A liquidator has statutory obligations to take control of the company assets, review its financial statements and demand repayment of outstanding debts and loans (which include any loans owed by the director or related parties).

This may lead to recovery proceedings against the director/related party.

How does a director/related party loan account arise?

A director loan account commonly arises from the following circumstances where the company is solvent and making a profit:

• The company loans money and/or property to the director
• In lieu of an ordinary salary, the director receives money periodically from the company by way of a loan which is likely to be offset against a future profit distribution (Division 7A requirements must be considered)
• The company pays for the director’s personal expenses.

Having an outstanding director loan recorded in a company’s financial statements may not seem a concern while a company trades profitably and is solvent. At the time, this type of loan may seem advantageous from a tax perspective and without risk.

Insolvency Risks

Given the current economic environment, directors should be aware that unforeseen circumstances can arise, which could cause financial stress on the company resulting in its liquidation.

If the Company is:

• No longer generating a profit, the loan cannot be offset against a distribution of profits
• Deemed to be insolvent, the loan may not be able to be offset against monies owed to the director ahead of other creditors

Directors should frequently review the value of any outstanding director / related party loans and the company’s financial position and performance.

What happens to director loans in a winding up?

As mentioned above, an Insolvency Practitioner (IP) will review the company’s books and records to determine the company’s recoverable property, including loans to directors/related parties. The IP must call in any monies owed to the company and if warranted, issue proceedings to recover such amounts.

If the loan is not repaid, legal proceedings could ultimately result in the bankruptcy of the director/related party. The director/related party should engage with the IP to attempt to resolve the claim in a timely and cost-effective manner to increase the likelihood of resolving the claim in a commercial outcome for both parties.

If you would like to know more or require advice about your company’s financial position, please contact Shane Cremin on (03) 9670 8700.

With James Lozankoski