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Directors: dividends & avoidance transactions

A recent High Court decision further pressurises company directors, when paying dividends, to comply with their fiduciary duties and directors’ responsibilities.

The High Court said a dividend paid during a period of poor financial performance was “a transaction at an undervalue”. Thus a liquidator, if appointed in the future, can claw back dividends paid during this period.

This means:

  1. Company directors must prepare a full and accurate solvency statement on the date of the proposed dividend.
  2. Directors must consider their fiduciary duties and directors’ responsibilities during the company’s lifespan.
  3. If a company pays a dividend when it cannot currently, or in the near future, pay its debts,  then when the company becomes insolvent:
    • Liquidators can void and claw back the dividend.

Directors’ duties: the facts of the case

A Ltd was a wholly owned subsidiary of B Ltd. A Ltd dealt in property acquisitions and disposals during periods of market volatility.  A Ltd’s directors owned and controlled B Ltd.

A Ltd sold a high value parcel of land to an investor’s consortium. The land was contaminated.  A 2014 court decision found A Ltd responsible for the contamination. The court ordered A Ltd to indemnify the consortium for the contamination clean-up costs.

A Ltd delayed payment. During this period, A’s directors resolved to pay a dividend to B Ltd. A’s directors signed a solvency statement based on A Ltd’s 2013 accounts. The consortium applied to court for a declaration that:

Claim 1

The dividend contravened the law, because A Ltd lacked sufficient profits to pay a dividend. A Ltd had an outstanding liability to indemnify the consortium.

Claim 2

A Ltd was not profitable. The solvency statement was not made in accordance with the Companies Act 2006 provisions.  The solvency statement referred to the 2013 accounts, but was made after the 2014 court order imposed additional liabilities on A Ltd.

Claim 3

Since the consortium was now A Ltd’s future creditor, the dividend was an avoidance transaction. The transaction was at an undervalue to avoid A Ltd’s obligations to pay its creditors.

The law on directors’ fiduciary duties and dividends

A dividend is a company distribution. Company directors, when proposing a distribution, must:

  1. Ensure the company has profits available to effect the distribution, and
  2. Base their decision on the company’s relevant accounts, i.e. recent financial year end accounts.

Directors often confuse the word “profit” with “distributable reserves”.  The definition of distributable reserves, with reference to a company, is:

“its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off”.

The High Court’s decision

The High Court dismissed Claim 1 and Claim 2. The High Court stated:

  1. The decision to pay a dividend could be based on previous financial year-end accounts, i.e.
    •   A Ltd’s 2013 accounts. There was nothing in law to state otherwise.
  2. The 2013 accounts supported the solvency statement, thus:
    • The directors formed the basis that A Ltd could pay its debts as they fell due.
  3. A Ltd had “distributable reserves” at the time of the 2013 accounts, and:
    • The statutory definition contains no reference to “future liabilities or commitments”.

Claim 3

The High Court then considered A Ltd’s trading. The High Court said its business was niche and its liabilities inconsistent. Therefore, when the directors proposed the dividend distribution, they:

  • Must have considered the company’s liability to pay the consortium.

The High Court accepted Claim 3.  The dividend was a transaction at an undervalue. Therefore, if A Ltd enters liquidation, the liquidator can claw back A Ltd’s dividend to its shareholders.

Where now for the consortium

The consortium can now serve a statutory demand on A Ltd. Then, if A Ltd does not pay the sum within the set time:

  1. A Ltd’s non-payment, given the statutory demand,  is prima facie evidence that it cannot pay its debts; so
  2. The consortium can apply to wind up A Ltd.
  3. If A Ltd is liquidated, the liquidator will claw back the dividend.

Impact on directors’ duties

This case shows the courts’ hardened approach to determining directors’ duties. A plethora of litigation will arise out of this decision. Company directors are now accountable for dividends paid during periods of poor financial performance.

Now, dividend payments are potentially classed as “transactions at an undervalue”.  So, company liquidators can reconsider recently paid dividends.  Company directors risk a liquidator demanding company shareholders:

  • Return the dividend sums to the company; or
  • Sell any property acquired using the dividend, and
    • Return the sums to the company.

In this event, a company’s shareholders will no doubt seek a court imposed indemnity from the directors for the directors’ breach of their duties.

Solvency statement

Note, the solvency statement does not only apply to dividend payments. To afford full protection, a company’s directors should sign a solvency statement prior to any high value transaction or company restructuring.

When making a solvency statement, the directors must have actually formed the opinions set out in the statement. This opinion should confirm, as regards the company’s financial situation, that the directors see no reason why the company should not be able to satisfy its debts in the immediate future. The directors of A Ltd passed this test.

Gannons’ advice

This case shows that directors should constantly consider their duties, i.e. to:

  1. Promote the best interests of the company for its members as a whole;
  2. Consider the company’s impact on the environment;
  3. Exercise independent judgement; and
  4. Not accept benefits from third parties.

The judiciary is responding to calls for reform. The case shows the judiciary now provides deterrents to breaches of directors’ duties.

 

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