When a company enters into liquidation one area that will always be investigated by the liquidator is whether there have been any payments of dividends that should not have been declared by the company.

Dividends are often advised as being a tax efficient way for a director/shareholder to extract value from their business however it seems in a number of cases that the accountant’s advice is not always followed when it comes to when a dividend can be paid.

In small companies where the directors and shareholder may be the same individuals and working with just one or two fellow directors the payment of dividends in lieu of a salary is very popular.

When deciding whether to take a dividend a director/shareholder needs to be certain that there are sufficient distributable profits or reserves from which to make the payment. If there is any uncertainty in this regard then the accountants should be approached for advice.

Dividends may be declared on an interim or final basis. Final dividends are paid once a year, with reference to the company’s annual accounts. A Final Dividend will be subject to the Articles of Association and typically the Directors will make a recommendation which will then be approved or reduced by the shareholders resolution. Once approved (or declared) it must be paid in accordance with the resolution passed by the shareholders. In large companies with may shareholders this process will be rigidly followed, in smaller companies where the directors and shareholders are small in number and in any event one and the same the formality is often lost.

Interim dividends may be paid at any time by a decision of the Directors without the need for the approval of shareholders.

In coming to a decision regarding dividends the directors need to keep in mind their “director duties” in particular they need to consider how removing profits from the company sits with their duty to promote the success of the company.

The Court of Appeal has recently had to consider the issue of illegal dividends and the result is that all directors need to have careful consideration of the Articles of Association, the accounts and advice given.

In smaller companies where their directors and shareholders are one and the same formalities might be disregarded, however it is clear from the Court decision that this is not acceptable. Inevitably if proper decisions are not made it can lead to too much money being extracted from the company and it ultimately entering into liquidation.

If a company enters into liquidation dividend payments can be challenged. When they are challenged by a liquidator, the lack of proper records relating to the payments will be an issue for the director/shareholder.

In the Court of Appeal’s recent decision, they reviewed the decision of the lower court. There were two directors of a company that entered into liquidation. The record keeping was poor, it had a Sage accounting system on which were separate journals for wages and dividends. Not all payments out of the company’s bank account were recorded in the management accounts. In the months leading up to the liquidation the company had paid £185,216 to the Directors. The liquidator had applied to court to recover those payments as being unlawful dividends as the company had no distributable profits. In their defence the directors argued that these payments were disguised remuneration.

The Chief Registrar found that the payments made and described as “dividends” were indeed dividends. He relied on the following:

  • The payments were described in the books and records as dividends, including one payment that had initially been recorded as wages and then reversed and entered as dividends.
  • No PAYE or NIC deductions had been made
  • The sums paid were round sums which in evidence from a director were described as “provisional dividends”, which suggested that they were distributions on account of anticipated dividends.
  • The Tax Returns made by the Directors declared payments received as dividends.
  • The original defence to the claim made was that the payments were lawful dividends.

The Registrar did however allow a payment to be retained by the directors where it was found that the Duomatic Principle applied. Essentially where it can be shown that all the shareholders who have a right to attend and vote at a general meeting of the Company assent to some matter which a general meeting of the Company could carry in to effect, that assent is as binding as a resolution in general meeting would be. In effect where the directors and shareholders are one and the same the formalities are relaxed. The Registrar found in favour of the directors on this particular payment having regard to the evidence and applying that the burden of proof was on the Liquidator.

At Appeal the Court found that the Registrar should have determined this particular issue so that the benefit of the doubt was given to the Liquidator and not the directors, this payment was therefore also ordered to be repaid to the Company.

On Appeal the Court found that Directors who receive money from a company cannot be heard to say:

“We have received company money: but our record keeping is so bad that the basis upon which we received it is unclear. So, by reason of our defaults we ask you to assume in our favour we took the money lawfully.”

It is essential that directors maintain well kept records so that they can be relied upon in the event that the company fails. A failure to do so could lead to a liquidator making a claim against the directors whether for unlawful dividends or other transactions.

Cognitive law has solicitors who can assist you with regard to your duties as a director, what to do when things are going well and also when business is not performing so well. In the event that your company does enter into an insolvency procedure we can also assist and advise you on the claims that you may face from the office holder that gets appointed.

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