Directors loan agreement: when should I get them?

Directors frequently make loans to the company of which they are director (and vice versa). The precise terms on which the director is prepared to lend and the company is prepared to borrow, as well as the allocation of risk, must be clearly recorded in a loan agreement. Shareholder approval may sometimes even need to be obtained if the director takes a charge over a significant proportion or value of company assets as security for the loan.

Why is it Important?

There are many circumstances in which company directors may want to make a loan to their company, especially where the company is new or in financial difficulty and the director is willing to lend on cheaper and more flexible terms than a bank. Loans involving directors can be an extremely valuable source of funding for a company in need of some extra finance. Sometimes it may even be the only available option, if the terms of other commercial lenders are too strict.

What it is / what should be included?

The purpose and circumstances of the lending will usually differ widely from loan to loan, so the agreement must be tailored carefully to ensure that it reflects the commercial reality. For example, where the lender is the sole director and shareholder of the company, he/she will have extensive control of the company and the agreement will probably be less extensive than a similar agreement where the borrowing company has several directors and shareholders. That said, the following points will form a useful foundation from which to start:
  • What is the loan amount and loan date? This is the lender’s main commitment to the borrower.
  • For what purpose is the loan to be used? This must be clearly defined and lawful.
  • Will the director charge interest on the loan? Tax advice may need to be taken on the implications this will have for the director’s personal position.
  • Does the director require security for the loan? In other words, will they take a charge over the company assets. Sometimes, shareholder approval will be required if this is the case.
  • Are there are any terms which the director requires as a pre-condition to the loan? These are commonly described as warranties and representations.
  • What are the repayment terms? Often this will be in instalments, according to a specified timetable.
  • What are the events of default? In other words, under what circumstances will the balance of the loan become immediately payable to the lender? Late payment and use of the loan outside the permitted purpose are common examples of triggers for immediate repayment.
  • Is the consent of any existing financiers required in order to make the loan?
One of the most important issues to consider before any director provides a loan to a company is whether doing so may give rise to a conflict of interest. Directors owe a duty to avoid any such conflict and declare any interest they have in the loan arrangement to the other directors, always ensuring it promotes the success of the company.

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