Illegal dividends – the court clarifies a point

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Illegal dividends – the court clarifies a point

Liquidators have a duty to maximise realisations for the benefit of the creditors.  One potential avenue they have to consider is pursuing the shareholders for repayment of dividends that were paid illegally – a common problem where director shareholders of small companies pay themselves a nominal wage through the PAYE and NIC system and top it up to a living ‘wage’ with dividend payments, only to see the company go into liquidation later on.  It’s a tax saving exercise many accountants advise their clients to adopt and it does work in the good times when there are distributable reserves, but this case has confirmed that it is a strategy that simply does not work when there are inadequate distributable reserves.

In the case of Global Corporate v Hale, the facts were typical of a small company – the director took a small salary topped up by payments which were shown in the books as ‘interim dividends’, and at the end of each financial year when the accountant produced the accounts, if there were not enough distributable reserves to cover the dividends that had been paid, they would be re-classified as salary and the tax paid, albeit late.

Let’s remind ourselves of the relevant law – the Companies Act 2006 says a company can only pay a dividend out of profits available for the purpose as determined in the company’s ‘relevant accounts’.  Where a dividend is paid illegally either because there are no relevant accounts or the relevant accounts show there are insufficient profits, then a shareholder who actually knows or believes this to be the case can be forced to repay it.  In this case the liquidator sought repayment by the director shareholder of the interim dividends he had received where there were inadequate reserves.

At first instance, the judge decided the dividends did not have to be repaid because, despite them being shown in the books as dividends, he said it hadn’t really been decided that the payments were dividends as the time they were paid, how they were to be treated was to be decided upon by the accountant later on when he produced the accounts.  The liquidator disagreed with the judge’s decision and appealed.

The Court of Appeal decided that the judge at first instance was wrong.  The C of A said the state of mind of the director when paying the dividends was irrelevant, the evidence in the books was the important issue – and the books clearly showed them to be interim dividends.   And as they were classified as dividends the Companies Act required their legality to be tested at the time the payments were made, and not later.

The decision means that dividends are assessed as to their legality each and every time a payment is made – even if this is every month  – and any efforts to somehow later re-classify those payments individually or as a whole simply does not work.  Directors will just be asked by the liquidator to pay back the money they have received, then if they do not do so, they could be forced to do so.

This case shows two things…

Firstly, if you are an accountant reading this blog, you have to educate your clients.  No longer can they rely you on you to somehow make things right later on down the line if the payments could be illegal, they have to call you now before or when they make the payment so you agree the proper treatment of the payments and indeed payment of tax if appropriate.

Secondly, if it’s happened that such payments have been made then this needs to be discussed at length before the company goes into liquidation so that you and the liquidator have a plan for dealing with it.  Do not leave it to chance or hope that the liquidator somehow just ignores it – some will for a short time, that is until you’ve put the company into liquidation – but as I started off by saying, liquidators have a duty to maximise recoveries and they will not ignore this because they will not put their own livelihood at risk just because the director of a company they are liquidating did not do what he/she should have done at the right time.  And this case, which was about less than £25,000 in so called illegal dividends, shows that liquidators do have an appetite for pursuing directors for even modest payments.

By |2019-08-04T09:10:19+00:00May 10th, 2019|English Insolvency Law, Liquidation|0 Comments

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