Shareholders and directors commonly lend money to their companies with a view to providing working capital or otherwise assisting their businesses. However, as a Court of Appeal ruling made plain, it is vital to formally record in writing the basis on which such loans are made and, in particular, the terms on which they are to be repaid.
The case concerned a successful commercial and residential property development company in which a businessman and two brothers were equal shareholders. The three were also the company’s directors for 20 years until the businessman was removed from the board by a shareholders’ resolution passed by the brothers.
The businessman launched proceedings, seeking to recover seven-figure, interest-free loans he had made to the company over the years to assist its business. The loans, together with sums loaned by the brothers, were credited to a directors’ loan account. He argued that, in the absence of any specific agreement to the contrary, the loans were repayable on demand.
The brothers did not dispute that the company was very substantially indebted to the businessman. They argued, however, that the three of them had orally agreed that, save in the event of the company’s sale or liquidation, the loans would not be repaid without the consent of all three of them. Following a hearing, however, a judge found that their defence to the claim had no real prospect of succeeding and entered summary judgment in the businessman’s favour for over £2.3 million.
Dismissing the brothers’ appeal against that outcome, the Court noted that, although it is commonplace for directors and shareholders to lend their companies money, it would be most unusual for them to bind themselves to leave it there indefinitely. A loan that is made other than for a fixed term is, on the face of it, repayable on demand and that is perhaps particularly so where a loan is interest free.
On the brothers’ case, the businessman had advanced loans to the company on the basis that he could never recover them except with the brothers’ consent or in the event of a sale or liquidation. He would have had no control over the money, which would have been tied up indefinitely, interest free. It was striking that there was no trace of any such unusual, and potentially draconian, term in any of the documents before the judge. Although his ruling was not free from flaws, it was open to him to conclude that the brothers had no viable defence to the businessman’s claim.