Making loans to directors

In businesses, especially owner-managed businesses in which the directors are also the shareholders, the line between company funds and personal funds can become somewhat blurred.

It is a fact of business life that directors utilise excess funds from their business to fund personal expenditure and therefore, enter the area of director loans.

As a director, your company can make a loan to you.

In fact, it can be a very tax-efficient way of extracting money from a business, since PAYE and PRSI is not payable on this money coming in…

In many instances, these loans are short-term and are repaid within a very short period of time.

(And you may have to declare it as a benefit if it is interest free or at a very favourable interest rate – in which case, it may well be taxable.)

However, there are very strict criteria involved where a loan is made by a company to one of its directors.

In this guide we explain some of the rules for directors who borrow from their company or holding company.

 

What is the general rule?

 

The general rule under the Companies Act 2014 (as laid out in Section 239 of Part 5), is that a company is not allowed to:

• Give loans or quasi-loans to a director or a connected person (a connected person being a spouse, parent, child, brother, sister plus other defined relationships);
• Enter into a credit transaction as creditors for directors or connected persons, for example, hire purchase agreement or lease agreement;
• Provide a guarantee or security for a loan or credit transaction for a director or connected person.

This is to protect the company’s assets in the interests of the business and all of its owners and creditors.

 

Are there any exceptions?

 

Yes, there are several exceptions to this general rule.

Exception 1 – Amount of the loan

The loan is legal if all of the company’s loans taken out by any and all the directors and connected persons come to less than 10% of the company’s ‘relevant assets’.

Relevant assets are the net assets on the company’s balance sheet at its last annual general meeting (AGM).

The following examples show how the rule works.

Example 1

Let’s say the stated value of your company’s relevant assets is €500,000.

In this situation, the total of all company loans to all directors and connected persons must be less than €50,000 (10% of relevant assets).

Example 2

If there has never been an AGM (because the company is relatively new for example), the relevant assets are the ‘called-up share capital’ of the company.

‘Called-up share capital’ means the original cost of the shares of the company and is stated on the company’s balance sheet.

This figure can be as low as €2.

In such a situation, the total of all company loans to directors and connected persons cannot be more than 20 cent (which is 10% of the called-up share value of €2).

Exception 2 – Summary approvals procedure (SAP)

A company can lend money and guarantee or provide security in connection with a loan to a director or connected person if 75% of the company’s owners (i.e. Shareholders) approve the arrangement.

The directors must also sign a statutory declaration of solvency (a statement in a specific format required by law) that the loan will not affect the ability of the company to pay its debts as they fall due.

This declaration of solvency must be made by all or a majority of the directors at a directors’ meeting not more than 30 days before the members’ resolution is passed authorising the loan (section 202(6), CA 2014).

The directors’ declaration must set out the:

• circumstances in which the arrangement is to be entered into;
• nature of the arrangement;
• name of the person to or for whom the arrangement is to be made;
• purpose for entering into the arrangement;
• nature of the benefit which will accrue to the company from entering into the arrangement; and
• declarants have made full inquiry into the affairs of the company and that, having done so, they have formed the opinion that the company will be able to pay or discharge its debts and other liabilities in full as they fall due during the period of 12 months after the date of the relevant act.

This process is known as the ‘summary approvals procedure’.

Note: If a director signs the declaration and the company gets into financial difficulties afterwards, the director may become liable for (have to repay) the debts to the company. Therefore, prior to using the SAP to legalise an activity, the directors should carefully consider the fact that they could be exposing themselves to unlimited liability.

Exception 3 – Loans between companies in the same group

Companies can lend money and provide guarantees and security to one another provided they are all companies within the same group.

There are rules that say exactly when a company is part of a group.

Exception 4 – Expenses

The company can pay the directors’ business expenses.

For example, the company can give money or guarantee a director’s credit card as long as this is issued to pay the business expenses of the business.

Exception 5 – Lenders

If a loan is provided in the normal course of business, this is allowed.

For example, if a company (such as a bank) lends money as part of its business, it can lend to directors.

However, the loans must be on the same terms as the company would offer to an ordinary person taking out the same loan.

 

What if the value of the relevant assets falls?

 

If the value of a company’s relevant assets falls, the loans may then breach the rules.

The directors must correct the situation within two months.

This may involve repaying some loans.

If directors fail to rectify this situation within the two months, the Act states the arrangements shall become void.

 

What terms and conditions apply to directors’ loans?

 

Directors and their companies can decide the terms and conditions that will apply to directors’ loans, provided they put these in a formal written agreement.

If there is no written agreement, the law sets out standard terms and conditions:

• The loan is repayable on demand
• The loan is interest bearing (5%)

 

What might happen if more money is borrowed than is allowed?

 

Borrowing more than is allowed is a criminal offence.

A director may face prosecution in the courts if they allow their company to loan more than is allowed by the law.

If a director or connected person borrows more than is allowed, the company can decide to cancel the transaction and look for the money back.

The company can demand:

• Repayment of the full amount
• Reimbursement for any loss suffered; and
• Repayment of any profit earned by the director or connected person on the transaction.

If the company cannot repay what it owes and is closed down (goes into liquidation), and the directors have borrowed more than is allowed from the company, the court may say that the directors must:

• Repay the loans; and
• Personally pay some or all of the money that the company itself owes.

This is likely if the directors have used the summary approvals procedure to make the loans legal (see Exception 2 above).

 

What’s process should be followed?

 

1. Agenda for the board

Proposing the loan to the director.

2. Board minutes

Recording:

• the proposed loan and all its relevant details of it (such as amount, interest payable, time frame, repayment dates/instalments, etc.)
• the need for shareholder consent to this loan
• the plan for obtaining shareholder consent, assuming that the board agrees this loan should be granted
• the outcome of the shareholder resolution process (once it has been undertaken)

3. A director’s loan agreement

4. Proposed special resolution to shareholders

Requesting consent to the loan (including all the relevant details)

5. Written special resolution by the shareholders

Confirming the shareholders consent to the loan

 

How to make a director’s loan

 

Step 1:

First, get director support.

You’ll need to propose the loan to the directors and ensure that there’s broad agreement to support it – ideally ahead of going to the shareholders to request their consent for this, which you will need to do.

Circulate the agenda or a note proposing the loan to all board members.

Request that the directors reply to indicate their support or attend a meeting to discuss whether they will support it.

You can then essentially ‘suspend’ the board discussions and freeze the resolution until you’ve got shareholder approval confirmed.

Step 2:

Draft the necessary Board minutes

Recording:

• the proposed loan and all its relevant details of it (such as amount, interest payable, time frame, repayment dates/instalments, etc.)
• the need for a declaration of solvency from the directors
• the need for shareholder consent to this loan
• the plan for obtaining shareholder consent, assuming that the board agrees this loan should be granted
• the outcome of the shareholder resolution process (once it has been undertaken)

Step 3:

Get a Declaration of Solvency from the directors.

The Declaration of Solvency must be made by all or a majority of the directors at a directors’ meeting not more than 30 days before the shareholders’ resolution is passed authorising the loan.

Step 4:

Get shareholder approval.

A draft written special shareholder resolution must be prepared, and it should ideally attach a draft loan agreement, setting out all the key details that are proposed.

This way, shareholders have the full picture of what is proposed, and you should not later materially alter these details if the shareholders sign off on them during this process.

Check out our shareholders resolution template

This should contain guidance in relation to the time frames for shareholders to confirm their agreement to what’s proposed.

These time frames will indicate the longest that you can wait for approval before the proposal must be treated as passed or unapproved.

If shareholders do not reply in time, you cannot treat their silence as assent.

Quite the opposite.

They must expressly confirm their consent to you, or the shareholder resolution cannot be treated as passed.

If they consent earlier than the deadline for their approval to be obtained, you can, however, move forward with your process and do not have to wait until the deadline date has passed.

Step 5:

If you get above 75% votes in favour of the loan, from those who are eligible to vote on this decision, you should record the approval in your board minutes.

However, it is important to note that if the special resolution is passed by 90% or less in nominal value of the voting shares, you must wait 30 days before you can finalise the loan agreement, including signing it with the director taking the loan.

Step 6.

Take care of housekeeping and tax considerations.

Make sure you then keep tabs on any repayments due.

Don’t let them fall overdue for payment as this can be treated as a breach of a director’s contractual duties to the company.