If you are a director of a limited company and receive tax-efficient dividends in lieu of wages, you really need to be aware of a legal case, recently heard in the Court of Appeal. The story concerns BAT Industries (BTI) and Sequana SA (SSA), dividends and insolvency.
The outcome underlines the care with which company directors must act, particularly as a director can become personally liable for any dividend payments subsequently found to be unlawful, if there were insufficient funds available to cover them at the time they were made.
A recent ruling from the Court of Appeal upheld an earlier High Court decision in the case of BTI 2014 LLC v Sequana SA & Others  that dividends can be challenged as transactions defrauding creditors under insolvency legislation.
The details that matter
Sequana had appealed against a number of points including that dividends it had received from one of its wholly owned subsidiaries, Windward Prospects, constituted a transaction defrauding creditors under section 423 of the Insolvency Act.
The case was complex and covered matters that took place over a number of years, but to ensure you as a company director understand the implications of the ruling, we’ll try and simplify matters.
Essentially, Windward provided an indemnity for certain potential liabilities relating to an environmental clean-up in Wisconsin USA that had passed to the claimant, who believed Windward was sufficiently capitalised and insured to cover the likely costs.
Over time Windward ceased to be a trading company and had simply become a vehicle for discharging these potential liabilities. There was also a debt due from Sequana to Windward which stood on Windward’s balance sheet.
Windward reduced its capital using the Solvency Statement method, under section 642 Companies Act 2006, where the directors state that having considered the company’s liabilities (including any contingent and prospective liabilities) they believed the company could afford its current debts and those likely for the next 12 months.
Windward then declared two dividends to Sequana totalling €578million – €443m in 2008 and €135m in 2009.
Whilst removing a parent company’s debt obligation to a non-trading subsidiary through capital reduction, followed by a dividend is not unusual, this case was complicated by Windward’s exposure under its indemnities was complex and extremely difficult to ascertain.
The High Court decided to dismiss all the claims made by BTI based on the Companies Act 2006 with respect to both dividends, but accepted its claims based on section 423 of the Insolvency Act 1986 with respect to the second dividend only.
It appears the decision to sell the business, which was taken between the time of the two dividend payments, affected the Court’s reading of the situation, believing the second dividend was paid to put assets beyond the reach of the creditors.
It was held that a dividend could be characterised as a ‘transaction for no consideration’ or at an undervalue for the purposes of section 423.
It is now clear that a dividend can be considered a ‘transaction’ used to put assets beyond the reach of actual or potential creditors and would therefore be no different to any transaction which is entered into with that purpose in mind.
The Court decision also confirmed there was no requirement under section 423 to show that there had been any dishonesty or ill will towards Windward’s creditors by any of its directors.
After the dividend was declared it was set off against Seuqana’s debt which clearly prejudiced the position of Windward’s creditors because its assets were depleted as a result.
Ultimately this means that directors need to proceed with caution with dividends where there are any concerns over contingent liabilities. It would be prudent to consider seeking insolvency advice when considering the payment of dividends or indeed any other ‘transactions’ in such circumstances.
However, Sequana said it is currently reviewing the terms of the decision and is likely to seek permission to appeal at the Supreme Court, so there may well be more to come – watch this space!
If the intricacies of legal arguments are too much to bear, here is a very simple view of the facts and what they mean.
A limited company paid two dividends to a parent company. The first was deemed to be legal, the latter was not. It was deemed the second payment of €135m, which was made after a decision to sell the business, was made to keep the money away from potential creditors.
The Court’s ruling highlights the care and vigilance with which directors like you need to act when paying dividends, especially as you could be become personally liable for any payment found to be unlawful.
Remember, Section 423 of the Insolvency Act is very wide and anyone can challenge a transaction by a company if they believe they are negatively impacted by it. It’s not limited to creditors and they don’t need to wait until your business becomes formally insolvent.
Among a raft of considerations, you need to ask yourself:
If you would like to discuss this or any other matter of a corporate or commercial nature please contact Neil Jones on 01543 431184 or email firstname.lastname@example.org