One trick which directors may be tempted to resort to when cashflow is tight, is to take funds from their company in the form of a loan rather than paying themselves a wage. The benefit of this from the company’s cashflow perspective, is that there is no PAYG or Workers Compensation liabilities associated with the funds loaned.
But what happens to overdrawn director loan accounts when the company is met with cashflow problems and a Liquidator is appointed?
Not only may the funds loaned to the Director be deemed to be unfranked dividends in accordance with Division 7A of the Income Tax Assessment Act 1936, there is also the risk that if the company goes into liquidation, a Liquidator will demand that the Director repay the loan account to the company.
If the loan is substantial and there is no formal agreement in place about, outlining instalments or other arrangements for the money to be paid back, a Liquidator may well seek to bring legal proceedings against the Director which may result in the Director having to declare bankruptcy.
The short term cashflow savings implemented by the company’s accountant has just been turned into a serious personal liability.
So what options are available?
The potential options available to a Director faced with a demand from a Liquidator for repayment of a loan account include the following:
- Repay the debt in full or offer to settle the debt owed to the company;
- Offset any liabilities the company has to the Director that are not already accounted for; or
- Take a full salary but reduce the cash taken out of the business to gradually offset the loan account.
A word of warning
Care must be taken when accounting for transactions through a director’s loan account, particularly in the event that set offs are to be applied in times of financial uncertainty and especially prior to a company being placed into liquidation.
A Liquidator once appointed will investigate all transactions through a director’s loan account to determine if they have characteristics of unreasonable director related transactions pursuant to Section 588FDA of the Corporations Act 2001. Any such transactions may be deemed voidable and may increase the quantum of the amount owing to the Company.
What if the director is unable to repay the loan in full?
In the event that a demand is received by a director, and the Director does not have the financial capacity to repay the loan in full, then it is imperative that the Director deals with the demand in a timely manner. Steps to be taken should include:
- immediately seek advice from their accountant and/or preferred insolvency specialist to deal with the demand in a timely manner;
- engage with the Liquidator and address their personal financial position with the Liquidator; or
- negotiate a commercial arrangement to compromise the loan or enter into a commercial arrangement to repay the loan over a period of time.
Seeking Expert Advice
If you or a client are faced with a demand from a Liquidator seeking repayment of a loan account, do not panic, there may be defences and options available to reduce the severity of the loan amount.
Shaw Gidley is able to provide specialist insolvency advice. We will be able to examine the facts and circumstances in which the loan was made to determine whether there may be a claim to set off liabilities for any debts the company may in fact owe the director and will be able to negotiate repayment of some or all of the debt on a commercial basis.
Shaw Gidley are experts in restructuring, turnaround and insolvency and provide free initial advice on these matters. Please contact our offices on (02) 4908 4444 or (02) 6580 0400.
