June 2011 – Dividends and directors’ loans are risky business


Business Law Update
June 2011

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Gary CousinsWelcome to our June newsletter. 

This month we have some advice for directors of limited companies on how to avoid finding yourself on the wrong side of the law when it comes to how you get paid. There’s some plain English legal advice on new rules affecting ALL websites and a round up of useful pointers from our blogs.

We hope you will find information relevant to your business in this month’s issue. Email your article suggestions or legal questions to marketing@business-lawfirm.co.uk.       

Gary Cousins
0121 778 3212

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Dividends and directors’ loans are risky business

Many directors of small businesses are taking huge risks when it comes to paying themselves, without realising – and it is often on their accountant’s advice.

It is very common that a company’s accountant will advise directors of owner-managed companies to take the majority of their pay as dividends with either no salary or a very low one. This has a financial advantage, particularly as far as national insurance contributions are concerned. The director then simply draws a monthly sum from the company’s bank account to live on and, at the end of the year, these monthly drawings are declared as a dividend.

The director comes away from such an arrangement feeling pleased that they have saved money from going to the taxman but little do they realise the huge risk they are taking with their family’s livelihood.

The worst case scenario (which unfortunately is becoming all too frequent these days) is that, after the company goes into liquidation or administration, or after the company is sold, a claim is made against the director to pay back up to 6 years’ pay!

From an accounting perspective, the monthly drawings are treated as loans from the company to the director. What many directors don’t realise, however, is that this type of loan to a director is only legal if there is a shareholders’ resolution approving it coupled with a ‘memorandum’ setting out the nature of the loan, the loan amount, its purpose and the extent of the company’s liability. There is an exception for a loan of not more than £10,000 but, as most directors wouldn’t be satisfied with annual earnings of £10,000, this is unlikely to be helpful.

So the first thing you need is a shareholders’ resolution coupled with a memorandum. Most accountants now realise this and will help you in drafting the paperwork.

But this is only half the problem. There are strict rules as to when dividends can be paid. For example, they can only be paid out of profits and cannot be retrospective. The idea is that you look at your profits and, if sufficient, you can declare a dividend that is then paid out. What you cannot lawfully do is backdate a dividend declaration to try to make a loan payment look like a dividend payment.

Backdating a dividend declaration is fraud and the courts do not like it, so don’t expect any sympathy from that direction.

So what can you do? Well, you should keep it legal and not pay yourself in this way. Often taking remuneration as a salary, or as payment for your services, is the best bet but this must be allowed in your company’s articles.

Alternatively, you can do what most directors in this situation do and hope for the best. After all, you don’t plan to sell the company any time soon, you and your fellow directors get on well and will never fall out with each other, and it won’t be your company that becomes insolvent, will it?

If none of these things happen, it’s unlikely that you’ll be found out. But, then again, if they do, and someone takes a close look at the company paperwork (as a liquidator for example is likely to do), you could find yourself having to pay back up to 6 years’ pay.

If you ever do find yourself at the wrong end of a claim for repayment of remuneration, take advantage of our offer of 30-minutes' free advice.

Plain English Legal Advice

New rules on use of cookies affect all websites 
New rules on the use of cookies by website operators came into force on 26th May 2011. You could be forgiven for having missed this change as guidance from the Information Commissioner’s Office (ICO) was only issued at the end of May. But any business with a website needs to know about the new rules and decide what changes need to be made to their website.

The main effect of the new rules is that, if you are a website owner, you will need consent from a user of your site to store a cookie on their computer. The ICO recognises that cookies perform a number of legitimate functions and that obtaining consent will, in many cases, be a challenge.

Nevertheless, the ICO states that the one exception to the need for consent will be interpreted narrowly. That exception is when a cookie is strictly necessary to deliver a service which has been explicitly requested by the user, such as is the case for online shopping baskets. The exception will not apply if you as a website operator decided, for example, that your website would operate better or be more attractive to users if it remembered their preferences or if it used a cookie to collect statistical information about the use of your website.

The good news is that the ICO has agreed to allow websites until 25th May 2012 to comply with the technical solutions of obtaining consent to cookies. However, it will still expect website owners to be able to demonstrate that they are taking steps to comply before this deadline and this will certainly mean that websites will need to conduct audits on how cookies are used and to keep evidence that this has been done. Further guidance has been issued by the ICO as to how they propose to enforce the new rules - the Privacy and Electronic Communications (EC Directive) (Amendment) Regulations 2011 to give them their full title.

So what should you do now? Read more detailed advice on Sue Mann’s blog here.

For further information on the legal implications of this change of rule for your business, contact Sue Mann on 0121 246 4437 or by email.
Blogs in brief 

Should you lend money to friends and family?
Ever been asked to provide a short-term loan to a friend or family member? Emotional pressure might have been very great and might even have clouded your judgement. Solicitor Nigel Musgrove provides some sound advice for anyone considering lending money to a friend in his latest blog.

How earthquakes, terrorist attacks and extreme weather affect your contracts
Acts of war, extreme weather conditions or a terrorist attack might seem like good enough reasons not to be held to deadlines or the precise terms of a contract. But this is not always so. Read more.

Leasing business premises – F is for forfeiture
Forfeiture is the landlord’s right to re-enter business premises and bring a lease to an end. In general, a lease can be forfeited where the tenant does not pay the rent, breaches the other terms of the lease or becomes insolvent. Read more.

Useful Links

Beginners guide to pitching for large contracts
If you are interested or involved in pitching for government or large company contracts you needs to know your RFIs (request for information) from your RFPs (request for papers). Real Business has published a useful article on this subject.

Tips from fellow business owners
Accounting software firm Sage has published 100 great business tips to help you and your business move forward. Compiled by asking business customers for their tips, we particularly liked number 24 from Caroline Murphy of cmdesigns: “Something I learned early on (and the hard way) is that it is always best to have a contract or written agreement before starting any work. It also helps having a friendly solicitor if it all goes belly-up!”

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Cousins Business Law is a member of the Law Society & regulated by the Solicitors Regulation Authority under number 485128. Head Office: Swan House PO Box 11543, Birmingham, B13 0ZL. Tel +44 (0)121 778 3212. Fax: +44(0)121 275 6155