Directors' duties in the context of dividend declarations and repayment of shareholder loans

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. Judgment 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 judgment 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 judgment 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. 

Jan 9, 2014

• Event: Defects discovered in work done by the Company

Jan 17, 2014

• Event: Rectification works by the Company finished
• Contingent Liability / Company's Financial Situation: Liability for suit not likely to materialise at this point. No contingent liability arose at this point.
• Decision on Breach of Directors' Duties: The Company was not in a financially parlous situation at this point.

Jan 21, 2014

• Event: Further defects discovered in work done by the Company

Aug 22, 2014:

• Event: Letter of demand sent to the Company

May 22, 2015:

• Event: Statement of claim filed in court against the Company

May 25, 2015:

• Event: Statement of claim served on the Company
• Contingent Liability / Company's Financial Situation: Contingent liability for the suit arose at this point in time. Even though the Company believed based on legal advice that it had a strong defence and would win, there was objectively some liability that could arise. The Court took the full amount claimed and applied a discount based on the director’s assessed belief as to how likely it was that the Company would win. The Court then assessed that the director should have applied a contingent liability of between S$441,000 – S$514,500 to the Company’s liabilities from this point onwards.
• Decision on Breach of Directors' Duties: The Company was not in a financially parlous situation or on the verge of insolvency at this point: The Company had secured five contracts; and Accounts for the end of the year showed that the Company had substantial funds in cash and in the bank. 

Dec 11, 2015:

• Event: The Company’s accounts showed that it had cash and cash equivalents of S$1,136,982, a bank balance of S$1,289,216 and other net assets of S$1,136,982.

Jul 13, 2016:

• Event: Dividends for 2015 paid (S$400,000)
• Contingent Liability / Company's Financial Situation: Despite the fact that the Company was facing a sharp drop in business, based on the accounts as at 31 Dec 2015, and taking into account the contingent liability arising from the suit, the Company was still solvent at this point.
• Decision on Breach of Directors' Duties: Procuring the payment of the dividends was not a breach of the director’s duties. 

Dec 27, 2016:

• Event: Further dividends for 2015 paid (S$500,000)
• Contingent Liability / Company's Financial Situation: Company’s accounts as at 31 Dec 2016 showed that it had net assets of S$157,683 without factoring in the liability for the suit. Taking into account the amount of contingent liability, the Company would have been balance sheet insolvent at this point. (Note: At this point in time, the law suit was still in progress, judgment on liability was still 10 months away and the director believed that the Company would win in its defence.)
• Decision on Breach of Directors' Duties: Procuring the payment of the dividends was a breach of the director’s duties. The director was ordered to repay this sum as damages for breach of directors’ duties.

2017:

• Event: Loan by director to Company repaid (S$682,394)
• Contingent Liability / Company's Financial Situation: Procuring the repayment of the loan was a breach of the director’s duties. The director was ordered to repay this sum as damages for breach of directors’ duties.

Oct 5, 2017:

• Event: Judgment granted to the plaintiff; the Company was found liable for the damage suffered. 

Nov 11, 2019:

• Event: Damages in the suit quantified at S$534,189 (Note: After judgment on liability, there would have been further proceedings for the assessment of damages. Damages would only be quantified after a decision in those proceedings.)