Under the Companies Act a company is prohibited (subject to certain exceptions) from making loans to its directors. A recent case highlighted the dangers to a director who is aware that his company has made loans in breach of that prohibition.

The case involved a father and son who were the directors of a company. Over time, the father had become less involved in the day-to-day management of the company in question. He was nonetheless aware that the company operated loan accounts in respect of both him and his son. After a few years the company became insolvent and the company's administrators applied to the court claiming that the directors had breached the prohibition on loans to directors under the Act.

The father was found liable to repay the outstanding amount on his own loan account. He was also found liable jointly and severally for some of the debt outstanding on his son's loan account. In other words, the father was held to liable for some of his son's indebtedness to the company also.

The fact that the father had been aware of the operation of the loan accounts was regarded by the court as being equivalent to his authorising each individual advance to his son - despite the fact that he had no actual knowledge of the amount of each of the advances made to his son.

The case also serves as a reminder that directors will also be guilty of a criminal offence if they breach the prohibition under the Companies Act on loans to directors. Accordingly, if a director becomes aware of this type of practice, then he should seek to stop it and to recover the amount of any outstanding loans from his fellow directors.

Stephen Trombala is a partner specialising in corporate finance with law firm Shepherd and Wedderburn. 0131 473 5720.

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