Being unable to repay any loan is a difficult financial position to be in. When you borrow money from third parties, there are set terms and conditions, and failing to keep up with repayments can put you at risk of fines and penalties.

Many directors borrow money from the company in the form of a Directors’ Loan Account (DLA). This account is typically used as an advance on the dividends the director is expecting to receive at the end of the year.

How does a Director’s Loan Account go overdrawn?

A DLA goes into debit and is overdrawn when the director borrows money from the company. When the company is making a profit, having an overdrawn DLA isn’t usually a problem. The profitable reserves are likely to be distributed (or some of them anyway) at the end of the company’s financial year. Some profits may be reinvested.

Problems arise when the company isn’t making a profit and the directors continue to withdraw funds that are not salary and would ordinarily be “tidied up” by their accountant at the end of the year.

Having an overdrawn DLA often arises:

• If the company has consistently made a profit over the years, and the directors become accustomed to withdrawing money from the company. They continue to access the same amount of money without thinking much of it.
• The company may have run into cash flow problems unexpectedly. A few late-paying customers in a short space of time can have a severe impact on the financial health of the company. Directors may have withdrawn money before the company experienced this run of bad luck.
• The director may have had every intention to repay their DLA within a set time frame, but circumstances changed and their account was in debit for longer than they planned. They are now in the position of being unable to repay what they need to, and the company needs that money back.

What happens if you can’t repay an overdrawn director’s loan?

If a director has borrowed from the company, they will be liable to repay the loan, whether the company is solvent or not.  

While the company is solvent, the overdrawn DLA isn’t an immediate problem, and in the longer term may well be set off against dividends, or a distribution in specie should the company cease trading and go into members’ voluntary liquidation.

If the company has become insolvent, the overdrawn DLA becomes a problem.

In an insolvency process, it’s the role of the insolvency practitioner (IP) to recover what is owed to the company to maximise potential returns to creditors. Any overdrawn DLA is an asset of the company, and the IP will look to recover the value of the loan.

At this point, it’s important that the director has an open and frank conversation about their financial position and ability to repay the loan. The IP will consider the personal circumstances of the director, and in some cases, come to an agreement whereby the director simply settles what he is able to. If the director is in financial difficulty, the IP will prioritise reaching an amicable agreement without the need for legal action or bankruptcy proceedings.

How to avoid having an overdrawn director’s loan account.

Some directors are unaware they have a DLA at all. They become accustomed to a “retrospective” dividend process, without being aware of a DLA they need to manage.

We recommend that every director keep a close eye on the balance of their DLA. Treat it as a third-party loan to ensure that the borrowing does not go beyond the ability to repay it.

If the company isn’t as profitable as it has been, and there are concerns about the solvency of the business, speak with our team before the situation worsens. When financial challenges are in their infancy, there are more options available to recover the company.

Call TruSolv on 0808 196 8676.