SSF Realisations Ltd v Loch Fyne Oysters Ltd & Ors

The court held that the November 2011 package of an interim dividend and an offsetting "management charge" was, in substance, a distribution to the shareholder which breached Part 23 of the Companies Act 2006 because it was paid in part out of capital. The management charge was characterised as a disguised distribution because there was no prior legal obligation on the company to reimburse the parent for historic services and costs; the directors therefore authorised a voluntary return of assets to the shareholder. The October 2011 management accounts understated liabilities by about £178,000 (creditor cut-off and accruals issues), so the distributable profits were overstated and the distribution exceeded available profits. As a result LFO was liable under section 847 to repay the part of the distribution made in contravention of Part 23 and two directors (Mr Craig and Mr Davidson) were liable for the same sum; one director (Mr Lucas) was excused under section 1157 for acting honestly and reasonably. The recoverable amount was quantified as £316,859.

This is a first instance claim by the joint liquidators of a subsidiary company challenging a November 2011 dividend together with an offsetting management charge recorded to eliminate an intercompany balance between the subsidiary (the Company) and its parent, Loch Fyne Oysters Limited (LFO).

Background and parties

• The Company, trading as Simson's Fisheries, was acquired by LFO in June 2008. By 2011 an intercompany receivable due from LFO to the Company had grown to about £944,089 in the October 2011 management accounts.
• In the context of a proposed acquisition of LFO by Scottish Salmon Company Limited, the Company’s board on 21 November 2011 resolved to declare an interim dividend and to assume a management charge in favour of LFO, entries being dated 27 November 2011.
• The Company later became insolvent; joint liquidators brought proceedings seeking repayment of unlawful distributions and directors’ liability.

Nature of the claim and relief sought

• The liquidators sought (i) repayment by LFO under section 847 of the Companies Act 2006 of any distribution made in contravention of Part 23, and (ii) compensation from the directors for breach of duty in authorising an unlawful distribution.

Issues framed by the court

• Whether the management charge was a genuine charge for services or a disguised distribution.
• Whether the accounts relied on by the directors (the audited accounts and the October 2011 management accounts) could be relied upon for the purpose of Part 23.
• The amount, if any, of the distribution paid out of capital and thus unlawful.
• Liability of the recipient shareholder (LFO) under s.847 and liability of the directors; whether any director should be relieved under s.1157.

Concise account of the court’s reasoning

• The management charge was held to be a voluntary distribution because there had been no prior agreement (express or implied) obliging the Company to reimburse LFO for historic services and costs; absent an obligation, the legal relationship was that of shareholder support, and the subsequent assumption of a liability was a return of value to the shareholder for no legal consideration.
• The October 2011 management accounts materially overstated distributable profits because of a prior-year creditor cut-off and accruals issue (net effect about £178,000). The distributable profits once corrected were £428,057.
• The Distribution ultimately offset against the intercompany debt totalled £744,916 (dividend £500,000 plus management charge ultimately recorded at £244,916). The part of the Distribution in excess of correct distributable profits was £316,859 and therefore contravened Part 23.
• By reference to s.847 the knowledge of relevant directors was imputed to LFO and the court concluded LFO knew or had reasonable grounds to believe that the distribution (in the relevant part) contravened Part 23; LFO was therefore liable to repay £316,859. Mr Craig and Mr Davidson were found in breach of duty and liable to compensate the Company for the same sum. Mr Lucas, despite being in breach, was relieved under s.1157 because he acted honestly and was unusually reliant on other directors and staff, and had less involvement.

Wider context

• The judgment applies established principles that substance prevails over form for distributions, clarifies the characterisation of intra-group accounting arrangements when no legal obligation exists, and reiterates that directors must ensure the accuracy of accounts relied upon to authorise distributions.

First instance: The claimant’s claim succeeded in part. The court held that the management charge was, in substance, a distribution and that the combined interim dividend and management charge (the Distribution) was made in contravention of Part 23 of the Companies Act 2006 to the extent it exceeded distributable profits as properly stated. LFO was ordered to repay £316,859 under section 847. Mr Robert H. Craig and Mr Bruce C. Davidson were liable to compensate the Company for £316,859 for breach of duty in authorising the Distribution. Mr Timothy Lucas was relieved from liability under section 1157 as having acted honestly and reasonably. The rationale was that the accounts on which the directors relied materially overstated distributable profits and there was no legal basis for the management charge, making it a disguised distribution paid in part out of capital.