If you run a company that is marginally solvent, pay yourself a nominal salary and top up your package by paying a dividend, and are at risk of going insolvent some time down the line, then this article is especially for you…
Few directors and shareholders truly understand the law on dividends in great detail. Why should you, you have many other, generally more important, things to worry about, don’t you? And your accountant doesn’t always explain the law in detail at the year-end accounts sign off. Again, why should they, there’s a lot of far more important issues to talk about?
The problem comes if the company should go into liquidation some time down the line as the dividends come into far sharper focus. That’s because liquidators have a duty to investigate insolvent companies’ affairs and that includes considering whether dividends that have been paid were, with the benefit of hindsight, unlawful and could therefore be upset. And upsetting an unlawful dividend could lead to legal action against you as a director – and this applies even if you did not receive any part of the dividend.
Let’s roll time on…
Your company is now in liquidation, and the company paid a dividend in the years leading up to the insolvency …
Does the liquidator have to prove that you knew, or should have known, that the dividend was unlawful? Or is forcing you to reimburse the company in liquidation for that dividend a matter of strict liability?
Can you rely on accounts prepared by your accountants in your defence?
Several recent cases have examined when a dividend can be upset as being unlawful. See a local lawyers’ blogs on those cases Careful consideration can pay dividends and When is a decision to declare an interim dividend a decision?
(By the way, Oliver Ward-Jones who wrote the latter of those two articles for that firm is a superb lawyer whom I can recommend whole-heartedly to provide you with the advice you may need on this subject)
The most recent case is Burnden Holdings (UK) Ltd v Fielding. In this case the court considered the important principles on dividends and when the directors can be forced to reimburse the company for dividends paid prior to liquidation.
A Summary of the Facts
In 2007, the Burnden group of companies demerged one of its subsidiaries. The parent was financed largely by its directors/shareholders. The de-merger was structured in such a way that the parent company distributed the shares in the subsidiary in specie to the shareholders. After that some of the shares were sold to a third party. Half of the sale proceeds were then loaned back to the parent, to help the group’s cash-flow.
A year later, the parent went into administration, and a year on from then into insolvent liquidation. The liquidator sought to upset the dividend.
Is it a matter of strict liability?
The court decided that to be successful the liquidator needed to prove that the directors were actually aware, or ought to have been aware of the facts that would have led to the dividend being unlawful, even if they did not actually appreciate that those facts would mean that the dividend was unlawful. This was not a strict liability offence, the liquidator needed to prove there was an element of fault on the part of the directors.
The decision is in contrast to a non-binding view stated by the judge in the Supreme Court case of Paycheck Services 3 Limited. The later Burnden case was in the High Court – the question is will it stand the test of time?
Can the directors rely on third party advisors?
The court decided that even if there were insufficient reserves, the directors would not have been culpable in declaring the dividend in this particular case as they relied on their accountant colleagues and external professionals to prepare accounts justifying the dividend, and it was reasonable for them to place their trust in them.
The facts were complex, but the conclusion clear.
This particular court had sympathy for directors who they considered had reasonably relied on the professionals around them to advise them whether or not a dividend is lawful, even if it later transpired that the accounts used to justify the dividends contained errors (providing that the directors were not aware of those errors).
If the directors had not taken professional advice at the time or if they were aware of errors in the accounts that they had relied on, they would not have received any sympathy, they would be culpable and forced to repay the dividend.
There are several lessons to be learnt here.
Firstly it is a reminder that transactions such a dividend payments which would otherwise be ok if a company is solvent, may be challenged later on if the company goes into liquidation. Directors need to be aware of such a risk.
Secondly, to try to ‘insure’ against such a risk, directors need to take professional advice at the right time, and that is certainly not after the event. It’s not wise for directors to operate in a bubble, in today’s complex world, professional advice might be expensive but nowhere near as expensive as not taking it.
Thirdly, even then, as in this case where the directors defeated the liquidator’s claim, the directors will find themselves out of pocket because they will not be able to recover all of their legal costs from the liquidator. There is a powerful argument for companies to take out directors’ and officers’ liability insurance where larger transactions are being contemplated.