Overdrawn Director's Loan Account Help

Posted on May 01, 2015 by Julie Frost

Over the last twelve months we have seen an increase in enquiries from directors of limited companies worried about their overdrawn director’s loan accounts. A combination of factors notably the reluctance of banks to lend to small businesses and a reduction in profits have conspired against directors of small companies. The result being many are now facing an overdrawn director’s loan account as well as an additional tax bill!

In an ideal world the director’s loan account would, if anything, always be in credit. But many directors view their own finances and their company’s finances as being one in the same, withdrawing funds when the need arises, rather than when profits are recognised.

As a Director you know that you should not be withdrawing bonuses or dividends from your company if it’s not making a profit. But this is easier said than done, especially when mortgages and everyday bills need to be paid. Of course, when a company is performing well and is profitable all is fine. The Tax bill can be reduced by shareholder/directors receiving a small salary and then taking dividends from the profits. But if a company’s performance has dipped, directors can face serious personal financial problems. This is where Frost Group can help.

What is a Director’s Loan Account (“DLA”)

Unlike a sole trader, the limited company is a separate legal entity and money earned by the business belongs to the company and not to the directors. The DLA is not a real bank account, but rather a virtual one in accounting records which tracks the flow of money between the limited company and its director. When a director puts money into and takes money out of a company it is initially terms a loan and accounted for as such in the DLA.

HMRC state that if you are a company director or ‘participator’ and take money out of your company that is not a salary or a dividend – over and above any money you’ve put in – you’re classed as having received the benefit of a director’s loan.

Tax Implications

If your director’s loan account is overdrawn, i.e. you owe the company money, then the company must pay tax on any amount you’ve not repaid by nine months after the end of your corporation tax accounting period. In these circumstances the company will incur a penalty tax of 25% of the loan.

The Directors may also be subject to the loan being treated as a taxable benefit if the interest rate charged is less than commercial rates and the amount of the loan exceeds £5,000. Let’s face it, in most cases these loans will
be interest free. There may also be income tax and national insurance implications for you and for your company.

So, if you are facing an overdrawn director’s loan account and a business in financial difficulty what options are available?

Restructure

If your company is insolvent but still a viable enterprise we can initiate a restructuring plan whether that be informally or using a formal insolvency process called a Creditors Voluntary Arrangement (“CVA”). Generally, if we can plan for creditors to be paid in full then an informal restructuring plan is achievable. If there is to be a deficit to the agreed claims of creditors then the most likely option is a CVA which will, at least, allow you to pay your creditors over a fixed period of time whilst allowing your company to continue trading.

As well as giving money back to your creditors this type of plan will also give you the time and potentially the income to allow you to repay the company. We can swiftly work out an arrangement covering the amount of debt you can pay and a payment schedule. Creditors will need to be notified in a CVA and invited to a meeting to vote on it. 75% of voting creditors must agree to approve the CVA and, once approved, the historic debt will be contained within the arrangement freeing you up to concentrating on a positive profitable trading scenario.

One note of caution; particularly if you have HMRC as a large creditor, it is likely that creditors will require that Directors receive a salary rather than allowing further Director’s loans to be generated. The downside here is that this is not so tax efficient, but if you do not draw all of the entitlement, it will at least allow for a managed reduction of the outstanding Directors indebtedness in a transparent manner.

If the company does not get the 75% vote from the creditors your business could face liquidation. The business must also adhere to the agreed payment schedule and if not creditors or indeed the Supervisor can apply to wind up the company.

Close / Liquidate the company

If you are forced to place the company into Liquidation, and your Directors Loan Account is overdrawn then the appointed Insolvency Practitioner will ask you to repay the amount for the benefit of creditors. This is bad enough, but the request will usually be made at a time when other personal guarantees, usually to the bank are being called and, as directors, you have just lost your prime source of income.

“So, lets just say I wrote the DLA off three weeks ago!” is a question we get more often than is comfortable.
The answer usually comes in two parts. Firstly we have to deal with the integrity of honesty that is expected
of the Insolvency Profession shown by the years required to train to become one. And secondly …

Investigations by a Liquidator

A Liquidator has to investigate a company’s financial transactions pre-insolvency. These investigations
usually cover a period of two to three years prior to the Liquidation commencing and will include, at the very least a review of the company’s bank statement and the accounting and Accountant’s records. Any write off three weeks prior to Liquidation will stand out like a sore thumb, as indeed do personal mortgage payments, payments of school fees and, regrettably, parental funeral costs. And yes we have seen all three.

The Liquidator is looking for transactions at undervalue, preference payments, instances of misfeasance and trading whilst insolvent, i.e. Continuing to trade when Insolvent Liquidation was clearly unavoidable. Directors can be held personally liable under any of these categories, and, if proven, individuals can also face periods of disqualification as Directors for anything between two and 15 years!

In short - the bad news

  • The liquidator will demand that the directors repay any amount owed on a director’s loan to pay the company’s creditors
  • A Liquidator can take legal action against a director and can make them bankrupt

“BUT I don’t have that sort of money.”

This is another well known, and quite understandable place for company directors to find themselves in. Lifestyles tend to grow as funds increase and running a business is not straightforward. It has good times and not so good times and we would not criticise someone for mis-reading a Company failing event for a cyclical downturn in fortunes, at least initially.

But if you genuinely have little, then it is not the Liquidators role to imprison you or hound you unnecessarily. For one thing both cost money that they are unlikely to have. Instead the approach will be to get as much out of you as cheaply as possible. They will expect it to be a challenge for you, but you going Bankrupt will offer as little return to them as it would for other unsecured creditors.

As Liquidators we are in a position of being able to negotiate a settlement with Directors and to let the creditors know the outcome and reasoning. We have to be able to justify any settlement / agreement and the best route is to be honest and open with us. Of course we will investigate for hidden or undisclosed assets (as is human nature you will want to perhaps protect or retain your assets) but by being transparent you will get the best outcome for your creditors and a settlement positive for you without the addition cost of solicitors and the Courts.

We do, of course always ask Directors not to confuse what they have with what they would like to spend for the problem to go away! The two can sometimes be very different and cause expensive problems later on!

Case Study

Recently we had a case where a director owed approximately £126,000, by way of a overdrawn Directors Loan. He did have several investment properties and a matrimonial home. Realising the properties would have been expensive and added little to the Directors ability to repay the debt and his Bankruptcy would not have provided
a return to creditors. We therefore worked out the equity in those properties and the director is now making an affordable and fixed monthly payment (basically the equity in the properties) over a period of two years in full and final settlement of his indebtedness.

What we can do to help you?

Again we place emphasis on honesty and transparency with us. Be upfront and then nothing will come back to
haunt you in the future. It is only once we have a full appraisal of your situation that we will be able to ‘tell it to
you as it is’, with best and worst case scenarios.

All our consultations are provided free of charge and are confidential and held at our offices in London, Croydon and Bournemouth or even at your home if you prefer.

If you have an overdrawn director’s loan account and a viable business we will certainly be able to help you in both the short and the long term with a restructuring plan. If your business is not viable then a Liquidation with settlement opportunities for your creditors is likely to be the best option.

Why can’t I simply Strike the Company off the register?

Policies at both Companies House and HMRC have evolved much in recent years and there was a time when the mere filing of the relevant form correctly led to the writing off of material assets within Companies. Our experience is that HMRC’s position has hardened comparatively recently with the position now not being as cut and
dried as it once was. That said, if the Company’s only material asset is a debt due from its Directors and they can
show that they have no material assets either and that there is no public interest reason for them to be made Bankrupt then a striking off of the Company can be allowed. This area and particularly the necessary due diligence that surrounds it, is a further area where we can again assist.

Having an overdrawn Director’s Loan Account and dealing with an overly aggressive Liquidator

If you believe that your Liquidator is waging a protracted overly aggressive campaign against you and your company and you would like some independent advice and assistance we can help you.

Recently there seems to be a pattern emerging of Liquidators using the lack of knowledge of the processes that most Directors have, to exhibit overly zealous and aggressive and particularly unrealistic expectations of the quantum of recovery they expect. This can include ruinous and expensive litigation and of course they try to charge for the privilege of such action as well as the extravagant fees charged by both sets of instructed solicitors.

We can assist many directors who are in this position by investigating the actions of these Liquidators on your behalf and, as we have said earlier in this article, after reviewing a Directors personal wealth: ‘saying it like it is!’ In our experience negotiation and mediation offer the best prospect to resolving such conflict. Call us for a free consultation and we will explain to you the best course of action to take.

For many, the first this matter rears its head is when they are in front of us. They have usually not amended their drawings policy and life style as the company’s financial fortunes have waned. And, as funds in the company have diminished so has its use of professionals such as Accountants and Solicitors to deal with its day to day issues. The result is shock as they walked in expecting to pay a small sum to close down a now defunct company, to be told that over a years’ worth of costs are going to have to repaid to the company!

"For many, the first this matter rears its head is when they are in front of us. They have usually not amended their drawings policy and life style as the company’s financial fortunes have waned. And, as funds in the company have diminished so has its use of professionals such as Accountants and Solicitors to deal with its day to day issues. The result is shock as they walked in expecting to pay a small sum to close down a now defunct company, to be told that over a years’ worth of costs are going to have to repaid to the company! We can provide independent advice and assistance to help you."

Jeremy Frost, Insolvency Practitioner