Case Study: Director Loan Accounts in Liquidation
An overdrawn director’s loan account can become a significant personal issue when a company goes into liquidation.
Drawings and personal expenses paid by the company can accumulate over time, leaving the director owing a substantial amount back to it.
Accountants often help directors manage these balances through dividends to reduce loan accounts or encouraging directors to take proper salaries to avoid loan accounts accruing.
However, cash flow can become tight, or directors may put off dealing with the personal tax consequences. The loan balance can then continue to grow.
Where a private company lends money to a shareholder or their associate, Division 7A may apply. Complying loan agreements, interest and minimum annual repayments may need to be addressed. Those arrangements require ongoing attention, and the loan still needs to be repaid.
In this matter, I was appointed liquidator of a company whose books recorded loan accounts owing to the company by both directors; however, we will focus on one of the directors, who owed the company a total of $281,500.
Establishing what was owed
As liquidator, my role is to investigate the company’s affairs and recover its assets for the benefit of creditors. That includes investigating money owed by directors and other parties.
Sometimes I need to engage the company’s accountant to reconcile the accounts and establish the correct amount owed.
Directors considering liquidation should raise these balances at the outset, before an appointment, so the position and potential consequences can be discussed. The loan will not disappear when a liquidator is appointed.
In this case, the loan was recorded in the company’s Xero file and in previous financial statements signed by the director.
I issued a demand for repayment. The director’s initial response was that the amount was not owed because the relevant payments had been wages.
I discussed this with the company’s accountant, who confirmed that the amounts were loans and had been disclosed as such in the financial statements.
Under section 1305 of the Corporations Act 2001, company books kept as required by the Act are admissible in legal proceedings and are prima facie evidence of what they record. That gives the records evidentiary weight, although they can be challenged with contrary evidence.
The director was entitled to question the balance. However, I was not provided with evidence that displaced the records, particularly the signed financial statements recognising the debt.
I maintained the demand and invited the director to discuss settlement.
Considering a settlement
A liquidator needs to consider what can realistically be recovered.
That requires an assessment of the strength of the claim, the director’s financial position and the likely costs of pursuing recovery.
Those costs can extend well beyond obtaining a judgment. Enforcement action and, potentially, bankruptcy proceedings can add substantial expense and delay.
In my experience, negotiating a settlement will often produce a better financial outcome for creditors. However, any offer needs to be assessed against the likely net recovery from the available alternatives.
In most cases, I ask the director to provide a statement of their assets and liabilities supported by a statutory declaration. That information helps assess their capacity to pay and whether an offer is reasonable.
In this case, the director initially offered $20,000, together with a statutory declaration of their assets and liabilities supporting the offer had a commercial basis for acceptance.
Assessed against their financial position, it was a reasonable starting point.
Following negotiations, we reached a slightly higher proposed settlement of $50,000, payable within thirty days of executing a Deed of Settlement, subject to obtaining the required approvals.
Approval to compromise the debt
You might expect that a liquidator could simply accept the offer and agree to the payment period.
There are, however, approval requirements to consider.
Under section 477(2A) of the Corporations Act 2001, a liquidator needs approval of creditors to compromise a debt where the amount claimed by the company exceeds $100,000. It applies to the amount claimed, rather than the settlement payment or the amount written off.
Approval can come from a creditors by resolution, the committee of inspection or the Court.
In this case, we called a creditors’ meeting so creditors could discuss the proposed compromise and payment terms.
I issued a report explaining the claim, the offer, the director’s financial position and the likely costs and risks of pursuing recovery. I recommended accepting the proposed settlement.
The liquidation had insufficient funds to pursue the claim. Creditors were also invited to provide funding if they preferred that course.
The outcome
The settlement remained subject to creditor approval until the meeting was held.
Creditors approved the compromise and the payment arrangement.
It was a positive outcome. However, earlier attention to the loan account may have prevented the balance from becoming such a significant issue.
Lessons for directors
Directors should understand their loan account balance and how it arose while the company is still trading.
Regular reviews with the company’s accountant can identify accumulating drawings, incorrect entries and amounts requiring attention. Records should clearly distinguish personal drawings from wages, reimbursements and repayments of money owed to the director.
If you are considering liquidation, discuss the loan account with the proposed liquidator before the appointment. Understand how it will be investigated and what it could mean for you personally.
Do not assume it will be ignored.
Any settlement will depend on the evidence, your financial circumstances and the required approvals.
Want to discuss liquidation?
If your company is experiencing financial difficulties and you are concerned about money you may owe to it, obtain advice early.
I can review the company’s position, explain how the loan account may be dealt with and help you understand the next steps.
