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Company Law

Analysis - guidance - compliance

11 APR 2013

Recovering unlawful dividends – the knowledge threshold in section 847

Under section 847 of the Companies Act 2006, a distribution made by a company to a shareholder in contravention of the Act is recoverable if the shareholder "knows or has reasonable grounds for believing that it is so made".  As is well known, the Court of Appeal in It's a Wrap (UK) Ltd (In Liquidation) v Gula[1] held that the shareholder must be assumed to know the law, so that it is sufficient for the purposes of recovery under section 847 if he is aware that the company has no distributable profits, even if he is not aware that a distribution in such circumstances contravenes the Act.  It is perhaps less well known that Arden LJ and Chadwick LJ also took the opportunity to consider the meaning of "has reasonable grounds for believing", and offered (obiter) two different interpretations.  Re Snelling House Ltd (In Liquidation)[2], in 2012, was the first case to cite It's a Wrap in this context, and although the judge did not expressly choose between the interpretations, the language which he adopted suggests that he preferred Chadwick LJ's reading.

It's a Wrap

The question for the Court of Appeal in It's a Wrap was whether shareholders who had received dividends knowing that the company had no profits, but not realising that the dividends were therefore unlawful under the Companies Act 1985, were obliged to repay them in accordance with section 277 of the Companies Act 1985 (the predecessor of section 847).  The court's unanimous conclusion was that the shareholders were, indeed, obliged to repay the dividends.

Since the shareholders in this case had actual knowledge that the company had no profits, the meaning of the phrase "has reasonable grounds for believing" did not have to be decided.  However, Arden LJ and Chadwick LJ offered their opinion as to its meaning.

Both judges considered that section 277 had to be read, as far as possible, so as to accord with the meaning of article 16 of the EU's Second Company Law Directive[3], which it sought to implement.  Article 16 provides for a shareholder to repay an unlawful dividend if he "knew of the irregularity of the distribution ... or could not in view of the circumstances have been unaware of it".  As far as the second part of this test was concerned:

  • Arden LJ considered that it meant that a shareholder would be obliged to repay a dividend if he "ought reasonably to have been aware" of the relevant facts constituting the breach, whilst
  •  Chadwick LJ considered, provisionally, that it meant that a shareholder would be obliged to repay a dividend if he "must be taken to have" or "may reasonably be taken to have" knowledge of the relevant facts constituting the breach.

In other words, Arden LJ's interpretation sets a comparatively low threshold for the level of knowledge which is required (a shareholder would meet this threshold if he would have known that the company had no profits but for his negligence), whilst Chadwick LJ's interpretation sets a high threshold (a shareholder would meet this threshold only if he must be taken to know (or may reasonably be taken to know) that the company had no profits).

Re Snelling House

The High Court's decision in Re Snelling House was the first to cite It's a Wrap in connection with the payment of unlawful dividends.  (To date, the only other cases to refer to the decision appear to be Poole v HM Treasury[4], a case concerning an EU insurance directive in which the court noted the Court of Appeal's conclusions on deemed knowledge of the law, and, more recently, Vardy Properties v Commissioners for HMRC[5]. In which the Tax Chamber of the First-tier Tribunal referred to the decision in the course of concluding that a dividend was unlawful because no accounts had been prepared.)

The court in Re Snelling House was faced with a claim by liquidators for relief in respect of various payments made by the company, including sums paid out as dividends.  The relevant facts in relation to the claim concerning the dividends were as follows:

  • the company was a private company with a sole shareholder who was also its sole de jure director
  • the sole de jure director's husband was found by the court to be a de facto director
  • the company paid out £150,000 in dividends, despite the fact that it did not have sufficient distributable profits for such distributions
  • when the company went into liquidation, the joint liquidators sought to recover the dividends.

Having quoted section 277, Mr Gabriel Moss QC, who was sitting as a deputy High Court judge, set out his decision in the following terms:

"Since R1 as sole director must be taken to have known of the lack of distributable profits and since no attempt had been made to comply with statutory requirements, R1 was [sic] must be taken to have known of the contravention and the payments were also misfeasances:  Re Kingston Cotton Mill [1896] 1 Ch 331 at 347, in addition to being repayable under Section 277 of the Companies Act 1985: It's a Wrap Ltd v Gula [2006] 2 BCLC 634 (CA)."[6]

Although he went on to address two ancillary points, he did not discuss the different interpretations of section 277 offered by Arden LJ and Chadwick LJ.

Given its brevity, it would perhaps be unwise to rely too heavily on this passage.  However, it is worth noting that the judge adopted language which corresponds to Chadwick LJ's analysis of section 277.  Instead of stating that R1 ought reasonably to have known that the company did not have sufficient distributable profits, he stated that she "must be taken to have known" that fact.

Comment

In a very different context, a Scottish court once remarked upon the danger of courts seeking to devise exact definitions of expressions used in statutes.  As the Lord President, Lord Dunedin, put it:  "... I do not think that exact definition is at all a profitable pursuit;  in fact, it always leads one into this trouble that one deserts the words which Parliament has used and substitutes others"[7].  By analogy, there is a danger, when transposing EU directives into domestic law, that some of the meaning of the original may be lost if different words are used in the UK legislation.

Article 16 of the Second Company Law Directive appears to set out the position in relation to the repayment of dividends clearly, providing for recovery if the shareholder "knew of the irregularity of the distribution ... or could not in view of the circumstances have been unaware of it".  This is a high threshold:  there is no reference here to what the shareholder "should" have known or "ought" to have known.[8]

The fact that section 847 uses different wording in its attempt to implement article 16 muddies the waters, for the expression "has reasonable grounds for believing" does not, on a natural reading, set the bar quite as high as "could not in view of the circumstances have been unaware".  If, however, we are to interpret section 847 to accord with article 16, it would seem that the higher threshold must prevail.  Whilst we await a definitive decision on the point, Re Snelling House suggests that the courts may, indeed, be inclined to this view, so that for the time being section 847 may be read as allowing for recovery only from a shareholder who either knows or "must be taken to know" (or "may reasonably be taken to know") that the dividend was paid in contravention of the Companies Act 2006.

A broader question is whether, in any case, section 847 and article 16 are drafted too restrictively.  It is well established that unlawful dividends may be recovered from the directors responsible for the payment[9], and recovery from a shareholder may be possible at common law in some situations to which section 847 does not extend[10], but why should the statutory provision not simply allow recovery from any shareholder who receives an unlawful dividend?  Although there are, in fact, formidable objections to such a sweeping revision of the obligation[11] - it would surely be unfair, for example, to require repayment from an innocent shareholder who had invested his share of the unlawful dividend unwisely and lost the entire amount - there may be scope for a more measured adjustment if the opportunity arises.

 


[1] [2006] EWCA Civ 544

[2] [2012] EWHC 440 (Ch)

[3] Directive 77/91/EEC

[4] [2006] EWHC 2731 (Comm) (first instance)

[5] [2012] UKFTT 564 (TC)

[6] [2012] EWHC 440 (Ch) at [19]

[7]Lord Advocate v The Huron and Erie Loan and Savings Company 1911 SC 612

[8] Arden LJ's rejection of the high threshold in It's a Wrap was based on the argument that the words in article 16 could not have been intended to refer to what she described as "inferred actual knowledge", because such knowledge would not have been referred to separately, being merely a species of actual knowledge.  There is certainly force in this analysis, but it does seem to be at variance with the clear wording of article 16.

[9]Re Exchange Banking Company, Flitcroft's Case (1882) LR 21 ChD 519 (CA); Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712.  For an interesting obiter discussion of the circumstances in which a director's liability arises, see Lord Hope's judgment in Holland v Commissioners for Her Majesty's Revenue and Customs [2010] UKSC 51 at [45] - [47].

[10] For a brief discussion of the common law liability of a shareholder, see Arden LJ's judgment in It's a Wrap (UK) Ltd (In Liquidation) v Gula [2006] EWCA Civ 544 at [11] - [12].

[11] A hint of some of the objections can be found in Robert Walker LJ's judgment in Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712, in his discussion at [45] of the windfall argument against imposing liability on directors when the company is solvent.

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