The perils of an assigned overdrawn director’s loan account cannot be overstated but they can particularly apply in certain specific instances when the loan account is bigger than the level of creditors in an insolvent liquidation.
When a debt is assigned it is in effect sold by the owner of the debt to another party. As a result, the right to collect the debt transfers to the new owner. You might think that if someone owes an overdrawn director’s loan account it should make no difference from the perspective of the person who owes the debt. Not always correct. How can this be a problem?
What Is The Circularity Protection For An Owner Managed Director?
The circularity protection for an owner managed director is the general restriction on a liquidator who is collecting in an overdrawn director’s loan account (or indeed other claims against the director) on the amount they can recover.
When the director owns the company they will be a shareholder as well. How is this relevant?
When a director owes more money to a company through an overdrawn director’s loan account and or other claims a liquidator may have against them than the debts and costs of liquidation, then if the liquidator recovered the full amount there would a surplus to go back to the shareholder. The effect of this could mean the shareholder director would be sending money around in a circle back to themselves.
Manolete v Hope
This was a point in the case of Manolete Partners PLC v Hope & Anor [2022] EWHC 1801 (Ch) the Court looked into some aspects of the unjust recovery or money going around in a circle issue. The Court examined various cases, including notably the case of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30 in respect of a claim in misfeasance brought by a Liquidator against a Director for having caused the company to pay a fraudulent Preference in disregard of the interests of the general body of creditors:
… the court has discretion over the relief, and it is permissible for the delinquent director to submit that the wind should be tempered because, for instance, full repayment would produce a windfall to third parties or, alternatively, because it would involve money going round in a circle or passing through the hands of someone else whose position is equally tainted …This was, in substance, a case of working out the true measure of loss caused to the company by reason of the director’s breach of duty, as opposed to capping the quantum of the claim against the director.
As a result of the perceived pointlessness to this position it is usually (but not always) considered the limitation on a liquidator is to recover not more than the costs of liquidation and the debts owed to creditors. For example, if a director owed a company £50,000 and costs of liquidation were £5,000 and the amount due to creditors was £15,000, then the director shareholder would usually only be required to repay £20,000, not £50,000.
Effect Of An Assignment
When an overdrawn director’s loan account is assigned the liquidator will typically receive a sum of money from the party to whom the debt is transferred (the assignee) but the assignee will not usually be constrained by the aforementioned circularity issue.
They have bought the debt with the right to collect it in full.
Unlike the purpose of liquidation (to realise assets to pay creditors) the assignee (the purchaser) has not purchased the debt to pay creditors; the assignee has taken a commercial decision to have the rights to the debt for its own benefit.
It therefore follows that the purchaser of an overdrawn director’s loan account can in the above example recover the full £50,000.
This therefore creates a different end result for a director (who is also the shareholder) depending upon who holds the rights to the debt.
However, the principle remains that £50,000 as a matter of liability is the same whether the debt is held by the liquidator or a debt purchaser to whom it has been assigned but the amount usually payable could be completely different.
Effect On A Director Of An Assigned Overdrawn Director’s Loan Account
For those reasons, if a director owes more to a company than the level of creditors and costs of liquidation then it may be in their interests to avoid an assignment by expeditiously coming to an arrangement with the liquidator about repayment of a relevant amount of the overdrawn director’s loan account.
This position applies not only to an overdrawn director’s loan account but also to claims generally that a liquidator or Insolvency Practitioner may have against directors.
For more information on this see our guide How Much Can A Liquidator Recover?.
