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What ability do liquidators have to recover dividends paid to owner-managers when the company is insolvent? Steven Fennell, barrister at Exchange Chambers, examines the answer in Global Corporate Ltd v Hale and says while the case might be one limited to its facts if it is followed in future cases involving more normal accounting methods, it may create real obstacles to liquidators seeking to recover monies from directors.
Global Corporate Ltd v Hale  EWHC 2277 (Ch),  All ER (D) 50 (Sep)
The Chancery Division ruled, in proceedings which arose out of the liquidation of a company, that payments made by the respondent director of the company did not amount to dividends and that sections 830 and 847 of the Companies Act 2006 (CA 2006) did not apply to them. The applicant company had purchased the claim under a deed of assignment executed by the liquidators of the company. The court, in dismissing the application for a declaration, held that the payments were not unlawful dividend payments—they did not amount to a transaction at an undervalue and/or a preference—and that the respondent was not liable for misfeasance, under CA 2006, s 212.
Powerstation UK Ltd (the company) traded as a vehicle tuning centre, with two directors and shareholders. Its financial difficulties began with the recession in 2008 and eventually led to its insolvent liquidation in 2015. The defendant director paid himself through a combination of salary and dividends on the company’s accountant’s advice. He took £1,383 per month in addition to his nominal salary, signing dividend tax forms each month. At the end of the financial year, the company’s accountant would decide whether there had in fact been sufficient profits and, when there were not, the shortfall would be declared as PAYE earnings and additional payments made to HMRC. This was not done for the final year of the company’s trading, when it had no distributable reserves.
The issues for the court were:
The judge highlighted the obvious contradiction between the director signing dividend tax forms every month and later re-characterising payments as PAYE remuneration when the company failed to generate sufficient distributable reserves. The director was an engineer with no accounting or legal background, and the judge accepted that he did not see the contradiction—he simply did what his accountant told him to do.
The judge decided that, on the facts, the company did not in fact declare and pay a dividend every month, despite the director signing the form. Instead, the director took a decision in principle to declare and pay a dividend which would be reviewed at the end of the year. The judge went on to decide that this meant that the monthly payments in the final period of the company’s trading were never in fact declared as dividends, and so the director could not be liable to repay them under CA 2006, s 847.
The judge found that the company would have been unjustly enriched if the director was not remunerated at the agreed rate of £1,383 above the nominal salary declared to HMRC through PAYE. Where services are supplied on the basis that they will be paid for—and there is no other claim—the law imposes an obligation to pay a reasonable sum. The judge explained that the director was simply causing the company to discharge a liability it had incurred, so there was no breach of duty. Similarly, there was no transaction at undervalue because the company received the benefit of the director’s work in return for the payments.
The facts of the case were unusual in that the director signed dividend tax forms every month. It is more common to see drawings treated as loans to the director which are discharged by the declaration of a dividend at the end of the financial year. The decision on the status of the dividends is probably limited to the relatively uncommon facts of the case.
If the decision on directors’ duties and transactions at undervalue is correct, it is potentially very far-reaching. It means that a director can play ‘heads I win, tails you lose’ with HMRC and their own company about how they are paid. If the company manages to make enough profit to allow dividends to be paid, the director will pay less tax than they would have had they been paid through PAYE. If the company doesn’t make enough profit, the director can say that they only agreed to work for the company on condition that they would be paid in excess of the amount declared to HMRC and so they can keep whatever they have taken.
The case is out of step with cases like GHLM Trading Ltd v Maroo  EWHC 61 (Ch),  All ER (D) 172 (Jan) and Re Mumtaz Properties Ltd, Wetton v Ahmed  EWCA Civ 610,  All ER (D) 237 (May) which emphasise that directors are the people in control of a company and cannot avoid liability or be held to a lower standard simply because they choose to run the company in an informal manner or without proper documentation.
The short answer here is that the defendant director must have known that he had a choice between paying himself a salary through the PAYE system and paying the high rates of tax which other employees have to pay, and choosing to pay himself through dividends and taking the risk that the money will not be there at the end of the year and that the payments will have to be returned if they cannot be re-characterised.
At the time of writing, it is not clear whether the case will be appealed. It certainly should be. If a director chooses to take the risk of paying themselves by dividends rather than salary, they should be held to that choice if the company later goes into liquidation.
As noted earlier, the facts of the case are unusual in that the director signed dividend tax forms every month and does not appear to have accounted for the payments to him as a loan to be converted to a dividend later, so the case is arguably of limited application in the future. However, if it is followed in cases involving more normal accounting methods, it will create real obstacles to liquidators seeking to recover monies from directors.
Interviewed by Stephanie Boyer.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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Dividends and distributions
Recovery of unlawful dividends by an insolvency office-holder
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