The Court of Appeal has considered whether interim dividends paid to a shareholder at a time when the company did not have sufficient distributable reserves, making the payments unlawful, could later be reclassified as salary payments.
Mr Hale was a director and shareholder of a company. His remuneration consisted of a small salary and additional periodic payments which were documented as interim dividends. At the end of each financial year, the company's accountant would review the books and if it appeared that there were insufficient distributable reserves to justify the dividends taken, those dividends would be reversed, re-classified as salary and the necessary tax paid.
The company later went into creditors' voluntary liquidation. The liquidators took the view that the payments documented as interim dividends had been unlawfully paid because the company had not had sufficient distributable reserves at the relevant times. It is a requirement of the Companies Act 2006 that a company can only make a distribution out of profits available for the purpose as determined by reference to the company's relevant accounts (sections 830 and 836). If a dividend is paid in contravention of these rules, a member who knows or has reasonable grounds for believing that to be the case is liable to repay the dividend (section 847). The liquidators demanded repayment of the dividends, and court proceedings were subsequently issued.
At first instance the judge had held that the payments documented as interim dividends were not repayable as unlawful dividends. This was because, notwithstanding the documentation, he considered that there had been no valid decision to pay the monies as dividends at the time they were paid - only a decision in principle which was subject to confirmation by the company's accountant at the financial year end.
The Court of Appeal rejected this approach, holding that the judge at first instance had been wrong to concentrate on the state of mind of the directors when authorising the disputed payments as dividends. The evidence showed that the payments were expressly declared by the directors as interim dividends and the state of mind of the directors in doing so was not relevant. Section 830 required the legality of the payments to be tested at the time the payments were made and it was immaterial that a subsequent realisation that the distributions should not have been made would prompt their being treated as remuneration instead.
The Court of Appeal decision is unsurprising, but provides welcome clarification that the lawfulness of a dividend or other distribution for the purposes of section 830 is assessed at the time it is made. Re-characterising it, after the event, as another form of payment is not possible.
As applied in this case, it is a common remuneration structure for director shareholders to receive a minimal salary and the balance by way of dividend. The case highlights that it is important for directors declaring a dividend, whether for this purpose or in other circumstances, to understand the requirement for the company to have distributable profits when they do so.