Toone & Ors v Ross & Anor, Re Implement Consulting Ltd

Payments made through trusts or other structures may be characterised as unlawful distributions by examining their true purpose and substance. It is unnecessary to establish that the structure was a sham. Where company reserves are transferred for the intended benefit of shareholder-directors in proportion to their shareholdings, the payments may be returns of capital despite their formal description as employment benefits or dividends.

Distributions must be tested when made against properly prepared accounts and the statutory requirements of Part 23 of the Companies Act 2006. Once a company is insolvent, or cannot reasonably be expected to meet its prospective and contingent liabilities, directors must have regard to creditors’ interests. Honest directors may remain liable for unlawful distributions where the statutory conditions are not satisfied.

Implement Consulting Ltd entered insolvent liquidation, owing substantial sums to HMRC. Its joint liquidators brought claims against two former directors concerning payments made between 2009 and 2013 through employee benefit trusts, an interest in possession structure, and later payments to shareholders.

The liquidators alleged that the transactions were, in substance, distributions of company capital made contrary to Part 23 of the Companies Act 2006, and that a later expense payment breached the directors’ duties because the company was insolvent. The central issues were the proper characterisation of the transactions, whether the statutory distribution rules had been complied with, and when creditor interests became relevant.

1. Characterisation of the payments. The court rejected the submission that the trusts could be challenged only by proving that they were shams. The correct approach was to examine the true purpose and substance of the transactions, including the surrounding documents, the intended beneficiaries and the way the arrangements operated. The court was entitled to look through the labels and structures used.
2. The payments into the employee benefit trusts and the interest in possession fund were intended to withdraw company reserves and place the money in the hands of the shareholder-employees in proportions matching their shareholdings. They were not reasonably incidental to the company’s business and were not made to promote its prosperity. In substance, they were returns of capital to shareholders.
3. Unlawful distributions. Under Part 23 of the Companies Act 2006, distributions could be made only from accumulated, realised profits available for distribution. The legality of a distribution had to be tested when it was made, using properly prepared relevant accounts. The required statutory formalities had not been followed. The trust and interest in possession payments, and the later £70,000 paid to shareholders, were therefore unlawful distributions.
4. The recipients knew the relevant facts constituting the contraventions. Under section 847 of the Act they were liable to repay the unlawful distributions. Knowledge of the statutory restrictions themselves was unnecessary.
5. Creditor interests and insolvency. The company was insolvent by 27 June 2011. The court applied the balance-sheet test by considering the company’s assets together with its prospective and contingent liabilities. The HMRC correspondence, the substantial potential tax liabilities, the absence of provisions, and the sharp fall in turnover showed that the company could not reasonably be expected to meet those liabilities, even though it continued paying other creditors.
6. From that date the directors had to take account of creditors’ interests. The payment of expenses to Mr Flanagan in March 2013, although not treated as an unlawful distribution, was made when the company was insolvent and breached the directors’ duties. The respondents were ordered to account for the resulting loss.
7. The court found that the respondents were honest, but their failure to obtain independent legal advice and understand the risks of the schemes was not reasonable conduct in the circumstances. The principal statutory remedy for the unlawful distributions was available notwithstanding their honesty. The court would hear counsel on the terms of the order.