Directors’ loans to companies and securities

It is increasingly common for directors who are also shareholders of companies to lend money to those companies.

Usually this is to facilitate cash flow for the company where, perhaps, bank facilities are unavailable.

Whereas many owner managers blur the line when it comes to their money and the company’s money, it is essential to recognise the distinct rights which the director has against the company, and to seek to protect his position so far as possible.

We would always advise that any director who is lending significant sums of money to his company should look at taking security for that loan in the event that the company is unable to repay the loan. Being a secured creditor is always preferable to being an unsecured one. While on the face of it this sounds straightforward, there are various issues to consider.

Type of security

While there are various types of security which can be taken, from a simple lien through to a mortgage, the most common way to secure a director’s loan would be by taking a charge (either fixed, floating, or both). A debenture is a common way to achieve this.

Taking a charge gives the lender (in this case the director) some protection as a secured creditor in the event that the company is unable to repay the loan. However, especially in the case of a director’s loan to a company, there are several pitfalls which can trip up a lender seeking security.

Pitfalls

It is essential that the consent of any existing lender is sought before new security is entered into. Failure to do so may result in a breach of the existing security, leading to further problems.

Any security should be in writing, and properly registered, in order to take full affect against third party creditors. Again, failure to do so may render the security invalid.

Security must be put in place at the time of the loan. Failure to do so may render a floating charge invalid as against any amounts lent prior to the charge being put in place.

Insolvency

In an insolvency situation, an administrator will look carefully at all such transactions, and will, where possible, seek to set aside anything which has not been correctly put in place. If the company was insolvent, or became insolvent as a result of the transaction, then it could potentially be challenged as being a “preference” or a “transaction at an undervalue”, in each case where the transaction occurred within two years of the liquidation/administration.

With regards to a floating charge such as a debenture, which is granted to a connected party (such as a director), then this will be invalid if granted in the two years prior to the onset of liquidation/administration.

Summary

Accordingly, as a director considering making a loan to your company, it is imperative that you take proper advice. This should include considering the company’s financial position, including projections for the proceeding two years, the solvency of the company, the likelihood of the security being set aside, and ensuring that any security is properly granted and registered.

If you would like to discuss this or any other corporate and commercial legal matter, please contact David Filmer on 01772 258321, or at David.Filmer@harrison-drury.com