The impact of Coronavirus will inevitably lead to Liquidations, with some Directors being subject to Liquidators’ Claims (Misfeasance Claims) to personally repay dividends
The adverse impact of Coronavirus on the trading fortunes of a company now means that Directors, as business owners, need to tread carefully as they may be personally liable to repay Dividends when the company goes into liquidation. If, as seems likely, we see an increase in liquidations as Government support is slowly wound down, then it is also likely that there will be an increase in directors of these companies who will be subject to Liquidators’ Claims (Misfeasance Claims) to personally repay non-legitimate dividends. Such improper paying of dividends is one example of misfeasance.
In this article we look at when a dividend is not legitimate and whether directors should even consider paying dividends in this pandemic-affected business environment.
The law on Distributions
This law applies not only to Dividends, but to any form of distribution to Shareholders. Put simply, a distribution is any transaction that transfers value to a Shareholder, or any other related party, because they are a Shareholder. This includes gifts and other transactions at undervalue. This article focuses only on Dividends.
Typically sums taken out of the company by business owners (for example: school fees, non-business personal expenses, holidays, etc.) are charged to their personal Directors’ Loan Accounts (DLA) during the company’s financial year, creating an overdrawn position. The company then, to redress that overdrawn position, declares a Dividend to repay the sums due, before the company’s Accounts are ﬁnalised.
Why are Dividends different?
Dividends are different to other earnings because they represent a distribution of post-tax proﬁts to the company’s Shareholders, payable to all Shareholders in proportion to their shareholding.
The problem with Dividends
The key difference, compared to remuneration, is that Shareholders are legally required to repay unlawful Dividends received, if they knew or ought to have known of the facts that made them unlawful. Where Shareholders are also Directors, facts known to them in either capacity will be relevant in this context.
What are the profits available?
The first port of call is the last annual Accounts. The balance will often show ‘retained’ earnings or ‘accumulated proﬁt and loss’ reserves. It is very important to determine which amounts of those reserves qualiﬁes as available to pay Dividends.
By law, only those proﬁts that have been ‘realised’ are available for distribution as a Dividend. Proﬁts from normal trading activity are typically realised proﬁts, as opposed to unrealised proﬁts from, for example, a revaluation of the company’s property, which are not automatically available for distribution until the revaluation is realised.
Further issues may arise if the company is subject to an audit, and additional considerations apply where the auditor’s report is qualiﬁed. Under the Companies Act 2006, an auditor’s statement will be required, conﬁrming that the qualiﬁcation does not affect the proposed Dividend.
What if the financial position has deteriorated since the last Annual Accounts?
Directors must consider the company’s position carefully, as any deterioration since the date of the last Annual Accounts will reduce the reserves from which a Dividend may be paid. Many companies affected by the impact of the Coronavirus could well find themselves in this position. Any subsequent losses could eliminate the potential for legitimate Dividends to be paid. A careful eye needs to be kept on matters.
This is of particular concern where business owners have made regular withdrawals, and debited the amounts to their overdrawn DLAs, with the intention of remedying the overdrawn loan position through the declaration of a Dividend often at year end. If the company then fails, the Director/owner will ﬁnd themselves liable to a claim from a Liquidator (Misfeasance Claims), either to repay the overdrawn DLA as a debtor of the company, or for the receipt of an illegal Dividend – not helpful if the money has already been spent.
What if the financial position has improved since the last accounts?
In this case, new Accounts should be drawn up to determine the proﬁts available for distribution. Subject to the ongoing working capital needs of the business, Dividends can then be declared, and money withdrawn from the business.
Should the company pay dividends, even if it has profits available?
The Directors must always consider the potential impact paying Dividends might have on the company’s cashﬂow. Will the company remain solvent? This means considering the immediate cash ﬂow implications of a Dividend, and the continuing ability of the company to pay its debts as they fall due.
Dividend repayment claims – sometimes called Misfeasance claims – from Liquidators are becoming ever more common as the impact of Coronavirus and difficult trading conditions bite.
Such claims are not always however straightforward for the Liquidator to pursue. Here at NDP we have significant experience over many years, of dealing with such claims for Directors.
The potential consequences of misfeasance being proven, of which the improper paying of dividends is just one example, might not stop with a liquidation claim. Director disqualification is also possible.