Overdrawn director's loan accounts in insolvency

An overdrawn director’s loan account (DLA) is rarely a cause for concern in a solvent company. It’s a common feature of owner-managed businesses, often balanced out at year-end via dividends, salary or expenses.

But once insolvency enters the picture, everything changes. That DLA is no longer just an internal number. It becomes a personal liability. And if it’s not resolved in time, the consequences for the director can be serious.

As an accountant, you’re often the first professional to spot this risk. Understanding how DLAs are treated in insolvency gives you a chance to help clients act early, and avoid personal fallout.

What insolvency does to a DLA

The moment a company enters insolvency, its assets must be realised for the benefit of creditors. That includes any funds owed by the directors. So if a DLA is overdrawn, the director effectively owes the company money. And it becomes the insolvency practitioner’s (IP’s) job to recover it.

That’s not optional. It’s a legal duty. The IP must pursue the debt, just like any other company asset. If the director can’t repay it in full, they could face settlement negotiations, enforcement proceedings or even bankruptcy.

That makes the DLA a serious exposure point. Especially where drawings were informal, cumulative or reclassified after the fact.

Why the usual fixes don’t work

In a healthy business, there are several ways a DLA might be cleared. But these often break down once insolvency is in play.

Backdated dividends: If the company is insolvent, it can’t legally declare dividends. Any post-dated reclassifications may be challenged, and in some cases, reversed.

Expense reimbursements: Valid offsets must be clearly documented. Without receipts or audit trails, claims will likely be rejected.

Salary adjustments: Paying arrears to offset a DLA is only viable if the business is still trading and has available funds. Once the company is in insolvency, that window closes.

If there’s ambiguity over how drawings have been recorded — dividends one year, loans the next — the IP will focus on substance over form. They’ll look at what actually happened, not what it was labelled. If money left the company without a lawful basis, it’s treated as a loan. And the director becomes liable to repay it.

What directors need to understand

It’s easy to see how this can catch directors out. Many are unaware that their drawings have left a technical debt on the balance sheet. Others assume it’ll be written off when the business closes.

But that’s not how insolvency works. The IP has a duty to recover everything they can for creditors, including DLAs.

If the DLA is substantial, the IP will assess the director’s personal financial position using points of reference such as:

•           A Statement of means

•           Evidence of income and assets

•           Property ownership details

•           Bank statements

If the director cooperates, a payment plan or partial settlement might be agreed. If not, enforcement can follow, including statutory demands, legal proceedings or personal insolvency.

How to reduce the risk before it escalates

If you’re advising a director whose business is in trouble, get ahead of the DLA risk as early as possible. Here’s what to focus on:

1. Get the DLA balance accurate and up to date

Include all informal drawings, benefits in kind and unpaid tax. Don’t rely on estimates or partial figures. If the IP finds a bigger number later, it undermines any chance of early negotiation.

2. Stop informal withdrawals immediately

Continuing to draw funds once the company is likely insolvent increases personal exposure—and raises red flags for the IP.

3. Identify and evidence any legitimate offsets

If business expenses have been covered personally, now is the time to prove it. Reimbursable costs can reduce the net balance, but only with proper documentation.

4. Don’t try to reclassify payments retrospectively

Post-insolvency adjustments, like calling a loan a dividend, are almost always challenged. They can even be seen as attempts to mislead, which brings wider scrutiny.

What if the director can’t repay the DLA?

If funds aren’t available, the IP may accept a reduced settlement or staged payments—especially if the director is transparent and cooperative. But concealment or non-engagement usually triggers enforcement.

In more severe cases, the director could face personal insolvency or disqualification.

The advice here is simple: openness gives you options. Evasion removes them.

Using a CVL as a solution

If the company is clearly insolvent, a Creditors’ Voluntary Liquidation (CVL) allows the director to retain some control. They can choose the IP, deal with the DLA proactively, and enter negotiations early.

By contrast, if a winding-up petition forces the company into compulsory liquidation, the Official Receiver takes over and options become limited. That’s why timing matters. A well-timed referral could make all the difference to your client’s financial and reputational outcome.

The takeaway for accountants

An overdrawn DLA might look harmless in a solvent company. But it’s one of the first things an IP will zero in on in insolvency. And it’s often the point where directors get personally stung.

The best way to protect your client is to raise the issue early, before insolvency formalities begin. Encourage good record-keeping. Discourage informal drawings. And when the business is under pressure, insist on a proper review of the DLA.

If there’s risk, bring in a licensed IP sooner rather than later. Early advice preserves options. Late action usually narrows them.