account is still overdrawn nine months after the year end, the solvent company must pay a temporary Corporation Tax charge of 33.75 percent of the balance. This is refunded when the loan is repaid.
Does the Section 455 tax charge reduce what I owe in insolvency?
No. The Section 455 payment does not reduce the amount the director owes. The loan remains repayable in full.
Can I clear my Overdrawn Directors’ Loan Account with a dividend?
Only if the company has sufficient distributable profits and the dividend is properly declared. If not, the dividend is unlawful and must be repaid.
What happens if I used company money for personal expenses?
These amounts are added to the Directors’ Loan Account and become repayable. In insolvency, they are treated as part of the debt.
What if my company is solvent but my Directors’ Loan Account is overdrawn?
The company can agree a repayment plan, charge interest or request repayment immediately. Alternatively, if the directors are majority shareholders, arrangements can be put into place with the help of the accountants to ensure repayment is made in a legal manner. In all cases proper documentation is essential to avoid future problems.
Can HMRC treat my overdrawn Directors’ Loan Account as salary?
Yes. If the loan is not repaid or cleared by a lawful dividend, HMRC may treat it as income and apply PAYE and National Insurance.
