Does An Overdrawn Director’s Loan Account Promote The Success Of A Company?

Overview Of Does An Overdrawn Director’s Loan Account Promote The Success Of A Company

The answer to the question does an Overdrawn Director’s Loan Account promote the success of a company? is perhaps best answered with the question How Can It?

What Is An Overdrawn Director’s Loan Account?

An Overdrawn Director’s Loan Account is an amount of money owed by a Director to a company when the amount they have had from the company by way of entitlements to salary, dividends, expenses and loans has been exceeded by what they have taken out of the company in payments or other forms of monies worth.

The result is the Director is overdrawn in much the same way they can owe money and be overdrawn with a bank. The difference is simply who the party is to whom they owe money.

What Is The Director’s Duty To Promote The Success Of A Company?

Directors appointed over a company have duties known as Directors’ duties.

One of those core duties is set out in Section 172 of the Companies Act 2006 being the duty to promote the success of the company. This is in a nutshell a duty to act in the best interests of a company and to recognise that a Director is a servant of the company to act in its interests and for their interests to be subordinated.

Loans To Directors To Promote Company Success

There can be instances in which loans to Directors might be in the best interests of a company. Examples of this might be to secure the appointment of a Director who is joining a company from a competitor and having to relocate. He or she might need a short term loan to enable a house move for example.

However, the question posed in the title of this post is not focused with such scenarios in mind. It is focused from the point of many owner managed small medium sized companies, that for convenience or otherwise enable Directors to go overdrawn on their loan account in respect of their regular drawings from a company. 

This may have the effect of delaying the payment of tax by the company and or the individual Director but this may well not be in the interests of promoting the success of a company. Delaying the payment of tax without making adequate provision for it for instance can be storing up insolvency issues for a later date when a Section 455 tax liability kicks into effect and the associated dangers of an Overdrawn Director’s Loan Account might sprout. It is difficult to see how that is in the interests of a company, particularly if the company is doing this for a short term cash saving when the payment of Director remuneration (and the associated tax) is likely for most owner managed businesses to be fundamental for a viable company. If the company is unable to do so would it have a viable future in any event in most cases?

What Is The Reason The Director’s Loan Account Is Going Overdrawn?

More crucially however is the matter of taking the company’s cash, paying it over to a Director through a series of loans that lead to an Overdrawn Director’s Loan Account and whether the company can afford this level of drawings if it cannot pay over the tax.

Alternatively, if the reason an Overdrawn Director’s Loan Account arises is because the company cannot declare distributions to shareholders without them being unlawful dividends then the solvency of the company may be in question. As a result, the level of Director’s loans perhaps should perhaps be curtailed. If a company is insolvent then paying away critical cash resources to a Director might not be in its best interests. 

If a company is perfectly solvent after taking into account its known future corporation tax liabilities then an Overdrawn Director’s Loan Account might perhaps be unnecessary because the company can consider declaring dividends. If at a personal level, a Director is good for the money then it might be in the best interests of the company not to declare such dividends so that a change of fortunes could lead to the Director swiftly repaying the loan and the company having its money back. 

Balance Sheet Distortion

However, what is perhaps all too common is an Overdrawn Director’s Loan Account arising because a company is unable to declare dividends and is strapped for cash. When this happens the company is then dependent on the ability of the Director to repay their loan account. This can create circular dependencies. 

The potential problem this creates is that in many small medium owner managed companies a Director depends on the company for their income and the ability of the Director to repay the Overdrawn Director’s Loan Account can then depend on the company’s future performance, as opposed to the means of a Director at the point when the loans are taken out of the company. This may risk distorting the company’s balance sheet because any asset sitting on the company balance sheet should be recoverable at the time, not based on its own future performance. It is perhaps difficult in such circumstances to see that such a situation is promoting the success of a company.

In a nutshell, the potential risk with an Overdrawn Director’s Loan Account is that it can put at peril the company’s cash flow and substitute what was the certainty of cash in the bank for the uncertainty of repayment of the loans by the Director.

Going back to the question posed which is: Does An Overdrawn Director’s Loan Account Promote The Success Of A Company? then if the Overdrawn Loan Account is not promoting the success of the company but either the Director personally, or storing up trouble for a later date or distorting the balance sheet, then it may amount to a breach of duty by a Director.