The most common mistake we see directors making is to carry on paying dividends (usually to themselves) long after any distributable reserves have been exhausted and when creditor arrears have built up. If the company were ever to fail this could lead to those dividends having to be handed back to a liquidator at the worst possible time when the directors’ have lost their main source of income and often face personal guarantee liabilities as well. Also director/shareholder overdrawn loan accounts often operate in conjunction with declaring dividends. Rather than receiving a monthly salary typically directors will draw sums in “lieu of salary” and at the year end a dividend is declared and posted to the directors’ loan accounts bringing the balance down to nil. This works fine until the company becomes insolvent and dividends can no longer be declared leaving the loan account on the balance sheet which has to be repaid. So in effect the directors have foregone salary, worked for nothing and owe the company a substantial debt exactly at the same time as their principal source of income has or is in danger of drying up. An invidious position. If there are doubts about your clients’ ability to continue as a going concern the following simple steps taken in time could significantly improve their position in the event of an insolvency:
- Obtain shareholder approval for any loans to directors above £10,000 to make them lawful.
- Ensure your clients do not continue to unwittingly build up loan accounts based on previous advice received given when the company was solvent.
- Consider advising directors to switch from dividends to salary. Directors are entitled to reasonable remuneration just like any other employee. Minute the reasons for doing this.
- Ensure that directors have written contracts of employment. In the event of any insolvency of the company if the directors are employees then statutory pay in lieu of notice, redundancy, arrears of wages/holiday pay claims currently up to £450 per week will usually be paid by the Redundancy Payment Service. For a director who has been paid at or above this level for at least twelve weeks prior to the insolvency and has say over ten years service (even if most of this was paid below the national insurance level) this claim could be worth over £10,000!
See our briefing sheet on this subject at https://mw-w.com/unlawful-dividends-briefing-sheet. If you are concerned that your clients have received unlawful dividends that might have to be returned, think your client should move on to being paid by salary or have any other business rescue and insolvency related query please give me a call.