Understanding directors’ loan accounts and liquidation

What happens to a directors' loan during liquidation?

The transactions held in your director’s loan account (DLA) represent the funds you’ve invested in your company, and the money you’ve withdrawn that isn’t via PAYE or a dividend payment.

If you withdraw more money from the company than you have invested, not including salary and dividends, the DLA becomes overdrawn. Although overdrawn directors’ loan accounts aren’t necessarily an issue when business is good, they do take on specific significance when a company enters liquidation.

Once a liquidator is appointed, all directors’ loan accounts will be scrutinised for transactions that may have placed the company’s success in jeopardy. But before we identify the potential problems of directors’ loan accounts and liquidation, let’s look a little more at how DLAs work in general.

When a director’s loan account is in credit

The limited company structure means that directors’ liability is limited to the amount of investment they’ve made in the company so if your account is in credit, depending on the balance, on the face of it your liability may not be significant.

But what if the DLA is overdrawn? There are tax implications when running an overdrawn director’s loan account, and HMRC can charge the funds taken as income if the rules and regulations aren’t followed. This facility is intended to be short-term, and if you routinely run an overdrawn DLA you risk HMRC intervention.

The potential problems deepen if the account is overdrawn, however, and your business needs to be liquidated. Essentially, the funds you’ve taken are owed to the company and appear on its balance sheet as an asset to be collected in by the liquidator.  

So what happens if a director’s loan account is overdrawn in liquidation and what are the ramifications for you as a director if you can’t afford to repay?

Overdrawn directors’ loan accounts and liquidation

Operating an overdrawn director’s loan account during the time leading up to insolvency, and when the company enters liquidation, can result in serious financial difficulty for you on a personal basis.

If it’s later found that you took a loan from the company that couldn’t be financially supported at the time, maybe because the business was already in decline, the repercussions can be severe.

The liquidator’s overall responsibility is to the company’s creditors – they have a duty to realise the business’ assets and collect in all debts for the benefit of creditors. Although there is a legal separation between you and the company, in these instances directors’ loans cannot simply be written off when the business experiences financial difficulty.

What are the possible ramifications?

So what should you do if you’re worried that your business will be liquidated and you’re running an overdrawn director’s loan account? It’s vital that you seek professional support as soon as possible, to find out your best options.

Seeking professional help and guidance

Directors’ loan accounts aren’t necessarily a problem if they’re regarded as short-term financial facilities and are handled correctly. All loans must be properly documented, and those over £10,000 approved by shareholders. Additionally, if you repay in full within nine months and one day of the company’s year-end, you won’t be liable for tax.

This is a complex area of business, however, particularly when a company declines. If you’d like to find out more about directors’ loan accounts and liquidation, Real Business Rescue can help.

We’re insolvency specialists and will provide independent advice on your situation. Please contact one of the team to arrange a free same-day consultation at one of our network of offices nationwide.