Outstanding Director Loans in a Liquidation – What needs to be considered
Mar 03 2026
It is not uncommon for Liquidators to find loan accounts outstanding from Directors to a company which has been liquidated. Often this occurs as a result of a decision by the Directors to take funds from a company as drawings to avoid paying the applicable taxes and superannuation for salaries and wages, particularly where a company is already in arrears with the tax office. Loan accounts may also accumulate to fund a Director's personal lifestyle even when a company is not profitable and is not paying all of its debts as and when they fall due, particularly outstanding taxes. Such loans are subject to the provisions of Division 7A of the Income Tax Act, which require proper documentation of such loans. However, Liquidators rarely uncover such documentation.
Prima facie, a Liquidator is able to rely on the company's books and records for the purposes of pursuing claims for recovery. However, when pursuing a Director's Loan Account, a Liquidator may be faced with allegations that the accounts were inaccurate or there was a misallocation of transactions by the company's bookkeeper or Accountant. Consequently, Liquidators will need to undertake a forensic tracing exercise in order to calculate the amount outstanding to the company which may be substantiated by supporting documentation e.g. bank statements, transfers etc. Often proving the legitimacy of these loans is problematic, particularly where funds are withdrawn in cash.
Company funds may have also been used to pay off a loan to purchase property secured by a mortgage held in the name of a Director or related party, which may expose the property for which the payments relate, to an equitable interest claim in the property by the Liquidator.
A Liquidator will attempt to recover a Director's loan account by initially issuing a formal letter of demand. Should the Director not respond within the specified period in the letter of demand, legal proceedings may be issued. Ordinarily, such proceedings would only be issued for an amount which is able to be substantiated by the Liquidator by third party independent documentation. Otherwise, such proceedings may be thwarted by legitimate defences raised by the Director.
Where a Director negotiates a settlement of an outstanding loan account which exceeds $100,000 or the terms of settlement exceed three months, the Liquidator will require creditor approval (or Court approval if not obtained from creditors) to compromise the debt (Section 477(2A) of the Corporations Act) or to enter into the settlement agreement exceeding three months (Section 477(2B) of the Corporations Act). Creditors who have their claims admitted for voting in the liquidation will be able to vote on these settlement proposals. The outcome of such voting is not always certain as non-institutional creditors may use their vote not based on commercial logic but rather for punitive purposes as a result of their prior dealings with the Director.
A consideration for a Director in settling any claim to recover a loan account is the tax implications where the loan has been compromised by the Liquidator which may trigger a deemed dividend for that Director’s income tax purposes. The Australian Taxation Office has a discretionary right to determine a course of action and possibly pursue a Director whereby Division 7A of the Income Tax Assessment Act may be triggered as a result of the compromise of the debt with the Liquidator.
It is vital for Directors to understand the implications of maintaining a loan account where funds are outstanding to the company for whatever reason, particularly in the event it is ultimately placed into liquidation.