Directors’ duties, dividends, and when payments are unfair

Michael Routledge v Richard James Skerritt, Catherine Yvette Gabrielle Skerritt, Skerritt Consultants Limited [2019] EWHC 573 (Ch).

In general, the ownership of shares in a company does not give the shareholder an automatic right to receive a dividend. The company’s articles can provide the extent to which a certain share carries a right to a dividend, and even if the right exists, a shareholder can receive dividends only if payment is recommended by the board of directors, acting in accordance with its powers.

In Routledge v Skerritt and Others, the High Court found that payment of dividends in respect of one class of shares, in preference to another, constituted unfairly prejudicial conduct and a breach of directors’ duties, in circumstances where the existence of a dividends policy had been contemplated but not formalised.

Background

Mr and Mrs Skerritt were directors of Skerritt Consultants Limited (the Company), a financial services company for which Mr Routledge, an IFA, worked on a commission basis. The Skerritts and Mr Routledge were friends and agreed that Mr Routledge should purchase shares in the Company. A special resolution was passed in 2005, which redesignated the 10,000 ordinary shares in the Company as 9,500 ordinary A shares and 500 ordinary B shares. Mr Routledge purchased the 500 B shares in the Company between 2005 and 2007 for £50,000.

The special resolution set out the rights attached to the A and B shares. In respect of the A shares, these included the right of the holder to receive dividends declared by the Company “before all other ordinary shareholders of the Company” and “in accordance with the policy in relation to dividends as made and as amended by the Company’s Board of Directors from time to time”. In respect of the B shares, these included the right of the holder to receive dividends declared by the Company “but only to the extent that there are profits available for distribution after the declaration of dividends to which the ordinary ‘A’ shareholders of the Company are entitled” and “in accordance with the policy in relation to dividends as made and as amended by the Company’s Board of Directors from time to time”. In respect of the B shares, these included the right of the holder to receive dividends declared by the Company “but only to the extent that there are profits available for distribution after the declaration of dividends to which the ordinary 'A’ shareholders of the Company are entitled” and “in accordance with the policy in relation to dividends as made and as amended by the Company’s Board of Directors from time to time”.

The parties also entered into a shareholders’ agreement in 2005 which provided that “dividends shall be declared in accordance with the policy on dividends as set out by the Board from time to time.”

The Board never implemented a dividend policy. However, between 2007 and 2017, dividends in the sum of over £8 million were paid to Mr and Mrs Skerritt, with further dividends going to Mr Skerritt in 2018. No dividends were paid to Mr Routledge, a fact about which he complained to Mr Skerritt only in 2014."

In 2017 Mr Routledge presented a petition under s.994 of the Companies Act 2006 (CA), asserting that his interests as a member of the Company had been unfairly prejudiced by reason of the non-payment to him of dividends on his B shares. Mr Routledge contended that as a result of the 2005 special resolution and the shareholders’ agreement both classes of shares had the right to receive dividends. He claimed that Mr and Mrs Skerritt had breached their duties as directors of the Company by conducting its affairs in such a way that they received all the dividends paid by the Company, whereas Mr Routledge received nothing, and by failing to give proper or genuine consideration as to whether any dividends should be paid in respect of the B shares.

The standard of conduct expected of directors

It is settled law that acts and omissions of directors in breach of their duties can constitute unfairly prejudicial conduct of a company¹ and that directors have a duty genuinely to consider whether to make distributions of the company’s profits to members². The judge in this case found that this is an aspect of a director’s duty under section 172 CA to act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to the need to act fairly as between members of the company.

She went on to conclude that ‘it is well-established that directors are obliged to give genuine and regular … consideration to the question of whether the company’s profits should be distributed to shareholders. Where there are different classes of shares with different rights as regards dividends, the directors would be obliged to consider the position in respect of each class, having regard to the requirement under section 172 of the 2006 Act to act fairly as between different members.’

On the facts, the judge found that although A shareholders had the right to receive dividends in priority to B shareholders, A shareholders did not have an ‘unqualified right.’ Dividends should have been declared in accordance with a dividends policy according to the wording of the special resolution and the shareholders’ agreement.

The decision in relation to dividends “is not a decision which is ‘at large’ or where the Company, whether at a board meeting or general meeting, has a complete discretion to declare dividends in favour of the A shareholders. Rather, decision makers are constrained by the board policy in relation to dividends and, without it, they cannot properly identify the evidence which can be declared in favour of the A Shareholders before the B shareholders.”

The existence of the board policy in relation to dividends was found to be critical to identifying the difference between the rights of A and B shareholders. Without it, the judge found there was no basis on which to treat the A and B shares differently in respect of dividends and they ranked pari passu in that regard, in accordance with the default position as a matter of law³. As such, depriving Mr Routledge of his entitlement was unfair.

The judge concluded that had the directors of the Company properly considered the payment of dividends as part of their duties, then they would or should have realised that not paying dividends on Mr Routledge’s B shares was unfair and unreasonable.

Moreover, the judge held that the Skerritts had breached their duties as directors by failing to adopt a valid dividends policy as required by the Special Resolution and the shareholders’ agreement, thereby also failing to take into account the need to act fairly between members and failing to exercise reasonable care, skill and diligence. No board policy on dividends being in place, the directors, in addition, breached their duties by failing to act in accordance with Company’s constitution when it came to paying dividends.

Delay no bar to relief

Although Mr Routledge was found to have acquiesced to not being paid dividends between 2005 and 2014, that acquiescence stopped in 2014 when he complained about the situation to Mr Skerritt. It was then a further three years before he presented his unfair prejudice petition.

Notably, the judge found that this acquiescence was not a bar to Mr Routledge seeking relief in respect of the dividends payable from 2014 onwards, in which time over £7 million was paid to Mr and Mrs Skerritt. Further, there was no delay in the issue of the petition.

Practical Points

Although it seems clear from the wording of the Special Resolution that the parties intended the A and B shares to have different rights to receive a dividend, any difference in rights was to be set out in a written policy. In the absence of such a policy, the courts will not simply infer its terms.

As a matter of practice, therefore, this case is a lesson to company directors to make sure that they only follow the written rules when it comes to recommending payment of a dividend, and that they evidence their adherence to the rules. Informal understandings or convention will not be enough. Dividend rights should be carefully drafted in the company’s constitution or in a dividends policy, and all shareholders should receive notification of that policy, and any changes, in writing. Directors should ensure that company minutes identify the dividends policy set by the board and show that dividend-related decisions were taken in accordance with the dividends policy.