Collas Crill explains... disguised or unintended distributions
16 September 2019
This guide is one in a series of 'Collas Crill explains...' in which we examine areas of Jersey law that frequently arise in practice. Further guides will be released weekly, click here to subscribe to receive the rest of the guides in this series to your inbox.
Jersey is a popular place to establish an asset holding company because the Law is modern, flexible and modelled on English companies legislation.
This guide looks at the key things you need to know about the payment of disguised or unintended distributions by a company under Jersey law.
Words in bold text are defined at the end of this guide.
The Law defines the term distribution widely as any distribution (whether in cash or otherwise) of a company's assets to its shareholders in their capacity as shareholders other than payments that are specifically excluded.
The Law also sets out a small number of rules that apply to the payment of distributions.
For more information on the provisions of the Law relating to distributions, see our guide Distributions by a Jersey company (click here).
Disguised or unintended distributions
Under English common law, a company may only distribute its assets to its shareholders in accordance with specific statutory provisions which allow it to do so. A distribution that is not made in accordance with those provisions is unlawful and invalid.
Historically, the unlawful distribution rule was an extension of provisions in the English companies legislation which implemented the maintenance of capital rule. This rule sought to preserve the capital of a company to ensure that it would be available to satisfy the claims of its creditors.
Although decisions of English courts are not binding on the Jersey court, it will frequently look to English decisions for guidance and it is generally thought that it will follow the cases in this area.
Today, the maintenance of capital rule has been significantly relaxed and the Law allows distributions to be paid from a far wider range of sources. Despite this, the unlawful distribution rule is still capable of applying to invalidate a transaction which:
- is structured to appear as though it is an arm's length transaction, but which is in substance, a disguised distribution; or
- although not intended to be a distribution, is in substance a distribution that has not made in accordance with the provisions of the Law.
In most cases, a distribution is clear. A company intends to make a distribution to a shareholder by paying it money, transferring an asset or forgiving a debt.
However, in some cases, a transaction may not be intended to be, or may not appear to be, a distribution. Examples of transactions which have been held to be unlawful distributions include:
- an exorbitant rate of interest payable under a debenture issued to a parent company;
- the transfer of an asset between commonly owned companies at less than fair market value; and
- the payment of remuneration to a person who was a director and shareholder of a company where the person had done no work at all for the company.
The courts have said that, in considering whether a transaction constitutes an unlawful distribution at common law, it is necessary to examine all of the relevant facts and look at the purpose and substance of the transaction rather than its form. If the transaction is:
- genuine and made at arm's length, then it will be valid, even if it is a bad bargain; and
- an attempt to improperly extract value from the company on the pretence of an arm's length transaction, it will be invalid.
Related party transactions
The context in which the rule frequently comes into play is related party transactions.
The two most common situations where the rule applies is when a company wishes to:
- lend money to its parent company or another company in same group on interest free terms or at an artificially low interest rate; or
- transfer an asset at less than fair market value to another company in same group or under common control.
In these situations, there will be an unlawful distribution even though the shareholder of the transferor does not directly receive the distribution.
Where the rule may apply, it is necessary for the company to treat any element of a transaction that would otherwise constitute an unlawful distribution (eg the difference between the book value and the market value of the asset) as a distribution and authorise it in accordance with the requirements of the Law.
For information on the authorisation process for a distribution, see our guide Distributions by a Jersey company .
company means a Jersey company that is not an open ended investment company.
Law means the Companies (Jersey) Law 1991.
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About this guide
This guide is one of a series of 'Collas Crill explains...' and gives a general overview of this topic. It is not legal advice and you may not rely on it. If you would like legal advice on this topic, please get in touch with one of the authors or your usual Collas Crill contacts.
This note is a summary of the subject and is provided for information only. It does not purport to give specific legal advice, and before acting, further advice should always be sought. Whilst every care has been taken in producing this note neither the author nor Collas Crill shall be liable for any errors, misprint or misinterpretation of any of the matters set out in it. All copyright in this material belongs to Collas Crill.