Updated: 5th February 2021
A Director’s Loan Account records money that you pay into your company, and funds that are withdrawn. It forms part of your company’s accounting system, and is required because a limited company is a separate legal entity to its owners/directors.
When you set up the business, you may have input a capital payment from your own funds. This is documented in the Director’s Loan Account, along with any other personal payments for smaller expense items. These transactions are treated as a loan to the business, and under normal circumstances you can expect to receive the monies back at some stage.
But what happens if the company starts to struggle financially, or has already become insolvent? Can you still gain access to the original capital payment, and any other inputs of cash from your own monies?
Shareholders of a limited company are the last group of creditors to receive payment in liquidation. There is an obligation for you as a director to act in the best interests of all creditors if you suspect that the company may be approaching insolvency.
Failure to do this can bring serious repercussions during the investigation that takes place during many insolvency procedures. An expectation exists that all limited company directors will be aware of, and understand the financial position of their company at all times, and act accordingly.
Therefore, as you have the power to influence your company’s situation in terms of cash flow and spending when solvent, your position in the creditor hierarchy is low. Unfortunately, there is usually little money left after secured and other preferential creditors have been paid.
It is imperative, therefore, that directors take responsibility for company finances to safeguard their own and other’s investment in the business.
Whether it’s payments to suppliers, payroll, tax or utility bills, as a director you must take action to avert any further decline in the company’s ability to pay. This should include seeking professional guidance from a licensed insolvency practitioner.
It is commonly thought that IPs are there simply to provide practical help when a situation seems beyond repair, but by approaching a professional firm sooner than later you can often avert the worst case scenario of having to wind-up the company.
You may find that with a few simple adjustments to spending, you can maximise the cash you have and navigate your way out of trouble. If not, and the company enters formal insolvency, you have acted in the correct manner and in the interests of your creditors.
There are various recovery options that may suit your business, from a Company Voluntary Arrangement to a pre-pack administration. The personal funds that you have tied up in your business are not necessarily at risk unless the company is liquidated, in which case all other creditors will be repaid ahead of the directors/shareholders.
There is a need to be careful how you operate your Director’s Loan Account, particularly when the company is struggling financially. If you take any money out during this time, the transactions will be investigated and may have to be repaid if it is found that other creditors have been denied monies because you have paid yourself.
Transactions will be scrutinised by the insolvency practitioner or liquidator, potentially up to two years prior to the date you entered insolvency, and as a director you could receive severe penalties if anything untoward is found.
You could face disqualification as a director for up to 15 years, financial penalties, and in the most serious cases a prison sentence.
This is how the original capital payment and any other large cash inputs are treated in the company accounts. Your business owes you money as it does suppliers, trade creditors, customers and HMRC.
In a way, you are a creditor like any other and are at risk financially if the market takes a downturn, or you lose a key customer. These are the risks of trading, but being in the last group of creditors to be repaid if the company is liquidated, unfortunately is part and parcel of directorship.
Real Business Rescue provide director advice online, over the phone, or in-person at one of our 101 UK offices or a place of your convenience. If you need advice on any aspect of insolvency, or wish to approach us with regard to potential cash flow problems, we can arrange a same day meeting without charge.
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