Directors’ loan accounts are easy to ignore while a business is trading. Money moves between the company and its owner, the accountant keeps a running balance, and any awkward questions can seem like matters to be sorted out when the year-end accounts are drawn up and settled by the declaration of a dividend.
However, if the company becomes insolvent, an overdrawn balance takes on a different character. It is an asset of the company and potentially money that should be available to its creditors. We see many of these in our practice and two recent judgments show what can happen when a director has not kept track of their obligations, and why even a liquidator’s decision to stop pursuing it may not be the end of the matter.
“You would have to ask my accountant”
In the recent case of St Mark Lions Limited (in CVL), the liquidator sought to recover an overdrawn director’s loan account from the company’s sole director. The amount in dispute was £112,506.
The director challenged the balance and gave various explanations for payments and accounting entries. But when questioned about the company’s affairs, he repeatedly said that the questions should be put to its accountants.
The judge found that his oral evidence did not support his defence. At points, the explanations advanced on his behalf were also difficult to reconcile with his own written account of events.
Deputy ICC Judge Curl KC drew a clear line between obtaining professional help and handing over responsibility. A director does not need an accountant’s technical knowledge, but he or she does need to understand why the company made particular payments and why it left particular liabilities unpaid.
An accountant’s job is to advise and prepare records; the director remains responsible for the decisions behind them.
That distinction becomes critical as a company’s finances deteriorate. In St Marks the Company faced a substantial corporation tax liability, and the outstanding director’s loan account was a substantial asset from which funds might be recovered to pay that liability.
The judge found that, once the company was bordering on insolvency, a reasonable director should have stopped drawing and increasing the loan account and taken steps to repay what was owed, at least to the extent needed to address the tax debt.
Here, the director himself was the borrower. Both the demand for repayment and the decision to repay were effectively within his control. Continuing to draw on the account while failing to address the company’s tax liability breached his duties as a director, the judge held.
The liquidator succeeded in recovering the £112,506 balance as part of a total award of £190,153.99, which included separate claims relating to other payments due for breaches of duty. The judge also said that, had the claim based on breach of duty failed, he would have entered judgment for the £112,506 as a debt owed to the company, subject to the appropriate procedural step.
What if the liquidator cannot recover it all?
HMRC v Quillan considered a different aspect in the life of a director’s loan. Here, the director owed his company £439,954 when it entered liquidation. Following an offer to settle, he paid £57,498. That left a balance of £382,456, which the liquidator did not expect to recover.
The question before the Upper Tribunal was whether that remaining balance had been “written off” for income tax purposes — and, if so, when. The liquidator had not formally released the director from the debt. Indeed, he later described in his Final Report in the Liquidation the balance as unresolved and said it had not been formally written off.
The Tribunal looked at what the liquidator had actually done. His final account stated that no further realisations were expected from the director’s loan account. In the context of that liquidation, this recorded his conclusion that the remaining balance had no recoverable value.
The Tribunal held that this amounted to a write-off under section 415 of the Income Tax (Trading and Other Income) Act 2005 but not a release.
A write-off and a release are very different things. Writing off a debt in this sense does not necessarily extinguish the underlying legal obligation to pay it; recovery could theoretically become possible later if there is a change of circumstances. But the absence of a formal release did not prevent the write-off from having an income tax consequence for Mr Quillan.
Timing mattered too. The Tribunal found that the write-off occurred when the liquidator issued his final account on 18 March 2019, placing it in the 2018/19 tax year. It was neither the earlier agreement to accept instalments nor the later dissolution of the company that fixed the relevant date on these facts.
Know what the account contains
The judgments address different circumstances and should not be treated as a single rule for every director’s loan. Together, though, they expose a common misconception: an overdrawn account cannot safely be left for someone else to explain or quietly disappear.
Directors should review the balance while the company is trading, understand what has been charged to it and keep the records supporting any claimed expenses, dividends or repayments. If financial pressure develops, the account deserves particular attention. Money owed by a director may be an asset the company needs to meet its obligations which a liquidator cannot ignore.
For a director, the question is not merely whether the accountant can produce a figure. It is whether the underlying transactions can be explained, and whether there is a credible plan to deal with what is owed.
How we can help at Buchler Phillips
Virtually every liquidation of a private company we see will have some level of Directors Loan account outstanding and every liquidator in these circumstances has an obligation to attempt to make recovery for the benefit of A Company’s creditors. We always try and work with Directors to try and find a solution but sometimes we can see no other option than to take action if a director refuses to engage or makes no attempt to make an acceptable suggestion for repayment. Court action should always be seen as a last resort but sometimes it can be the only way to bring a director to the table.
If you are a company director potentially facing these issues, do not try to pretend that the problem isn’t there or hope that it will go away. It won’t. Buchler Phillips are always ready to discuss the issues with you to try to find a pragmatic and workable solution to the benefit of all Parties.
Written by Jo Milner, Managing Director at Buchler Phillips, a UK based independent boutique firm with an impeccable Mayfair heritage, specialising in corporate recovery, turnaround, restructuring and insolvency.