News | October 19, 2021

You can’t rewrite history

That is the message in Bass & Ors v Buchanan [2021] EWHC 2740 (Ch), which demonstrates yet again that a company director faced with a misfeasance claim by a liquidator cannot escape judgment by reclassifying the nature of the payments he or she has received from the company.

The joint liquidators of Bronia Buchanan Associates Limited brought proceedings against  Bronia Buchanan, the sole director of the company, seeking:

  • a declaration that Ms Buchanan was a debtor of the company in the amount of £286,421.45;
  • a declaration that the reclassification of sums outstanding on her director’s current account on 10 September 2014 as ‘drawings’ was ineffective to release Ms Buchanan’s liability to the company;
  • alternatively, a declaration that if the reclassification was effective to transfer anything and/or to reduce or release any liability, it was a transaction at an undervalue and/or a breach of her duties as a director;
  • an order for payment pursuant to ss 212(3), 234, 238(3), 241 IA 1986 or at common law.

The company got into the usual difficulties with tax. Ms Buchanan took legal advice from her solicitor husband who in turn sought accountancy advice: according to the company’s balance sheet his wife had an outstanding director’s loan of over £200,000 which had been in existence since 2007. The advice was to reclassify the sum as drawings rather than loans as it appeared that was what they were, given the minimal salary the company had paid Ms Buchanan, although it was recognised at the time that this would raise separate issues with the Inland Revenue which would have to be addressed in due course.

The company went into liquidation.

The liquidator relied on a simple case in debt but also sought the orders summarised above. Ms Buchanan’s case was that once the court determined the true nature of the payments, it was clear that the reclassification resulted in no material change to the company’s financial position but reflected her proper entitlement to remuneration for her services to the company. If that were the case, she had not breached any duties to the company. Furthermore, she had relied on professional advice, so even if the court determined that she had breached her duties, she had acted honestly and reasonably, such that, having regard to all the circumstances of the case, she ought to be excused from liability under s 1157 Companies Act 2006,.

ICC judge Burton reviewed a number of familiar cases: Henderson & Jones Limited v Garry Patrick Price (a summary of the case law), Re Idessa (UK) Limited (on the burden of proof as to unexplained payments out of company funds), Re Mumtaz Properties Limited (on the status of company accounting records), Re The Sky Wheels Group of Companies Limited (on the nature of periodic drawings) and Global Corporate Ltd v Hale (in which the claimant sought to recover sums paid to a company director by way of interim dividends during a period when the company was in financial difficulty, but in previous years, the monthly payments had been adjusted when the accounts were audited at the end of the financial year and it was determined whether the company had made sufficient distributable profits to be able to declare dividends).

Having done so and reviewed the evidence, ICC Judge Burton found:

“The last-minute attempt to reclassify the payments as ‘drawings’ could not alter the basis upon which they had been paid and received throughout the Company’s prior trading periods. I have little doubt that if such a retrospective accounting adjustment were possible, most companies’ owner-directors would adopt a similar practice. They would approve payment to themselves of a salary below the income tax threshold and then take more than that amount out of the company on a monthly basis in the hope of earning sufficient dividends by the end of the year to repay any debt due from them to the company. If it then transpires that the company makes a loss, or worse, enter liquidation, they would change the accounts to show that whilst creditors may not be paid in full, they should nevertheless receive what they consider to be a fair amount to compensate themselves for the hours they spent working for their own company, even though it has not been sufficiently successful to pay all of its debts.”

Following Global Corporate, she noted that there had been no board resolution at the relevant time and that the reclassification was of no legal effect. She went on:

“I also reject [counsel for the respondent’s] submission that Ms Buchanan has a corresponding claim for remuneration, on what appears to be a quantum meruit basis, which can be set off against the overdrawn loan account. In Global Corporate,Arden LJ suggested that once a company is in liquidation, such an unliquidated claim would need to be proved for in the liquidation and that unless the payments can be validly re-characterised as payments for services lawfully made by the company prior to the liquidation, it was difficult to see how they could provide a defence. I have found that the sums cannot be re-characterised. No question of set off arises. They were sums borrowed by Ms Buchanan from Company money against the hope of future dividends. Such dividends did not materialise and the loan must be repaid.”

An attempt to run a limitation point cut no ice either:

“[Counsel for Ms Buchana] contends that because the sums due under the loan account were shown in the Company’s accounts as ‘debtor’ sums, … they thereby either became immediately due and owing at the time they were incurred or, at the latest, when the Company’s year-end accounts were prepared. Consequently, the limitation period prescribed by section 5 of the Limitation Act 1980 expired before the Applicants’ application was issued.”

The judge found that the effect of s 6(2)  Limitation Act 1980 was that time for repayment did not start to run until a demand was made by the company. As director of the company Ms Buchanan made no demand on herself to repay. The first formal demand was made on 10 March 2017. The proceedings were commenced within six years of that date, so within the six-year limitation period.

The liquidators’ claim was allowed in full.