If it looks like a dividend and sounds like a dividend, it's a dividend

The Court of Appeal has issued a welcome clarification of rules regulating the payment of dividends to shareholders in Global Corporate Ltd v Hale [2018] EWCA Civ 2618.

Facts

The case was appealed from the ruling of Judge Matthews in the High Court [2017] EWHC 2277 (Ch). At issue were several payments made by Powerstation UK Limited (the “Company”) to Mr Hale, who was a director and shareholder of the Company at the relevant times.

Payments described as ‘dividends’ which totalled £23,511 were paid by the Company to Mr Hale between 24 June 2014 and 26 October 2015. The Company fell into liquidation on 25 November 2015 with a deficiency of £173,594.99. The liquidators considered the payments to be unlawful dividends as the Company’s accounts showed there were insufficient reserves from which to pay dividends pursuant to s830 Companies Act 2006 (“CA06”). A request was made to Mr Hale for repayment of the monies. When this was not forthcoming, the liquidators assigned their rights to the claim to the Appellant, Global Corporate Limited (“GCL”).

GCL brought claims for repayment of the £23,511, arguing that they were unlawful dividends, or in the alternative, transactions at undervalue or a preference payment. At trial, Mr Hale accepted that the Company had been balance sheet insolvent, but argued the dividends were lawful partly on the basis of an accounting practice used by the Company in the past whereby dividends were paid instead of salary for tax reasons. If at the end of the year it transpired that there were not enough reserves for dividends, the dividends would be reversed, reclassified and paid as salary, and additional tax forwarded to HMRC.

High Court ruling

Judge Matthews found that the payments were not unlawful, primarily on the basis that the accounting practice described by Mr Hale meant that the payments were not finalised at the time they were made. Instead, Judge Matthews considered that no decision was made to pay dividends (notwithstanding the transfer of money) until the end of the year when the accountant decided whether the payments needed to be classified as dividends or salary. Following this reasoning, the payments were not dividends, and s830 CA06 did not apply.

Additionally, a claim for misfeasance was dismissed on the ground that even if Mr Hale had an obligation to repay the money, he had an equal claim as quantum meruit for the services provided to the Company by him.

Concerns

The High Court ruling had appeared to open the door to director-owners to pay interim dividends to themselves regardless of the financial health of their business and simply have them reclassified at a later date if the dividends were subsequently considered to be unlawful according to s830 CA06.

The case was also inconsistent with Guinness PLC v Saunders [1990] 2 AC 663 in which the House of Lords held that quantum meruit claims stand as unliquidated claims for which a director would need to prove in the liquidation.

Court of Appeal

The Court of Appeal overturned the High Court’s ruling, noting that the trial judge had wrongly focused on Mr Hale’s intention when authorising monthly payments to himself as dividends rather than asking whether the payments were lawful distributions of the company's assets under s.830 CA06.

Mr Hale had not denied that the payments made by the Company were not dividends, but it was suggested by the judge that the interim dividends were not definitive since they were reviewed and (if required) reversed by the accountant at the end of the tax year. 

The Court of Appeal noted that the payments were declared as interim dividends by the directors, declared to HMRC as dividends, and taxed accordingly as dividends. The fact that the accountants could later change the characterisation did not stop them being dividends at the time of payment. As the distributions were dividend payments under s830 CA06 and given that the Company was balance sheet insolvent according to its last accounts at 30 April 2014, and there were no reserves from which to pay dividends, the dividend payments to Mr Hale were considered unlawful.

Guinness was also reaffirmed, with the Court restating that quantum meruit cannot act as a set off or defence against a claim by a company against its directors since a contract for remuneration would need to be agreed in accordance with the Company’s articles of association, and more importantly, after liquidation, a quantum meruit claim (even if valid) is an unsecured claim requiring proof in the liquidation.

Conclusion

The Court of Appeal’s clarifications clear the waters muddied by the High Court, reaffirming that:

1. Companies must have sufficient reserves to pay dividends at the time they pay them, whether or not they intend to rectify any deficiency at the end of a tax year;
2. Quantum meruit will not act as a defence or set off to claims made by companies against their directors;
3. Trial judges, while under a duty to assist those appearing in person, must not go so far as to introduce new lines of inquiry or questioning for which there is no evidence or indication.