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Overdrawn director’s loan account cannot be reclassified as remuneration when it suits - Bass v Buchanan considered

In the case of Bass & Ors v Buchanan [2021] EWHC 2740 (Ch), sole director Bronia Buchanan was ordered to repay her director’s loan account balance of £286,421.45 which she had retrospectively sought to re-characterise as remuneration. The case serves as a useful reminder that a director cannot escape a misfeasance claim by seeking to reclassify the nature of payments made to them after the event.

Background

Talent agent Bronia Buchanan incorporated Bronia Buchanan Associates Limited,  which we will refer to as the Company in this article, in 2003 as its sole director and shareholder.

In 2007, the Company instructed bookkeepers who had explained they could provide attractive tax structures.

Ms Buchanan received a salary of £6,000 per year. Since 2007, Ms Buchanan also had a substantial overdrawn director’s loan account, DLA, having paid herself a further c.£3,000 per month, and with the Company not having been profitable enough to declare sufficient dividends to clear the DLA.

Ms Buchanan claimed the bookkeepers had told her "all was well financially" but in 2012 the Company received a demand from HMRC for unpaid tax. In August 2014 the Company received a letter from HMRC demanding payment in full in 7 days.

The director sought legal advice from her solicitor husband, who in turn approached insolvency practitioners in relation to the Company’s insolvency, sending a memo stating “The balance sheet shows a director’s loan has been in existence since 2007 and currently has a balance of £201,562”.

In September 2014 the director’s husband met the insolvency practitioner Mr Lewis at the Ivy, which we will refer to as the Ivy Meeting, at which meeting he claimed he was advised the Company should identify the DLA funds as drawings rather than loans, given Ms Buchanan’s minimal salary. The director accordingly instructed the bookkeeper to amend the loans to appear as drawings to “regularise the position prior to liquidation” – which the Company became subject to in December 2014 with the appointment of Mr Lewis and Mr Bass as joint liquidators.

Claims

The liquidators claimed that the reclassification of the payments as drawings rather than loans did not accurately reflect the reality and that the director remained indebted to the Company. A claim was issued in November 2020 after correspondence commenced on the issue some 5 years previously with a formal letter of claim sent in March 2017.

The case came before ICC Judge Burton in July 2021.

Mr Lewis, by now retired and no longer a joint liquidator, gave evidence in relation to the Ivy Meeting seven years prior, stating that he would never have advised to reclassify the DLA as drawings. He had been a licensed insolvency practitioner since 1986 and chartered accountant for 50 years and there was no mention of drawings in emails before or after the Ivy Meeting. The court accepted that he had not given advice to reclassify the DLA at the Ivy Meeting.

Despite assertions that she exclusively relied on the Company’s bookkeepers, contemporaneous file notes and emails from the Company’s accountants from 2011 to 2014 clearly demonstrated that Ms Buchanan was aware that the overdrawn DLA was problematic. The accountants had explained that the debt would be due from Ms Buchanan personally if the Company went into liquidation and Ms Buchanan had stated the loan would be repaid in 2012.

Despite the contradictory file notes, Ms Buchanan claimed she did not breach her duties to the Company, as she had relied on professional advice, acted honestly and reasonably and the reclassification reflected the true position of the remuneration paid to her.

Court decision

The judge held that it is simply not open to a director to recreate history and the basis upon which they have historically received money from a company. Following Re Idessa (UK Ltd) [2011] EWHC 804 (Ch), the liquidators had established that significantly more had been paid to Ms Buchanan than was accounted for as salary or dividend, and as such the burden of proof lay with the director to show that she was entitled to receive those monies.

The judge considered Global Corporate Ltd v Hale [2018] EWCA Civ 2618 (which we discussed in detail here) where the director had issued interim dividends when the company was insolvent and claimed he had a quantum meruit entitlement to those funds, which was rejected. Applying Hale in this case, ICCJ Burton rejected any claim for quantum meruit from Ms Buchanan and found the funds had been borrowed against the hope of future dividends. As these did not materialise, the loan was repayable.

Finally, Ms Buchanan’s counsel argued that the claim was statute-barred as the outstanding balance of the DLA dated from 2010 to 2013, and claimed the six year period had expired. The judge found there had been no contractual period set for the loan to be repaid, and the director had never issued a demand on herself. As such the first ‘demand’ was the liquidators’ letter of claim in March 2017 and therefore the claim was well within the limitation period.

As the sums due were held to be a debt to the company and were not salary or a dividend, Ms Buchanan was ordered to repay £286,421.45 plus interest.

Comment

Following the widely reported case of Global Corporate Ltd v Hale, there has been little further commentary or guidance provided by the courts on the reclassification of dividends or payments to directors. This case serves as a useful, and welcome, reminder to insolvency practitioners that directors are not able to seek to reclassify payments after the event in order to avoid their liabilities, or to rely on quantum meruit arguments to justify their overall remuneration. Essentially, if directors will seek to avail themselves of the popular and ‘tax efficient’ approach by receiving minimal salary, any payments in excess are vulnerable to becoming repayable if the company ultimately faces solvency difficulties.

For more information on this article please contact Olivia Reader or another member of our Restructuring & Insolvency team.

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