This is the second in a series of articles considering the general question of Directors’ duties and responsibilities. As previously set out in the first article understanding such duties are vital for directors as a failure to adhere to them can ultimately constitute a finding of “unfitness” and possible disqualification as acting as a director. This can have an enormous impact on a person’s livelihood and career prospects.
This article deals specifically withExcess Remuneration and Dividends.
EXCESS REMUNERATION AND DIVIDENDS
1.The general issue explained
The allegation is normally framed on the basis of a director withdrawing excessive remuneration and/or dividends, the level of which isn’t appropriate to the financialstanding of the company at the time the payments were made.
This can be applicable to either;
A failure to act in accordance with the Companies Act 2006 (which sets down specific circumstances in which dividends can be drawn)
In accordance with a director’s general fiduciary duties to the company and, more particularly, its creditors.
Shareholder & director
The same is also true in respect of a director who is also a shareholder of the company.
If that particular director allows dividends to be paid to himself / herself as a shareholder which the company cannot afford, this too can constitute misconduct on the following basis:
It is a breach of the Companies Act 2006 to pay a dividend which exceeds net profits(after taxes) available for distribution.
It is also a breach of a director’s fiduciary duties to do thiswhere such a payment could lead to risks to a company or its creditors and it can lead to a finding of unfitness.
Generally speaking, distributions by a company must not exceed the distributable profits of a company as defined in Companies legislation.
Ideally, a dividend should satisfy the following criterion:
It should not exceed the amount of profits retained to the end of the accounting period. Note: if a company has made losses for several years and then makes a profit, it may not be able to pay a dividend because the current year’s profits are insufficient to provide a net retained profit.
It should be only be paid whilst the company is a going concern or, if not, then there is adequate provision to pay all other creditors of the company.
It should be paid in accordance to the availability of funds necessary to enable the company’s on-going trading, rather than simply stripping out all available monies.
The availability of distributable profits should be after allowing for any written off assets or after providing for any income which is unlikely to be paid.
The directors should be reasonably confident, on an objective basis, that the Company faces no short-term trading risks (other than in the ordinary course of business) and that payment of a dividend will not inhibit the company’s ability to deal with any such risks.
A decision to pay a dividend should ideally be documented in a directors’ board meeting minute together with the reasons for payment in accordance with the above criterion. As ever, proper paper trails are vital should something later go wrong.
2.Can a person be disqualified if the remuneration appeared reasonable at the time?
The quick answer is no – subject to evidence of the decision making process.
If a company allows a director to draw remuneration which appeared reasonable on the basis of information available to that person at the time, this is not seen as acting improperly.
This is even the case where hindsight demonstrates that the remuneration was overly generous.
However, the reasonableness of the payment will have to be establishedby the directorand similar considerations need to be made to payment of remuneration as apply to dividends earlier in this article. A good and proper paper trail is therefore very important and this should if possible include comments / sanction from the FD or the company’s accountants.
3.Can a failure to recover unlawful dividends result in possibledisqualification?
The quick answer is that it is likely to.
Failure by directors to recover repayment of an unlawfully paid dividend does not always in itself amount to misconduct justifying a finding of unfitness. In the case of Re: Thornton Construction Limited, the directors were able to show that they had relied on the advice of company solicitors who had indicated, (wrongly) that such payments would not be recoverable.
However, in the absence of such incorrect advice, failure to take appropriate action to recover such dividends could easily constitute a finding of unfitness which could then lead to disqualification as acting as a director.
As a caveat to this we also point out that under the Companies Act 2006 a director has a duty to independently consider such advice. In the above circumstances, if a director was aware of an ability to recover a dividend or obtain a repayment, despite this advice s/he could still be liable for failing to recover such sums.
4.Does there have to be a minimum period over which the payments to directors are made?
The quick answer is No.
Payment of excessive remuneration over even a short period can lead to a finding of unfitness against a director. It is also likely that a director paying himself / herself even a relatively small amount ahead of paying company debts/creditors in circumstances where the company was struggling will lead to a finding of unfitness and can then lead to disqualification as acting as a director.
5.Will the court look at other benefits in kind when considering director disqualification?
The court will take into account payments not only of “physical” money but also benefits in kind. Examples of benefits in kind include payments of pension contributions, private medical insurance, cars and repayments of loan capital.
The court will essentially look at the “entire package” when deciding on the question of excessive remuneration. This can (and often does) include the payment of a dividend, where the director is also a shareholder.
6.How often should the question of directors’ remuneration be looked at?
The answer is regularly.
The courts will examine whether remuneration which happened to be reasonable in one period was reasonable in another period. As any director knows, the financial position of a company can vary almost daily and as such, just because a payment was reasonable in one period, will not make the same sum reasonable in another.
A minimum of a year on year analysis is sensible by the director or board of directors when determining the levels of remuneration or dividends. However, a more frequent review is recommended, especially if the company’s financial performance is deteriorating or there appear to be obvious financial trading difficulties in the near future (e.g getting wind that a key customer of the company is in financial difficulty and may enter in to insolvency).
7.Is the market value of the directors’ services relevant when considering director disqualification?
Normally it is not.
The simple question to be answered is whether the “package” could be properly afforded by the company at the time it was made.
Market rate of a similar role isn’t relevant when establishing whether it was reasonable or not. It is also irrelevant if the director could have earned more elsewhere for doing the same job. The “going rate” is irrelevant and evidencing that a person took home less than the market rate is irrelevant.
It does not matter either what a director needed to draw on at the time in order to“make ends meet”. The court has no sympathy for director’s taking excessive remuneration to pay pressing issues at home, such as care home fees for an ill relative, or school fees for a director’s children.
The duty on a director is to ensure that the company can afford to make payments it does at the time it does.
8.Collective responsibility of all directors in matters of remuneration.
It is important to understand that there is a collective responsibility on all the directors of a company to consider the company’s financial position when determining both how much each individual director should withdraw from the company and also the combined total of all the directors’ remuneration.
If a director fails to request that the board considers the overall effect on the company of the combined remuneration and the company later fails, this can amount to misconduct and a finding of unfitness even if that particular director’s remuneration package was not in itself excessive. Whilst this might seem unfair, it is the collective position of the company which the court is concerned with. It might help mitigate a director’s period of disqualification, but it will not act as a defence to a claim that he was paid less than other directors of the company of a similar standing.
The Court may also look at the roles of directors and whether the payments to them all or each individually were reasonable in light of their contribution. This is aimed at dealing with non-executive directors who are unable to take dividends from a company(because of a lack of distributable profits) but who may instead draw an income as a directors salary, despite providing comparatively less input into the development and growth of the company.
9.Payments to employees. Do they matter for the purposes of director disqualification?
The same principle applies.
If an employee is paid excessively and this damages the financial viability of a company, the directors can be found guilty of misconduct in agreeing that inappropriatelevel of salary.
Additionally, employees who are paid excessively could potentially be subject to director disqualification proceedings themselves as a De Facto or Shadow director. This is because a director is defined as an individual acting in this capacity regardless of his/her description.
This can be even more serous where the employee is an “associate”, as case law recognises the use of family and friends to extract value from a company (see our comments below on family members).
10.What happens if a director reduces his level of remuneration?
This can obviously help when answering allegations of excessive remuneration. However, if the effect of the reduction still meant that the “package” could not reasonably be afforded by the company, a finding of unfitness is still likely and could lead to the director being disqualified.
11.What about payments to family members?
This is often a “thorny” issue.
Payments to family members are normally fine so long as those individuals are doing something of value for the company. In circumstances where it can be shown that the value of the work done was “referable” to what they were paid, this should avoid anycriticism. However, once again, a good paper trail is needed – an employment contract and details of what they have been doing or have produced as part of their employment are all vital in defeating any claims for disqualification.
Family members simply on the payroll in order to extract money from the company for no obvious reason or role can constitute misconduct by the directors in the event the company later fails. This is quite common in husband and wife appointments as directors, where only one of them is running the company and the other is just named perhaps for income, tax or corporate governance purposes.