Overdrawn Directors’ Loan Accounts: Legal Implications

When you run a business, there are many rules you need to be aware of, some of which concern financial transactions regarding your limited company. You must understand and abide by legal company rules to avoid litigation or problems with your company. As a director of your business, there are times when you may engage in financial transactions with your company. This can also apply to other company directors and can take place through a director’s loan account. However, sometimes, this can become an overdrawn director’s loan account. This article explores the legal implications of personal liability, shareholder approval, and remedies for overdrawn directors’ loan accounts.

What is a Director’s Loan Account?

A director’s loan account records financial transactions between directors and the company. However, it does not include the following:

• salaries;
• dividends;
• expenses being repaid; or
• any money a director has loaned or paid into the company in the past.

A director’s loan account can, for example, be one of the following:

• zero if a director has not taken any money from the company apart from the above transaction; or
• in credit if they have lent money to the company, such as to purchase assets, meaning they are a creditor of the company. 

However, a director’s loan account could also be an overdrawn director’s loan account.

What Does it Mean if a Director’s Loan Account is Overdrawn?

If a director’s loan account is overdrawn, this means that a director has borrowed money from the company which totals more than they have lent it and is not money taken as:

• salaries;
• dividends;
• expenses being repaid; or
• any money a director has loaned or paid into the company in the past.

As the director owes the company money when their account is overdrawn, the director’s account is a company asset. This means the company can recover it if it wishes.

What are the Legal Implications?

Whilst overdrawn director’s loan accounts are lawful, there are strict rules about them.

In addition, if a company lends to a director, causing an overdrawn director account, the following rules must be complied with:

• those detailed in the Companies Act 2006; and 
• the company’s Articles of Association. 

The Companies Act 2006 says that if a company loans to a director, which will result in an overdrawn director’s account, the company members must approve this where the amounts are over £10,000 and under £50,000 through a resolution. This includes:

• if making the loan to a director of any holding company; and 
• if guaranteeing or giving security for a loan to one of the company directors from any other person.

When Does a Company Director Act Unlawfully?

As a company director, you must understand when you may have acted unlawfully regarding any overdrawn director’s account. Here are some circumstances which could render a company director as acting unlawfully regarding an overdrawn director loan:

• where you fail to obtain the shareholders agreement required for an overdrawn director account, meaning you have breached Section 213 of the Companies Act 2006; or
• where you are charged with misfeasance through a Section 212 claim under the Insolvency Act 1986 during insolvency proceedings as you breach your fiduciary duties.

The second scenario can arise when, for example, you have not acted in the company’s interest. For instance, if you have borrowed money when your company cannot afford to lend.

You may be able to defend a misfeasance claim if you can prove you acted:

• honestly; and 
• you unknowingly committed the breach; or
• when committing the breach you tried to preserve the interests of all parties involved. 

If you are found guilty of misfeasance, the following implications could arise:

• a court could order you to pay back money to the company;
• you could lose your legal right to be a company director and be disqualified for any period between 2 and 15 years; or
• you could be declared bankrupt as you personally owe the debt to the company. 

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Key Takeaways

As a company director running your business, you must be aware of overdrawn director’s loan accounts. A director’s loan account records the financial transactions between a director and your company. These do not include certain transactions such as salaries and dividends. Directors’ loan accounts can be in credit or at zero levels. When a director’s loan account is overdrawn, they owe the company more money than they have put into it, becoming an asset of the company. 

A director can only have an overdrawn directors account where rules in the Companies Act 2006 have been complied with and the company’s Articles of Association. A company director acts unlawfully if, for example, they do not obtain shareholder approval for a loan of a specific count as defined in the Companies Act 2006. A company director could also commit misfeasance when having an overdrawn director’s loan, which could result in, for example, a company director’s disqualification. 

If you need help understanding overdrawn director’s loan accounts, our experienced disputes and litigation solicitors can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.