Updated: 9th January 2021
When a company becomes insolvent the ‘veil of incorporation’ that separates its directors from the business can be removed, and a significant risk emerges of personal liability for some or all of the monies owed.
This risk can materialise if you’ve taken too much dividend from your company in the past, but particularly if it’s linked with the business’ financial decline and insolvency. This situation may be revealed if an administrator or liquidator is appointed, and they identify instances where unlawful dividends have been taken, or investigate the causes of insolvency.
The money taken via dividends that are later deemed unlawful is an asset of the business and can be reclaimed by the insolvency practitioner (IP) for the benefit of creditors. It’s one of the debts owed to the business, and as such, they cannot ignore it.
When you declare a dividend it must be financially supportable by the business. This means there must be sufficient distributable profits available to cover the sum, otherwise the dividend will be regarded as illegal or unlawful.
Taking an illegal dividend is a serious issue in itself, but when the company is also facing insolvency, the consequences for directors can be severe. It’s a director’s duty to know where their company stands financially at all times, so claiming no knowledge of its insolvent position simply alerts officials to a potentially deeper problem.
There are a number of serious ramifications for directors in this situation. If insolvency is directly related to taking too much dividend from the company, you face penalties and sanctions, including disqualification as a director and personal liability if you cannot afford to pay the money back.
You may also face a hefty tax bill if HMRC decide to charge income tax and National Insurance on the amounts you’ve taken, plus the prospect of wrongful trading allegations if you’ve continued to trade whilst insolvent.
Although dividends are a tax-efficient way to extract funds from a company, it’s vital to carry out the necessary checks and adopt the correct procedures prior to declaring one. It’s easy to declare dividends in the belief that the company can support them, when in reality there may be other financial outgoings pending that you haven’t considered.
Rectifying an unlawful dividend is a process for the appointed office-holder during the course of their investigations. If they determine that one or more dividend payments were taken when the company didn’t have available distributable profits, they’ll take the necessary steps to reverse the dividends.
If shareholders have received unlawful dividends and they aren’t obliged to repay the money, you and other directors will be pursed for repayment so the company can use the money to repay its creditors. This introduces the possibility of personal bankruptcy if you can’t afford to pay from your personal funds.
Following a strict protocol when declaring dividends, including diligently recording the figures and decision-making processes, helps you mitigate the risks as a director and protect yourself from personal liability.
A director’s duty is to promote the success of the company, and taking an illegal dividend can be seen as failing in this duty. You’ll also face questions surrounding your knowledge of the company’s financial position, i.e. whether you knew or should have known that it was approaching insolvency.
There’s much at stake when your company is insolvent and illegal dividends are a factor, and you need to obtain professional assistance as soon as you can. You’ll be able to find out more about the threat of personal liability, identify your options and those for the company, and establish the best way forward.
Real Business Rescue are insolvency specialists. Our partner-led team will provide independent advice on your situation, and offer valuable support at this worrying time. Please contact one of the team to arrange a free same-day meeting – we work from an extensive network of offices throughout the UK.
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