Overdrawn Directors’ Loan Accounts – Part 2
In this two part series, solicitor and founding partner James Edward of James Edward & Associates and Barrister Louise Bowmaker of Enterprise Chambers, take a look at the legislation relating to directors’ overdrawn loan accounts.
In Part 1 we looked at the Companies Act 2006 but as stated in our earlier blog above the 1985 Act will continue to apply to loans entered into prior to 1 October, 2007. In Part 2 of this series we examine out a case study where James Edward & Associates acted for a liquidator who identified an overdrawn loan account and brought a claim, which successfully concluded in a substantial settlement.
Part 2: Case Study involving an overdrawn loan account under the Companies Act 1985 (“the 1985 Act”).
Background
The company was incorporated on 17 April 1997 and the directors during its lifetime were:
(a) Mr M: 18 April 1997 to winding up;
(b) Mr M’s daughter: 1 July 2004 to 31 March 2009 (“D”);
(c) Mr M’s son: 01 July 2004 to 31 March 2009 (“S”).
The company’s business was management consultancy particularly advising the health profession.
It appears that Mr M was the driving force behind the Company. In fact, he made this clear in his interview with the Liquidator’s solicitors where he described himself as being in 2005 “principal director and the principal income generator”. The involvement of D and S was not as clear. Mr M said that they did each have a role in the business doing administrative work in the beginning and that “when they came out of university they were more active”.
Mr M said that D was the bookkeeper from 2006 to 2007. The role that D and S played in the running of the Company was relevant to any consideration of their liability; as detailed below.
In his Questionnaire Mr M stated that he was the only shareholder in the Company. However, he said during his interview, that his son and daughter received dividends from the Company. He also disclosed that a third of the dividends declared were paid to him, D and S which we also consider in further detail below.
The Company was wound up on 1 July 2009 after a petition was presented by HMRC for £150,000 in respect of unpaid tax and VAT in March 2009. It was estimated that the deficiency in the liquidation was close to £500,000.
The Director’s Loan Account – claim against Mr M
The accounts for the year to 31 March 2008 (“the 2007/2008 Accounts”) revealed that Mr M owed the Company £194,638 (he had owed £143,138 at the end of the 2007 accounts year).
Liability under the Companies Act 1985.
Mr M was liable under the provisions of the Companies Act 1985. The loan contained in the 2008 accounts was given by the Company prior to the change in the law on 6 April 2008 and was therefore governed by sections 330 to 342 of the Companies Act 1985.
Section 330 of the Companies Act 1985 states that any loan to a director is unlawful. There are several exceptions in the following sections but none of these applied to this case.
Section 341 provides that any transaction entered into in breach of section 330 is voidable at the instance of the company and that where an arrangement is made by a company for a director of the company or a person connected with such a director in contravention of section 330, that director and the person so connected and any other director who authorised the transaction or arrangement (whether or not it has been avoided in pursuance of subsection (1)) is liable-
(a) to account to the company for any gain which he has made directly or indirectly by the arrangement or transaction; and
(b) jointly and severally with any other person liable under this subsection to indemnify the company for any loss or damage resulting from the arrangement or transaction
Mr M was, in the Liquidator’s view, clearly liable under section 341.
Mr M made clear in the narrative attached to his questionnaire that he used company money for his own purposes in late 2008. It could therefore be argued that he owed the Company more money than was shown in the 31 March 2008 accounts. Mr M stated during his interview that he has bank statements up to the point at which the Company ceased trading.
The Director’s Loan Account – possible claim against D and/or S
Section 341 (2)(b) makes it clear that it is not only the director who has the benefit of the illegal loan who is liable but also any other director “who authorised the transaction or arrangement’.
Accordingly, if the Liquidator could prove that S and D authorised the loan to Mr M they would be liable for the amount approved.
In Neville (as administrator of Unigreg Ltd)-v- Krikorian [2006] EWCA Civ 943 the Court of Appeal held that “a director who knowingly allows a practice to continue under which lending by the company to his co-director is treated as acceptable has authorised the individual payments which are made in accordance with the practice notwithstanding that he did not have actual knowledge of each individual payment at the time that it was made.” Mr M made it clear in his interview that D and S knew about the Company’s practice of lending to him.
It was important for the liquidator to establish when D and S became aware of the practice as they would only be liable for debts accrued after that date. Such information was difficult to ascertain, but there were some documents that S and D ought to have knowledge of existing, as they were, directors of the Company. They could not therefore simply argue that they were inactive as this in itself could well be a dereliction of duty.
The accounts for the year ended on 31 March 2008 showed a loan owing to the Company the sum of £194,638. These accounts were signed off by the board when D and S were still directors of the Company so they must have known about their contents. Similarly, they ought to have had knowledge of any other accounts that were signed off during the period 1 July 2004 to 31 March 2009.
successful outcome
The claim against Mr M for the return of the £194,638 that he owed the Company was clearly strong. The sum was set out in the 2007/2008 accounts and was admitted to still be owing by Mr M in interview. Had an ordinary application been issued it might well have been possible to obtain judgment against Mr M at the first hearing without directions for evidence.
In addition the liquidator could have pursued S and DC for the loan as they were jointly and severally liable as they were clearly directors during the time when the loan was incurred and Mr M said that they were aware of his use of Company monies.
Following the service of a Statutory Demand and a strongly worded letter of claim the Liquidator was able to settle the claim without recourse to litigation or third party funding.
This article was written by James Edward, a Solicitor and the founding partner of James Edward & Associates and Louise Bowmaker of Enterprise Chambers Lincoln’s Inn London. If you have any queries relating to directors overdrawn loan accounts or any other matters please contact James Edward on 0207 467 3980 or click here.
disclaimer
The information and any commentary on the law contained in this article is provided free of charge for information purposes only. No responsibility for its accuracy and correctness, or for any consequences of relying on it, is assumed by any member or employee of James Edward & Associates. The information and commentary does not and is not intended to amount to legal advice and is not intended to be relied upon.
You are strongly advised to obtain advice from a Solicitor about your specific case or matter and not rely on the information or comments in this article.