Unlawful Loans to Directors

Subject to a number of exceptions - for example, loans not exceeding £5,000 - the Companies Act 1985 provides that a company must not make a loan to a director of the company itself, or of its holding company.

Breach of this prohibition can have very serious consequences for the directors of a company. The company will be entitled to rescind the loan and demand its immediate repayment by the borrower. It will also be entitled to recover any loss or damage it suffers resulting from the transaction from any of the other directors who authorised the transaction. This liability is joint and several, which means that if the borrower is unable to repay the loan, one or more of the other directors may ultimately end up "holding the baby" and bearing responsibility for making good the company’s loss. A director who authorised the loan will avoid liability if he is able to show that he did not know of the relevant circumstances constituting the contravention.

The operation of these rules is graphically illustrated by a recent case. A company had made two unlawful loans to directors - one of £200k to A and one of £2.2m to B, A’s son. The High Court ruled that the company was entitled to recover from A an amount equal to both loans. The Court of Appeal upheld that decision as a matter of general principle, ruling that for a director to be liable for authorising a loan, it was enough if he had acquiesced in a practice whereby unlawful loans to directors were regarded as acceptable. It is not necessary to show that he authorised each individual payment. The Court ruled, however, that A was not liable to repay the whole of the £2.2m. He was only liable for the difference between the amount the company would have recovered from B, had it taken proceedings to enforce repayment of the loan as soon as A discovered that the loan to B was unlawful, and £2.2m.

If you would like to know more about rules concerning loans to directors and the implications of this case, please email David Dees.

Filed: 26/10/2007 16:24:32