How Is A Director’s Loan Account Dealt With In A CVL Process?

When a company enters a creditors voluntary liquidation (CVL) process, the role of the Insolvency Practitioner (referred to as the Liquidator) is to realise the assets of the company, investigate its financial affairs and ultimately attempt to yield a return for the benefit of creditors. When undertaking the steps to place a company into voluntary liquidation, the Insolvency Practitioner will work with the directors to understand whether there is a director’s loan account balance. This will either be reflected in the accounts as a company asset (i.e. the director owes money to the company) or a company liability (i.e the company owes the director).

In this article, we’ll look at what a director’s loan account is, what happens to it upon liquidation, and why clearing the balance in the period leading up to liquidation may not be as simple as you would think.

What Is A Director’s Loan Account?

When a limited company is trading it is not uncommon for a director to loan funds to or receive a loan from their limited company. This could be physical cash movements in and out of the company bank account, or simply a reflection of a purchase made by the director for the benefit of the company, or vice versa. Any such transactions will be recorded in the company’s accounting records as a director’s loan account.

The operation of a director’s loan account is particularly common in small director-owned SMEs where the directors are remunerated as a combination of salary and dividends for tax efficiency purposes. Month by month, payments to the director will typically be allocated against the director’s loan account and then ‘tidied up’ at the year-end with the help of an accountant to understand what should be treated as salary, what should be treated as a dividend, and what, if anything, should remain in the accounts.

Although this is practical, being remunerated in such a manner presents a great risk for directors if the company subsequently enters an insolvency process, such as a CVL.

Do Overdrawn Loan Accounts Have To Be Repaid?

In short, the answer is yes. If a director’s loan account is overdrawn when a company enters CVL (or any other insolvency process) it must be repaid to the company. As mentioned above, the Liquidator has a duty to maximise asset realisations for the benefit of creditors.

Most insolvency firms, like us, will work with the director to agree a suitable repayment plan. However, if the director becomes uncooperative or simply refuses to pay, the Liquidator is obliged to seek other avenues of recovering payment which could include legal action and/or a bankruptcy petition.

Cooperation is key in such scenarios. At My Liquidation, we have worked with many directors to calculate what they are due to repay to a company and agree an achievable repayment plan that works for all parties. If the director’s loan is to be repaid over a long period of time, it may be necessary for the Liquidator to apply interest to the loan and/or seek some form of security (such as a charge over a property) for the benefit of creditors.

What If The Company Owes The Director?

If a company enters an insolvency process owing the director in respect of a loan account, that is treated as an unsecured creditor claim. This will rank as a claim in the CVL or other insolvency process alongside the claims of the majority of other creditors.

If you are a director and are considering loaning funds to your company, it may be worthwhile considering obtaining security over the company’s assets by way of a floating charge. This will mean that you rank ahead of the claims of other creditors in the event of a subsequent CVL or other insolvency process. There are exceptions to the rule, and we would recommend that you speak to us if this is your intention.

Repaying All Or Part Of The Director’s Loan Account Before Liquidation

When a company is struggling to pay its debts and a director’s loan account exists (i.e. the company owes money to the director) there will always be a temptation for the company to repay the loan account to the director before taking steps to place a company into liquidation.

As mentioned previously, a Liquidator has a duty to review the financial affairs of the company. If such a transaction occurred, the Liquidator would have to consider whether it constitutes a preference pursuant to section 239 of the Insolvency Act 1986 and/or misfeasance pursuant to section 212 of that same Act, for example. In broad terms, this means that the company, acting by its director(s), has opted to prefer the claim of the director over all other creditors. The ramifications of this being that the Liquidator must seek restitution from the director as an asset in the liquidation for the benefit of creditors.

Accordingly, whilst repaying a loan account in contemplation of a CVL may seem like a reasonable action, it will most likely be overturned.

Similarly, if the accounting records of a company reflect that an overdrawn director’s loan account existed but was omitted from the Statement of Affairs presented to creditors in the days leading up to liquidation, it will most likely be unearthed as part of the Liquidator’s investigations in any event. Material omissions from a Statement of Affairs may also result in disqualification action against the director by the Insolvency Service.

Using a company loan to repay a director’s loan account

Since the beginning of the coronavirus pandemic in 2020, there has been an increase in companies taking out loans, commonly in the form of a Bounce Back Loan or a CBILS (coronavirus business interruption loan scheme).

Our next article will specifically cover how businesses have been using such loans, including repaying their director’s loan accounts and the ramifications of this. Watch this space!

Considering A CVL?

If you are considering a CVL but have some questions relating to how your director’s loan account will be treated, please contact us for some free, confidential and no-obligation advice.

If you’d like to find out how much a My Liquidation CVL could cost, you can get an indicative quote from us in minutes using our Instant CVL Quote Calculator. Unlike many Insolvency firms, My Liquidation does not operate a strict upfront payment structure and we strive to work with our clients to find a mutually agreeable approach. We will also work with you to ensure that should you want to set up a new company in the future, you will not fall foul of the various insolvency restrictions.