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Overview of illegal / unlawful dividends, Bounce Back Loans and the recovery process

Bounce Back loans 

During the coronavirus outbreak the Bounce Back Loan Scheme was launched to assist businesses financially who, as a result of the COVID-19 outbreak, were affected financially with cash flow issues, lack of revenue and could benefit from additional finance. The government stated the loans had to be used for the ‘economic benefit’ of the business but were not intended for the personal use of Directors and Shareholders. However, many businesses did consequently declare the loan as a dividend and they are now facing scrutiny.

Directors that utilised the Bounce back loans to increase their own wages, boost savings, buy luxury items such as hot tubs, boats and cars etc, order endless Deliveroo or even just to survive personally and pay their domestic bills via dividends during the pandemic should be worried and concerned if the correct procedures were not followed at the time. If there were insufficient distributable profits to support the payment of the dividend it will be considered illegal under the Companies Act 2006.

Sanctions – what could happen

Ultimately Shareholders and or Directors personally could be subject to a claim for damages and or to repay an unlawful dividend plus costs and interest as a result of an unlawful dividend payment(s). There will be no protection from the limited liability of the company for them to hide behind. Director disqualification for up to 15 years can also be a consequence and with some facing fines and prison sentences. If Judgment is obtained following proceedings being issued, the enforcement of the Judgment could centre around liquidating the personal assets of the Directors or shareholders in the absence of payment being received with a view to recovering money owed.

Directors and Shareholders have to also be mindful that there are people already involved in their finances that may have to highlight potential illegal dividends, so they should not just bury their heads on the sand in the hope no-one will notice these past transactions. There are potential tax consequences and your accountant may even be required to report you under anti-money laundering regulations. Your lender is also obliged legally to inform the National Crime Agency if it suspects the Bounce Back Loan has been misused and used in a fraudulent manner.

Even if a company enters into liquidation there will be no escape as past transactions including how the Bounce Back Loan was used will be analysed by the liquidator accordingly which could lead to a liquidation investigation, as unlawful dividends are assets of the company which need to be recovered for the benefit of creditors.

Retrospectively consider the timing of any dividends following receipt of the Bounce Back Loan. By applying for a Bounce Back Loan it could be argued that this was necessary because there was no profit in the company, therefore the drawing of a dividend or an increase in salary directly after being in receipt of the Loan demonstrates itself that it was illegal.

What are Dividends

A Shareholder’s right to an amount of money from a company is a dividend, not to be confused with the payment itself. The right is the dividend, not the payment.

Shareholders can lawfully receive dividends to receive a return on their investment if certain conditions are met, but the company’s creditors must be borne in mind as dividends can only be paid out of profit. Profit is not just money in the bank or assumed by reference to the last profit and loss account, it has to be accumulated profits or reserves from previous years.

In order to pay a dividend, Directors must first declare it and reference to the relevant companies accounts must be made to justify the same. If it is not declared, it is not a dividend, potentially resulting in the transaction having to be returned to the company. The correct procedure must be followed and you cannot declare a dividend retrospectively or process it after year-end to justify monies received throughout the year as this is considered to be fraudulent.

Unlawful dividends

A dividend will be unlawful and likely to be repaid if the correct procedures are not followed, there was insufficient profit or the company was insolvent when paying the dividend. This ensures creditors are protected from Shareholders taking excessive dividends.

If a dividend is found to be unlawful for an insolvent company, the Director could have to repay the illegal proportion of the dividend as this would be considered to be a breach of a Director’s duty, given they should have been aware that it was illegal. There is a requirement to keep company records so they cannot say they were not aware and ignorance is not a defence either. There will be tax consequences accordingly and no-one wants to become subject to a HMRC tax investigation!

Problems with owner managed businesses

If the Directors and Shareholders are the same people and for tax and National Insurance purposes the Directors have been receiving a minimal salary, with “top ups” via dividends throughout the year, there is scope for unlawful dividends to be made if the company profits are miscalculated by the Directors and or poor record keeping occurs. The processes must still have been followed with regards to checking available profit and by making reference to the relevant accounts first, otherwise the dividend will be unlawful.

As far as the Bounce Back Loan is concerned whist the term ‘economic benefit’ allowed you to pay salaries, bills and even your own normal salary as a Director if you were on the payroll, it did not entitle you to increase your salary or pay bonuses through a dividend because of the large cash injection the business would have received through the loan. Therefore whilst payment of your minimum salary would be acceptable additional payments would not, unless paid out of accumulated profit, as these would be dividends. If as a Director you only take the ‘optimum amount’ as a salary for National Insurance purposes, you would probably have already withdrawn that amount before the Loan was received. You were also not entitled to use the Loan to pay shareholders as this would not be for the ‘economic benefit’ of the business.

Who will be liable

As a Shareholder you could be liable to repay an illegal dividend if you knew or had reasonable grounds to believe that the company was unable to support the payment when this was issued. If you were unaware, liability could pass to the Director who authorised it or any of the Directors as the distribution of illegal dividends is a joint and several liability.

Directors have the duty to act within their powers, the duty to promote the success of the company, the duty to exercise reasonable care, skill and diligence and the duty to consider the interests of the company’s creditors when the company becomes insolvent or is at a real risk of insolvency. This duty needs to be balanced against the interests of the shareholders and creditors should be prioritised if there is a risk of insolvency, especially if the payment of an unlawful dividend is what tips the company into the red.

Our solicitors can provide advice to both creditors who believes a Bounce Bank Loan may have been misused and Directors facing allegations which you feel are unfounded. We will provide advice on your rights and the options available to you. If you have taken a Bounce back loan and this article causes you any concern please feel free to contact Louise Boyle, Tim Flower or Mark Lello.