Understanding Overdrawn Director's Loan Accounts

Overdrawn Director's Loan accounts: Costs, Repayment, and Process

A director’s loan account is a record of company financials which documents any transactions between the company and the director which are not classed as salary or dividends.

If you haven't taken money out of the company (which is not classed as dividends or payroll) your director’s loan account will have a zero balance or may even be in credit if you have put your own money into the company at any point.

The complexities arise once a director’s loan account becomes overdrawn - that is, a director has taken more money out of the company (which is not classified as a salary, dividend, or expense reimbursement) than they have put in.

A director’s loan account can be a particularly complex issue for company directors to understand. Unlike with sole traders where taking money from the business is a relatively straightforward process, withdrawing money from a limited company is a different matter altogether. This is because a limited company is classed as a separate legal entity from its directors, therefore the company's money belongs to the company and not the directors.

What is an Overdrawn Director’s Loan Account?

An overdrawn director’s loan account is where you, as a director, have taken more money out of the company (that is not classed as salary or dividend) than you have put in.

Having an overdrawn director’s loan account isn’t necessarily a problem so long as these transactions are accurately recorded and you can afford to repay the overdrawn amount or offset it within nine months of your company’s year end. If you find yourself unable to repay your director’s loan on time, however, this is where problems can arise.

Whilst left unpaid, this loan is considered an asset of the company – a crucial matter should the company later become insolvent.

Overdrawn Director's Loan Account in liquidation

Overdrawn director's loans can become a major issue should a company become insolvent and subsequently enter into liquidation proceedings..

In formal liquidation proceedings, any overdrawn director’s loan account would be considered a company asset to be recovered for the benefit of its creditors. If the balance of the overdrawn director's loan is significant, the appointed liquidator - which will typically be a licensed insolvency practitioner - will almost certainly look to the directors to repay the outstanding loan amount back to the company so that the money could go towards repaying outstanding creditors as far as possible. 

But what happens if the director cannot afford to repay their overdrawn director’s loan account in liquidation? Unfortunately it may be the case that a director has to consider personal insolvency proceedings, such as an IVA or bankruptcy, to deal with the outstanding debt, or otherwise come to an agreement with the appointed liquidator regarding how much is owed and a possible repayment plan.

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Can an Overdrawn Director’s Loan Account be written off when insolvent?

Typically an overdrawn directors loan account can be written off, however, this will trigger a tax liability which could be considerable in some cases. If the company is insolvent, however, writing off an overdrawn directors loan is not a viable option.

Even if the company has written off the overdrawn amount, a liquidator is able to reverse this transaction and ask that the company director repays the overdrawn director's loan account to the company in order to repay creditors. Essentially, an overdrawn director's loan cannot be swept under the carpet just before the business goes into liquidation to avoid paying creditors; historical accounts and invoices will be scrutinised and money will be tracked to ensure proper processes have been carried out. This is a liquidator’s duty.

While there might be legitimate ways to reduce the balance of an overdrawn director's loan account and thus reduce your personal liability, e.g. reasonable claims for expenses or unclaimed business mileage, the remaining balance will still typically pose a problem for the director of an insolvent company.

Depending on the amount you owe on your directors' loan account, and the overall value of assets and liabilities of your company, you may be able to come to an arrangement with the appointed insolvency practitioner when it comes to repayment. This is something you will need to discuss with your insolvency practitioner during your conversations.

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Can I declare the balance of an Overdrawn Director's Loan Account a divided when insolvent?

Sometimes a company will try to reduce the amount of the overdrawn director's loan account by declaring the balance as a dividend or bonus . But if the company then goes into liquidation, this could be setting the company and director up for a massive fall.

During liquidation, all recent company affairs including accounts and transactions will be investigated by the appointed insolvency practitioner. If it transpires that creditors are missing out on payment they are owed whilst a director has taken a huge dividend or bonus to clear an overdrawn director’s loan, this could raise legitimate claims against the director.

The director will need to prove that that particular dividend/bonus was in the best interests of the company and its creditors but, considering the company’s precarious position, this will be very hard to justify and the dividend may be classed as unlawful. It is likely to be the case that the director is asked to repay the overdrawn director’s loan amount back so that the liquidator can use these funds to repay creditors.

What if you cannot repay an overdrawn directors' loan during liquidation?

If you are unable to repay your overdrawn loan back into the company, this is likely to impact on creditors. A liquidator will assess the amount of the overdrawn director's loan account and will look to realise funds in the best interest of creditors. From their perspective, you have taken money from the company that belongs to the company and this company owes them money. So in effect, you have spent their money.

The liquidator will look to recover this money, particularly where the overdrawn loan account and other assets are sufficient enough to cover their costs and release some funds for creditors.

You should seek advice from one of our licensed insolvency practitioners at the earliest possible opportunity if this situation has arisen; we have offices around the country and are here to provide the expert help and guidance you need.