Directors who draw funds from their limited company should be aware of their liabilities if the company then goes into insolvency.
Directors of private companies often use loan accounts to fund drawings from the company, which are then written off by a dividend for the same amount at the end of the financial year.
The Companies Act 2006 changed the provisions for loans to directors of limited companies. Whereas previously, companies were not allowed to make loans of more than £5,000 to directors, under the new Act all companies can make loans to their own directors or directors of holding companies, as long as they get shareholder approval.
Shareholder approval must be validly obtained i.e. by passing a resolution in accordance with the Act and the company’s constitution. If the approval is not validly obtained the loan will have been made illegally. Should the company then fall into insolvency, the outstanding amount would be recoverable from the director by the administrator or liquidator.
Kay Waddington, a commercial partner at North West law firm Stephensons Solicitors LLP, said: “Because the loan has been made unlawfully, the director would not be able to set off other amounts owed to him by the company, such as his salary or other benefits if the company was insolvent.”
“If the director is then a creditor of the company which becomes insolvent, the director would need to be aware of sections 239 and 240 of the Insolvency Act 1986 relating to preferences.”
This could make any repayment of that loan in the period of up to two years before insolvency a preference that is recoverable by an administrator or liquidator. Where a preference is in favour of a director, they would need to show in court proceedings that the repayment was not made with a view to placing him in a better position that he would otherwise have been and that it should be refunded to the company.