How often have you advised a husband and wife about both being directors and shareholders of their own company? Following on from this, how far do you go in advising the spouse about the level of their fiduciary duty? The extent of this fiduciary duty was put to the test in August 2006 at the High Court and provides some serious points to consider.
Background
Northampton-based BRI Business Recovery & Insolvency were instructed to deal with the liquidation of Queensway Systems Limited, which was a company operated by a husband and wife who were both equal directors and shareholders. From enquiries made, it was evident the husband controlled the day-to-day business. The wife stated she did not hold office but, “….stayed home with (the) children….”
No remuneration was taken by either director. Instead, the husband would draw funds against a loan account to provide for all personal needs throughout the year. A dividend would then be declared at the year end, which extinguished the accumulative loan account balance.
In March 2001 the husband followed this practice and declared a dividend that wiped out the loan account balance. However, due to trading difficulties, the company ceased trading in August 2001 and eventually went into liquidation on 12 October 2001.
The Joint Liquidators, from BRI Business Recovery & Insolvency, challenged the 2001 dividend by saying it either contravened Section 330 Companies Act 1985 and was, therefore, void or, the declaration was a breach of duty and misapplication of funds.
The arguments
The husband claimed the dividend was based upon distributable profits as at year ended 31 March 2001. Therefore, the declaration was valid in accordance with Section 270 Companies Act 1985. The wife argued she did not benefit from any dividend and was not present at any meeting to approve such declaration. The Court were satisfied the wife was not present at any meeting to resolve the declaration of dividend. The husband added that he had informed the wife in a conversation.
The Joint Liquidators argued that before assenting to a dividend, shareholders must have the appropriate or full knowledge of the issues. Merely being told of an event did not constitute assent. It was also pointed out that the dividend had been declared four days before the year end and as accounts were not finalised, Section 270 Companies Act could not apply. Furthermore, the company was insolvent on the basis it could not pay its debts (primarily a VAT liability) as they fell due. The Court agreed on all points.
The decision
It was abundantly clear the wife took no part in operating the company. She was a housewife and mother who was recorded as a director and shareholder of Queensway Systems Limited.
However, in considering her obvious lack of involvement, the court stated:
- “I do not find that [wife] knew that a loan account was being operated by [husband]; but if she had applied her mind at all to the question whether there was any justification for the payments being made, as it seems to me it was her obligation to do, she would have discovered immediately there was none.”
- “She was content to allow the company to fund their joint life-style”
- [Therefore] “…was also sufficiently participating in or giving her sanction…”
The Court ruled that the dividend was invalid and should be repaid, together with interest and costs. In ruling that both husband and wife were jointly and severely liable, it was also determined the wife could not obtain relief under Section 727 Companies Act 1985 given the comments above.
After receiving the judgment, Peter Windatt said,
“The case of Queensway Systems Limited (in liquidation) -v- Walker and another sends out a stark message to Directors and their advisors. It further demonstrates the court will not excuse the duties of a director on the mere basis they were not involved in the daily operations of the company. Courts will look at what directors know or ought to have known.”
“Many family businesses consist of husband and wife directorships and this case emphasises the need for both to have a grasp on the company finances and controls. In addition, the decision sends out a warning that the declaration of dividends should not be exercised lightly and that steps must be taken to allow proper decisions to be made.”
If you have a client who has a problem and feel that they would benefit from a fresh approach, please feel free to contact BRI. All initial BRI meetings are FREE OF CHARGE, completely independent, confidential and without obligation.
Important Note: This Briefing has been prepared as background information for the general professional adviser and is not a comprehensive statement of the law – we recommend that expert advice be taken on specific issues arising in practice.
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