If you’ve noticed that your directors’ loan account is overdrawn and your business may be going into liquidation, you need to tread very carefully. An overdrawn directors’ loan account in liquidation can cause you some serious problems personally. We’re here to help. In this blog, we’ll explain how to deal with an overdrawn directors’ loan account.
What is an overdrawn director’s loan account?
An overdrawn director’s loan account occurs when a director takes too much money out of the company. Taking money from the company as a dividend usually works fine if the company is making more of a profit than you are taking out. However, when company profits drop or evaporate, and the director still takes the same amount of money out of the business in the same way, you’re almost sure to end up with an overdrawn director loan account.
It’s a very common issue that we help directors with. In most cases, the reason that the company director has an overdrawn director’s loan is due to needing the money that they have taken from the company to feed their families and pay bills, mortgages and rent.
Only limited companies can have a director’s loan, as the director is a separate legal entity from the company. This gives the director more protection in these scenarios, providing that they have not committed any wrongdoing within the limited company. All wrongdoing is assessed when a limited company enters liquidation.
How do directors’ loan accounts work?
When you take too much money from the business, the account becomes in debit. If you add more money to the account, it becomes in credit. Ideally, directors should leave the account at zero balance or in credit to avoid any issues with tax implications or personal liability down the line. We’ll let you know more about what happens with an overdrawn director’s loan account in liquidation.
Company directors who are in financial distress will still need to pay tax to avoid issues with HMRC. Read our blog on what to do if you are having difficulties paying HMRC.
What happens if my directors’ loan account is overdrawn?
If your director’s loan account is overdrawn when the company enters liquidation, it will be classed as an asset of the business. The appointed insolvency practitioner has a duty to try and recover it. In short, they will ask you to pay it back, and this can cause huge problems for directors who are unable to repay the overdrawn director’s loan account.
As well as recovering funds from your overdrawn loan account, the practitioner will try to repay the company’s creditors. They may do this through the sale of company assets. A company asset may include stock, machinery and even leftover company money.
How to deal with overdrawn directors’ loan accounts
Before you appoint any insolvency practitioners to help you with your liquidation, you will need to ensure that they have checked for any overdrawn director’s loan accounts. We speak to many directors who forget to check these and end up being made personally liable for thousands of pounds later down the line.
The key is to understand exactly what position your director’s loan account is in BEFORE you make any decisions. Even more importantly, if you do have an overdrawn directors’ loan and you are placing your business into liquidation, how will the insolvency practitioner handle the overdrawn director’s loan account? Licensed insolvency practitioners have a legal duty to recover funds from overdrawn director’s loans and raise funds for creditors that the company owes.
Where do I find out if I have an overdrawn director’s loan account?
In most cases, an insolvency practitioner has the discretion to accept a settlement on any overdrawn director’s loan accounts and allow the director to pay the settlement over a period of time. All insolvency practitioners handle these types of things differently, and in our experience, you’re better off being guided early by someone like us at Director First. We won’t judge, and our sole aim is to help you understand the complete picture before you are asked to make any decisions.
The key to a successful outcome is to understand your personal position regarding overdrawn directors’ loan accounts. Firstly, we will help you check if you have one. You can find out if you have an overdrawn director’s loan account by checking your last set of filed accounts from the corporation tax accounting period. The overdrawn loan will normally appear in the section called “assets” and may also appear in “debtors.”
Be aware that if your last set of filed accounts is out of date, then your overdrawn director’s loan position could have changed considerably, as you have probably taken more money out of the company since then, increasing the outstanding loan. It’s very important to keep up with your income tax, National Insurance contributions and the company’s year-end and seek professional advice if you require it. HMRC will not hesitate to begin legal action if they can make reasonable claims against your limited company.
Another place you can see any overdrawn directors’ loan accounts will be on the company’s balance sheet. Your balance sheet can be viewed on your accounting software if you use one. It’s a good idea to use software to keep on top of your accounting records. If you are going to use your software to determine an overdrawn director’s loan account, be sure that your software is up to date. If it’s not accurate, you will not be able to rely on the information that it provides.
Stop taking dividends
Dividends can only be declared from a business’s profits. If your business has become insolvent, you can no longer declare a dividend. Many directors fall into the trap of continuing to take, drawing above their salary even though the business has become insolvent.
If this happens and the business enters liquidation, the insolvency practitioner will go back to the point where the business became insolvent and convert all the payments made to the director above their salary and convert amounts to an overdrawn director’s loan account.
What to do if you have an overdrawn director’s loan account
Once you understand if you have an overdrawn director’s loan account, the next question is, what are you going to do about it?
Firstly, it’s critical that you don’t sign up and appoint any insolvency practitioner until this issue has been thoroughly reviewed and an agreement reached. An insolvency practitioner can negotiate a deal with a director in which the director will pay back only a percentage of their overdrawn director’s loan account. Practitioners can also give you an extended time to repay your settlement.
Will I have to pay my overdrawn director’s loan account?
The amount that you repay on your overdrawn director’s loan account will depend on your personal asset position and affordability. For instance, if you are in rented accommodation with very limited affordability, then in some cases, your overdrawn director’s loan account will be written off by the insolvency practitioner.
If you own property and have equity in the property, the insolvency practitioner will not be able to justify writing off your overdrawn director’s loan account and will want you to pay more of it back. This can lead to personal bankruptcy as a result of your overdrawn director’s loan account. Another option is to use personal assets and personal funds to pay for the overdrawn director’s loan account.
If you’re worried about the consequences of having an overdrawn director’s loan account and placing your business into liquidation, please get in touch, and we can start working with you on a solution. The sooner you reach out, the more likely you are to achieve a better outcome with your director’s loan.
My company is becoming insolvent, what do I do?
If you notice that your company is becoming insolvent, you need to seek advice early. You may be advised to enter an insolvent liquidation. When you enter company liquidation, you will no longer be working to meet the company’s interest and will instead be trying to minimise the negative effects on the company’s creditors. Every action you take should be in the best interests of your creditors.
The last thing you should do is borrow money from other people or pay yourself back with your own money. This will be labelled as a preference payment and is never a good idea for limited companies.
We’re here to help you as the director, so contact us for independent advice on overdrawn directors’ loan accounts.
I'm Chris Worden, Managing Director at Director First. With over 7 years of experience, I help UK directors navigate the complex world of UK corporate insolvency. We offer free and independent advice to UK directors and advise them about what options may be available to them if their limited company starts to struggle.
I am passionate about helping other directors overcome their business challenges and get back on their feet, as I was once in the same position as them. I had a business that became insolvent, and the advice out there was confusing and overwhelming. I am here to provide honest and valuable advice to UK directors.
I am proud to say that we are one of the only 5-star corporate insolvency companies on Trustpilot with hundreds of 5-star reviews, and we publish videos weekly on our YouTube channel. Our channel is designed to educate UK directors about insolvency and debt advice.