Overdrawn Director’s Loan Accounts in Liquidation: Recovery & Defences

An overdrawn director’s loan account (DLA) is one of the most common and most exposed, liabilities a director faces when a company fails. It is at once a tax problem (the section 455 charge), a company-law debt and, frequently, the springboard for misfeasance, unlawful-dividend and disqualification proceedings. This guide analyses how liquidators recover overdrawn loan accounts, the principal causes of action and the defences available to directors, drawing on Manson v Smith, Toone v Robbins, Re D’Jan and Burnden Holdings v Fielding.

What an Overdrawn DLA Is

A director’s loan account records the running balance of amounts owed between a director and the company. It is overdrawn when the director owes the company, typically where the director has drawn cash, paid personal expenses through the company or taken “dividends” in anticipation of profits that never materialise. An overdrawn DLA is, in law, a debt owed by the director to the company and an asset on the company’s balance sheet.

While the company is solvent, an overdrawn DLA is principally a tax issue. When the company becomes insolvent, it becomes a recovery target: the liquidator’s duty is to get in the company’s assets for the benefit of creditors, and the director’s debt is one of them.

The s455 Tax Dimension

Where a close company makes a loan to a participator (typically a director-shareholder) that remains outstanding nine months and one day after the end of the accounting period, the company is charged to tax under section 455 of the Corporation Tax Act 2010. The s455 charge is currently levied at 33.75% of the outstanding loan (mirroring the upper dividend rate). The charge is, in principle, repaid to the company when the loan is repaid, released or written off, but the timing and interaction with insolvency are critical.

If the loan is written off or released, the amount is generally treated as a distribution (or as earnings) in the director’s hands and taxed accordingly, and there are anti-avoidance rules (“bed and breakfasting”) targeting loans repaid and quickly redrawn. We explain the mechanics in our resource on the section 455 directors’ loan charge and the investigation angle in our directors’ loan account investigation guide. On insolvency, HMRC will frequently be a creditor in respect of unpaid s455 tax, PAYE/NIC and other liabilities, giving it a direct interest in the liquidator’s recovery of the loan itself.

The DLA on Liquidation

On the company entering insolvent liquidation, the liquidator will review the accounts and the DLA. An overdrawn balance is treated as a debt immediately due and recoverable. The liquidator will usually issue a demand for repayment, and, if it is not met, will consider which cause of action offers the best route to recovery and the fewest defences. Directors frequently underestimate the strength of the liquidator’s position and the range of claims available.

Liquidator Recovery Routes

A liquidator pursuing an overdrawn DLA typically has several overlapping causes of action:

• Simple debt claim. The overdrawn balance is a debt due to the company. If the balance is admitted and unexplained, the liquidator may simply sue for it (or seek summary judgment).
• Misfeasance under s212 IA 1986. Section 212 of the Insolvency Act 1986 provides a summary procedure to recover sums where a director has misapplied or retained company money or been guilty of breach of duty. This is the workhorse provision for DLA recovery.
• Unlawful dividends. Where “dividends” were paid without distributable profits or proper authorisation, they are unlawful distributions repayable to the company.
• Breach of duty. Claims for breach of the statutory directors’ duties (CA 2006), including the duty to exercise reasonable care, skill and diligence (s174) and duties owed to creditors once insolvency threatens.

The duties owed by directors shift towards creditors as insolvency approaches, the so-called “twilight zone.” We analyse that shift, post-BTI v Sequana, in our guide on directors’ duties in the twilight zone.

Re-characterisation: Dividends and Remuneration

A common director defence is that the overdrawn balance is not really a loan at all, but represents dividends or remuneration that should be netted off. The leading modern authority is Toone v Robbins [2019] 2 BCLC 264, where liquidators sought to recover payments the directors characterised as remuneration and dividends.

The court held that the directors bore the burden of showing that the payments were properly authorised. In the absence of resolutions or contractual entitlement, payments described as “remuneration” could not be retained and payments treated as dividends were unlawful distributions where the company had not prepared accounts demonstrating distributable profits. Crucially, the directors could not invoke the company’s unjust enrichment to retain unauthorised remuneration and were ordered to repay.

To stand up, a dividend re-characterisation requires: distributable profits at the date of the distribution, evidenced by relevant accounts (s830 and s836 CA 2006); proper declaration and authorisation; and that the director knew or ought to have known of any unlawfulness if the company seeks repayment of an unlawful dividend (the It’s a Wrap line of authority). Retrospective “paperwork” created after liquidation carries little weight.

Misfeasance and Breach of Duty

Section 212 IA 1986 allows the liquidator to bring delinquent directors to account summarily. The substantive question is whether the director misapplied or retained company money or breached a duty. In Re D’Jan of London Ltd [1994] 1 BCLC 561, Hoffmann LJ articulated the standard of care expected of a director, now reflected in s174 CA 2006, as that of a reasonably diligent person having both the general knowledge, skill and experience reasonably expected of a person in that role (the objective limb) and the actual knowledge, skill and experience the particular director has (the subjective limb, where higher). Drawing down an overdrawn loan account while the company is unable to pay its debts will frequently breach that duty and the duty to have regard to creditors’ interests.

Misfeasance framing matters because it engages the rules considered below on set-off and limitation and because it can support parallel director disqualification and, where HMRC liabilities are involved, personal liability notice exposure.

Set-off: Manson v Smith

Directors who have both lent money to the company (a credit balance) and later misapplied money (a debit) often assume the two net off. They do not where the liability is for misfeasance. In Manson v Smith (Liquidator of Thomas Christy Ltd) [1997] 2 BCLC 161, a director had lent the company some £109,000 but had also been ordered, in s212 misfeasance proceedings, to repay about £27,000 of improper debits. He sought to set the £27,000 off against the £109,000 the company owed him under the insolvency set-off rule.

The Court of Appeal refused. It confirmed the rule, settled for over a century, that there is no set-off between a misfeasant’s liability to repay money he has been ordered to restore and a debt owing to him by the company. The insolvency set-off rule (then rule 4.90 of the Insolvency Rules 1986, now rule 14.25 of the Insolvency Rules 2016) does not apply to a misfeasant’s restitutionary liability.

Limitation: Burnden Holdings (UK) Ltd v Fielding

Directors often raise the six-year limitation period as a defence to historic DLA drawings. That defence frequently fails. In Burnden Holdings (UK) Ltd v Fielding [2018] UKSC 14, the Supreme Court held that directors are to be treated as trustees of the company’s assets that come into their hands or under their control. Section 21(1)(b) of the Limitation Act 1980 provides that there is no limitation period for an action by a beneficiary to recover trust property, or its proceeds, from a trustee who has converted or misapplied it.

Because a director who misapplies company money is in the position of a trustee, an action to recover that property (or its traceable proceeds) is not time-barred by the ordinary six-year period. This significantly extends the liquidator’s reach to historic drawings and undermines a limitation defence in misfeasance and breach-of-trust framed claims. (Directors should still consider whether a particular claim is properly characterised as recovery of trust property or as a mere money claim, where different limitation analysis may apply.)

Assigned Claims and Litigation Funding

Since the Small Business, Enterprise and Employment Act 2015 permitted liquidators to assign statutory causes of action, claims against directors, including misfeasance and DLA recovery, are frequently assigned to specialist litigation funders who pursue them commercially. Directors should expect a well-resourced, determined claimant rather than a cash-strapped liquidator likely to settle cheaply. Procedural questions about how such assigned claims are pursued have been considered in cases such as Manolete Partners plc v Hayward and Barrett Holdings Ltd [2021] EWHC 1481 (Ch). The practical effect is that the assignment of a DLA claim materially raises the litigation risk to the director.

Defences and Mitigation

• Genuine credit balance / accounting error. Demonstrate, with contemporaneous records, that the account is not in fact overdrawn or that debits were mischaracterised. The burden, post-Toone, is on the director.
• Lawful dividend. Prove distributable profits at the date of distribution (by reference to relevant accounts), proper authorisation and declaration. This converts apparent drawings into lawful dividends.
• Authorised remuneration. Evidence of a service contract or authorising resolution may support a remuneration characterisation, but not retrospectively manufactured.
• Relief under s1157 CA 2006. The court may relieve a director from liability for breach where they acted honestly and reasonably and ought fairly to be excused. This is discretionary and rarely succeeds where the company was insolvent and creditors were prejudiced.
• Limitation , available only where the claim is genuinely a money claim outside s21(1)(b); Burnden will usually defeat it for misapplication claims.
• Quantum and methodology. Challenge the liquidator’s reconstruction of the DLA where records are incomplete; require the claim to be properly evidenced.
• Negotiated settlement. Early, realistic negotiation, often combined with addressing the s455 and disqualification dimensions, is frequently the best outcome, particularly given the absence of a set-off and limitation shield.

Practitioner Checklist

1. Reconstruct the DLA from the company’s books and identify each debit and its character (cash, expenses, “dividend,” “salary”).
2. Map the tax position , outstanding s455 charge, the consequences of write-off and any PAYE/NIC exposure, alongside the company-law debt.
3. Identify the liquidator’s likely cause(s) of action , simple debt, s212 misfeasance, unlawful dividend, breach of duty and the defences available to each.
4. Test any dividend/remuneration re-characterisation against Toone v Robbins: were there distributable profits and proper authorisation, evidenced contemporaneously?
5. Assume no set-off for misfeasance liabilities (Manson v Smith); advise that a credit balance ranks only as an unsecured claim.
6. Do not rely on limitation for misapplication claims (Burnden Holdings v Fielding); s21(1)(b) Limitation Act 1980 usually applies.
7. Anticipate an assigned claim and a commercially motivated funder rather than a passive liquidator.
8. Consider s1157 relief and the prospects of negotiated settlement, factoring in disqualification and PLN exposure.
9. Address collateral consequences , director disqualification under the CDDA 1986 and, where HMRC debt is involved, personal liability notices.

Frequently Asked Questions