Overdrawn directors’ loan accounts – what are the risks when a company becomes insolvent?

Recently released government statistics confirm that corporate insolvencies continue to be at a high level. In fact, the number of creditors’ voluntary liquidations, which account for more than 75% of all corporate insolvencies, is only slightly less than 2023 levels, which represented the highest annual total since 1960, when records began.

It is in this context that we remind directors of the implications of not monitoring their loan accounts, particularly when there is a possibility of their company entering an insolvency process.

What is a director’s loan account (DLA)?

A director’s loan account records transactions between the company and its director. This does not normally include salary or dividend payments.

What happens to an overdrawn DLA when a company enters an insolvency process?

An overdrawn DLA becomes a company asset that must be repaid by the director personally. The appointed insolvency practitioner has a duty to maximise asset realisations so directors will be pursued to repay amounts advanced to them by the company. Ignoring this obligation can have severe personal financial consequences for a director, including a damaged credit rating, disqualification from acting as a company director or even bankruptcy.

Illegal dividends

When it becomes apparent that a company is heading towards insolvency there is a temptation for directors to try to protect their personal position by attempting to reduce their overdrawn DLA. Where the director is also a shareholder, this is often done by declaring an interim dividend. The dividend can be paid out, and then immediately repaid into the director’s overdrawn DLA to reduce the amount due to the company. Alternatively, it can be done by journal entries to get to the same position. However, dividends are unlawful when insufficient accumulated profits exist to cover the dividends declared. An insolvency practitioner will examine all payments made to directors and seek to recover illegal dividends. In addition, if a director has breached their fiduciary duty to the company this can be reported, and a period of disqualification can follow.

Loans to directors: requirement for members' approval

Section 197 of the Companies Act 2006 requires any loan to a director of a company to be approved by a shareholder resolution. If the loan has not been so approved, the transaction is voidable by the company (or the liquidator or administrator) so that the director must repay it. This point is often overlooked by directors.

Will an overdrawn DLA be written off during an insolvency process?

As described above, an insolvency practitioner has a duty to creditors to maximise asset realisations. If a director does not have the means to repay their DLA in full, the insolvency practitioner has the option not to formally write off the debt. This leaves the door open to reinstate the company after it has been dissolved and pursue a director if they subsequently come into funds. Alternatively, if the debt is formally written off, HMRC will apply a S415 Income Tax charge on the director.

Recently in the case Quillan v HMRC (2025), the First Tier Tribunal found that despite the fact that Mr Quillan’s overdrawn DLA was only partially paid, and his liquidated company dissolved after the completion of the liquidation, there had been no formal agreement to write off the debt. It was held that in these circumstances no S415 Income Tax charge arose.

What should a director do to avoid the risks associated with an overdrawn director’s loan account?

1. Keep accurate and up-to-date financial records. If this is done, then a director will be able to regularly review their loan account to prevent excessive withdrawals.
2. If a director’s company is in financial difficulties it is best to seek professional advice at an early stage. An expert can look at the overall picture and offer a range of possible solutions, for the benefit of creditors, as well as mitigating risks for the director personally.
3. If an overdrawn DLA cannot be avoided, then advice should be sought to produce a structured repayment plan, to minimise any financial distress.
4. Consider whether it may be better to take a regular salary, rather than relying on there being sufficient distributable profits at the end of the year to pay a dividend large enough to clear an overdrawn DLA.