What happens when a director is owed money by their company?

The thing that archives all money you pay into your company and all funds that you withdraw from it, is known as a Director’s Loan Account.

A limited company is in fact a separate legal entity to it’s owners and directors, and therefore the Director’s Loan Account actually forms part of your business’ accounting system.

Upon starting a new business venture, you may find that you have to input a capital payment and use your own personal funds in order to do so. This information will be documented within the Director’s Loan Account.

It’ll also keep track of any and all other personal payments that have helped to cover business expenses. Transactions such as these are known as a type of loan to the company, and you’d usually expect to get their own money back at some point, further down the line.

Though, you’re likely wondering what’d happen to this money if the company started to face financial difficulties, or even eventually become insolvent. Would you ever be able to access the funds you’d loaned to the business? Would you ever see your money again or would it rather be lost forever? We’re here to answer all these questions and more for you. 

Where do directors lie in the hierarchy of creditors?

A limited company’s shareholders are the very last group of creditors that receive any payment during a liquidation. Though, as a director of the company, there is an obligation for you to act in the best interests of the remainder of the creditors, if you start to believe the business is approaching the insolvency process.

If you fail to act in the best interests of the company’s creditors you could find yourself in a large amount of legal trouble. An investigation normally takes place during a business’ insolvency and if you’re caught acting immorally towards the creditors of the company at this stage, you could face serious repercussions.

Consequently, as the ability to influence your company’s situation in terms of both spending and cash flow when solvent lies with yourself, your place in the creditor hierarchy is quite low down. Sadly, there is usually little money left after secured and other favoured creditors have been reimbursed.

During any companies’ insolvency process, it isn’t abnormal for a director to square off their loan account to develop funds for creditors. However, if this figure is on the smaller side, the liquidator may well decide that there’s an inadequate number of assets to carry out a formal liquidation process. If so, they’ll look to have the company struck off the register all together.

Once the company has been placed in to liquidation the liquidator can demand that director repays the amount owed to the company in order to pay the company’s creditors. If the directs fail to repay the amount requested by the the liquidator, he/she can take legal action against the director or even make him bankrupt.

What should you do if the company starts to fall behind on payments?

As the company director you have a duty to take any action you can in order to help with avoiding any more decline in the business’ ability to pay. This could be in the form of payments to suppliers, payroll, utility or tax bills, etc.

One of the most useful ways you can help the company out is by seeking professional advice and guidance from a licensed insolvency practitioner.

If you approach an insolvency practitioner as soon as possible, you’ll be giving your company the best chance of going through the process painlessly and smoothly. You can often even completely avoid any wind-up situations if you act quickly, so make good use of your time and think ahead, so that the business doesn’t go out with an unwanted bang.

It is often the case that with just a few basic adjustments to the way you’re spending money, you can normally maximise the cash you have and find a way to get out of the financial trouble for good. Even if the company doesn’t manage to get out of the financial mess it has found itself in, you’ll still have done the right thing and acted in the most moral way possible. This is also known as acting with the best interests of your fellow creditors.

Entering Insolvency

You have a wide variety of recovery options to choose from, but picking the right one for your business’ situation is essential. You’ll be faced with the choice of anything from a Company Voluntary Arrangement to a Pre-Pack Administration. As long as the business remains in a state where it hasn’t been liquidated, the personal funds you have tied up in the company will not necessarily be at too much risk.

If the company does become liquidated, all other creditors will receive repayment before any of the directors/shareholders.

You should undoubtedly operate your Director’s Loan Account carefully, especially when the company is facing financial struggles.

If you decide to take any money out during this period of time, the transactions will most likely be under investigation and end up having to be repaid in full if it turns out that other creditors were denied monies because you chose to instead pay yourself. Once again, it all comes down to a case of ensuring that you’re acting in the best interest of your creditors.

Transactions will be examined by the insolvency practitioner or liquidator, potentially up to two years preceding the date you filed for insolvency. As a director you might receive severe penalties if any inappropriate action on your part is discovered.

You could potentially face a ban as a director, which would see you disqualified for up to 15 years, financial penalties, and in the most serious cases you may even have to serve a prison sentence.

A loan to the business

As we have previously alluded to in this article, the original capital payment and any other large cash inputs are treated in the company accounts as loans. You’re owed money by your business in the same way that it owes suppliers, trade creditors, customers and HMRC.

In many aspects you’re a creditor like any other, as you’ll be put at financial risk if the market takes a fall from grace or the business fails to hold onto a key customer/client. These are the unfortunate risks of trading, as they are in any other financial sales role, though being placed at the bottom of the pile when it comes to receiving your repayments is simply how it is for those in roles of directorship.

Conclusion

When a director is owed money by their company, they are considered a creditor. In the event of the company becoming insolvent, or unable to pay its debts, the director’s claim for unpaid debts will be treated the same as any other unsecured creditor. This means that the director may not be able to recover all, or even any, of the money they are owed. In the event of liquidation, the assets of the company will be sold and the proceeds will be used to pay off the company’s debts in a specific order of priority as set out in the Insolvency Act 1986.

If there are insufficient funds to pay all creditors in full, they will be paid a proportion of what they are owed, known as a dividend. If the company enters into an administration, the administrator will try to rescue the company as a going concern or achieve a better outcome for the creditors than in a liquidation. In this case, the director may not get paid at all.