For limited companies, overdrawn director's current accounts are a common problem when facing an insolvency situation.
To recap, an overdrawn current account is when a company stops making profits but the directors continue to take out drawings which will be later voted as dividends, so effectively owing the company money until the dividend is voted.. Efficient and correct in good times for a company, but this approach can cause problems when losses are made, there are insufficient reserves to cover the dividends and directors can find themselves with personal liability problems.
What about partnerships then?
Partnerships of course have their own tax benefits, but if the partnership has not been making any money and there are overdrawn current accounts, then the unique situation arises where the partners are joint and severably liable for the account. In an insolvent situation this could be very damaging on top of the personal liabilities of the partners to the creditors.
In a limited liability partnership the partners will not be joint and severably liable for the overdrawn account but it will be, in effect, the same as a directors overdrawn current account. So in an insolvent situation the same rules apply. An LLP will not offer complete protection against creditors and we have blogged on the subject before on what you need to know about limited liability partnerships
So for a partnership what are the Solutions?
Well, options include:
Repay the debt you personally owe to the company.
Offset any loans the partners have made to the company (this is called set off).
Make a lot of profits in future periods to offset it!
A company can use a Company Voluntary Arrangement to reverse the current year directors drawings into the PAYE Scheme if there are insufficient reserves to pay a dividend. However, for a partnership that may not operate a PAYE Scheme this is not possible. A partnership voluntary arrangement or PVA may be an option, which will allow the partnership to continue to trade with money owed to creditors paid off over time and the partners will need to pay off the overdrawn account as they are in effect debtors of the partnership.
What happens in a winding up of a partnership if there are overdrawn current accounts?
In any liquidation the liquidator can demand that partners repay their overdrawn current account to the partnership for the benefit of the creditors. They can take legal action to make partners pay this or even make them bankrupt.
So, partners may be at risk of losing their home if their current account is overdrawn and not recovered.
The important thing is to take advice on this matter from professional advisors before it becomes an unsurmountable problem.