ABOUT THE AUTHOR: Simon Savident TEP is Managing
Director of Guernsey Trust Company Limited and STEP Guernsey Branch
Committee Member
G uernsey companies are governed principally by the
Companies (Guernsey) Law 2008 (the 2008 Law), which came
into effect from 1 July 2008.
One of the many developments introduced by the 2008 Law was a
complete overhaul of the rules governing the declaration of
dividends and the introduction of additional types of
distribution.
The revised system is designed to better protect creditors of a
company by requiring directors to expressly consider the solvency
of a company before declaring a dividend or distribution. This is a
valid rationale and enhances the respectability of Guernsey
registered companies. However, company boards have inadvertently
fallen foul of the prescribed procedures by failing to take advice
and by applying the previous regime, rather than the current
law.
These innocent departures from the statutory provisions can have
very serious ramifications and could lead to personal liabilities
on the directors.
The regime before the 2008 Law came into
force
Immediately before the enactment of the Law, Guernsey companies
were governed principally by the Companies (Guernsey) Law, 1994
(as amended). Section 33 of this law stated: ‘A company shall
not pay a dividend except from profits available for the
purpose’.
That was (in most cases) the extent of the statutory restraint
on the payment of a dividend. Therefore the directors could
lawfully declare a dividend if the company in question had
accumulated sufficient profits over time and need pay no heed to
the cash low or solvency of the company.
Reasons for change and the new regime
When Guernsey was developing the 2008 Law, the international
business climate was one of credit tightening, recession, corporate
failures and insolvencies. It was, therefore, deemed appropriate
that the priorities of a board when considering the declaration of
a dividend should be the current financial health of the company
and not the historical accumulations of accounting profit.
If the company cannot be shown to pass the Solvency
Test immediately after the distribution, then it is not
lawful
Thus, the 2008 Law introduced a new test, known as the ‘Solvency
Test’ that is required to be applied whenever a distribution of any
nature is contemplated (see below). If the company cannot be shown
to pass the Solvency Test immediately after the distribution, then
it is not lawful. Section 304 states that:
‘(1) a company may pay a dividend if (a) the board of directors
is satisfied on reasonable grounds that the company will,
immediately after payment, satisfy the solvency test, and (b) it
satisfied any other requirement in its memorandum and articles’
Further:
‘(6) the board of directors must approve a certificate stating
(a) that in their opinion the company will, immediately after
payment of the dividend, satisfy the solvency test, and (b) the
grounds for that opinion.’
The Solvency Test
So what is the Solvency Test and how does a company pass it?
Section 527 states that:
‘(1) For the purposes of this Law a company satisfies the
solvency test if (a) the company is able to pay its debts as they
become due, (b) the value of the company’s assets is greater than
the value of its liabilities (c) [further requirements set out for
companies supervised by the Guernsey Financial Services Commission
– not covered in this article].
(2)... the directors – (a) must have regard to (i) the most
recent accounts of the company, and (ii) all other circumstances
that the directors know or ought to know affect, or may affect, the
value of the company’s assets and the value of the company’s
liabilities, and (b) may rely on valuations of assets or estimates
of liabilities that are reasonable in the circumstances.’
Assuming the board can satisfy themselves that the company will,
immediately after dividend declared, satisfy the Solvency Test,
what form should the ‘certificate’ referred to in Section 304 (6)
take?
This is not further specified and, if appropriately worded, the
minutes of the meeting at which the board considers and reaches its
decision could themselves be held to represent this certificate.
Alternatively a separate certificate may be drawn up for signature.
There is no requirement that said certificate (in whatever form) be
lodged or filed with any external party.
Possible snares to trap the unwary
1Failure to document the consideration of the
Solvency Test It is all too easy, when performing what may be
seen as a routine, recurring task such as the declaration of a
dividend, to refer back to previous minutes and copy the same
process year on year. However, when the previous actions were taken
under a now-repealed law, this can lead to problems.It need not
even be the case that the company would have failed the Solvency
Test if properly applied. If the procedures laid out in the 2008
Law are not followed and documented, then it is likely that an
unlawful dividend has been declared and advice should be taken as a
matter of urgency.2Failure to
consider the company’s Articles This is a trap for those
seeking to comply with the 2008 Law, but forgetting to check what
their Articles have to say about dividends. Companies formed before
July 2008 will most likely have Articles based on long established
precedents. These generally stated (not unreasonably given the then
laws under which they evolved) that dividends could only be
declared out of profits available for the purpose (mirroring the
1994 law).A company which has not updated its Articles to remove or
amend this wording will need to comply with both subsections of
Section 304(1) as above and apply the Solvency Test as well as
establishing that it also has profits available for the purpose and
documenting both issues.A solution to this duality of tests is to
update the company’s Articles so that only the Solvency Test need
be applied thereafter.3Failure to apply
the Solvency Test to other transactions that now qualify as
distributions As well as the more easily identifiable
dividends, other transactions are now classed as distributions and
the Solvency Test must be applied (and passed) by the board before
sanctioning them. These are:
- An issue of shares as fully or partly paid bonus shares
- A redemption or acquisition of any of the company’s own shares
or financial assistance for an acquisition of the company’s own
shares
- A reduction of share capital
- A distribution of assets to members during and for the purposes
of its winding up
- A distribution of assets to members during and for the purposes
of an administration order
- A distribution of assets to members of a cell of a protected
cell company during and for the purposes of a receivership order,
or
- A distribution of assets to members of a cell of a protected
cell company during and for the purposes of the termination of the
cell.
In all of the above, it is vital that the board apply the
Solvency Test and properly sign a certificate certifying its having
been passed
Directors’ liabilities in the matter of unlawful
distributions
Section 309 of the 2008 Law allows that:
‘[an unlawful distribution] may be recovered by the company from
the member except to the extent that (a) the member received the
distribution in good faith and without knowledge of the company’s
failure to satisfy the Solvency Test, (b) the member has altered
his position in reliance on the validity of the distribution, and
(c) it would be unfair to require payment in full or at all.’
Section 309 (2) continues to include that, where the relevant
sections of the Law have not been followed or that reasonable
grounds for believing the company would satisfy the Solvency Test
did not exist at the time the certificate was signed:
‘a director who (i) failed to take reasonable steps to ensure
the procedure was followed, or (ii) voted to approve the
certificate (as the case may be) – is personally liable to the
company to repay to the company so much of the distribution as is
not recoverable from the members.’
Thus it can be seen how important is the correct following of
procedure and consideration of what is reasonable evidence to the
board.
Further developments to the distribution
regime in the 2008 Law
At the time of writing a consultation process has recently ended
as part of a general tidying up of certain parts of the 2008 Law
that, with the benefit of use and experience, are not quite having
the desired or anticipated affect.
One of the questions raised in consultation concerns the
possible removal of the part of the Solvency Test that applies to
the comparison of Asset values to Liability values (the ‘Balance
Sheet Test’) and, instead, a focus purely on the ability to meet
debts as they fall due (the ‘Cash Flow Test’).
Perhaps of most importance and interest to directors are
proposals to introduce some form of ‘Whitewash’ provisions to
relieve the liability of directors where distributions have not
been properly declared in accordance with the 2008 Law but it can
be demonstrated that, had the proper procedures been followed, the
company would either have passed the Solvency Test at the time of
the original declaration and/or (not confirmed which yet) would
pass the Solvency Test at the time of the ratification.
These proposals, if implemented, should allow for an appropriate
level of relief for innocent mistakes by boards where the breach is
procedural rather than due to financial deficiency and would avoid
the costly process of applying for relief from the Courts (the only
currently available source of relief).
What to do if you are concerned that an
unlawful distribution has been made
The best advice is to seek legal assistance from a Guernsey
lawyer as soon as an individual director or the board become aware
of the breach in the distribution process.
However, we have witnessed differing opinions on the
appropriateness of certain remedies, including:
- restatement of dividends into loans until a fresh dividend can
be declared properly to clear
- recovery of distributions from members
- ratification of past breaches by board or members
It should be noted that reliance on the last of the above is
particularly dangerous in the absence of any statutory whitewash
provisions.
As always, the best approach is to avoid the breach in the first
place. Ensure the board are properly aware of the issues in advance
and don’t be afraid to take advice.