Payments to directors must be fair to the company

27 November 2016

There are numerous obligations placed on directors of a company to ensure that the interests of shareholders and creditors are protected. Clearly, shareholders’ investments in a company and creditors’ ability to be repaid by the company would be prejudiced if the directors were able to pay themselves without any restriction.

Companies Act requirements

Under section 161 of the Companies Act 1993) the directors may bestow a benefit on a director (such as payment of a salary, the making of a loan or the giving of a guarantee for debts incurred by a director) if the directors are satisfied that to do so is fair to the company. The right to give a benefit to a director is subject to any provision in the company’s constitution. Directors who authorise the payment, benefit, loan or guarantee must sign a certificate stating that, in their opinion, the payment or benefit is fair to the company. They must also state in the certificate the grounds for that opinion. If the requirements of section 161 are not complied with, or the directors did not have reasonable grounds for their opinion that the benefit was fair to the company, then the director who received the benefit will be personally liable to repay the amount of the benefit (except to the extent to which the director proves that it was fair to the company at the time it was made).

Claim by liquidators for payments of salaries to directors

The requirements of s 161 are often not met. While the company is trading successfully this doesn’t usually cause any problems for the directors. However, it can become a problem if the company is placed into liquidation. In the case of liquidation the liquidators will be looking for ways to recover any payments made from the company (whether to directors, shareholders or parties outside the company) so that the company’s creditors can be repaid and any remaining value returned to the shareholders. That situation arose in the case of Madsen-Ries v Petera.

In Madsen-Ries v Petera, the directors of a trucking company in financial difficulty had paid themselves salaries without complying with the requirements of s 161. Among various claims made against the directors in legal proceedings brought against them by the liquidators was a claim for repayment of those salaries. The Court of Appeal upheld the High Court Judge’s decision that the payments were fair because the company gained full value from the work carried out by the directors, but was of the view that determining fairness to the company did not involve considering the interests of creditors. It went on to say that the decision by the directors to “purchase” services from one of their number is no different from any other trading decision they make, and that the directors could still be liable where payment was made to them in breach of other duties imposed on them – such as the duty not to trade recklessly. (Other directors’ duties which could be breached in these circumstances are the duty to act in good faith in the interests of the company, the duty to exercise their powers for a proper purpose and the duty to exercise powers for a proper purpose.)

You’re a director

If you are a director of a company and you want to make sure that you will not be required to repay any payments made to you or benefits conferred on you by the company, you should ensure that the requirements of s 161 of the Companies Act are met. You should also ensure that you fulfil the duties imposed on you under the Companies Act. If you are not sure how to meet the requirements of s 161 or whether you are meeting your responsibilities under the Companies Act you should take professional advice.

Please email me at [email protected] with your ideas for future articles. Keep an eye out for next month's column, where I will discuss another relevant rural legal issue.

Barbara McDermott is a partner of Norris Ward McKinnon, specialising in commercial and rural law. With offices in Hamilton and Huntly, we have friendly, expert legal advisors ready to help you with your business and personal legal matters.

Barbara McDermott