Mark Harper QC and Louis Doyle QC look at the litigation risks inherent in a company’s board acting on a dividend policy which fails to take account of the changing pandemic landscape
Owner/directors paid by dividends are not helped by the Self-Employment Income Protection Measures. (Individuals working through their own personal service companies (PSC) – a company owned and controlled by them – will not qualify in the vast majority of cases for assistance under the Government’s Statutory Self-Employed Scheme. On the other hand, there is a respectable argument (at least) that an employed director (that is, one whose remuneration is subject to PAYE etc, as opposed to remuneration being drawn by a self-employed director) may be capable of being furloughed under the newly-announced Coronavirus Job retention Scheme, subject to the mandatory proviso that the furloughed employed director does no work for the furloughing company subject to compliance with statutory duties (on the basis that such compliance arises under statute and is not rooted in any employment contract)).
The income and future profitability of some companies will be impacted by the measures imposed because of the pandemic.
The state of the law, as identified by Zacaroli J in Burnden Holdings (UK) Ltd (in liquidation) v Fielding  EWHC 1566 (Ch is prescient. That case involved a claim against two directors by the company and its liquidator in relation to a grant of security to the directors for a loan made by them and a distribution in specie of the company’s shareholding in a subsidiary. The distribution was attacked as unlawful and in breach of fiduciary duty because it contravened the requirements of s.263 of the Companies Act 2006 (distributions only from distributable profits) and s.270 (distributions justifiable by reference to accounts). It was also attacked as a breach of fiduciary duty under s.172(3) because the directors knew that the company was, or was likely to become, insolvent, and failed to consider creditor interests. In dismissing the claim, Zacaroli J held that liability for the unlawful dividend was fault-based, not strict. If the directors were unaware of the facts rendering the dividend unlawful, they could not be personally liable if they had taken reasonable care to secure the preparation of the accounts which showed that a lawful dividend could be paid, even if it emerged ultimately that there were insufficient profits to do so. The warning, however, is what directors, in present circumstances, must be taken as knowing in taking reasonable care in the preparation of accounts. Specifically, how might a short-term dividend policy be balanced against a company’s longer-term cash needs, especially where institutional lending policy is likely to be increasingly conservative as pandemic conditions persist?
Questions for directors to pose in relation to dividend policy:
Is your dividend policy still fit for purpose?
For the purpose of any proposed dividend, how are you assessing the solvency of the company, including taking account of contingent and prospective liabilities?
Even in a clearly solvent company, to what extent would the hypothetical s.172 director retain profits for the future?
How do you protect yourself from any suggestion that decisions to pay dividends were not influenced by the need of the director/shareholder for income, as opposed to the needs of the company, especially where the facts point to such a conclusion?
Should directors consider paying owner/directors on PAYE?
Insolvency Practitioners will scrutinise any withdrawals of profits or funds from limited companies during this time and therefore all withdrawals of the same need to be informed by advice (although the mere fact of obtaining advice is not a complete protection; a court will look at the source of the advice, the instructions given, the expertise of the adviser, the substance of the advice and the extent to which the advice was actually relied upon). Claims by liquidators and administrators for breach of fiduciary duty, breach of trust etc are capable of being conducted under the summary procedure under s.212 of the Insolvency Act 1986 and are easily coupled with non-Insolvency Act claims, most obviously breaches of the Companies Act 2006; neither are such office-holders susceptible to applications for security for costs.
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