Tens of thousands of company directors are taking unnecessary risks by failing to take security for loans they make to their companies, warns a leading insolvency specialist.
David Ellis, a partner at Black Country firm, Higgs & Sons, believes the problem of unsecured loans could lead to many directors being doubly penalised if their company subsequently fails.
"Most directors of private limited companies will have lent money to their companies at some time," said Mr Ellis, who is head of Higgs’ corporate and commercial team, and is a licensed insolvency practitioner.
"Often such a loan is put in place when the company is first formed and does not have a good enough track record to borrow from a bank. Other lending takes place to inject additional working capital when the business is growing or when reduction of the available funding from other sources occurs."
The ability to borrow from the directors often gives the company flexibility and can enable it to keep trading or to take advantage of business opportunities that would not be possible otherwise.
"Lending to the company is not a problem if the company prospers as it can pay back the loan as and when finances permit. Problems arise, however, if the company should subsequently fail. If no security has been taken then the director will rank with the other unsecured creditors to share any remaining funds after the costs of liquidation and preferential creditors have been paid," noted Mr Ellis.
Higgs & Sons recommends that directors protect themselves by putting in place security as early as possible, preferably as soon as the company is formed. Security can take the form of either a general "floating charge" over all the assets or a specific "fixed charge" over premises, plant or other valuables.
If security has been taken the debt owing to the director will be repaid before any payment is made to the unsecured creditors, provided that the asset in question is still owned by the company at the date of its failure.
Mr Ellis cautions that there are a number of requirements that have to be complied with in order for the security to be valid. The wording should be professionally drafted; the charge should be put in place before the funds are made available and the security should be registered at Companies House and/or at the Land Registry in accordance with applicable time limits.
"Provided action is taken early enough and the correct procedures are followed, it is open to company directors to strengthen their personal position considerably," said Mr Ellis. "Many directors are so focused on making the business succeed that they leave it too late to consider putting such protection in place."