Hollingworth Instruments: connected-party dealing and unlawful distributions
Hollingworth Instruments Ltd is a private company with three shareholders: Arjun (55%, managing director), Beth (30%, finance director) and Carl (15%, an employee shareholder with no board seat). The last filed accounts show net assets of £900,000 but profit and loss reserves of only £120,000. In March the company contracted to buy a workshop unit from Arjun's wife for £420,000; an independent valuation puts it between £350,000 and £450,000. In July the board declared and paid a dividend of £200,000, which took the reserves into deficit. In September the company lent Arjun £80,000 interest-free to help him buy a house. In October the board granted him a five-year service contract with a guaranteed minimum term. None of these steps was put to the members, and no declaration of interest was minuted. Beth has now resigned from the board and Carl is demanding answers.
1. What member approval did the purchase of the workshop unit require, and could it still be obtained?
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Buying a non-cash asset from a person connected with a director is a substantial property transaction under sections 190–196 CA 2006. Arjun's wife is a person connected with him under section 252, so the arrangement is caught. The section 191 threshold is met on any view: the asset value of £420,000 exceeds £100,000, and it also exceeds 10% of the company's asset value. The transaction therefore required prior approval by ordinary resolution of the members; none was sought, so it is voidable at the company's instance under section 195, and Arjun and his wife may be ordered to account for gains and indemnify the company for losses. The section 195(2) restitution defences are unlikely to assist where a valuable asset remains in the company's hands and money has moved out.
Independently, Arjun should have declared his interest to the board under section 177, and the conflict engages section 175.
Approval could still be sought, but it must be given by disinterested members. Section 223 disregards Arjun's own vote, leaving Beth and Carl-45% of the issued shares but 100% of the votes cast-able to pass the resolution by simple majority. Without full disclosure of the valuation, that resolution would itself be attackable.
2. The £200,000 dividend: what was unlawful, who must repay it, and what is Beth's exposure?
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A company may only distribute profits available for the purpose under section 830 CA 2006, measured by reference to the relevant accounts under sections 836–837. Hollingworth's reserves were £120,000, so £80,000 of the dividend had no lawful source. Strong net assets of £900,000 do not help: distributable profit is accumulated realised profits less realised losses, and unrealised revaluation surpluses or share capital cannot be distributed.
The consequence under section 847 is that the recipient of an unlawful distribution who knew, or had reasonable grounds for believing, that it was unlawful must repay it. Carl, a non-director who may simply have received a routine dividend, has a good argument that he did not know. Arjun and Beth, as directors who authorised the payment knowing the reserves, plainly did.
Directors who authorise an unlawful distribution in those circumstances are also liable to repay or compensate the company, and breach of section 171 (acting within powers) and section 172 is engaged. If the accounts used were properly prepared and complied with section 836, the members are protected and the directors' liability shifts to the quality of those accounts. Here the board knew the reserve figure, so section 847 exposure is real. Beth faces a personal repayment claim and possible disqualification risk if the company later fails.
3. What approvals were needed for the £80,000 loan and the five-year service contract, and what follows from the failure to obtain them?
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A loan to a director requires member approval under section 197 CA 2006. The section 207 exemption applies only to loans not exceeding £10,000, so a loan of £80,000 is well outside it. Failure to obtain approval makes the loan voidable at the company's instance under section 213, and Arjun must account for any benefit and indemnify the company against loss. The loan also raises the section 175 conflict and, if it remains outstanding, questions about whether it is repayable on demand and whether it constitutes a de facto distribution.
A service contract guaranteeing a term of more than two years needs member approval under section 188; five years plainly does. Under section 189 the offending term is void and the company may terminate the contract at any time on reasonable notice, and the director must repay payments made under the void term. Section 217 additionally restricts payments to a director for loss of office without approval.
In each case the same arithmetic applies as for the property: Arjun's vote is disregarded under section 223, and Beth and Carl together can approve. The practical advice is to hold a general meeting immediately with full disclosure, ratify what can be ratified, unwind what cannot, and record the interests properly.