Directors cannot avoid unlawful distribution claims by asserting that dividends should be retroactively re-categorised as remuneration for services they have provided to the company, the Court of Appeal has confirmed in Global Corporate v Hale  EWCA Civ 2618
The court confirmed that the legality of a payment to directors must be tested at the time when it is made. Any "subsequent realisation that the distributions should not have been made" will not cure an unlawful distribution.
This will be welcome news for insolvency practitioners (IPs) currently investigating and pursuing claims against directors. It sets aside an unhelpful first instance decision and confirms that a distribution described as a dividend but not paid out of distributable reserves will be unlawful.
Powerstation UK Limited (the company) had two directors, who were also its sole shareholders and only full time employees. When the company began to experience financial difficulties, the directors restructured their remuneration. They reduced their monthly salaries to £456 each, and received an additional £1,383 each per month by way of dividend. At the end of the financial year the company's accountant would check whether or not there were sufficient distributable reserves out of which a dividend could be declared. If there were not, the £1,383 payment would be re-characterised for accounting purposes and attract a PAYE charge. The directors completed dividend tax forms throughout the year.
The company went into liquidation, and the liquidators assigned the claim against one of the directors to a third party. The third party brought a claim to recover the sums paid to the director during the period when the company had no distributable reserves.
HHJ Matthews held that:
The first instance decision in Global Corporate v Hale was questioned in two subsequent High Court judgments. Both declined to apply the unjust enrichment approach. They noted that HHJ Matthews had not had the opportunity to consider the decision of the House of Lords in Guinness plc v Saunders  2 A C 663 because this case had not been cited in argument before him.
In 1990 the House of Lords heard an appeal of a former director of Guinness plc against a judgment for £5.2 million. The director had been paid that sum by a committee of the board for services he had provided. The director claimed that the committee had the power to make the payment under the company's articles of association or, in the alternative, that he was entitled to a reasonable sum for his services in order to prevent the company's unjust enrichment at his expense.
The court held that the equitable principle that a director cannot make an unauthorised profit from his position trumped the unjust enrichment argument. As neither the contract for services nor the payment to the director had been entered into in accordance with the company's articles of association, the director was not entitled to the sums he had been paid.
The applicant appealed the Judge's dismissal of the claim to recover the sums paid to the directors as unlawful dividends. There was no appeal against the dismissal of the measfeasance, transaction at undervalue and preference claims.
Lord Justice Patten delivered the leading judgment. He held that:
Patten LJ referred briefly to the decision in Guinness plc v Saunders, and noted a further difficulty with any attempt by a director to rely on a unjust enrichment claim as a defence and set off against a misfeasance claim. Once a company is in liquidation, any such claim would be an unliquidated claim for compensation which would need to be proved in the liquidation.
Lady Justice Asplin and Lord Justice Coulson agreed with Patten LJ's conclusions and reiterated his criticism of the Judge's approach to cross-examination at first instance.
IPs will welcome the Court of Appeal's decision. The judgment confirms that a dividend not paid out of distributable reserves is unlawful. The legality of any such payment should be tested as at the date it was made.
Equitable principles prohibit directors (as trustees) from making an unauthorised profit. These principles take priority over any entitlement a director may have to receive payment for services provided to the company. Directors don't have a free pass to re-categorise dividend payments as remuneration after the event simply in order to avoid an unlawful distribution claim by the company, even when following advice from external advisers. There will be a collective sigh of relief from insolvency professionals that this controversial High Court decision has been set aside.
Contributor: Tessa Durham
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