A Director's Loan Account ("DLA") records the money a director has borrowed from their company or their company has borrowed from them. If you have loaned money to the company, you will be a creditor in the pool on non-preferential unsecured debts. However, if you borrowed money from the company, you will have an Overdrawn Director's Loan Account. That will be an asset in the liquidation that the Liquidator will seek to recover.

How do they tend to work?

There are only a limited number of ways that a director can extract money from a company, mainly being through payroll, invoiced services or dividends (when they are also a shareholder), typically speaking all other monies taken will be a loan account. The difference between a Directors Loan Account and the other methods of extraction is that the monies are borrowed and repayable to the company.

You may be familiar with taking a low salary to stay below the PAYE/NI threshold, around £12,500 per year, to maximise tax efficiency. If you make top up payments to yourself above the payroll sums, some people refer to them as “drawings”, you are operating a Directors Loan Account.

The plan for that arrangement is that the company makes enough profit to declare a dividend big enough to wipe out the loan account at the end of the year. If the company doesn’t make sufficient profit, then you are left with an Overdrawn Loan Account, owing money to the company.

Whilst not as common as some of the other items on the list, unlawful dividends can be linked to Directors' Loan Accounts, especially where dividends are paid to wipe-out the DLA when the company does not have sufficient reserves. Part 23 of the Companies Act 2006 set out the rules sets out the law in respect of declaring dividends. There have been a few important cases heard on the matter but as a very brief overview:

Section 830 of that Part, clearly states that distributions can only be made from profits available for the purpose. If your company does not have sufficient profits to declare the dividend, then there it is probably an unlawful dividend.

The distribution also needs be justified by reference to accounts. If you have failed to do follow that statutory process, then there is also scope for the dividend to be unlawful.

If a Dividend is considered to be unlawful, the Liquidator will take steps to recover the amounts received by shareholders. The recovery is only likely to be the portion of the dividend that is considered to be unlawful, but that could still be significant.

A transaction at undervalue is defined in Section 238 of the Insolvency Act 1986.

In summary, if at any point in the 2 years prior the company going into Creditors Voluntary Liquidation, it entered into a transaction at significantly less than market value (such as a giving a gift or selling of valuable assets for a minimal sum) then it is possible for a Liquidator to challenge that transaction. In order to challenge the transaction, it must have been entered into at a time when the company was unable to pay its debts or becomes unable to pay its debts as a result of the transaction.

If a potential Transaction at an Undervalue involves a connected party then it is presumed that the company was insolvent, and it is for the connected party show otherwise.

The transaction can be challenged through a court application, requesting that company is restored to the position it would be if the transaction had not been entered into.

A Preference is defined in Section 239 of the Insolvency Act 1986.

In summary, a preference occurs when the company puts a creditor (or surety, or gaurantor) in a better position than they would have been, had the transaction not been entered into. As an example, if your parents had lent the company money, and just prior to liquidation, you paid them back in full without taking into consideration any other creditor. That would be a pretty clear preference.

As with a Transaction at Undervalue, the company needs to have been insolvent at the time of the transactions but, unlike a Transaction at Undervalue, that is never presumed and insolvency needs to be proven.

Additionally, the Liquidator needs to show that there was a desire to put the recipient in a better position. In cases where the transaction is to a connected party, desire it presumed and it falls on the director to prove otherwise.

For preferences to connected parties, the time period is 2 years prior to the company going into Creditors Voluntary Liquidation. For non-connected parties, that time limit is reduced to 6 months prior to the liquidation.

The transaction can be challenged through a court application, requesting that company is restored to the position it would be if the transaction had not been entered into.

Wrongful Trading is defined in Section 214 of the Insolvency Act 1986.

Wrongful Trading occurs when a director knew, or ought to have known, that the company had no reasonable prospect of avoiding liquidation, and continued to trade to the detriment of creditors.

In that scenario, the Liquidator has the ability to apply to court for the director to make a contribution to Liquidation estate. The Act says "as the court thinks proper" and the Liquidator will undertake a review of the position and claim for the losses to creditors that had been incurred after the point of no return.

If the director can show that they took every step with a view to minimising the potential loss to creditors, then the court will not rule against the director.

The test for "knew or ought to have known" is broken down into two parts, firstly on the general knowledge, skill and experience that you would be expected to have as a director, and secondly the actual general knowledge, skill and experience that you do have. With all Officeholder claims in insolvency, it is not black and white and careful consideration of the matter is undertaken prior to any action is taken.

Whilst a Liquidator will often seek legal advice on the merits of the potential claims, making a claim through the courts is a lengthy and potentially costly process, and is a last resort. In most cases, it is in everyone’s best interest to deal with the matter through negotiations before the matter comes before a judge.

Whilst there is a very real threat of legal action in these cases, especially where communications or negotiations break down, all other options will be explored prior to making a court application.

This page is for information purposes only, and is not legal advice.

If any of these issues affect you, you should seek your own independant legal advice.