Fair pay for fair work? “Dividends” in owner-managed companies.
22nd May, 2019
There have been a number of Court decisions in recent years grappling with the application of established legal principles to modern-day practices adopted by many owner-managed businesses for remuneration.
The situation is a common one. The same person is both a shareholder and director of the limited company. They “take” payment for their hard work by paying over company funds to their personal account, or using company funds for personal expenditure. Little if any thought is given at the time to the nature of such payments.
When the going is good, at the end of the accounting year their accountant will help them to regularise the position, and usually, no issue arises.
But if there is a dispute between the individuals in the business, or if there is insolvency, various issues can arise.
In simplified terms the legal avenues available to remunerate an individual for their work for a company is either:
Salary. Usually least advantageous from a tax point of view. All payments must be the subject of the correct deductions by the company for income tax and national insurance (employer and employee contributions), and there will be tax returns clearly stating the earnings;
Dividends. Only payable to a shareholder in the company, and only out of “distributable profits”, and the process laid down by statute must be followed. This includes having regard to a set of accounts showing various required information, and holding a properly convened board meeting to consider whether it is appropriate to declare the dividend (which will be recorded in a board minute); or
Payments under a contract if a legitimate contractor is involved.
Frequently an owner-manager will describe monies they receive from their company during the course of the year as “dividends”, but will not be able to show compliance with the statutory procedure.
To “fit” the practice with the legalities, and having had the chance to consider the position with their accountant or lawyer, a properly informed director will usually have to accept that in fact, the payments received were loans. At the end of the year the profit position will be analysed and, provided there are sufficient distributable reserves and the process is correctly followed, dividends can be declared. Often a journal entry is made to cancel out the loans, rather than require the company to pay the dividend in cash to the director and that to then be used to pay down the loan.
But where the monies are properly categorised as loans, they are liable to be repaid. If one of the individuals leaves the business then the company, as a creditor, may take steps to claim repayment. The departing director may maintain that the monies were not a loan. However, in the absence of proof that the monies were salary (by reference to tax records) or properly declared dividends, the monies will almost certainly be loans. In our experience, a well-considered Statutory Demand by the company may place the leaver in some difficulty and force repayment.
Where there is insolvency, control of the company passes to the insolvency office-holder, and they will require the directors to repay any loan balances. Set-off is frequently argued but rarely available on proper analysis.
In a 2017 decision, the Court accepted a novel argument by a director that monies received were his because he was entitled to payment for his hard work on a “quantum meruit” basis. “Quantum meruit” is well-known to the Courts: it is part of their equitable (fairness) remit to do justice between parties, and effectively means a reasonable sum of money to be paid for work done when the amount is not stipulated in a contract. This decision muddied the waters somewhat.
Clarity has recently been restored when on 27 November 2018 this case was successfully appealed in the Court of Appeal (Global Corporate Ltd v Hale  EWCA Civ 2618).
As a result, quantum meruit will not be realistically arguably in other cases. This is good news for companies looking to recover loans owed to them. For directors, the key will be to ensure that where they intend that they are remunerated by dividends they follow the process required by the Companies Act in every case.
We have experience acting for both companies (in and out of insolvency) and directors in such cases. There is no charge for making an enquiry with us, so if you have a similar issue then get in touch to see if we can help.
Dispute Resolution & Insolvency
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