What Happens if You Have an Overdrawn Director’s Loan Account? Consequences and Steps to Take

What Happens if You Have an Overdrawn Director’s Loan Account? Consequences and Steps to Take

A director’s loan account (DLA) allows company directors to easily withdraw funds or make personal expense payments using company money, with the intention that the sums will be accounted for separately and repaid. However, many directors fail to closely monitor their DLA balance, risking serious repercussions if it becomes overdrawn. This essay will analyse what constitutes an overdrawn DLA, explain the potential consequences in a company liquidation scenario, and provide steps directors can take if faced with an overdrawn account.

Defining Key Terms

First, it is important to understand some key terminology. A DLA essentially serves as an internal ledger recording drawings made by directors that fall outside of normal remuneration channels like salary or dividends. It may include cash withdrawals, personal expense payments made from company funds, repayments of borrowed sums, crediting of dividends allocated, and more. If more money has been withdrawn than paid back in, the DLA balance goes into deficit, meaning the director owes the company money.

An overdrawn, deficit balance thus indicates that funds have been taken out of the company by a director without sufficient recompense. This alone does not necessarily pose an issue. However, problems arise if the company enters financial difficulties and liquidation procedures commence, as outstanding debts in a DLA can have severe repercussions for directors personally.

DLA Deficits in Liquidation 

During solvent liquidation, a government-appointed liquidator sells all company assets, pays off creditors to the extent possible, and distributes any surplus to shareholders. An overdrawn DLA balance effectively represents money owed by a director to the company. As such, it is categorised as a company asset the liquidator has a responsibility to pursue.

By law, DLAs with deficits above £10,000 left unpaid for over 9 months and 1 day following a financial year-end can also trigger income tax charges for directors. However, regardless of the sum owed, an aggressive liquidator will likely utilise court powers to force repayment of any amounts through threats of personal bankruptcy, charging orders on homes, and other measures. This remains the case even if the company previously wrote off the debt.

The outcome is directors losing the ‘corporate veil’ protection normally separating their finances from the company’s. Facing extensive powers designed to recover funds for creditors, they can be made personally liable for DLA debts to the detriment of their own assets and livelihoods. Clearly this risk should not be ignored. Monitoring deficits and taking prompt action if identified is crucial.

Taking Control of an Overdrawn DLA 

Upon discovering an overdrawn DLA, directors should remain calm but treat the situation seriously. Some key initial damage control steps to take include:

  • Carefully reviewing DLA transactions to understand where the deficit originated and how much is owed
  • Implementing stricter financial controls around withdrawals/personal spends
  • Consulting an accountant to ensure proper accounting and tax compliance
  • Assessing current and forecasted company cashflows to gauge repayment capacity
  • Prioritising future profits toward repaying the amounts owed

If trading conditions are poor and overdraft sums significant, more aggressive measures like securing a loan or additional investor capital to clear debts may be necessary. Directors should also consider suspending personal withdrawals and minimising avoidable expenses in the interim.

Implementing Plans to Strengthen the DLA

In addition to clearing existing deficits, steps must be taken to improve ongoing DLA governance. It is apparent that lack of oversight, budgeting, and financial discipline has enabled balances to go unchecked. Recommended best practices directors should adopt include:

  • Frequently monitoring DLA balances monthly as a minimum
  • Creating a DLA usage budget limiting withdrawal amounts
  • Separating and controlling personal vs business expenses better
  • Maintaining detailed records of all DLA transactions
  • Ensuring timely repayments are made before problems spiral
  • Never using the DLA to fund personal lifestyle expenses
  • Taking professional advice on maximising repayment capacity

By institutionally enforcing accountability around the DLA through budgets, process controls, diligent monitoring, and financial prudence, directors can avoid repeats of overdrawn situations in future.

The risks posed by overdrawn DLAs in liquidation make averting deficits and exercising tight governance essential. Carelessness can quickly land directors in hot water, while even small oversights can snowball into significant personal liabilities. Tough actions like insolvency or bankruptcy may result. But by recognising issues early and consulting experts to maximise repayment potential, the worst outcomes can be avoided. Directors in such situations must respond swiftly and decisively to protect both company and personal finances.

For more information contact Ballards LLP at 01905 794 504

Disclaimer. This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.

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