Key takeaways
- The director of a company was held to have breached his fiduciary duties to the Company by declaring dividends at a time when the Company was in a financially parlous situation.
- The Company was found to be in a financially parlous situation after taking into account contingent liability for a law suit that the director had been advised the Company would likely win. Judgement in the law suit (which went against the Company) was only given some two years after the dividends were declared.
- Liability was imposed entirely separately from any consideration of section 403 of the Companies Act 1967 which requires directors to declare dividends only out of profits and gives creditors a claim against the directors for any dividends declared in excess of profits.
Claim to recover dividends and repayment of shareholder’s loans made
A director has a duty to act in the interests of the company. In determining the interests of the company, the law considers the interests of company’s creditors once the company is in a financially parlous situation.
In OP3 International Pte Ltd v Foo Kian Beng [2022] SGHC 225 (15 September 2022), OP3 International Pte Ltd (Company) carried on a business of interior decoration and had been sued by a former client for negligence in the works it carried out. It was eventually found liable for the sum of S$534,189. It was put into liquidation.
The Company, through its liquidator, then brought a claim against its director, who was also its shareholder, for breaching his directors’ duties owed to it. A few years prior to the judgement in the case for negligence for work done, the director had procured that substantial amounts in dividend payments and loan repayments were made to him. The liquidator sought to recover these sums from him on the basis that in making those payments, he had breached his fiduciary duty to the Company as the Company had been in a financially parlous situation at that time. In procuring the Company to make those payments, he had failed to act in the best interests of the Company, as determined by the interests of its creditors.
Directors to make a practical assessment of company’s financial health
The Court noted that past cases had stated that a director’s duty to consider the interests of a company’s creditors arises when a company is on the verge of insolvency or in a parlous financial situation. However, it noted that the real difficulty is that it remains unclear when one would consider a company to be in a parlous financial situation or on the verge of insolvency. It then stated that there is no fixed or static point on a continuum to determine whether the company is in a parlous financial situation or on the verge of insolvency. Accordingly, whether and to what extent the director should consider the interests of creditors requires a practical assessment of the financial health of the company.
The table below summarises the key dates, findings and holdings of the Court. However, the following key takeaways can be extracted:
- A key factor in determining whether the Company was in a financially parlous state was the potential liability for the negligence claim against it. In this respect, the Court ruled that the point at which the director had to consider and apply a contingent liability to the Company’s financial situation arose at the point the statement of claim was served on the Company in 2015. This point in time is prior to the actual decision on liability (which only took place in 2017) and the award of the determined judgement sum (which only took place in 2019).
- The amount to be taken into account for the contingent liability was held to be around 40% of the amount claimed. This is because the director had taken and received legal advice that the Company had a strong defence and would be likely to win the suit. Hence, instead of accounting for the contingent liability at the full S$1.4 million claimed, the Court applied a discount of around 60-65% and arrived at the sum of around S$441,000 – S$514,500.
- It is noteworthy that notwithstanding that the director reasonably believed based on legal advice that the Company would win the law suit, he was still required to apply a contingent liability to his assessment of the Company’s financial situation. This is significant as it is after the application of contingent liability as assessed by the Court that the Court determined that the Company was in a financially parlous situation, thereby calling into question the payment of dividends. Accordingly, a director should bear in mind that a contingent liability should be taken into account even if the director is of the view that the contingency is not likely to arise.
- When considering the issue of dividend payments, it is usual to focus only on section 403 of the Companies Act 1967, which provides that no dividend is payable except out of profits and further that the directors will be liable to creditors for the amounts paid in excess of profits. The Court in this case ordered that the director pay the Company the amount declared as dividends in breach of his duty to the Company as losses caused by his breach of duty. As the creditors did not bring a claim based on section 403, it is not clear whether there were profits as set out in the accounts. But if this case is not overturned on appeal, it suggests that in declaring dividends, it is not enough for directors to only consider the issue of profits but also whether the company is in a financially parlous situation taking all contingent liabilities into account.
