Unlawful Returns of Capital in the Context of Transactions at an Undervalue (Satyam Enterprises Ltd v Burton and another)

Distributions are known as every description of distribution of a company’s assets to its members, whether in cash or otherwise. Distributions allow company members to withdraw value from the company and they can take a variety of forms for example, they can be by way of gifts or charitable donations and dividends. Directors can be held to be in breach of their fiduciary duty should they take advantage and distribute value out of the company either in excess or at undervalue.

The case of Satyam Enterprise Ltd v Burton and another [2022] All ER (D) 23 August 2022 involved a transfer of properties between two companies which had the same director and shareholder. The Court had to consider whether the director was in breach of his directors’ duties because the consideration given for the sale of the properties was below the market value. There was a undervalue of £77,000.  The High Court held that the transaction was lawful because the defendant had intended to sell the properties at market rate and not extract value from the selling company. The ruling of this case was similar to the one given in the case of Progress Property Company Ltd v Moorgarth Group Ltd [2010] UKSC 55 where the Supreme Court held that the sale of the company assets was not unlawful as the director had genuine belief that the sale had been at market value. This case provides an example of the potential issues that a director may face when making distributions that are either in excess or under the market value.

More generally, the two basic requirements which need to be fulfilled when making a distribution are that the company must have profits available to make the distribution and secondly the distribution must be justified by reference to the relevant company accounts.

Safeguards are in place for distributions to protect the company’s creditors rather than the shareholders. The rationale is that if directors are allowed to make any form of distribution no matter the value, then this would ultimately compromise the potential creditors of the company as shareholders would have the unrestricted power to remove company resources.

A distribution will be unlawful if it either is undervalued or it is more than the available distributable profits. In the case of a distribution in excess, it will only become unlawful at the point in which it exceeds the company’s actual available profit.

Directors could also be liable under the Insolvency Act 1986, where a director makes a distribution of dividends and at the time the company is insolvent and there are no genuine grounds to believe that the distribution would benefit the company and the company subsequently goes into liquidation.

In such circumstances, the liquidator may apply for an order requiring any current or previous director to be held liable for wrongful trading. This is if it appears that the director was aware or ought to have known that the company was heading for insolvency.

To avoid being liable for undervaluing assets directors should obtain consent and approval prior to the transfer or sale of a business asset. There should be a professional valuation of the asset to ensure that the accurate price and value is given.

In regard to dividends, directors should not make any dividend payments unless they have up to date and accurate profit figures on which to base the authorisation on. This evidence needs to show that the company has sufficient available profits. If this is not the case, then no dividends should be paid.

While in the Satyam Enterprises case, the High Court held that there was no unlawful distribution and therefore no breach of the director’s fiduciary duty, what happens in cases where the judge holds that there have been unlawful distributions by a director?

In such a case, the director at fault will be in breach of their statutory and common law duties but they may also find themselves personally liable to repay the company for any shortfalls caused by the unlawful distribution. However, this is as extensive as it gets as the Company Act 2006 does not impose any criminal sanctions on the director.

The ruling in the Satyam Enterprise case provides guidance to directors that they will be in breach and may be held personally liable if they undervalue transactions. However, it should be stressed that transfers which are undervalue do not automatically mean that there has been an unlawful distribution of capital. In order to ascertain whether there has been a breach of directors’ duties there needs to also be evidence to show that the director had intention to undervalue. In regards, to dividends, a director cannot use the defence that they were unaware of the company accounts before issuing dividends, as it is part of their duties to be up to date with the company’s accounts. While there are no criminal ramifications for both, it is advisable that directors act accordingly and adhere to their duties to avoid any breach and personal liability, as breaches can also lead to a 15-year disqualification.