Insolvency risks for directors - director loans

Directors' loans are common in many UK companies, allowing directors to borrow money from the business. While these loans can be useful for short-term financing, they become a significant risk area when a company enters insolvency.

Under the Companies Act 2006, loans exceeding £10,000 require shareholder approval. However, many directors borrow informally, leading to accounting and legal complications, especially when a company faces financial distress.

Directors’ loans insolvency risks

Problems arise when directors take loans without proper documentation, fail to repay them, or use company funds for personal expenses. Key areas of concern include:

• Lack of proper approval - loans exceeding £10,000 must be approved by shareholders, and failure to do so can make the transaction unlawful.

• Inadequate documentation - if loans are not properly recorded, it may be difficult to distinguish between salary, dividends, and borrowings, raising red flags in insolvency.

• Loans to avoid tax - directors may have use loans to avoid paying tax on salary or dividends, which if reported by the liquidator can lead to action by HMRC.

• Overdrawn DLAs in Insolvency - if a director owes money to the company when it enters insolvency, it is treated as an asset to be recovered, and failure to repay can lead to legal consequences.

Will the Insolvency Practitioner take action?

When a company enters insolvency, the appointed Insolvency Practitioner (IP) will investigate directors’ loans to determine if any wrongdoing has occurred. The IP may take action if:

• The loan was not properly authorised or documented.

• The director has made significant withdrawals without clear justification.

• There are signs of misconduct, such as excessive loans while creditors remained unpaid.

• Funds were withdrawn when insolvency was foreseeable, worsening creditor positions.

Potential consequences

The key risks include:

• Demand for immediate and full repayment - if a director cannot repay, they may face personal financial difficulty.

• Breach of fiduciary duties - if a director has taken excessive or unjustified loans, they may be deemed to have acted against the company’s best interests, leading to potential claims.

• Misfeasance Claims - under the Insolvency Act 1986, a liquidator can pursue directors for misfeasance if they have misused company funds.

• Wrongful trading - if a director continued trading while knowing insolvency was unavoidable and took loans from the company, they may be personally liable.

• Disqualification - directors who misuse company funds or breach duties risk disqualification under the Company Directors Disqualification Act 1986, barring them from holding directorships for up to 15 years.

How we can help

If faced with an insolvency-related claim, obtaining specialist legal advice is crucial to mitigating liability and ensuring the best possible outcome, whether some form of negotiated outcome or mitigation strategy demonstrating that you as a director, acted in good faith.