Directors of companies need to keep the above statement in mind following the decision in Bass v Buchanan  EWHC 2740 (Ch).
Following the company entering into a Creditors’ Voluntary Liquidation in December 2014 the liquidators conducted a review of the books and records of the company and brought proceedings against the director in relation to sums she had drawn prior to the liquidation.
The director had an outstanding director’s loan account of over £200,000 which had been in existence since 2007. There was a declaration in September 2014 that the sums outstanding should be reclassified as ‘drawings.’
Following an interview at the liquidator’s office the liquidator wrote to the director stating that the reclassification did not accurately record the true nature of the payments and therefore the director remained indebted to the company for the amount that had been reclassified. The director, as so often happens in cases such as these, claimed that the amount she received from the company should have been recorded as a salary. The actual annual salary received by the director was £6,000 and did not reflect the time that the director spent working for the company. The director accepted that she ought to have therefore declared the payments to HMRC as income but sought to excuse the failure by her reliance on professional advisers.
ICC judge Burton reviewed a number of relevant authorities including Global Corporate Ltd v Hale (a case in which the director had sought to argue that interim dividends could be paid and then adjustments made (so that payments could become salary) when the accounts were audited at the end of the financial year, and it was determined whether the company had made sufficient distributable profits to be able to declare dividends).
ICC Judge Burton found:
“The last-minute attempt to reclassify the payments as ‘drawings’ could not alter the basis upon which they had been paid and received throughout the Company’s prior trading periods. I have little doubt that if such a retrospective accounting adjustment were possible, most companies’ owner-directors would adopt a similar practice. They would approve payment to themselves of a salary below the income tax threshold and then take more than that amount out of the company on a monthly basis in the hope of earning sufficient dividends by the end of the year to repay any debt due from them to the company. If it then transpires that the company makes a loss, or worse, enters liquidation, they would change the accounts to show that whilst creditors may not be paid in full, they should nevertheless receive what they consider to be a fair amount to compensate themselves for the hours they spent working for their own company, even though it has not been sufficiently successful to pay all of its debts.”
Following the Global case, it was noted that there was no board resolution at the relevant time and that the reclassification was of no legal effect. ICC Judge Burton went on:
“I also reject [counsel for the respondent’s] submission that Ms Buchanan has a corresponding claim for remuneration, on what appears to be a quantum meruit basis, which can be set off against the overdrawn loan account. In Global Corporate, Arden LJ suggested that once a company is in liquidation, such an unliquidated claim would need to be proved for in the liquidation and that unless the payments can be validly re-characterised as payments for services lawfully made by the company prior to the liquidation, it was difficult to see how they could provide a defence. I have found that the sums cannot be re-characterised. No question of set off arises. They were sums borrowed by Ms Buchanan from Company money against the hope of future dividends. Such dividends did not materialise and the loan must be repaid.”
The director also sought to argue that the claim by the liquidator had been made outside of the relevant limitation period and this argument was rejected as the sums owing were shown in the Accounts as ‘debtor sums’ and therefore became due and owing at the time they were incurred. ICC Judge Burton found that time for repayment did not start running until a demand was made by the company, and there had not been any such demand made until there was a formal demand made by the liquidators on behalf of the company.
Directors faced with their company being in financial difficulty have many issues to consider and the prospect of dealing with insolvency issues can be complex and stressful. The best advice is not to ignore them!
If you require any advice, please do not hesitate to contact me on 01273 284055 or email me email@example.com. You can also visit our insolvency service page for further details on all our insolvency services.