In Brief: Director/Shareholder remuneration A closer look at what can be clawed back on insolvency

Introduction

Current practice in relation to sole director/shareholder companies is that it is tax is efficient to take funds out of a company by way of dividends, with perhaps a low salary equal to the tax free limit. Over time directors can often come to see the combined sums reaching their account simply as their “remuneration”. However, there are key differences between a salary and a dividend aside from their tax treatment which mean that a well advised director may wish to periodically review how funds are taken from a company. This article considers the position of dividends upon an insolvency of a company, particularly in light of the effect of the coronavirus.

The coronavirus crisis has resulted some companies taking on a lot more credit than in normal times would be seen as healthy for a business. That credit may take the form of voluntary credit in the form of bounce back loans, CBILS or CLBILS, or involuntary credit such as accruing rent arrears. Either way, when combined with lower footfall and the threat of lockdowns during the Christmas period, the fact is that some companies’ balance sheets will never have been under so much pressure. On the other hand, government backed loan schemes, restrictions on rent enforcement and restrictions on winding up petitions have meant that companies are not presently facing the usual cash-flow and creditor pressure which may, in normal times, push them into an insolvency process. The ONS concluded that last month 63% of businesses across all sectors were faced an insolvency risk.

The position of dividends

Whether under the articles of association, Companies Act 2006 or the common law, dividends can only be declared and paid out of a company’s distributable profits. If a dividend is paid otherwise than out of distributable profits then it is liable to challenge as an unlawful dividend which, upon application to the Court, can be ordered to be returned to the company. Following a company’s insolvency an insolvency practitioner will often look at dividends taken from a company to assess whether they were taken at a time when there were distributable reserves. If not, it is the duty of the insolvency practitioner to attempt to obtain a return of funds.

The recent case of BTI 2014 LLC v Sequana SA & others [2019] EWCA Civ 112 established the principle that the payment of dividends can be transactions at undervalue for the purpose of s238 Insolvency Act 1986 (and also s424 transactions defrauding creditors). This adds an extra head of claim which an insolvency practitioner may bring to obtain recovery of dividends taken at a time when a company is insolvent. The look back period in relation to a s238 transaction at undervalue claim is two years from the date of the formal insolvency. Often, in relation to a claim for dividends under s238 it will not be possible to look back that far due to the requirement under s238 that the transaction take place at a time when the company is insolvent, meaning that dividends taken in good faith at a time when the company was solvent are likely to remain unchallenged. However, due to the current circumstances of higher debt, lower income and less creditor pressure, it is possible that the time in which companies are trading during the twilight period of insolvency is longer than normal. This means that the period that insolvency practitioners may look to recover dividends which are drawn as “remuneration” is also likely to be longer. It should also be noted that in the case that the director is also the shareholder, there is a statutory presumption of insolvency which is applicable to a s238 claim meaning that the director/shareholder will have the burden of proof in relation to proving the company was not insolvent at the time of the dividend(s).

Points to consider

Most directors are acting upon the advice of the company’s accountants in taking their “remuneration” in the most tax efficient way. They are acting honestly and taking a sum which is commensurate with the value they provide to the company. It will come as a surprise to some directors that most of the remuneration they have taken over the period of, say, 12 months may actually be repayable to the company upon its insolvency as unlawful dividends and/or as transactions at undervalue, with such funds being paid to meet creditor claims on an insolvency. It would be advisable for a director to now consider how their “remuneration” is taken in light of the changed trading conditions, and if necessary consider re-weighting that “remuneration” towards salary rather than dividends.

The Financial Reporting Council has provided guidance in relation to declaring dividends during the coronavirus pandemic, which would be well worth a review by directors who are yet to review their dividend policy in this period. Amongst other things, the guidance recommends paying close attention to capital reserves at all times, including when the dividend is actually paid, as well as when it is initially proposed.

Finally, it should be noted that the presumptions in a director’s favour against a wrongful trading claim implemented by the Corporate Governance and Insolvency Act 2020 have not been renewed, meaning that directors now face the same wrongful trading risk as they did prior to the Coronavirus but with possible increases in the risk factors such as higher debt, lower income and an uncertain Christmas trading period.

Contact / Queries

If you would like further information in relation to D&O policies and how they work, or would like to discuss any concerns surrounding transactions which may give rise to a claim against you, please contact James Williams using the details below:

James Williams
Partner
Restructuring & Insolvency

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