 |
 |
|
|
You know the scenario - small (or sometimes not so small) business, variable profitability, PAYE is a cash flow issue so you advise the director(s) to draw a set sum each month which will be taken care of by way of a dividend once the annual accounts have been prepared.
Everyone's a winner Rodders, this time next year, etc. All well and good unless the company enters into an insolvency process - as you will see below! But first a bit of background.
The rules governing payment of dividends can be found in the company's memorandum and articles of association, in the Companies Act 1985, in the Insolvency Act 1986 and under common law.
Memorandum and articles of association
The power to declare dividends generally lies with the members at a General Meeting. Such a resolution requires a simple majority of votes and the payment in question cannot exceed the amount recommended for payment by the directors.
Generally directors are authorised to pay interim dividends with the approval of a board resolution in anticipation of shareholder consent in a General Meeting.
Companies Act 1985 ("CA85")
Subject to any restrictions in the company's memorandum and articles, the payment of dividends is governed by section 263 CA85. This provides that a company may only make distributions out of accumulated, realised profit (to the extent not previously distributed or capitalised) less accumulated realised losses (to the extent not written off).
Section 277 CA85 provides that where a shareholder knows, or has reasonable grounds for believing, that at the time the distribution was made it failed to pass the section 263 test, that shareholder is liable to repay the dividend (or the offending part of it).
Insolvency Act 1986 ("IA86")
The directors or shareholders could be required to repay the amount of the dividend pursuant to section 238 IA86 if at the time of the payment:
- The company was insolvent and
- The directors had no reasonable ground for believing the dividend payment would benefit the company.
Only a liquidator or administrator can bring an action under section 238 IA86.
Common law
The fiduciary duties imposed on directors under common law provide that they must act at all times in the best interests of the company. Furthermore, that they will hold all the assets of the company on trust for the benefit of its members. Directors are in breach of these duties in the event that they make a payment without regard to the future cash requirements or future solvency of the company and can be ordered to repay the amounts distributed.
Ignorance of section 277 CA85
Astonishingly, some nine months ago a High Court judge ruled that being unaware of section 277 CA85 was a valid defence to an unlawful distribution! This decision immediately begged the question how could it be proved that the directors / shareholders knew section 277 existed?
The case was It's a Wrap (UK) Limited (in liquidation) v Gula. The defendants argued that the payments of dividends were merely a tax efficient way of drawing a salary and that they had been advised this was normal business practice and not unlawful.
The court found in their favour, finding that the defendants would not have paid the dividends had they known that doing so was a breach of CA85.
Court of Appeal decision
Not surprisingly, the liquidator of It's a Wrap Limited appealed - successfully.
Because section 277 CA85 derived from a European directive, a line of cases including Friedrich Binder GmbH & Co KG v Hauptzollamt Bad Reichenstall applied which, as we all know, provides that a person is taken to know the context of Community law as soon as it is published in the Official Journal.
Therefore the liquidator did not need to prove that the defendant had knowledge of section 277 CA85 but merely show that the defendant had been aware that the company had no profits at the time of the distributions. There was no need to demonstrate that the defendant knew that the distributions were unlawful.
Client management issues - time to dust off the PI Policy?
In our experience the beneficiaries of dividends are very quick to point the finger of blame at their professional advisors and any advice to draw salary by way of dividends should be accompanied by an appropriate caveat covering insolvency. Bear in mind that we live in litigious times and his professional advisors may well be the losing defendant's first port of call. If that happens, the claim defended and the case reported we will let you know!
|
|
|
|
|
|
|
