The many challenges of the overdrawn director’s loan account

As the number of formal insolvencies begins to increase and there are signs that recessionary pressures in 2023 will witness a further wave of company failures, it is often unwelcome news to a company director that as well as losing his company, the liquidator will be pursuing him for monies withdrawn from it i.e. an overdrawn loan account “ODL” has been created .

From the liquidator’s viewpoint, the first place to start when determining if there is an ODL tends to be the most recent set of signed accounts.  On the basis that the director and the external accountant have agreed/discussed the ODL, and the statutory accounts have been signed, a specific balance can be pursued.

However, it is not unusual to find that statutory accounts have not been signed for a number of years which leaves a considerable period of time for transactions to take place, and a differing view to emerge between the director and the liquidator about what represents valid business expenses, rather than a director simply drawing cash from the company bank account.  Thus, arriving at a balance that can be agreed is often fraught with discussion, argument and negotiation.

There have been many reported court cases in the last twelve months or so reflecting the actions of either the liquidator or The Insolvency Service pursuing a director who obtained a bounce-back loan and withdrew the money for personal purposes rather than applying it for business reasons. That position is clearer to pursue.

Ignoring the bounce-back loan position meantime, the liquidator will want to establish if a director has drawn so much from the company that an ODL exists.  For example, the liquidator might look at a company’s bank statements from the date of the last set of signed accounts and allocate withdrawals to the director.  This is often the approach when the liquidator is dealing with a one-man personal services company and there are no obvious reasons for money to be spent on company-related matters.

The task for the director is to try and demonstrate why some (all) of the transactions listed are not personal, or perhaps contend that some of the money should be treated as dividends or salary, and therefore excluded from the calculation.

The difficulty with dividends is that the HMRC rules are fairly clear on what constitutes a dividend. Further, a company that has been in financial difficulty for some time and hence not earning distributable profits is unlikely to be able to declare a dividend.  Indeed, there are cases where a director has sought to suggest that monies withdrawn are dividends, only to find the liquidator pursuing him on the basis of recovering such money because there were insufficient reserves to support the payments.

Another option is for a director to claim that a salary should be applied in reduction of an ODL. Of course, if he has been in the habit of paying himself below the NIC threshold for many years (which can be evidenced by annual accounts, payroll records and personal tax returns) it is hard to persuade a liquidator that, for some strange reason, the recent period permits a substantial salary.  Compounding the director’s misery with this line of defence are the Income Tax Regulations which provide that if a director has taken a salary and wilfully ignored the PAYE/NIC deductions relating thereto, such deductions can become a personal liability.

It is not uncommon for a director to blame the external accountant for the existence of an ODL and claim that he had never been advised of the personal financial liability should liquidation arise.  Enquiry with the external accountant will often produce letters, file notes etc. making it quite clear that the director had been advised of the implications of an ODL but had not taken action to rectify matters. Blaming the external accountant rarely produces a successful outcome for the director and of course, company law makes it clear that it is the director who is responsible for the accounts, accounting records and transactional activity rather than an external party.

Invariably it is possible to reach a negotiated settlement with a director, possibly repaying the balance over a specific period of time but if all reasonable dialogue fails, court action against the director is probable.

In the last few years, a number of litigation funders have emerged who undertake legal action on the liquidator’s behalf and fund the process. Thus, a “clever” director who thinks that by denuding the company of all cash means that he will not be pursued, may well find that his personal assets are under attack by a litigation funder with deep pockets to pay legal expenses.

Experience suggests that where an ODL exists a director should not ignore the position and hope that “everything will sort itself out eventually”. If the company is subject to liquidation and there is an ODL, either evidenced by signed accounts or a calculation drawn from the accounting records, the director is unlikely to be able to walk away financially unscathed.

It is an area that can be cause much frustration, annoyance and financial hardship to a director  : not an issue to be ignored.  It always pays to obtain specialist advice as soon as possible.

This article is written by Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, Aberdeen. The views expressed in this article are his rather than those of the firm.