Things to consider when taking Directors Dividends
It is common practice for Directors of owner managed business to take a basic salary per month and then draw dividends from the company as long as the company has sufficient reserves.
This approach has very little risk associated as long as the reserves are not adversely affected by the dividend withdrawn.
One case that has recently come to light shows how not to manage your director dividends and the implications this can have.
In the case of Global Corporate v Hale, the Court of Appeal set a new precedent in the treatment of director salaries and what constitutes an illegal dividend.
Hale was the director of a limited company getting a basic salary every month as well as drawing a monthly dividend.
This practice was carried out for a number of years at the end of the financial year the company accountant would prepare the financial statements, reclassifying the additional payments as PAYE where reserves were insufficient to support the dividend payments.
The Company subsequently entered liquidation and the reclassified PAYE payments made to Hale were challenged on the basis that they were in fact dividends.
The Court of Appeal held that these payments:
- could only be classified as dividends since that is what the company had treated them as.
- The Judgement specifically highlighting the fact that where directors take funds on one basis for a particular reason that benefitted them at the time, it is not open to them to seek to subsequently reclassify the payment in a more favourable way.
- Once reclassified as dividends, the payments became illegal as there were insufficient reserves within the Company at the time that the payments were made.
- As such, all illegal payments made to Hale were repayable to the Company. Hale attempted to run a quantum meriut defence (an argument for payment of the reasonable value of services performed) to mitigate the award against him, but the appeal judges rejected the claim. The judgement emphasised the fact that even if a valid quantum meriut claim exists, it cannot be made against illegal dividends on the basis that those distributions were not lawful.
It is at no point disputed that a director is entitled to be remunerated for the work they are carrying out for the company, but as a director they must receive proper authorisation for this.
What does this mean for creditors
Should a company that owes you money go into liquidation there is now a precedent where you can ensure the correct route for Dividends has been followed. If this is found to not be the case the director has to repay the illegal dividend, there will be more money to pay out to the creditors and therefore creditors should ask questions regarding the possibility of illegal dividends when a customer of theirs goes through the insolvency route
If you would like any information or advice on reclaiming money owed to you through an external resource please get in touch.
