Kort Egan takes a look at Re Bronia Buchanan Associates Ltd (in liquidation)  EWHC 2740 (Ch)
In Re Bronia, ICC Judge Burton had to consider whether a director could retrospectively re-characterise a director's loan as 'drawings' in order to release the director from liability to the company. ICC Judge Burton concluded that such an approach was impermissible.
The joint liquidators of Bronia Buchanan Associates Limited ("the Company") applied for declarations that the sole director, Ms Bronia Buchanan ("the Director"), was a debtor of the Company in the amount of £286,421.45 (or such other sum as the Court thought fit) and that the reclassification of the sums outstanding on the director's current account on 10 September 2014 as 'drawings' was ineffective to release the Director's liability to the Company.
The Company was incorporated in June 2003. The Director engaged a bookkeeper in 2007. The Director switched to a new firm of accountants, Blinkhorns, on the bookkeeper's recommendation. The bookkeeper reassured the Director from 2007-2010 that "all was well financially" but in late 2012 the Director received demands for unpaid tax from HMRC and it became apparent that there was problems with the accounting carried out by the bookkeeper. The bookkeeper was dismissed and a new bookkeeper employed. The former bookkeeper refused to release the electronic files unless a substantial payment was made. That sum was not paid and so the new bookkeeper was left with incomplete records.
Blinkhorns produced the accounts for the year ending June 2013. The Director stated that she was heavily pregnant and suffering from pre-eclampsia when she was asked to sign off the accounts in March 2014. The Director accepted that she was not able to devote time to considering the accounts in detail and had signed off the accounts without due consideration.
On 18 August 2014, HMRC demanded £127,541.04 be paid within 7 days. The Company could not meet that demand in the prescribed timeframe and the Director instructed her a solicitor, Mr Drew, to advise. Mr Drew was also the Director's husband. The Company ceased trading in September 2014 and entered liquidation.
Mr Drew sought professional advice from a Mr Lewis. Mr Lewis was appointed joint liquidator of the Company on 2 December 2014 and was formerly the senior partner of the firm of insolvency partners in which the other joint liquidator, Mr Bass, was a partner.
Mr Drew's evidence was that Mr Lewis advised him that the director's loan should be identified as drawings rather than loans as it appeared that was what they were given the minimal salary the Company had paid the Director.
The Director and Mr Bess contended that, pursuant to that advice, the appropriate entries were made in the Company's accounts to correct the outstanding 'loans' as 'drawings' ("the Reclassification").
Following an interview at the liquidators' office, Mr Bass wrote to the Director on 24 July 2015 explaining that he did not consider that the Reclassification accurately recorded the true nature of the payments and that, in his view, the Director remained indebted to the Company for the Reclassification Amount.
The Director contended that the amounts received from the Company should have been recorded as salary at all times. It was submitted that the annual salary received by the Director of £6000 was not commensurate with a director who often worked 15 hours a day for a business with an approximate annual turnover of £500,000, eight employees and, at one time, more than 400 clients.
The Director accepted that she ought to have declared the payments to HMRC as income but sought to excuse that failure by saying that at all material times she relied on the advice of professional advisers.
It was also submitted that, pursuant to Section 5 of the Limitation Act 1980 ("the LA 1980"), all of the amounts comprising the Reclassification Amount were sums due under a contract and because each amount became due in year-end accounts from 2010-2013, the six-year limitation period had expired by the time the application was issued on 30 November 2020.
ICC Judge Burton referred to the principles summarised by District Judge Kelly in his approved ex tempore judgment in Henderson & Jones Limited v Garry Patrick Price  EWHC 3276 (Ch). That judgment refers to the following dicta amongst others:
- "I am satisfied that, whether it is to be viewed strictly as a shifting of the evidential burden or simply an exchange of the well-settled principle that a fiduciary is obliged to account for his dealings with the trust estate, that Mr Aslett is correct to say that, once the liquidator proves the relevant payment has been made, the evidential burden is on the respondents to explain the transactions in question" – Lesley Anderson QC in Re Idessa (UK) Limited  EWHC 804;
- "Moreover, persons who have conducted the affairs of limited companies with a high degree of informality, as in this case, cannot seek to avoid liability or to be judged by some lower standard than that which applies to other directors simply because the necessary documentation is not available..." – Arden LJ, as she then was, in Re Mumtaz Properties Limited  EWCA Civ 610;
- "I do not consider that such periodic drawings can simply be re-characterised as remuneration as and when it might suit one of the recipients so to contend. Or at least that cannot be done without acknowledging that the manner in which they had previously been disclosed to HMRC had been incorrect, with all the consequences in terms of the payment of additional tax, interest and penalties that this might entail" – Snowden J in Re The Skey Wheels Group of Companies Limited  EWHC 1112.
The judge accepted Mr Lewis' evidence that he did not advise that the director's loan should be reclassified as 'drawings'.
The judge noted the following facts:
- A file note from Blinkhorns dated 2 March 2011 recorded that the Director had been informed that there were insufficient reserves to meet the amounts that the Director had taken out of the Company and that the amounts due should be repaid;
- The Director acknowledged in her letter of instruction to Blinkhorns dated 28 March 2012 that the balance on her director's loan account was £83,780.96;
- The accounts ending on 30 June 2011 expressly referred to the Director owing the company £83,781;
- Blinkhorns expressly stated in a letter to the Director of 27 March 2014 that the director's loan account consisted of "monies that you have drawn from Bronia Buchanan Ltd over the years which have not been cleared by either a salary or dividends and therefore, they stand to be repaid";
- The Company's annual accounts dealt separately with the salary and dividend payments made to the Director each year;
- Taking into account monthly payments and the Director's official salary of £6000 per annum, the Director received payments at an annual rate of approximately £61,000 in the period leading up to the Company's liquidation.
ICC Judge Burton stated at paragraph 86:
"In my judgment, it is simply not open to a director to recreate history and the basis upon which they have historically received money from a company. Following Re Idessa, having established by reference to the Company's accounts that significantly more was paid to Ms Buchanan than was expressly accounted for as salary or dividend, the burden of proof lies with Ms Buchanan to show that she was entitled to receive those monies."
The judge found that, as reflected by the failure to declare them as such, the payments from the Company's account were not, nor were they ever intended to be salary for which the Director would be liable to pay income tax and national insurance. The judge also noted that no evidence was provided that a resolution had been passed pursuant to the Company's articles of association in respect of the amounts claimed to be paid by way of 'drawings'.
The judge also rejected the Director's limitation defence. Counsel for the Applicants submitted that there was no contractual period within which the loan was to be repaid and so the relevant section of the LA 1980 was section 6.
ICC Judge Burton held that pursuant to section 6(2) of the LA 1980 the time for payment did not begin to run until a demand was made by the Company for the Director to repay the debt. The Director made no demand and the first formal demand was made on 10 March 2017. Proceedings were commenced within six years of that date and hence limitation had not expired.
The Director did not dispute quantum. As a result, the judge found that £286,421.45 was to be paid plus interest. That sum consisted of the balance on the director's loan account in addition to the sum which was shown as an outstanding liability on the Director's drawings ledger.
The case should stand as a stark warning that directors cannot recreate history and the basis upon which they have historically received money from a company.
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