06 Dec 2018

Global Corporate Limited v Dirk Stefan Hale [2018] EWCA Civ 2618 

Dividends that constitute unlawful distributions are illegal at the point they are made and cannot be cured by subsequently treating them as remuneration. 

The Court of Appeal has handed down a welcome judgment for litigator insolvency practitioners in the case of Global v Hale. Whilst the decision at first instance may have been limited to its facts, it raised concerns about directors being able to effectively recreate history in respect of payments they receive from companies, clouding what should be straightforward claims to recover them.

What were the facts?

The case was a typical small enterprise scenario involving a director/shareholder of a company.

On the advice of accountants, regular monthly payments made to a director had been treated as remuneration up to the personal allowance limit and 'dividends' thereafter. The dividends in dispute were relatively modest (£23,511) and were paid over 16 months. 

The company subsequently went into liquidation and the liquidator sought repayment on the basis that the dividends were unlawful distributions under the Companies Act 2006, a claim that was ultimately brought (among others) against the director by Global, having taken an assignment from the liquidator. 

The 'dividends' were demonstrably treated as dividends: they were recorded as such in the company's books and records and 'dividend tax vouchers' were prepared by the accountants, signed by the director and filed with HMRC. The quirk was as follows:

  • At the end of each year the company's accountants would review the payments made to the director. 
  • If there were not sufficient distributable reserves to justify them as dividends, they would be 'reversed', treated as remuneration and the necessary tax paid, an exercise the accountants described as 'restructured management adjustments'.
  • This is what had occurred for the two prior financial years.
  • The company had gone into liquidation before this exercise had been carried out in respect of the dividends in dispute.

What was decided at first instance?

Whilst it was accepted that the dividends would have been unlawful distributions for lack of distributable profits, the Judge rejected the claim. He considered the decision to make the payments as dividends to be 'provisional' and a decision 'in principle' that was conditional on the accountant's review. If the payments were not dividends, the relevant provisions of the Companies Act 2006 could not apply and they did not have to be repaid as unlawful distributions. 

The Court also rejected Global's claim for breach of duty under section 212 of the Insolvency Act, applying the quantum meruit rule on the basis of the work done by the director and to prevent the company from being unjustly enriched were he not paid for his services.

Global appealed the decision.

What did the Court of Appeal decide?

The appeal was allowed for two reasons:

1. evidentially, the payments when made were expressly declared as dividends. It could not be said they were not declared definitely or at all; and

2. the payments were distributions within the meaning of the Companies Act 2006 when they were made, and that is the time when their legality must be tested. The distributions were unlawful. It was irrelevant that they were subsequently treated as remuneration, which could not cure the illegality of the original payments.

In respect of the quantum meruit rule, it followed that this did not apply. The Court of Appeal referred to the House of Lords' decision in Guinness Plc v Saunders (a decision that the Judge was not directed to at first instance): in short, a contract of remuneration will not be implied where the company's own internal rules have not been followed. The Court of Appeal also highlighted the further difficulty that the director could not set the quantum meruit claim off against the dividends, as they were unlawful. 

It should also be noted that the director was a litigant in person and the Court of Appeal found that the Judge's ultimate finding that the dividends had not been declared definitively or at all was based on a line of cross-examination introduced by the Judge himself (as opposed to the director's own evidence), which the Court of Appeal considered was 'inappropriate'.

What did the Court of Appeal make of the 'restructured management adjustments'?

One of the many talking points from the original decision was that the payments had effectively been allowed as remuneration but the requisite tax had not been paid (as it had in previous years).

Some of the commentary following the decision of the Court of Appeal has remarked that it was the subsequent treatment of the dividends as remuneration that was unlawful; however, it was the dividends that were illegal and their subsequent treatment was found to be 'immaterial'. 

The Court of Appeal did not comment directly on the legality of the 'restructured management adjustments' but did say that, at most, treating the dividends as remuneration would allow the payments to be notionally repaid to the company and then re-applied in a way that does not offend the Companies Act 2006.

Key takeaways

Directors who receive dividends that are subsequently challenged by an office-holder often seek to obscure the treatment of the payments and argue that they were remuneration (or something other than dividends) or that the monies were no more than what they were entitled to. The Court of Appeal's decision confirms that arguments such as these should not be considered of substance. 

The case also highlights the fine line a Court must tread when one party is a litigant in person and how the latitude afforded to the litigant in person can go too far.