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When a company becomes insolvent, it sometimes becomes apparent that a director owes an amount to the company in respect of an overdrawn DLA at the date of insolvency. Directors are sometimes unaware of how this has occurred and the financial implications for them personally as a result.
This article explains what a DLA is, the importance of being aware of the net DLA position especially if trading issues or potential insolvency is foreseen and how DLA transactions are treated on insolvency.
What is a Director Loan Account (DLA)?
A Director Loan Account (DLA) is maintained in the company’s accounting records and details certain transactions between a director and the company (excluding salary/wages, business expense repayments and shareholder dividends).
If a director has loaned more money to the company than they have withdrawn from the company the DLA will have a credit balance. In an insolvency, the director will rank as an unsecured creditor and will be able to submit a claim for the net balance owed to them.
Conversely, a DLA will be overdrawn if the director has withdrawn more money from the company than they have loaned to it. In an insolvency, an overdrawn DLA balance is a potential asset of the company which the Office Holder has a duty to investigate and recover for the benefit of creditors.
Salary/Wages
A director’s salary/wages are paid to a director under an employment contract and processed through the company’s payroll scheme. These typically do not feature in a DLA, unless there is an amount unpaid, in which case may be included as a credit in the DLA (effectively as money loaned to the company).
Drawings
Drawings are amounts withdrawn by directors which are not salary/wages or business expense repayments. It is common for directors to take out money as drawings rather than salary/wages for beneficial tax planning reasons. Drawings reduce any DLA credit balance.
It is inappropriate for directors to reclassify any prior drawings as salary ahead of any insolvency event. This will likely be challenged by the Office Holder in an insolvency and considered director misconduct. Any misconduct reported to the Insolvency Service could lead to the disqualification of directors.
Shareholder dividend offset
In the ordinary course of business, where funds are not readily available to a director to repay an overdrawn DLA balance and the directors are also shareholders of the company, it is possible for company profits to be used to declare dividends which can be offset against the DLA balance to reduce or clear the amount which is due by the directors.
Where there is a risk of insolvency, however, the company may no longer be generating profits and any retained profits are likely to have been eroded. In these circumstances, the company would be unable to declare dividends to offset against drawings leaving the director personally liable to repay the overdrawn DLA balance.
Considerations for directors
It is important for directors to be aware of the company’s financial position and understand how their drawings compare with money they’ve loaned to the company.
If there is any concern, a director could look to protect their position by taking future payments as salary/wages (provided salary/wages could not be deemed excessive for the role the director performs). Although this could be more costly for the company overall, it may be necessary for directors to avoid exposure to personal liability.
Alternatively, the director could stop drawing funds from the company altogether.
How to check if a DLA exists
- Review the company’s accounting records
- Review the company’s financial accounts:
- a DLA with a credit balance will be included as a creditor
- an overdrawn DLA will be included as a debtor
- Ask your accountant
DLA Example
Mr Jones is the sole director and shareholder of a company.
Mr Jones calculates that he needs £4,000 a month to meet his personal living costs. Mr Jones draws a salary of £1,000 per month and the additional £3,000 is debited to his DLA. By the end of the company’s financial year the director’s DLA is overdrawn by £36,000.
When the annual accounts are finalised, the company made a £40,000 profit. These profits are subsequently declared and paid as a dividend to Mr Jones as the sole shareholder. Mr Jones would receive a credit to his DLA of £36,000 and a further payment of £4,000.
The director continues with the same level of drawings for the following financial year. The company makes a loss of £50,000 during the year, due to some bad debts and the business being affected by the COVID-19 pandemic. Accordingly, the company is not able to declare a dividend to shareholders.
The company trades for a further 3 months but due to increased trading losses, mounting creditor pressure and severe cashflow problems, the director seeks advice from an Insolvency Practitioner. Mr Jones concludes that there is no option but to cease trading and place the company into liquidation.
At the date of insolvency Mr Jones’ DLA has an overdrawn balance of £45,000 (15 x £3,000) which he is personally liable to repay to the company.
In this scenario, Mr Jones may have been able to reduce his personal liability by increasing his salary payments to an appropriate level and reducing/ceasing his non-salary drawings.
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Shona Campbell
Lianne Fraser
