Mark Harper QC: Directors’ Loan Accounts

DIRECTORS’ LOAN ACCOUNTS

Many limited companies are operated on the basis that owner directors will be remunerated for their services to the company by the declaration and payment of annual dividends. Loan accounts will be drawn against in the expectation that the loan accounts will be extinguished or diminished by subsequently declared and paid dividends. But what if the company cannot afford to or it is not prudent for it to declare and pay dividends? What is the liability of the director on his loan account?

This issue was considered by Mr. Justice Snowden, the Vice-Chancellor of the County Palatine of Lancaster in the case of Re Jones [2020] EWHC 1112 (Ch) an appeal from a decision of a Deputy District Judge to set-aside a statutory demand served by a company on a former director who was indebted to the company under his loan account.

The Judge decided that periodic drawings on a loan account could not be recharacterized “after the event” as having been payments of remuneration. There could not be a lawful binding agreement between the company and the director that the loan account would only be repayable from declared dividends.

It was however arguable that the director had a legitimate expectation that the company would not demand repayment of the loan account unless and until the company had considered whether or not to declare a dividend and had decided, in good faith, that it could/should not declare a dividend and it would be inequitable for the company to demand repayment of the loan unless and until that step had been taken. Reference should be made to the judgment at paragraphs [50] – [53], [61] – [62], [66] – [68] and [70].

This case is a timely reminder for directors and those who advise them as to the risk inherent in directors making drawings against loan accounts in the expectation of payments of dividend. The principle is that a drawing on a loan account brings with it the liability to repay the same and dividends (if declared) can only be set-off against that liability. Directors need to be aware of this and ensure that they have dividend and loan account policies in place that are fit for purpose. Equally if a company is looking to recover a loan account that has arisen in such circumstances then it will need to consider how it will justify not having declared dividends either at all or in an amount that would clear a loan account debit balance.

MARK HARPER QC

mharperqc@kingschambers.com

8 June 2020

 

 

 

 

 

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