Overdrawn Directors’ Loan Accounts in insolvency – the consequences for directors could be severe.
Is your company insolvent? Could it be heading towards liquidation?
Overdrawn Directors’ Loan AccountS (DLA) are not just a technical detail. When a Company enters an insolvency process a DLA becomes due and payable and is a legal debt that you, as a director, may be personally liable for. This is not time to look the other way. If mishandled, this could lead to legal action against you for the debt which could lead to disqualification from being a director of a limited company – or even bankruptcy.
In this article we look at what a DLA is and why an overdrawn DLA at liquidation can have such potentially severe consequences. We also make suggestions as to the steps you can take if you do have an overdrawn DLA, including reviewing your DLA balance with your accountant and seeking early advice from a Licensed Insolvency Practitioner.
What is a Directors’ Loan Account?
A Directors’ Loan Account records the level of funds withdrawn from or paid into the business by a director outside contractual pay or expense reimbursements. In small and medium-sized companies, directors often draw cash informally during the year and rely on profits to clear the balance through dividends.
If those profits don’t materialise – or the company enters insolvency – any overdrawn balance becomes a personal liability. That’s when overdrawn DLAs and insolvency collide – and the director is expected to repay what is owed.
How common are overdrawn Directors’ Loan Accounts in Liquidation? Are they widely understood by directors?
Overdrawn DLAs are not uncommon – they are one of the most frequent issues we see in liquidations, and we often find they are not widely understood by directors.
- It is estimated by R3 (our trade body) that around 60% of Creditors’ Voluntary Liquidations involve overdrawn DLAs.
- Insolvency Practitioners routinely flag overdrawn DLAs as key assets to pursue during liquidations
We often find that company directors are not fully aware of the consequences of an overdrawn DLA when a company is insolvent. In short, if you are a company director facing insolvency, this is an issue you cannot afford to ignore.
What happens to an overdrawn DLA during liquidation?
When your company enters insolvency:
- The Liquidator, inherits, by virtue of his/ her appointment all the powers that the directors have over the Company.
- As part of their statutory duties, they actively pursue repayment of any overdrawn DLA.
- Informal arrangements, offsets, or verbal understandings carry no legal weight
- Any assumption that future dividends would clear the overdrawn balance is irrelevant as the Company will have ceased to trade and loses the ability to declare dividends once the company is insolvent.
Where no proper paperwork exists – such as dividend minutes, board approval or PAYE records – the director is often left exposed. That’s why DLAs and insolvency can create a problem for directors.
What are the penalties and risks?
Directors who cannot repay an overdrawn DLA may potentially face:
- County Court Judgment
- Enforcement action
- A bankruptcy petition if the debt exceeds £5,000
Could I be disqualified as a director?
Mismanagement of DLAs may result in director disqualification for up to 15 years. This is especially likely if illegal dividends were paid or if DLAs are misused as well as other elements of misconduct.
What are the common mistakes directors make with Directors’ Loan Accounts in insolvency?
Directors often fall into these four traps:
- Drawing funds with no plan for repayment.
- Declaring dividends without profits or paperwork to justify these dividends.
- Repaying themselves ahead of creditors or writing off the debt.
- Assuming the liquidator will be unaware of what has happened or will write off the loan.
What should I do if I have an overdrawn DLA?
If you’re facing financial difficulty and are worried about a possible overdrawn DLA:
- Stop drawing funds informally.
- Review your DLA balance with your accountant.
- Avoid declaring dividends without profits and clear documentation, and
- Seek advice from a Licensed Insolvency Practitioner as early as possible.
If liquidation is already underway:
- Be open about the overdrawn DLA.
- Provide full records and co-operate with the Insolvency Practitioner.
- Explore repayment or settlement
Why is early advice so important?
At Antony Batty & Company, we have many years’ experience advising Directors regarding DLAs. We understand how quickly a seemingly minor issue can become a major liability. We are always willing to listen and where possible will try and work through a solution without resorting to legal action where possible.
“When liquidation is the only remaining option, it’s essential that businesses and directors receive sound advice from their accountants and are referred to us promptly. This helps to avoid the pitfalls of overdrawn directors’ loan accounts and unlawful dividends, which can lead to costly, protracted and highly stressful outcomes.”– Antony Batty
We have helped hundreds of directors negotiate settlements, avoid court action, and understand their responsibilities clearly. If you are unsure about your position, we’re here to help.
Contact us today. One conversation could save you months of stress – and potentially £thousands in personal liability.
