It’s a Wrap (UK) Ltd v Gula [2006] EWCA Civ 544

A company in liquidation sought to recover unlawful dividends paid to director-shareholders when there were no profits available for distribution. The Court of Appeal held that shareholders are liable under section 277(1) Companies Act 1985 if they knew the facts constituting the contravention, regardless of whether they knew the legal requirements prohibiting such distributions.

Facts

It’s A Wrap (UK) Ltd, a company in liquidation, sought recovery of dividends totalling £28,000 paid to the respondents, Mr and Mrs Gula, who were directors and shareholders. The company made trading losses of £17,641 and £36,591 in 2001 and 2002 respectively, yet dividends of £14,000 each were paid to the respondents in both years. The payments were deliberately classified as dividends for tax efficiency purposes. The respondents admitted knowledge that the company had made only losses, but claimed they were unaware that declaring dividends without profits contravened the Companies Act 1985.

Issues

The central legal question was whether section 277(1) of the Companies Act 1985 requires a shareholder to have:

Option One

Knowledge of the relevant facts constituting the contravention (fact-based knowledge); or

Option Two

Knowledge of those facts AND knowledge that the Act was contravened (knowledge of both facts and law).

Judgment

The Court of Appeal (Arden LJ, Sedley LJ, and Chadwick LJ) unanimously allowed the appeal, holding that fact-based knowledge is sufficient for liability under section 277(1).

Interpretation of Article 16 of the Second EC Directive

Lady Justice Arden held that section 277(1) must be interpreted in conformity with Article 16 of the Second EC Directive (77/91/EEC), which it implements. She reasoned:

“the expression the ‘irregularity’ of the distributions refers to a quality of the distributions, namely that they were in fact made contrary to article 15 as indicated in the opening words. It follows from this that all the company must prove is that the shareholders knew the facts constituting the factual position that the distributions were contrary to the Act. This is fact-based knowledge.”

Presumption of Knowledge of Law

The Court applied the general principle that persons are presumed to know the law. Arden LJ stated:

“there is nothing in the wording or purpose of article 16 to oust the general principle that a person is deemed to know the law. This is not a penal provision. Given that the purpose of the provision is to support the maintenance of capital rule, there would in my judgment have to be clear indications in article 16 for the court to reach the conclusion that the general principle was excluded.”

Policy Considerations

Sedley LJ emphasised the protective purpose of the provision:

“The important provision for recoupment of funds illicitly paid out in this way cannot have been intended to be defeasible by a plea of ignorance, particularly on the part of those who, by becoming directors, have accepted legal responsibilities which affect the interests of others.”

Application to the Facts

Since the respondents knew there were no profits available for distribution yet received dividends, they had the requisite fact-based knowledge. Arden LJ concluded:

“Since Mr and Mrs Gula knew that the company had no profits, they knew that the distributions had been made in contravention of the provisions of the Act for the purpose of section 277(1).”

Implications

This case establishes that shareholders cannot escape liability for repaying unlawful distributions by claiming ignorance of company law. The maintenance of capital principle, which protects creditors, takes precedence. Directors and shareholders must understand that receiving dividends when there are no distributable profits creates liability regardless of whether they understood the legal prohibition. The decision harmonises UK company law with EU requirements under the Second Directive and reinforces the fundamental principle that ignorance of the law is no defence in civil matters concerning capital maintenance.

Verdict: Appeal allowed. The respondents were liable to repay the unlawful dividends to the company. Fact-based knowledge of the circumstances constituting the contravention is sufficient for liability under section 277(1) of the Companies Act 1985; knowledge of the legal requirements is not additionally required.

Source: It’s a Wrap (UK) Ltd v Gula [2006] EWCA Civ 544