England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
(His Honour Judge Micklem, sitting as a Judge of the High Court)

		Royal Courts of Justice
		Wednesday 10th July 1985

LORD JUSTICE DILLON: This is an appeal by the plaintiff, Precision Dippings Ltd. (hereinafter called "the Company") against an order made by His Honour Judge Micklem on 6th December 1984 when sitting at Bristol as a deputy judge of the High Court in the Chancery Division. By his order the judge allowed an appeal by all three defendants against an order of the Registrar which had awarded the plaintiff judgment under Order 14 against all three defendants and instead the judge gave all three defendants unconditional leave to defend the action. This appeal is, however, only against the judge's order in so far as it relates to the first defendant, Precision Dippings Marketing Ltd. (hereinafter called "Marketing"). By the appeal the company contends that as against Marketing the judgment under Order 14 awarded by the Master should be restored, but the company accepts that the second and third defendants, Mr. Wynne-Jones and Mr. King, should have unconditional leave to defend the action.

It used to be the rule that a plaintiff had no right of appeal where a judge had granted a defendant unconditional leave to defend under Order 14. That is not the rule now. Even so, where the issue which the judge below has held to be a triable issue is an issue depending on disputed matters of fact, the Court of Appeal would be unlikely to interfere. But that difficulty does not arise in the present case since the company in its appeal depends on a short point of law against facts which are not, so far as this point is concerned, in dispute.

The point of law raised arises under the Companies Act 1980, and is a matter of some importance in Company law. For that reason, we have taken time to put our judgments in writing.

Before I turn to the relevant statutory provisions, I can set out the main facts quite shortly.

The company was incorporated as a company limited by shares on 21st March 1962. From 9th July 1982 it was a wholly owned subsidiary of Marketing. Again, from that date Mr. Wynne-Jones and Mr. King were the only directors of the company and the only directors of and only shareholders in Marketing.

In precise detail the company's issued share capital consisted of 50 A Ordinary shares, to B Ordinary shares and 5 C Ordinary shares. 49 of the A Ordinary shares and 49 of the B Ordinary shares were held by Marketing alone. The remaining A Ordinary share was held by Marketing and Mr. Wynne-Jones jointly and the remaining B Ordinary share was held by Marketing and Mr. King jointly. The 5 C Ordinary shares were held by a third party, but as they were an unusual type of share carrying no rights to dividend and no voting rights and merely the right to receive back the paid up capital in a liquidation, they do not matter for any purposes of this appeal and can be disregarded.

On 16th September 1982 the company paid a cash dividend of £60,000 to Marketing in respect of the A and B Ordinary shares. The claim of the company in the action is to recover the amount of that dividend, with interest, from Marketing as the recipient and from Mr. Wynne-Jones and Mr. King as the directors of the company who paid it on the ground that the payment was in contravention of sections 39 and 43 of the Companies Act 1980 and so was ultra vires the company. Mr. Wynne- Jones and Mr. King say, and for the purposes of this appeal this is accepted, that at the time of the payment of the dividend they were not aware of the relevant requirements of those sections. They also say, and this again the company accepts for the purposes of the appeal, that they were advised by the company's auditor that the sum of £60,000 could be paid by way of dividend so long as the dividend was paid by way of available profits.

The payment of the dividend exhausted the company's available cash. Nearly a year later, on 10th August 1983, the company went into creditors' voluntary liquidation. There is no doubt that by the commencement of the liquidation the company was insolvent and there will be a substantial deficiency as regards creditors - even preferential creditors. This action is brought by the company acting by its liquidator.

Section 39 of the 1980 Act provides by subsection (1) that "a company shall not make a distribution. . . . . . . except out of profits available for the purpose." The term "distribution" includes a dividend such as the dividend in the present case, and the effect of the subsection is clearly, in my judgment, to make it ultra vires for a company to pay a dividend except out of profits available for the purpose, just as it has long been held to be ultra vires for a company to pay a dividend out of capital: see Flitcroft's case 21 Ch D 519.

Subsection (2) of section 39 contains a definition of profits available for distribution. This in many respects changed the law. It prevents, for instance, the distribution by way of dividend of unrealised profits or the distribution of profits by way of dividend without making provision for earlier realised losses. Clearly the legislature must have had the interests of creditors in mind, and not merely the interests of members, in enacting this group of sections in the 1980 Act.

Sections 40 and 41 contain provisions, not directly relevant to this appeal, restricting the distribution of assets of public companies and as to distributions of investment companies.

Subsection (1) of section 43 then provides that subject to the following provisions of that section the question whether a distribution might be made by a company without contravening section 39, 40 or 41 (the relevant section) and the amount of any distribution which might be so made shall be determined by reference to the relevant items as stated in the relevant accounts, and the relevant section shall be treated as contravened in the case of a distribution unless the requirements of section 43 about these accounts are complied with in the case of that distribution.

Subsection (2) identifies the relevant accounts for any company in the case of any particular distribution. It is common ground that the relevant accounts for the company in relation to the £60,000 dividend were its accounts for the year ended 31st March 1982.

Subsection (3) of section 43 sets out various requirements where, as here, the relevant accounts are the last annual accounts of a company. In particular paragraph (c) of subsection (3) provides that if by virtue of anything referred to in the auditor's report in respect of those accounts the report is not an unqualified report, the auditors must also have stated in writing (either at the time the report was made or subsequently) whether in their opinion that thing is material for the purpose of determining by reference to the relevant items as stated in those accounts whether that distribution would be in contravention of the relevant section. A copy of that statement must also, under paragraph (d), have been laid before the company in general meeting.

In the present case it is common ground that the auditors' report in respect of the company's accounts for the year ended 31st March 1982 was not an unqualified report; it contained a qualification as to the basis of valuing work in progress (which appeared in the company's balance sheet at a figure of £11,000).

It is also common ground that up to the time when the dividend of £60,000 was paid no such statement by the auditors as was, in view of the qualification of their report, required under paragraph (c) of subsection (3) had been made, let alone laid before the company in general meeting.

On 10th April 1984, however, which was after the company had gone into liquidation, the auditors issued a statement at the request of the A and B Shareholders in the company that "in our opinion the basis of valuation of work in progress referred to in our audit report on the company's accounts for the year ended 31st March 1982 was not material for the purposes of determining whether the distribution of £60,000 paid in September 1982 would have been in contravention of sections 39 and 43 of the Companies Act 1980". Thereafter on 10th May 1984 the holders of the A and B Ordinary shares of the company purported to hold an Extra-ordinary General meeting of the company and passed an Ordinary Resolution of the Company accepting the auditors' statement of 10th April 1984.

It is submitted, but not very strenuously, on behalf of Marketing that this resolution of 10th May had the effect of ratifying and confirming the payment of the dividend of £60,000 and curing anything that had been wrong with it.

Plainly, however, in my judgment, the resolution could not have had that effect as, apart from anything else, the company was by then insolvent and in liquidation. If the position immediately before the company went into liquidation was, as the liquidator contends, that the payment of the £60,000 dividend was ultra vires and Marketing was accountable to the company as a constructive trustee for the amount, or was otherwise liable to repay it to the company, then the statutory scheme for distribution of assets under the 1948 Act came into operation on the commencement of the winding up; thereafter the members had no power to override the liquidator's title or ratify to the detriment of the creditors anything done previously by the directors.

The main argument for Marketing, therefore, on this appeal has been that the auditor's statement of April 1984 shows that the company had profits available for dividend when the £60,000 was paid. The absence of an auditor's statement at that time was therefore, it is submitted, a mere procedural irregularity, and it is submitted that under company law a mere procedural irregularity has never been allowed to invalidate something done, as this was, with the unanimous agreement of all members entitled to vote at meetings of the company.

Reference is made to the well-known line of cases exemplified by Re Oxted Motor Company [1921] 3 KB 32.

I do not, however, regard compliance with paragraph (c) as a mere procedural matter which can be waived or dispensed with by the members entitled to vote. The group of sections beginning with section 39 and including section 43 is a major protection for creditors, and the requirement of paragraph (c) of an auditor's written statement, where the auditor's report in the relevant accounts has been qualified, is an important part of that protection.

The tenses used in paragraph (c) (". . . the auditors must have . . . . . stated whether that thing is material for the purpose of determining . . . . . whether that distribution would be in contravention . . ." ) show that the statement in writing by the auditors is to be available before the distribution is made. Compare Re Duomatic Ltd. [1969] 2 Ch 365 at 374 E - F. As it was not available before the dividend was paid, then, under subsection (1) of section 43, the requirements of section 43 were not complied with in the case of this dividend and the relevant section, section 39, is, by the mandatory terms of section 43(1), to be treated as contravened.

We are not concerned in this case with whether anything could have been done to restore the situation while the company remained solvent, by an ex post facto statement of the auditors and a confirmatory resolution of the members. In the present case what was done in April and May 1984 was too late on any view as the company was by then insolvent and in liquidation.

The payment of the dividend of £60,000 was therefore an ultra vires act by the company, just as if it had been paid out of capital or in any other circumstances in which under any of the other provisions of section 39 and the following sections there were not profits available for dividend.

In those circumstances, can Marketing have any defence to the company's claim for repayment of the £60,000 with interest?

In this connection, subsection (1) of Section 44 of the 1980 Act provides as follows:

"Where a distribution, or part of one, made by a Company to one of its members is made in contravention of the foregoing provisions of this Part of this Act and, at the time of the distribution, he knows or has reasonable grounds for believing that it is so made, he shall be liable to repay it or that part, as the case may be, to the company or (in the case of a distribution made otherwise than in cash) to pay the company a sum equal to the value of the distribution or part at that time."

There can be no doubt that because Mr. Wynne-Jones and Mr. King were the only shareholders in and directors of Marketing and were also the only directors of the company, Marketing must be taken to have known all the facts. But it did not in fact know the terms of sections 39 and 43.

I do not find it necessary to examine the wording of subsection (1) of section 44 since by subsection (2) the provisions of section 44 are declared to be without prejudice to any other obligation imposed on a member to repay a distribution unlawfully made to him. I would put the position quite shortly. The payment of the £60,000 dividend to Marketing was an ultra vires act on the part of the company. Marketing when it received the money had notice of the facts and was a volunteer in the sense that it did not give valuable consideration for the money. Marketing accordingly held the £60,000 as a constructive trustee for the company: see Rolled Street Products (Holdings) Ltd. v. British Steel Corporation [1985]2 WLR 908 at 949 per Lord Justice Slade and at 954 per Lord Justice Browne-Wilkinson. That situation did not change before the company went into liquidation.

Accordingly Marketing is, in my judgment, accountable to the company for the £60,000. It is nonetheless argued for Marketing, somewhat as an afterthought, that, even though Marketing has no locus standi to seek relief under section 448 of the Companies Act 1948, it might, if granted leave to defend, obtain relief at the trial under section 61 of the Trustee Act 1925. I cannot, however, for my part see any case whereby, under the guise of excusing a breach of trust under that section, the court could or would authorise Marketing to retain an ultra vires payment made to it by the company in breach of the statute; for the purposes of an application under section 61 the breach of trust to be excused would be the failure or refusal of Marketing to repay the £60,000 to the company, and the argument for relief would have to be the same argument which I have rejected in holding Marketing liable, that the making of the distribution in breach of the 1980 Act was a mere procedural irregularity.

Accordingly Marketing has, in my judgment, no defence to the company's claim for repayment of the £60,000 with interest. I would accordingly allow this appeal, set aside the order of the learned judge and restore, as against Marketing, the order of the District Registrar.

SIR EDWARD EVELEIGH: I agree.

Appeal allowed with costs. Application for leave to appeal to the House of Lords refused.