If your company is facing liquidation, you may be wondering what happens to your Director’s loan. Many Directors take money from their company outside of salary and dividends, which is recorded in the Director’s loan account.
When a company is liquidated, any overdrawn Director’s loan is considered an asset of the business, meaning the liquidator will seek repayment. If you cannot repay, you could face legal and financial consequences.
In this guide, we’ll explain what happens to a Director’s loan in liquidation, your responsibilities, and what steps you can take to manage the situation.
What are Company Director loans?
A Director’s loan occurs when a Company Director takes money from a business that is not classified as:
Salary: Wages paid through PAYE, which are subject to Income Tax and National Insurance contributions.
Dividends: Payments made to shareholders from company profits, typically after Corporation Tax has been deducted.
Expenses: Reimbursements for business-related costs, such as travel, office supplies, or mileage, which are not considered taxable income.
When a Director withdraws money from the company outside these categories, it is recorded in the Director’s loan account (DLA). This account tracks all transactions between the Director and the company, including:
Money withdrawn: Any funds taken from the business that are not salary, dividends, or expenses.
Money repaid: Any repayments made by the Director to clear or reduce the loan balance.
The DLA acts as a running total of how much the Director has borrowed from or lent to the company. If a Director withdraws more money than they have put in, the DLA becomes overdrawn, meaning the Director owes money to the company.
What happens to a Director’s loan in liquidation?
When a company enters liquidation, a licensed Insolvency Practitioner (IP) is appointed to close the business, sell company assets, and distribute funds to creditors. The IP will recover as much money as possible for the company’s creditors, which includes collecting any outstanding Director’s loans.
If the Director’s loan account is overdrawn — meaning the Director has taken more money from the company than they have repaid — the loan is considered a company asset. The liquidator is required to recover the outstanding balance, just as they would with any other debt owed to the company.
At this stage, Directors must act quickly and understand their options, as failure to repay the loan could lead to legal action, personal liability, or even bankruptcy.
If the Director owes money to the company
If your Director’s loan account is overdrawn, meaning you owe money to the company, you are personally responsible for repaying it. The liquidator will formally request full repayment of the loan as part of the liquidation process.
If you fail to repay, the liquidator has the authority to take legal action to recover the outstanding amount. This could include court proceedings, which may lead to personal bankruptcy if the loan is substantial and you cannot settle it.
An overdrawn Director’s loan is one of the most serious issues a Director can face during liquidation. If the liquidator believes that:
- The loan was taken when the company was already insolvent.
- The Director had no realistic ability to repay the loan.
- The loan was taken irresponsibly, possibly as an attempt to avoid paying creditors.
Then, they may investigate the Director’s conduct further. If misconduct is found, the consequences could be severe, including:
Director disqualification: You could be banned from acting as a Company Director for 2 to 15 years.
Legal proceedings: If wrongful trading or misfeasance is proven, you could be taken to court and held personally liable for company debts.
Criminal prosecution: In serious cases, fraud or financial misconduct could result in fines or imprisonment.
Addressing an overdrawn Director’s loan as early as possible is essential to avoid these risks.
If the company owes money to the Director
If the company owes you money, meaning your Director’s loan account is in credit, you are classified as an unsecured creditor. This means you will only be repaid after secured and preferential creditors have been paid.
In liquidation, debts are repaid in strict order. Secured creditors, such as banks with a mortgage on company property, are paid first. Next, preferential creditors receive payment, including employees owed wages and HMRC for unpaid taxes. Unsecured creditors, including suppliers, trade creditors, and Directors, are at the bottom of the repayment hierarchy.
As a Director, this means your chances of recovering the full amount depend on the company’s remaining assets. If funds are sufficient, you may receive full repayment. However, if assets are limited, you might only receive a partial payment or nothing at all.
Related: Who Are Preferential Creditors?
Director’s loans in a Members’ Voluntary Liquidation
A Members’ Voluntary Liquidation (MVL) is used when a company is solvent and can fully pay all its debts. Directors often choose this process for tax-efficient company closure, as capital distributions through an MVL can be taxed at a lower rate under Business Asset Disposal Relief (formerly Entrepreneurs’ Relief).
Since an MVL is a solvent liquidation, it is a straightforward and controlled process, provided all financial matters, including Director’s loans, are addressed before completion.
What happens to a Director’s loan in an MVL?
If your DLA is overdrawn, meaning you owe money to the company, you must repay the loan in full before the liquidation is finalised. As the company is solvent, Directors are expected to clear any outstanding debts to ensure a smooth process. Failure to repay could delay the MVL or impact the final distribution of company funds.
If the company owes you money, meaning your DLA is in credit, you will be repaid before shareholders receive their final distributions. Since all creditors must be paid in full before the MVL can proceed, Directors in this position are more likely to recover the full amount owed.
Related: The Ultimate Guide to Members’ Voluntary Liquidation
Director’s loans in a Creditors’ Voluntary Liquidation
A Creditors’ Voluntary Liquidation (CVL) is used when a company is insolvent and unable to pay its debts as they fall due. In this situation, the company must be closed, and a licensed Insolvency Practitioner is appointed to recover company assets to repay creditors.
Since the company does not have enough funds to cover all its debts, the liquidator’s primary responsibility is to act in the best interests of creditors. This means they must collect as much money as possible, including any outstanding Director’s loans.
What happens to a Director’s loan in a CVL?
The liquidator will demand full repayment if your Director’s loan account is overdrawn. An overdrawn DLA is classed as a company asset, so it must be recovered to maximise returns for creditors. The liquidator will assess your financial position and, if necessary, may pursue legal action to recover the outstanding amount.
If you fail to repay, the liquidator has the authority to take legal action against you. This could result in:
- Personal liability, where you are held personally responsible for repaying the debt.
- Bankruptcy — if the debt is substantial and you cannot afford to repay it.
- A negotiated settlement, where you may be allowed to repay a reduced amount.
If the liquidator suspects funds were withdrawn irresponsibly or you continued taking loans while the company was already insolvent, they may launch a misfeasance investigation. This could lead to serious consequences, including:
Director disqualification: A ban from serving as a Company Director for up to 15 years.
Court action: If wrongful trading or misfeasance is proven, you could be held personally liable for company debts.
Criminal prosecution: In extreme cases, fraudulent behaviour could lead to criminal charges, fines, or imprisonment.
If you have an overdrawn Director’s loan and your company is struggling financially, it is crucial to seek professional advice early to explore your options and avoid serious legal and financial consequences.
Related: Is a Creditors’ Voluntary Liquidation Right For My Business?
Can a Director’s loan be written off in liquidation?
In most cases, no. When a company enters liquidation, the Insolvency Practitioner is legally required to recover as much money as possible for creditors. Since an overdrawn Director’s loan is a company asset, the liquidator will pursue full repayment.
However, in some cases, the loan may not be fully repaid. If you cannot afford to repay, the liquidator will assess whether legal action is worthwhile. They may decide not to pursue the debt if you lack personal assets or the cost of legal proceedings outweighs the potential recovery.
A negotiated settlement may be possible, where the liquidator accepts a lower amount or allows repayment in instalments. Directors who cooperate and provide evidence of financial hardship are more likely to secure this option.
If a Director deliberately avoids repayment or misuses company funds, the liquidator may take legal action.
What happens if a Director cannot repay their loan?
If you cannot repay an overdrawn Director’s loan, there are a few possible options. You may be able to negotiate with the liquidator to agree on a reduced repayment or a structured payment plan.
If repayment is impossible, you might need to consider personal insolvency solutions, such as an Individual Voluntary Arrangement (IVA) to repay the debt over time or, in extreme cases, bankruptcy.
Failing to address the debt could lead to legal consequences, including Director disqualification or court action to recover the money. Since every case is different, seeking specialist insolvency advice early is essential to explore the best possible outcome.
How Clarke Bell can help
If your company is entering liquidation and you have an overdrawn Director’s loan, Clarke Bell is here to guide you. With over 30 years of experience and a team of licensed Insolvency Practitioners, we have helped thousands of Directors navigate insolvency and manage their financial obligations effectively.
We will assess your situation and provide expert advice on handling your Director’s loan, exploring repayment options, and ensuring you take the best course of action for your circumstances.
Contact us today for a free, no-obligation consultation and find out how we can help you through the liquidation process.
