Why do companies make loans to directors?
Companies may lend money to directors as a gesture of goodwill. Directors can apply for company loans to obtain more favourable interest rates than what financial institutions, like banks, could offer them. Company loans, if approved, also will likely have less stringent underwriting requirements compared to banks. Directors may also need loans in case of personal emergencies, or require the money to meet expenses in order to carry out their directorial duties (e.g. transport expenses).
What is considered a company “loan”?
The definition of company loans do not just include standard loans – i.e. a sum of money handed over with a promise for repayment. Singapore law also defines company loans to include:
#1. Quasi loans:
This is a transaction where the company pays expenses incurred by the director, with the understanding that the director will reimburse the company later on.
#2. Credit transactions:
Examples of credit transactions include:
- Renting out housing or land to directors (e.g. a bungalow for the director to live in), in exchange for payments
- Providing goods and services to directors (e.g. chauffeur service, grocery hampers, laptops, etc.) in exchange for payments
Basically, this involves the company providing goods, services, or property/land use in return for payments from the director.
#3. Guarantees to directors:
These refer to the company providing a guarantee or security for a loan, quasi-loan, or credit transaction made for the benefit of a director. For instance, if the company agrees to act as a corporate guarantor for a personal loan that the director takes on, that would count as a guarantee to a director.
Can a company make loans to its directors?
It depends on whether the director is a shareholder, or not.
If the director is not a shareholder: Generally, no. Company loans are only allowed under 4 specific circumstances (outlined below). All other company loans that do not meet these 4 requirements are not allowed.
If the director is a shareholder: Yes, company loans are generally allowed, subject to some requirements.
Company loans to directors who are also shareholders
Companies may make loans to directors who are also shareholders. Some requirements that you must bear in mind are:
- You must hold a Board meeting, and pass a Board resolution to approve the company loan to the director-shareholder. This means that a majority of the Board of Directors must agree to the loan. You must document that the company loan provided to the director-shareholder has been given because of their status as a shareholder.
- Company loans cannot be made in order for the director-shareholder to reduce their tax liabilities (e.g. as opposed to paying the director-shareholder a director’s fee, director’s salary, etc.)
- There must be an IOU or some other official document to record the company loan, with a repayment schedule. You must create a debtor-creditor relationship. You cannot just make a company loan knowing that the director-shareholder has no intention of paying back the money.
- If the company has previously extended loans to other shareholders, then the loan terms (e.g. interest rate, any collateral, repayment schedule etc.) should be similar. Loan terms should not be biased in favour of director-shareholders just because the have a seat on the Board.
Restrictions on company loans to directors include the directors’ family members
Restrictions on company loans to directors include not only the directors, but also the director’s family members, who include the director’s spouse, children (including adopted children) and step-children.
Why are there strict restrictions on company loans to directors?
These safeguards exist because directors are supposed to represent the interests of the company, and shareholders. Company loans that are made to directors (particularly generous loans, at zero or very low interest rates) may adversely influence the objectivity of directors. Unscrupulous management teams may use company loans to buy favour from directors. It is therefore a matter of good corporate governance and public policy to ensure that company loans are only made to directors under a strict set of guidelines. This helps to protect shareholder interests, and minimises the possibility of directors being bought over by management.
What are the requirements to make company loans to directors?
Company loans made to directors who are not shareholders are only allowed under a narrow set of 4 reasons.
The 4 reasons where company loans to directors are allowed are:
Reason 1: Loan to pay director’s necessary expenses
The company loan is made to the director to pay expenses needed to fulfill the director’s duties. This loan must be approved in a shareholder’s meeting.
Reason 2: Loan to purchase housing for director
If the director is a full-time employee of the company or a related company, and the loan is specifically for the director to purchase a house to live in. This loan must be approved in a shareholder’s meeting.
Reason 3: Loan as part of employee benefits scheme
If the director is a full-time employee of the company or a related company, and the company loan is part of a company-wide employee benefits scheme. This means that company loans must also be made available to other employees, and not just the directors. Company loan benefit schemes must be approved in a shareholder’s meeting.
Reason 4: Loan as part of money lending business
If the company’s primary business involves money-lending, and the loan to the director is made by the company conducting its primary money-lending activities. Money lenders must have the relevant licenses from the authorities. This loan does not need to be approved in a shareholder’s meeting, since it is simply the company conducting its primary business.
How do I approve a company loan to directors?
Step 1: Arrange a shareholder meeting
Arrange a shareholder meeting at least 14 days in advance. If you receive at least 95% approval from shareholders, you can do away with this 14-day-advance-notice requirement, and you can hold the meeting earlier.
Step 2: Pass an ordinary resolution authorising the company loan to directors
An ordinary resolution is basically a shareholder vote. You must receive over 50% of shareholders’ votes in order to pass the ordinary resolution to make the company loan. During this meeting, you must disclose the purpose and amount of the loan.
Step 3: Disburse the company loan
Once shareholder approval has been granted, the loan can be disbursed to the directors.
Additional conditions for company loans
If shareholder approval has not been obtained for the company loan, then the loan must be repaid in full within 6 months of the next Annual General Meeting.
Also, if shareholder approval was not sought before the company loan was made, then the directors who receive the loan become personally liable for any losses the company suffers as a result of making the loan. For instance, if the loan amount was particularly large, and the company was unable to meet its expenses (e.g. payroll, marketing, R&D, etc.) and suffered a loss, the directors must repay the company for these losses.
What happens if directors do not adhere to these rules on company loans?
There are strong penalties in place to punish directors who make company loans illegally. It is a criminal offence for any director who authorises a company loan that does not meet the requirements explained above. According to the Companies Act, such directors can be jailed up to 2 years, or fined up to $20,000.
Interest rates on company loans to directors
There is no legal requirement for interest to be charged on company loans to directors. You can have 0% interest, or charge any other interest rate you wish.
Tax implications for company loans to directors
If the company loan is interest-free, or has an interest rate lower than the average prime-lending rate, then such company loans may be taxable. Whether or not such a loan is taxable depends on whether the director receiving the loan is a shareholder of the company.
Director receiving loan is NOT a shareholder:
For income tax purposes, company directors are considered as company employees, even if they don’t hold full-time employee positions. Therefore, any interest benefits that such directors receive from company loans are viewed as an employment benefit, and are therefore taxable.
The formula for calculating the value of the interest benefit:
Amount of loan outstanding (at end of each calendar year) * Average prime-lending rate of each calendar year
Director receiving loan is a shareholder:
If a company loan is made to a director-shareholder in their capacity as a shareholder, then they would not be deemed to be employees for income tax purposes. As such, no taxes need to be paid on interest benefits for company loans.
Making company loans to shareholders
There are no restrictions in Singapore law for companies making loans to their shareholders.
With that being said, company directors have a fiduciary duty to serve the best interests of the company. Directors must properly evaluate whether company loans to shareholders will serve the best interests of the firm.
Interest rates for company loans to shareholders
The company has discretion over what interest rate to charge shareholders. There is no legal requirement to charge interest. The company is free to provide interest-free loans, or to charge whatever rate they see fit.
Tax implications for company loans to shareholders
Shareholders receiving company loans do not need to pay tax on any interest benefits they receive.
Directors must act honestly and exercise due skill, care, and diligence when taking company loans
Directors also have a fiduciary duty to act with due skill, care, and diligence. This means that they must not take company loans if they can reasonably expect these loans to harm the best interests of the company. For instance, if a director knows that the company will need all the money it can muster for R&D in the next 12 months, then the director should wait till a later point in time before applying for a company loan.
Directors who breach this duty to act honestly and with due skill, care and diligence can be sued by their shareholders. Furthermore, directors can have criminal charges filed against them – punishments include being jailed for up to 12 months, and/or being fined up to $5,000.
Beware of shareholder lawsuits against directors for company loans
Shareholders may sue directors for improper loans. Loans don’t even have to actually be improperly disbursed for lawsuits to occur – shareholders can allege that improper loans were made, and initiate legal action against company directors. Defending such legal action is extremely expensive and stressful. It’s therefore important to carry Directors and Officers (D&O) Liability Insurance to protect directors against potential lawsuits. Directors & Officers Insurance would protect directors against such lawsuits. This type of insurance would pay for lawyer’s fees and damages/settlement amounts, which can easily add up to several hundred thousand (or even millions!) of dollars.
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