We’re seeing a lot of these at the moment.
To declare and pay a lawful dividend (under the Companies Act 2006 legislation) dividends can only be paid out of “profits available for the purpose”. These are the company’s accumulated realised profits less its accumulated realised losses.
There needs to be a set of accounts that show there are sufficient distributable profits. These can be;
• The company’s last annual accounts
• Interim accounts (more up to date management accounts) or
• Initial account (where there are no annual account)
Of course, that doesn’t usually happen in practice.
Directors are often advised to draw very low salaries and draw drawings on account of anticipated dividends and profits. At the end of the accounting year when the accounts are prepared, they’ll vote a dividend from the profits to cover the drawings they’ve taken in the year.
This usually works when there isn’t a global pandemic and profits are decimated.
Over the last 18 months many companies have struggled to generate profits, but the directors haven’t changed their remuneration strategy. Instead, they’ve carried on taking a small salary and drawing funds on account of dividends. When there aren’t any profits, drawings on account of dividends become a director’s overdrawn loan account.
The problem with an overdrawn director’s loan account is that it’s repayable to the company. If a company is insolvent that makes it more of a problem.
A bounce back loan thrown in can make matters worse. This provides the funds for directors to carry on making the drawings and, potentially, increasing the director’s overdrawn loan account.
What would we do in these circumstances if the company was insolvent? We’d review the financial position of the company and advise the director of the best course of action. Should a liquidation be the best outcome, we’d negotiate with the director what he could repay which may be paid over several years. We’d help guide him through setting up a new business (if that’s what he wants to do).
Should you have any directors in this position please don’t hesitate to contact us to review the position and help the director resolve matters.
Call me, Tim Corfield on 077869 65009 at any time or any of the Griffin & King team for a completely no obligation chat or meeting.