22 Jun Loan Accounts
Frequently in corporate insolvency administrations, the company’s financial statements disclose that there are related party loans (usually provided to or by directors or shareholders). The two primary forms of loans are:
- Debit loans – loans owed to the company by the recipient; and
- Credit loans – loans where the company owes the provider of the funds.
In our experience, the most common debit loans identified in a company’s financial statements relate to directors’ drawings in lieu of a wage. Where a company operates profitably, these drawings are set-off against end of year profit distributions thereby reducing the loan account.
In the event of an external administration of a company (e.g. liquidation/voluntary administration), any debit loan account becomes a debt due to the company. Accordingly, the external administrator must seek to recover this debt and in a worst-case, this may result in the bankruptcy of the debtor.
We often encounter directors who are not aware of the implications of a debit loan account and seek to claim such a loan account as wages paid. Such arguments are rarely successful given the documentation required does not usually support such an argument, for example no PAYG was paid on these “wages”.
We recommend that advisors explain the implications of drawings in lieu of wages to their clients, as the ramifications can be significant.
When a company is facing financial difficulty, it is not uncommon for the directors/shareholders or their related parties to provide funds by way of a loan to support the company’s cashflow requirements. These loans may or may not be provided subject to any security agreement.
In the event that no security is attached to the loan and the company subsequently enters into an external administration, the funder will rank equally with the insolvent company’s other unsecured debts and may only recover a portion of their debt, if any.
It should be noted that if security is intended to be granted for the loan, such documentation must be prepared and signed prior to the loan being provided. A retrospective security may be invalid under the Personal Property Securities Act (PPSA) and may also result in breaches of officer’s duties and give rise to potential voidable transactions.
Credit loans obtain the same voting rights as any other unsecured creditor in most external administrations, with the following exceptions:
We recommend that detailed supporting documentation, including documentation showing the provision of the funds to the company be retained in order to verify a claim made in any external administration. In the event that either a vote is taken or a dividend is declared, external administrators must carefully consider any related party claims ensuring sufficient supporting documentation has been provided.
In a voluntary administration of an insolvent company, a related party credit loan may be compromised to assist in a return to unrelated parties. The purpose of a voluntary administration is for an insolvent company’s affairs to be restructured in such a way that maximises the chance of its business continuing or providing a greater return to creditors than a liquidation. Practically this means that a pool of funds is made available for distribution to unsecured creditors which results in them receiving more than they would receive if the company were to be placed into liquidation. A voluntary administration can keep a company’s business trading and bring finality to pressure from creditors.
The most common use of credit loans in a voluntary administration is for those debts to be deferred and not be claimed from the pool of funds established for distribution to ordinary unsecured creditors. A basic example is as follows:
|Total Funds Available||400,000||300,000|
|- trade creditors||700,000||700,000|
|- related party credit |
|- statutory creditors||800,000||800,000|
|Total Creditors’ claims||2,200,00||1,500,000|
|Return to creditors (cents / dollar)||18||20|
As can be seen from the above example, creditors will receive more from the proposed DoCA as a result of related party credit loans not claiming from the pool of funds made available.
In summary, both types of loan accounts become important in the event of an insolvency situation.
The above is not intended to be legal advice and we recommend that a related entity entering into any loan with a company seek advice from a suitably qualified solicitor or advisor prior to providing the funds.
Contact SV Partners for specialist advice on the options available to deal with unmanageable debt and the implications of any loan accounts in an external administration.