If your company enters liquidation, the company debts can be written off. But this does not include the director’s loan which is considered a personal debt as we explain below.
Closing a Company with Outstanding Directors Loan
It’s important to remember that a directors loan is money taken from a company that is not a salary, dividend or expense repayment; neither is it money loaned or paid into the company bank account by a director.
While directors have the right to borrow from a company, it would be a mistake to think this then becomes their personal money. As a seperate legal entity to the director, the company then becomes a creditor to its own director and, before closure of the limited company, it needs to be repaid.
What are the Rules on Repaying the Overdrawn Loan Account?
In normal circumstances – so when a company is not in liquidation – an overdrawn director’s loan account must be repaid within nine months and one day of the company’s financial year end. If the amount owed is more than £10,000 and it is not repaid within this time, then the director may be liable for income tax as HMRC could see this as a withdrawal and instead require income tax and national insurance to be payable.
After the nine month period, the clock starts ticking. Fail to pay and the limited company will incur a corporation tax penalty of 32.5% of the loan.
HMRC will also charge the company interest on the loan until a point where the corporation tax levied on the loan or the director’s loan account is repaid. Once HMRC has picked up that there is financial difficulty, matters and the tax burden will only increase.
So What Happens to the Director’s Loan Account in Liquidation?
When a company goes into liquidation, the appointed insolvency practitioner (acting as liquidator) assess who owes the company money with the intention of securing the best possibile return for creditors.
As such, where they discover that a director themselves owes money, the director will be asked to repay what is owed, so that the liquidator can fulfill their clearly stated responsibility to company creditors. That can mean a challenging situation for directors, perhaps even being forced into personal bankruptcy.
This situation could actually worsen still if the company is forced into compulsory liquidation. In this case the liquidation is overseen by the Official Receiver, They may actually look with even more forensic scrutiny at the actions of directors, and that could look to charges of misfeasance or wrongful trading.
The essential point is that overdrawn directors loans are not seen as company money, but the directors money. Hence there is no protection from liability and they must be paid back by directors.
One option which is sometimes mooted is that directors sometimes come to an arrangement with the liquidator whereby the money paid back towards the overdrawn director’s loan is used as payment for the liquidation fees. Your appointed insolvency practitioner will be able to discuss whether this is a possibility based on the level of your overdrawn director’s loan and your ability to repay this to the company.
Overdrawn Director’s Loan Accounts in Insolvency & Personal Liability
Owing an overdrawn directors loan could hold you liable in the following ways:
- The liquidator could choose to pursue adirector through the courts. This could well be the case if the assets (when sold) are insufficient to pay creditors and a large outstanding director’s loan is seen as one of the few routes available.
- Directors can be pushed into personal bankruptcy when unable to pay back overdrawn loans.
- The insolvent limited company could face an Insolvency Service probe if there are questions as to why the loan account is overdrawn. There could be suspicions as to why a large amount is owing when the business is insolvent and why did directors allow matters to reach this stage?
- Potentially, the director could then face prosecution such as for wrongful trading and be hit with fines and disqualification from running a limited company for up to 15 years.