Directors' Duties - What Constitutes Misconduct Part 2
This is Part 2 of a series of booklets considering the general question of Directors’ duties and responsibilities and in particular, what conduct can ultimately constitute a finding of “unfitness” and possible disqualification as acting as a director.
This booklet deals specifically with Excess Remuneration and Dividends.
Unfitness is governed by section 6 of the Company Director Disqualification Act 1986 (“CDDA 1986”).
This series of booklets is intended to guide you through the general standard of behaviour expected by the Courts on either: (i) an objective basis – i.e. the standard expected of directors generally; and (ii) a subjective basis – i.e. the higher standard expected of directors having regard to their qualifications, skills and experience.
Although cases are always judged on their own individual facts, certain common threads can be determined from the various decisions made by the Courts when determining unfitness pursuant to Section 6 of the CDDA 1986.
EXCESS REMUNERATION AND DIVIDENDS
1. What is the general issue when considering directors’ responsibilities?
The allegation is normally one of a director withdrawing excessive remuneration and/or dividends which isn’t appropriate to the financial circumstances of the company at the time the payments were made. This can be applicable either to a failure to act in accordance with the Companies Act 2006 (which sets down specific circumstances in which dividends can be drawn) or in accordance with a director’s general fiduciary duties to the company and, more particularly, its creditors.
The same is true in respect of a director who is also a shareholder. If that director allows dividends to be paid to himself as a shareholder which the company cannot afford, this too can constitute misconduct. 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 this where 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:
- i) 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.
- ii) 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.
- iii) It should be paid in accordance to the availability of funds necessary to enable the company’s on-going trading, rather than stripping out all available monies.
- iv) 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.
- v) 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.
2. Can I be disqualified as a director if the remuneration appeared reasonable at the time?
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 so where hindsight demonstrates that the remuneration was overly generous. However, the reasonableness of the payment will have to be established and similar considerations need to be made to payment of remuneration as apply to dividends (see comments above).
3. Does a failure to recover unlawful dividends result in director disqualification?
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 evidenced 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 constitute a finding of unfitness.
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 before a director disqualification order is made?
The answer is No.
Payment of excessive remuneration over even a relatively short period can lead to a finding of unfitness. 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.
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ALTERNATIVELY, CONTACT THE DISQUALIFICATION TEAM ON 020 7841 0390
5. Does the court look at other benefits in kind when considering director disqualification?
6. How often should the question of directors’ remuneration be looked at?
7. Is the market value of the directors’ services relevant when considering director disqualification?
8. Is there collective responsibility of all directors in matters of remuneration?
9. What about payments to employees. Do they matter for the purposes of director disqualification?
10. What if a director reduces his level of remuneration? Does this avoid being banned as a director?
11. What about payments to family members? Will this result in me being banned from acting as a director?
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