Overdrawn directors’ loan balances – Part 1

Something that crops up in a significant number of the cases that cross my desk is the issue of an overdrawn director’s loan account, and the implications that has for both the company and the director.

In owner managed businesses, it is not uncommon for there to be a balance due by one or more of the directors to the company. Sometimes this is borne out of the misconception of the directors that the money is “theirs” anyway and so company funds are used to cover personal expenditure, whilst on other occasions it is a genuinely planned loan to cover some personal cash requirement.

A common reason in recent years has been where monies have been withdrawn in the short term with a view to “correcting” the position later on with a dividend to cover the earlier withdrawals – but a lack of available profits has meant that a dividend could not be declared, and so the loan balance remains.

Regardless of how the loan balance comes about, there are very real implications for both the company and the director involved should the company start to find itself in a distressed position.

If the loan remains outstanding nine months after the accounting year end in which the loan arose, then there is a tax charge payable by the company to HM Revenue & Customs of 32.5% of the loan balance. This is repaid to the company when the loan is repaid, but that repayment takes time to be made, and in distressed times, represents funds tied up that could otherwise be helpful in easing creditor pressure.

Let’s say that a company is running short of cash and has found itself with arrears of taxes due to HM Revenue & Customs, whether that be for VAT, PAYE or Corporation Tax, or perhaps with key suppliers. Negotiating a repayment plan with those creditors is most definitely a sensible way to move things forward, and sharing the company’s financial position and so justifying the proposed repayment plan as achievable is common practice.

However, I have often found key creditors are unwilling to agree to repayment plans where there are significant overdrawn director’s loan balances – the rationale being that if the director repaid the loan now, then there would then be additional funds available to meet debts or reduce the repayment term being negotiated.

It is hard to argue with that view. Unless the company is in the business of lending money, and has done so with the director on normal commercial terms – which happens just about never! – then why should the creditors defer their rights to receive payment just because some of the company’s funds have gone to the directors personally, instead of being available to pay them?

But it may be that the loan position is at a level where it is not possible to simply repay it. If the director in question has a good relationship with his bank, then a personal loan at competitive interest rates may be an option. Alternatively, other loan providers have entered the market in recent years, but these loans can come with much higher interest rates, and the repayment of that debt may then become a problem.

In my next blog, I shall consider what happens with director’s loan balances should the company enter an insolvency process.

For more information contact Duncan Raggett, Insolvency Practitioner (duncan.raggett@aab.uk) or your usual AAB contact.