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Be wary of the dividend trap

11 Feb 2019

At what point do company directors come under a duty to consider the interests of its creditors?

Specifically, when does the duty of a director under section 172(1) of the Companies Act 2006 to act in a way that promotes the success of the company become qualified by the duty under section 172(3), in certain circumstances, to consider or act in the interests of the creditors of the company?

This was the issue before the Court of Appeal in the recently decided case of BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 which concerned the payment of a dividend. In his judgment David Richards LJ identified four potential points when the duty of directors to consider the interests of creditors arose:-

  • When the company is actually insolvent;
  • When it is on the verge of insolvency;
  • When it was likely to become insolvent; or
  • When there was a real, as opposed to a remote, risk of insolvency.

Whilst the Court considered that these descriptions were too vague to serve as a useful test for the important step of engaging the creditors’ interest duty, it nevertheless considered that a test falling short of established insolvency was justified. Accordingly, the creditors’ interest duty arose when the directors knew that the company was or was likely to become insolvent; in that context “likely” meant probable.

Neil Harrold

Implications

For liquidators and creditors of insolvent companies, it is frequently the case that the company has been paying dividends up until a late stage prior to it going into liquidation (tax treatment of dividends vs PAYE/NIC being a usual motivating factor). In the light of the test in the BTI case, liquidators should conduct a detailed review of all dividends paid and other payments made (as well as the reasons for them being paid) after the time when the company first experienced financial difficulties (e.g. – commencing negotiations with HMRC to enter into a Time to Pay arrangement to clear tax arrears).

For directors, it is essential that, prior to making any decision to pay a dividend, they must take steps (and document them) to satisfy themselves that, not only is the company not actually insolvent at that time that the decision is made to pay the dividend (as well as on the date of payment, if later), but also that the company is not likely to become insolvent either imminently or by reason of the payment of the dividend. This applies not only to dividends, but also other payments made where the company is or is likely to become unable to pay all its debts as they fall due.

In cases of doubt, directors should seek appropriate professional advice before acting.

For more information on any of the above, or how we can help you or your business, please contact Neil Harrold, or call 0191 232 8345.