Dividend payment legality not based on later 'state of mind', says Court of Appeal

Out-Law Legal Update | 17 Dec 2018 | 11:10 am | 3 min. read

LEGAL UPDATE: When considering if dividend payments by companies now in liquidation were lawful,  the Court of Appeal has ruled   that the legality depends on the payments themselves and not the state of mind of the payers at a later date.

Before it entered insolvency Powerstation UK would pay director and shareholder Dirk Hale £1,383 a month in addition to his nominal salary. On the advice of his accountant Hale signed dividend tax forms each month relating to the payments. At the end of each financial year, other than the final year of trading, Powerstation's accountant considered the finances of the business and would decide whether or not the extra money could be categorised as dividends or whether it would be declared as PAYE earnings with additional payments made to HMRC.

Global Corporate Limited took an assignment of the action against Hale, and claimed that these final payments were unlawful as they were in breach of section 830 of the Companies Act 2006, (CA 06) which says that  distributions should only be made out of profits available for that purpose.

The High Court rejected the claim on two alternative grounds:

  • that the disputed payment of dividend was nothing more than a decision in principle. It wasn't until the end of the year that the final decision was made and that decision was subject to confirmation from the accountant; and
  • that there had been no valid decision to pay the monies as dividends and therefore s.830 and s.847 of CA 06 could not apply.

The High Court Judge said that in any event the payments made to Hale could be considered remuneration which he was entitled to for the services provided using the 'quantum meruit' argument that Hale could not be expected to work for free, so an implied contract of services would be enforced.

Global won its appeal against the High Court judge's dismissal of the claim to recover the £23,511 as unlawful dividends.

One of the issues at the first hearing was that Hale was not legally represented. At cross examination the judge, as he is entitled to do, asked Hale a number of questions to get further clarity on the payments and what Hale actually thought. The appeal judges ruled that the High Court judge's line of questions was inappropriate. The High Court judge found that there had been no definitive decision made about declaring a dividend, but this had not formed part of Hale's case, which had in fact said the opposite. The appeal court judges said that this finding had been based upon the judge's own line of questioning and there was no evidential basis for it.

The Court of Appeal said that section 830 of CA 06 should apply, disagreeing with the High Court ruling. They said that at the point of the payments the money counted as "gratuitous distributions" from Powerstation's assets and that section 830 is specifically targeted at distributions and their examination, as and when they are made. The appeal judges said that a subsequent realisation that a distribution should not have been made will not allow the payment to be treated as remuneration.

This subsequent action could not cure the illegality of the original payment, they said: it was the payment itself that had to be looked at, and not the state of mind of the director when authorising the payment. If the focus had been on the actual payments themselves and whether or not they were lawful distributions of Powerstation's assets at the time they were made, there would have been only one answer, they said.

The appeal judges also turned their attention to the potential 'quantum meruit' defence. A 1990 case between Guinness and Saunders ruled that 'quantum meruit' could not imply a contract for remuneration when that kind of contract could only be agreed in accordance with a company's articles of association. But in this case a more fundamental difficulty arose.

The appeal judges said that once Powerstation was in liquidation any claim for 'quantum meruit' would be an unliquidated claim for compensation that Hale would have to claim for in the liquidation. Unless the payments themselves could have been re-characterised and treated as payment of services prior to the liquidation then it was difficult to see how a claim for 'quantum meruit' could apply. This was accepted by Hale's representative at the appeal and was not further pursued.

Daniella Thompson is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com