What Happens When An Insolvent Company Owes A Director Money?
It’s not an uncommon scenario, unfortunately – director lends company money, company enters insolvency, company owes director money, director wants money paid back…
In many cases, directors loan money to their company and charge interest (and the business does not pay corporation tax on it). In the future, the company pays the interest to directors minus income tax at the 20% basic rate, as explained in the government guide on when you lend your company money.
But as this article will explore, insolvency status puts the director’s investment at risk.
If the company can improve its cash flow and ultimately secure its future, then there is no reason to suggest that the director cannot receive their investment back at some point.
However, if the insolvency leads to liquidation, it significantly decreases the likelihood of the company paying back the director.
Director loans
It’s common for directors to put their own money into a business when setting it up to help the company start trading.
We have previously explained how a director’s loan account works (including what happens if you’re overdrawn). In the article we cover other reasons why you may have a balance on the loan account:
- You loan money to the business during tough trading times or where a capital injection is crucial to financing a project
- You are paid via a mixture of PAYE salary and dividends, and the account balance accumulates each month
In short, a director’s loan account records any money that you pay into the business (and also any funds you withdraw). This investment you make counts as a loan.
As with any loan, you would expect to receive the money back in the future, perhaps with a return on your investment too.
However, if the company becomes insolvent, that creates uncertainty.
If the business enters insolvency
If the company is continuing to sell well and has the potential to get out of debt, an insolvency practitioner may recommend a Company Voluntary Arrangement (CVA):
- In a CVA, the company continues to trade while paying back creditor debts in regular instalments
- If successful and cash flow improves, the company avoids liquidation
In this scenario, if the company avoids liquidation then the money owed to the director should be safe.
However, in terms of company director duties and insolvency, there is a change in focus if the business is struggling financially.
During insolvency, directors’ duties change from targeting profits for the company to minimising losses for creditors.
That likely means not making any withdrawals from the director’s loan account while the company remains insolvent.
If the company cannot pay back its independent creditors, the insolvency practitioner – or if the situation worsens, the liquidator – can investigate any transactions that contributed.
They can look back at the past two years prior to insolvency too. For more information on this, read our guide explaining what antecedent transactions are for an insolvent business.
Penalties for wrongful trading can include director disqualification for up to 15 years and liability for company debts.
If the business goes into liquidation
But what happens if an insolvent company owes a director money, cannot improve its cash flow and goes into liquidation?
As the liquidators close down the business, they aim to pay back as much of the debt to creditors as possible.
However, this is a problem for any directors who have loaned personal money to their company. When a company goes into liquidation or administration, they are low down the list of creditors in terms of who gets paid back first.
The hierarchy includes, in the following order of priority:
- Secured creditors with a fixed charge
- Preferential creditors
- Secured creditors with a floating charge
- Unsecured creditors
- Shareholders / directors
In other words – secured, preferential and unsecured creditors must all receive repayment first before any directors who loaned money to the company.
In the majority of cases, there is very little if any money left to return by this point. Therefore, there is a high risk that directors who loaned personal funds to the company will not get their money back if the business goes into liquidation.
Final thoughts: What happens when an insolvent company owes a director money?
In summary, it is unlikely that directors will receive repayment for their loan if the company goes into liquidation.
However, if the company is insolvent but ultimately able to improve its cash flow, directors’ investment could be safe.
This is just one of the many reasons why directors need to take action quickly if it looks as though the company’s ability to pay its outgoings on time is under threat.
Acting quickly can prevent a tricky financial situation from getting worse – business rescue experts can advise on the best course of action and help the company recover.
We are Hudson Weir, insolvency practitioners with vast amounts of experience. For more information about our services, please don’t hesitate to get in touch.
