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Overview Of The Creditor Duty And Its Effect On An Overdrawn Director’s Loan Account

The matter of the Creditor Duty and its effect on an Overdrawn Director’s Loan Account highlights the potential problem of when the Creditor Duty is triggered and what is to be done about it.

The Creditor Duty And Its Effect On An Overdrawn Director’s Loan Account

What Is The Creditor Duty And When Is It Triggered?

When the Creditor Duty is triggered the Directors need to balance and consider the interests of creditors alongside those of the shareholders. They can no longer act with only the interests of shareholders in mind.

This was set out by the Supreme Court in the Sequana decision (BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25).

Insolvency does not mean there has to be an inevitable Liquidation or Administration but it certainly has to be bordering on insolvency with an insolvency procedure not being some remote prospect.

A company’s insolvency can be tested with reference to its cash flow position in terms of being able to pay debts when they fall due or its balance sheet by considering the extent to which its assets might be more or less than the level of its creditors.

The Creditor Duty is therefore notably triggered when a company is in its twilight zone. 

What Is An Overdrawn Director’s Loan Account?

An Overdrawn Director’s Loan Account is a balance at a given point in time that a company Director owes to the company.

Directors will typically have an ‘account’ with the company to keep track of their transactions with it. They may have loaned money to the company or received money from it. They may be entitled to monies from it in the form of a dividend or salary. 

The Creditor Duty On A Sliding Scale?

The Creditor Duty is a duty that appears to operate on something of a sliding scale (“the Creditor Duty Sliding Scale”). The more obvious the insolvency of the company and closer to insolvent Liquidation, it is axiomatic the interests of creditors will supersede those of the shareholders.

The Creditor Duty Sliding Scale (1)

So for example, upon it being accepted an insolvent Liquidation (such as Creditors Voluntary Liquidation or Compulsory Liquidation) is inevitable, the interests of creditors will be paramount and the interests of shareholders who in all likelihood will no longer have a financial interest in the company’s assets, will at that point in effect largely cease.

What Is The Problem With The Creditor Duty Sliding Scale?

The problem with the Creditor Duty is perhaps highlighted by the words of Lewison J as he then was in the Wrongful Trading case of Hawkes Hill Publishing Co. Limited [2007] BCC 93 (“Hawkes Hill Publishing”):

Of course it is easy with hindsight to conclude that mistakes were made. An insolvent liquidation will almost always result from one or more mistakes. But picking over the bones of a dead company in a courtroom is not always fair to those who struggled to keep going in the reasonable (but ultimately misplaced) hope that things would get better.

That case was not a breach of duty or misfeasance case which is at the heart of the Creditor Duty; it was a Wrongful Trading case. However, the Creditor Duty turns on the point of insolvency and which usually is critical also in any Wrongful Trading case. 

A key takeaway here is that although in the case of Hawkes Hill Publishing, the judge dismissed the Wrongful Trading claim it had not stopped the Directors from being sued with all the stress and cost associated with the same.

Indeed in light of Section 239 of the Companies Act 2006, being the ability for example of an owner managed company to ratify the breaches of duty by the Directors, this will likely mean the Creditor Duty’s dominant impact will be felt when a company goes into insolvent Liquidation or Administration. Although it still exists as a duty in a solvent company, the Creditor Duty is very much in the background.

The problem with the Creditor Duty Sliding Scale is that it might potentially conceivably be clouded by some ambiguity when a Director is making decisions in the middle of that sliding scale and it might be somewhat uncertain as to the extent of the company’s solvency.

Effect Of The Creditor Duty And An Overdrawn Director’s Loan Account

The effect of the Creditor Duty on an Overdrawn Director’s Loan Account could likely be an issue for many SMEs which are owner managed.

A notable problem is the effect of a Director who draws money out of the company to live off without considering how to record or treat the transfer of money from the company’s bank account into their own bank account. In doing so during the year their Director’s loan account may swell. The more cash from the company they hoover up, the more the loan account may balloon to the extent that it might become the biggest asset sitting on the company’s balance sheet.

Two problems may sprout from such a position:

  • What if the Director has not provided sufficient thought to the position and or never intended to repay this sum to the company, particularly when the company does not have the distributable profits (reserves) available to declare a Dividend (to solidify the Director’s permanent retention of the sums drawn)?
  • The company (which might already be insolvent) will be liable under Section 455 of the Corporation Tax Act 2010 for tax at the rate of 33.75% if the overdrawn Director balance is not repaid within 9 months and one day after the year end, thus making the company conceivably even more insolvent.

If the Director never intended to repay the sums extracted from the company during the year, then although the company’s balance sheet on the face of it may appear solvent, it might well be supported (in this hypothetical scenario that appears not all that uncommon) by an Overdrawn Director’s Loan Account balance which is in effect worthless. However, such an event suggests a provision might be required to show the balance sheet in proper light. When making an accounting provision for the balance not being repaid (or where repayment as with any debtor is doubtful), suddenly the company might no longer look solvent and healthy but potentially completely the reverse. 

In this scenario, the Overdrawn Director’s Loan Account has in effect supported the balance sheet and might have been conceivably inflating it.

What Could Happen On Liquidation?

The potential problem if the company at some point shortly thereafter were to go into Liquidation is that a Liquidator who investigates may discover that the point of insolvency when the Creditor Duty kicks in was a point during the financial year. As a result, a breach of duty or misfeasance claim may have arisen in respect of some or all the funds a Director has withdrawn for their personal benefit during that period.

So what, you might say. The Director who has the Overdrawn Director’s Loan Account is liable to repay it in any event. You might say that a supplemental claim for a breach of duty adds little or nothing to that as there cannot be a double recovery.

Well not so fast because…

What if the company has another Director whose loan account is not overdrawn? What if the Director who is overdrawn cannot repay it and or goes into Bankruptcy?

The risk therefore is the other Director might still have some liability for such a breach of duty. Although this Director might not have personally benefitted from the overdrawn balance, it is possible they might be in the firing line for having permitted it to happen. This could potentially be a particular risk if they can be shown to have abdicated their responsibilities as Director.

Even if such a Director has not abdicated their responsibilities sufficiently to cause them to be liable to compensate the company, it could still potentially be a matter that features in Director Disqualification Proceedings as something considered unfit conduct.

Oliver Elliot Comment

Oliver Elliot Comment !

It is important that if an Overdrawn Director’s Loan Account is such a dominant asset on a company’s balance sheet such that it is supporting the solvency of a company, that great care is noted of the Creditor Duty otherwise it could be an unwelcome issue on insolvency.

GET IN TOUCH FOR HELP

For a free no obligation chat about any of the matters detailed above, please do get in touch for help. An expert will call you back or if you prefer exchange emails.

We can explore your situation and consider the best way to help you and your business needs. You can call us 020 3925 3613 or fill in the form below and will get back to you quickly. We Know Insolvency Inside Out.

Author: Elliot Green
Last Updated: May 20, 2024

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Disclaimer: The Creditor Duty And Its Effect On An Overdrawn Director’s Loan Account

This page is not legal advice and is not to be relied upon as such. This article The Creditor Duty And Its Effect On An Overdrawn Director’s Loan Account is provided for information purposes only. You should take independent advice on the facts of your case. No liability is accepted for reliance upon this post.

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