It's A Wrap (UK) Ltd v Gula & Anor [2006] EWCA Civ 544

Case No A3/2005/2186[2006] EWCA Civ 544
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM the Chancery Division
Mr Nicholas Davidson QC
HC04C03156
Venue Royal Courts of Justice, Strand, London, WC2A 2LLDate Thursday, 11 th May 2006
Before
LORD JUSTICE CHADWICKLORD JUSTICE SEDLEYLADY JUSTICE ARDEN DBE
Between
It’s A Wrap (UK) LtdAppellantGula & anrRespondents
(Transcript of the Handed Down Judgment ofSmith Bernal WordWave Limited190 Fleet Street, London EC4A 2AGTel No: 020 7421 4040 Fax No: 020 7831 8838Official Shorthand Writers to the Court)
Mrs Jane Giret QC and Stephen Tudway (instructed by Messrs Sprecher Grier Halberstam) for AppellantStephen Robins (appeared pro bono) for Respondents
Judgment
[1]This appeal raises a short point of law. Section 277(1) of the Companies Act 1985 (“the Act”) provides a statutory remedy against a shareholder for recovery of an unlawful distribution paid to him if he knew or had reasonable grounds to believe that it was made in contravention of the Act. I will call the first kind of knowledge actual knowledge, and the second kind of knowledge constructive knowledge. The question that we have to decide is this: if a company brings a claim against a shareholder under this section, is the actual or constructive knowledge that the section requires actual or constructive knowledge of : i) the relevant facts constituting the contravention, or ii) those facts and in addition the fact that the Act was contravened?[2]The judge held that the second of these alternatives was correct. In my judgment, the judge was wrong on this question of law. I reach my conclusions by the following steps:a. A. section 277(1) has to be interpreted in conformity with article 16 of the Second EC Directive on Company Law (77/91/EEC) (“the Second Directive”), which it is designed to implement.b. B. article 16 has to be read in the context of the rules on distributions in article 15 of the Second Directive and the general principles of Community law.c. C. the provisions of sections 263 to 276 of the Act are designed to implement article 15 of the Second Directive.d. D. on its true interpretation, article 16 means that a shareholder is liable to return a distribution if he knows or could not have been unaware that it was paid in circumstances which amount to a contravention of the restrictions on distributions in the Second Directive, whether or not he knew of those restrictions.e. E. accordingly section 277 must be interpreted as meaning that the shareholder cannot claim that he is not liable to return a distribution because he did not know of the restrictions in the Act on the making of distributions. He will be liable if he knew or ought reasonably to have known of the facts which mean that the distribution contravened the requirements of the Act.[3]I explain each of these steps more fully below. Then I consider the application of the law to the facts of this case. I use the phrase “fact-based knowledge” to denote knowledge of the facts making the particular distribution unlawful. A. Section 277(1) has to be interpreted in accordance with article 16 of the Second Directive[4]Section 277 of the Act provides as follows:- “(1) Where a distribution, or part of one, made by a company to one of its members is made in contravention of this Part and, at the time of the distribution, he knows or has reasonable grounds for believing that it is so made, he is liable to repay it (or that part of it, as the case may be) to the company or (in the case of a distribution made otherwise than in cash) to pay the company a sum equal to the value of the distribution (or part) at that time.(2) The above is without prejudice to any obligation imposed apart from this section on a member of a company to repay a distribution unlawfully made to him; but this section does not apply in relation to- (a) financial assistance given by a company in contravention of section 151, or (b) any payment made by a company in respect of the redemption or purchase by the company of shares in itself.(3) Subsection (2) of this section is deemed included in Chapter VII of Part V for purposes of the Secretary of State’s power to make regulations under section 179.” (a) financial assistance given by a company in contravention of section 151, or (b) any payment made by a company in respect of the redemption or purchase by the company of shares in itself.[5]The Second Directive was adopted on 13 December 1976 and its scope, as stated in the long title, is: “coordination of safeguards which, for the protection of members and others, are required by Member States of companies within the meaning of the second paragraph of article 58 of the Treaty, in respect of the formation of public limited liability companies and the maintenance and alteration of their capital, with a view to making such safeguards equivalent” (77/91/EEC).[6]Section 277(1) implements article 16 of the Second Directive. Article 16 provides as follows:- “Any distribution made contrary to Article 15 must be returned by shareholders who have received it if the company proves that these shareholders knew of the irregularity of the distribution made to them, or could not in view of the circumstances have been unaware of it.”[7]Under the Marleasing principle, or principle of conforming interpretation, the courts of the United Kingdom must interpret section 277(1) in a manner that is so far as possible in conformity with the provisions and objectives of article 16. That means that the court must find the meaning of article 16 and then see whether section 277(1) can bear that meaning. For this purpose the court may choose an interpretation of section 277(1) which is not its natural meaning. A fuller explanation of the principle of conforming interpretation can be found in the recent case of IDT Credit Card Services plc v Customs and Excise [2006] EWCA Civ.29. B. Article 16 has to be interpreted in the light of the rules on distributions in the Second Directive and the general principles of Community law[8]Article 15 of the Second Directive provides that, except for reductions of capital, distributions to shareholders may not be made when on the closing date of the previous financial year the net assets as set out in the company’s annual accounts are, or following the distribution would become, lower than the amount of the subscribed capital plus undistributable reserves (article 15.1(a)). Uncalled capital must be deducted from the amount of subscribed capital (article 15.1(b)). Furthermore, the amount of a distribution to shareholders may not exceed the amount of the profits as at the end of the financial year plus any profits brought forward and sums drawn from reserves available for distribution less any losses brought forward and sums placed in reserve in accordance with the law or the company’s constitution (article 15.1(c)).[9]Article 15 further provides that, where interim dividends are permitted, interim accounts must be drawn up showing that the funds available for distribution are sufficient and the amount to be distributed may not exceed the total profits made since the end of the last financial year for which the annual accounts have been drawn up, plus any profits brought forward and sums drawn from reserves available for this purpose, less losses brought forward and sums to be placed to reserves pursuant to the law or the company’s constitution (article 15.2). Article 15 also makes provision for derogation from article 15.1(a) in the case of investment companies with a fixed capital (article 15.4). It is not necessary to go into those provisions in this judgment.[10]The United Kingdom’s treaty obligation in respect of directives such as the Second Directive is to ensure that its law achieves the result of that article in its domestic law, although it is free to choose the form and method of implementation: see now article 249(3) (formerly article 189) of the Treaty on European Union. Article 15.1 meant that a number of changes had to be made to United Kingdom company law. It is not necessary to analyse all the differences between article 15 and the law of the United Kingdom. However, it is important to note that under article 15 there had to be company accounts which showed the profits it was proposed to distribute. In other words it would be necessary to justify any distribution by reference to company accounts. The First EC Directive on Company Law (68/151/EEC) provided for the public filing of annual accounts of a company with limited liability. Our domestic law also provides for annual accounts to be circulated to members: see section 238 of the 1985 Act.[11]As to remedies against shareholders who receive dividends not lawfully made, the general law of the United Kingdom was, arguably at least, not to exactly the same effect as article 16. To make good this point, it is sufficient to compare some of the features of the liability of shareholders under section 277(1) with that of members under the general law, since no-one has suggested that section 277(1) does not properly implement article 16 in this respect. Liability under the general law is in fact preserved by section 277(2) (see above). Liability under the general law attaches where the shareholder knew or ought to have known that the distribution was unlawful. Mr Robins submitted that it would apply where the shareholder had acted unconscionably, but the authorities under the general law on distributions impose the former test: see for example Moxham v Grant [1900] 1 QB 88.[12]The following are some of the differences between the two types of liability, that is, liability under section 277(1) and liability under the general law. First, section 277(1) only applies where the distribution contravenes the Act, and thus it does not apply where the distribution for instance violates a provision of the general law or the company’s constitution. Secondly, there is no defence in section 277(1) for the member who acts on advice. The member is instead left to sue the person who gave him inaccurate advice (if he can). By contrast, under the general law a shareholder may be able to claim that he did not have the requisite knowledge where he acted on advice. As a constructive trustee he would be able to claim that he was entitled in appropriate circumstances to relief under section 61 of the Trustee Act 1925 (see the definition of “trustee” in section 68(17) of that Act). (I would add, however, that there is no inquiry under the general law into the question whether the shareholder was aware of the law’s requirements regarding the payment of dividends.) In sum, the remedy under article 16 is more absolute and stringent than that available under the general law. That is no doubt because it has been tailor made to facilitate the recovery of unlawful distributions whereas the remedy under the general law is an adaptation of the law of constructive trusteeship. However, the need for some form of actual or constructive knowledge on the part of the shareholder is common to both forms of remedy.[13]Presumably because of the differences between liability under article 16 and liability under the general law, Parliament enacted section 44 (1) of the Companies Act 1980, which became section 277(1) on the consolidation of the Companies Acts 1948 to 1983. These provisions apply not only to plcs (to which alone the Second Directive applied) but also in relation to private companies. However, it has not been suggested that we should interpret section 277(1) differently because the company in this case, It’s a Wrap (UK) Limited, was a private company. It is possible that in some circumstances the same enactment may be construed differently according to whether it applies in circumstances covered by a directive: Gingi v Secretary of State for Work and Pensions [2001] EWCA Civ. 1685. In this instance, however, it is clear that the intention of Parliament was to create the same liability for members of private companies as for members of public companies and accordingly section 277(1) should be interpreted in the same way for all companies.[14]Directives also have to be interpreted in the light of the general principles of Community law: see Kolpinghuis, Case no 80/86 [1987] ECR 3969. One of those principles is that a person is taken to know the content of Community law as soon as it is published in the Official Journal of the European Communities: see for example Friedrich Binder GmbH & Co. KG v Hauptzollamt Bad Reichenstall, Case 161/88[1988] ECR 2415 at para. 19. Here the Community instrument was a directive and accordingly (article 16 not having created directly applicable rights) a person was not bound by article 16 until it was implemented in UK law. This has now happened by the enactment of primary legislation. Thereupon, the further presumption in English law that a person is presumed to know the law is brought into operation: for this presumption, see generally Halsbury’s Laws of England para. 1324. Advocate General Darmon expressed the view at para. 34 of his opinion in the Binder case that this presumption would arise in national proceedings in most member states. Accordingly, in my judgment the right approach to the interpretation of article 16 is to proceed on the basis that, when implemented, the general presumption that ignorance of the law is no defence will apply unless on a true interpretation of the directive it is excluded. C. The provisions of section 263 to 276 are designed to implement article 15 of the Second Directive.[15]The changes necessary to implement article 15 of the Second Directive were first made by the Companies Act 1980. They are now contained in sections 263 to 276 in Part VIII of the Companies Act 1985. In particular, section 270 provides: “270. Distribution to be justified by reference to company’s accounts(1) This section and sections 271 to 276 below are for determining the question whether a distribution may be made by a company without contravening sections 263, 264 or 265.(2) The amount of a distribution which may be made is determined by reference to the following items as stated in the company’s accounts - (a) profits, losses, assets and liabilities, (b) the following provisions - (i) in the case of Companies Act individual accounts, provisions of any of the kinds mentioned in paragraphs 88 and 89 of Schedule 4 (depreciation, diminution in value of assets, retentions to meet liabilities, etc), and (ii) in the case of IAS individual accounts, provisions of any kind and (c) share capital and reserves (including undistributable reserves).(3) Except in a case falling within the next subsection, the company’s accounts which are relevant for this purpose are its last annual accounts, that is to say those prepared under Part VII which were laid in respect of the last preceding accounting reference period in respect of which accounts so prepared were laid; and for this purpose accounts are laid if section 241(1) has been complied with in relation to them.(4) In the following two cases - (a) where the distribution would be found to contravene the relevant section if reference were made only to the company’s last annual accounts, or (b) where the distribution is proposed to be declared during the company’s first accounting reference period, or before any accounts are laid in respect of that period, the accounts relevant under this section (called ‘interim accounts’ in the first case, and ‘initial accounts’ in the second) are those necessary to enable a reasonable judgment to be made as to the amounts of the items mentioned in subsection (2) above.(5) The relevant section is treated as contravened in the case of a distribution unless the statutory requirements about the relevant accounts (that is, the requirements of this and the following three sections, as and where applicable) are complied with in relation to that distribution.” (a) profits, losses, assets and liabilities, (b) the following provisions - (i) in the case of Companies Act individual accounts, provisions of any of the kinds mentioned in paragraphs 88 and 89 of Schedule 4 (depreciation, diminution in value of assets, retentions to meet liabilities, etc), and (ii) in the case of IAS individual accounts, provisions of any kind and (c) share capital and reserves (including undistributable reserves). (a) where the distribution would be found to contravene the relevant section if reference were made only to the company’s last annual accounts, or (b) where the distribution is proposed to be declared during the company’s first accounting reference period, or before any accounts are laid in respect of that period, the accounts relevant under this section (called ‘interim accounts’ in the first case, and ‘initial accounts’ in the second) are those necessary to enable a reasonable judgment to be made as to the amounts of the items mentioned in subsection (2) above.[16]This provision, which is derived from article 15 of the Second Directive, demonstrates the importance of the company’s accounts as the reference point for assessing whether there are profits available for distribution for the purposes of the Second Directive. D. On its true interpretation article 16 means a shareholder is liable to return a distribution if he knows or could not have been unaware that it was paid in circumstances which amount to a contravention of the restrictions in the Second Directive, whether or not he knew of those restrictions.[17]The true interpretation of article 16 is a question of Community law. In the interpretation of Community instruments, the Court of Justice has regard to the recitals to a directive. In the present case, the recitals include the following provision:
“Whereas Community provisions should be adopted for maintaining capital, which constitutes the creditors’ security, in particular by prohibiting any reduction thereof by distribution to shareholders where the latter are not entitled to it and by imposing limits on the company’s right to acquire its own shares; …”
[18]This sounds like the familiar and fundamental rule of English company law, namely the rule in Trevor v Whitworth (1887) 12 App Cas 409 that the Companies Acts by implication prohibit a company from returning capital to shareholders except in one of the ways expressly permitted by the Acts. United Kingdom company law may indeed have influenced the recital to the directive. The underlying rationale for this rule is that capital constitutes the security for creditors. A distribution that is not paid out of profits available for distribution is paid out of the reserves that must remain available for the payment of debts. The claims of shareholders rank behind those of creditors. It is a factor to be borne in mind that any defence given to shareholders who receive a distribution paid in contravention of this Act detracts from the protection available to creditors. One of the objects of the Second Directive was to give protection to creditors by harmonising restrictions on the profits which may be used for the payment of distributions.[19]Article 16 does not, however, require a member to return a dividend to which they are not entitled in all circumstances, but only “if the company proves that these shareholders knew of the irregularity of the distribution made to them or could not in the circumstances have been unaware of it”.[20]Article 16 starts with the words “Any distribution made contrary to article 15”. The article therefore is concerned with the factual position, namely the position where the result of a distribution is that it was contrary to article 15, irrespective of whether that was due to anybody’s fault. This is consistent with an intention to preserve undistributable reserves for the benefit of creditors.[21]Article 16 goes on to make it clear that the onus of proof is on the company. This would follow without question under English law since the company is the claimant. What the company must prove is one of two matters: knowledge of the “irregularity” of the distributions made to the members or alternatively that the shareholders could not in view of the circumstances been unaware of “that irregularity”. I turn to consider the meaning of this part of article 16 below. E. It follows from propositions A to D above that section 277 must be interpreted as meaning that the shareholder will be liable if he has fact-based knowledge that the distribution contravened the Act.[22]I return now to consider the meaning of that part of article 16 which requires the company to prove that the shareholder “knew of the irregularity of the distributions made to [them], or could not in view of the circumstances been unaware of it”.[23]In my judgment 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.[24]I then turn to the concluding words “or could not in view of the circumstances have been unaware of it”. In my judgment these words describe a situation where the company cannot prove actual knowledge. They do not include the situation where the court can infer actual knowledge in the face of denials by the shareholders. Inferred actual knowledge is simply a form of actual knowledge and accordingly it does not need to be mentioned specifically. On this basis the concluding words of article 16 must be directed to a situation where the shareholders ought reasonably to have been aware of the factual situation that the distribution contravened the Act. It follows that article 16 has been correctly implemented by section 277(1) in this respect even though it uses different wording.[25]That leads to the question whether the expression “in view of the circumstances” refers only to external facts or includes subjective matters affecting the shareholder. Suppose that the shareholder is, for instance, a director of many public companies and a qualified accountant. In my judgment those circumstances have to be taken into account under article 16. No question arises in this case as to whether circumstances that diminish a shareholder’s responsibility ought also to be taken into account, for instance that the shareholder is a person with limited capacity for understanding of company accounts. My provisional view is that those circumstances would have to be taken into account but the same would not follow in the case of a shareholder who does not bother to look at those accounts, although he is able to do so. Provisionally, I do not consider that the expression “the circumstances” enables a shareholder to pray in aid matters personal to him as a ground for reducing his awareness of the irregularity below that reasonably to be expected of a shareholder with his characteristics.[26]It follows from the above analysis that 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. Section 277(1) must so far as possible be interpreted in the same way.

Concluding points on interpretation

[27]In these circumstances, I reject the central proposition of Mr Robins that a shareholder must in all circumstances have knowledge of the requirement of the Act that the distribution contravened. I accept the submission of Mrs Jane Giret QC for the appellant that, if that were the law, it is likely to be difficult in practice for a company to show such knowledge is a significant number of cases.[28]Mr Robins submits that his interpretation is consistent with the obiter dictum of Robert Walker LJ, as he then was, in Bairstow v Queen’s Moat Houses [2001] 2 BCLC 531 at 547. “The prospect of the former directors being able to obtain contribution from innocent recipients of unlawful dividends was debated (somewhat inconclusively) in the course of the appeal hearing. The statutory remedy [under section 277] is not in point (since it is available only to the company, and only against a shareholder with actual or constructive knowledge of the unlawfulness of the dividend.”[29]In my judgment Robert Walker LJ was not intending to define the requirements of section 277(1) and that this dictum thus cannot be taken as representing a considered statement that fact-based knowledge is not sufficient.[30]The next authority that I must consider is Swain v Puri [1996] PIQR 442. In that case this court held that the expression “reasonable grounds to believe” meant actual knowledge or “shut-eye” knowledge of the actual risk of injury to a child trespasser or of primary facts that the court considers provides reasonable grounds for believing that the risk exists. As that was a decision on the Occupiers’ Liability Act 1984 it has no bearing on interpretation of section 277(1) which must be interpreted so as to conform with article 16 of the Second Directive.

Application to this case

[31]This is an appeal against the order dated 16 September 2005 of Mr Nicholas Davidson QC sitting as a deputy judge of the Chancery Division. By his order the judge entered judgment for the defendants and gave the claimant permission to appeal. The respondents were directors and shareholders of the appellant. The appellant was placed into creditors’ voluntary liquidation on 20 January 2004. The facts are uncontroversial and may be shortly stated. In respect of the years ending 31 December 2001 and 31 December 2002, the appellant made trading losses of £17,641 and £36,591 respectively. Notwithstanding that there were no retained realised profits, the respondents caused the company to pay them dividends of £14,000 each in respect of 2001 and 2002 also. The 2002 accounts were signed by the first respondent in his capacity as a director. The appellant (acting by its liquidator) brought proceedings for the return of these dividends. It relied on the provisions of section 277(1) of the Act. It is common ground that the distributions contravened section 263 of the Act. This prohibits a company from making a distribution out of profits available for the purpose. It is unnecessary to consider in this connection what profits would have been available since there were no profits of any description.[32]The judge found that the respondents had deliberately classified the payments as dividends for the purpose of gaining a tax advantage and that they were aware that the appellant had made only losses in 2001 and 2002. He also found that the respondents would not have done anything to contravene the Act if they had been aware of the fact that the declaration of the dividends involved a contravention of the Act. The judge went on to hold that under section 277 the words “is so made” meant “is made in contravention of this Part” and so required the defendants to know or have reasonable grounds to believe not just the facts giving rise to the contravention but also the legal result of that contravention. As the respondents did not have that knowledge, the judge held that there was no liability to repay the dividends.[33]The judge did not consider the application of the second half of section 277. He recites in his judgment that Mr Gula had written to the liquidator on 2 August 2004 stating that:- “… the directors’ dividends shown on accounts to which you refer for December 2001 and December 2002 were not paid as dividends. These amounts were taken as salary over the course of the year. The fact that they are shown as dividends is an accounting method as advised and set up by our then accountant Russell Lebe, as a tax efficient way of drawing a salary. We were also advised that this was the normal practice for small businesses and was not contravening any laws.”[34]The judge also relied on Thorne v Silverleaf [1994] 1 BCLC 637 at 645f and 646 e-h. This is a decision of this court on section 217 of the Insolvency Act 1986 which requires knowledge that another person is acting “in contravention” of section 216. As this decision concerns a different statutory provision, particularly given that it has no basis in Community law, I do not consider it assists in this case.[35]In my judgment, the judge asked the wrong question. There is no suggestion that the respondents did not know the position as shown by the accounts, namely that the company had no profits available for distribution. For the reasons given above, it is not necessary for the company to show that the shareholders knew the provisions of section 263. (Likewise, it is unnecessary to rely on the Latin root of the word “dividend” to reach this conclusion, as Mrs Giret submitted as a subsidiary argument for inputing knowledge to the respondents.) 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).[36]There remain some procedural matters with which I must deal. First, neither party has asked this court to make a reference for a preliminary ruling to the European Court of Justice. Secondly, the judge permitted Mr Gula to give evidence as to what had happened without going into the witness box. We are told that he gave Mr Gula the opportunity of going into the witness box but said that he did not have to do so. Once Mr Gula had had that opportunity, but declined it, the judge should not have allowed him to give evidence in the course of his submissions.

Disposition

[37]In the circumstances I would allow the appeal.[38]I have had the advantage of reading in draft the judgments of Arden and Chadwick LJJ. I agree with the conclusion at which they both arrive. I agree too that it has to be arrived at on the basis of what the respondents knew, not of the alternative category of what they had reasonable grounds for believing. They knew that they were paying themselves dividends when there were no profits, which is unlawful. Did they therefore know that they were acting unlawfully?[39]Neither article 16 nor s.277 gives any help in finding the answer. One has to go back to first principles. I agree that the decisive principle here, both in domestic and in European jurisprudence, is that people are taken to know the law. There are exceptions to this principle, notably by way of restriction on the creation of criminal liability: see for example R v Hart [1982] 1 WLR 481, DC; cf. A-G’s Reference No 1 of 1995 [1996] 1 WLR 970 CACD. But the present provision is not penal: it is designed to protect those who have a prior call on a company’s funds from the appropriation of them by those who control the company. 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.[40]I agree that this appeal should be allowed. My reasons are, in substance, those which have been set out by Lady Justice Arden in her judgment. But, as I differ from her on one (albeit immaterial) point and as we are differing from the judge on a point which may be of some general importance, I add a short judgment of my own.[41]The obligation to repay a distribution, imposed on a member of a company by section 277(1) of the Companies Act 1985, arises where two conditions are satisfied. The first is that the distribution has been made in contravention of Part VIII of the Act. The second is that, at the time of the distribution, the member “knows or has reasonable grounds for believing that it is so made”.[42]The first of those conditions is established by ascertaining the relevant facts as they were at the time that the distribution was made. That must be done by having regard to the legal rules set out in Part VIII of the Act – in particular, to those rules in sections 270 to 276 (“Relevant accounts”). When the facts have been ascertained by reference to those legal rules, other provisions in Part VIII – sections 263 to 269 (“Limits of company’s power of distribution”) – when applied to those facts provide the answer to the question “has the distribution been made in contravention of Part VIII?”[43]In carrying out that inquiry regard must be had to section 263(2) of the Act for the purpose of determining whether or not there has been a distribution and the amount of that distribution. Regard must be had to the company’s accounts (as defined in section 270(3) and (4) of the Act); and effect must be given to the requirements in sections 271 to 276 of the Act in determining to which accounts it is permissible to have regard. The amount of profits, losses, assets and liabilities, provisions, share capital and reserves is to be determined by reference to the items stated in the accounts – section 270(2) of the Act. That will determine, for example, the amount of profits available for distribution for the purposes of section 263 of the Act; or the amount by which net assets exceed the aggregate of called-up share capital and undistributable reserves for the purposes of section 264. The question then, in the context of section 263(1) of the Act, is whether the distribution is made otherwise than out of profits available for the purpose; or, in the context of section 264(1), whether the making of the distribution would reduce the amount of the net assets to less than the aggregate of called-up share capital and undistributable profits. More complex provisions apply in the case of investment companies (sections 265 and 266 of the Act) and in the case of insurance companies with long term business (section 268 of the Act). But the approach is consistent in each case. In order to determine whether there has been a contravention of one or other of the provisions in Part VIII of the Act which seek to prohibit the making of distributions, it is necessary to ascertain the facts and apply the legal rules. The question whether or not there has been a contravention does not turn on whether the company making the distribution knew the facts or knew the legal rules.[44]The second of the two conditions can be established in one or other of two ways. First, by establishing that, at the time of the distribution, the member “knows that [the distribution] is so made”. Second, by establishing that, at the time of the distribution, the member “has reasonable grounds for believing that it is so made”. The phrase “has reasonable grounds for believing that” plainly connotes some degree of knowledge or belief which falls short of actual knowledge. For the moment I will assume for convenience - but without intending to pre-empt further consideration of the true meaning of that phrase - that “has reasonable grounds for believing” can be equated with some concept of constructive knowledge. So the condition is that the member has actual or constructive knowledge that the distribution “is so made”.[45]There is not, I think, any real doubt that the words “it is so made” mean “the distribution is made in contravention of Part VIII of the Act”. But that leaves open the question whether what is required is knowledge (actual or constructive) that the distribution does contravene of one or other of the statutory prohibitions; or whether it is enough that the member has the relevant knowledge of facts which, if they exist, would lead to the conclusion that the distribution does contravene the statutory provisions. To put the point more shortly: is it necessary to establish that the member knows (or is to be taken to know) the legal rules and the consequences of those rules when properly applied to the facts.[46]If that question arose in a purely domestic context, some support might be found in the authorities for the conclusion that knowledge of the facts alone is not sufficient: what is required is knowledge that, on those facts, the distribution does contravene one or other of the statutory provisions. There are observations in the judgments in this Court in Thorne v Silverleaf [1994] 1 BCLC 637, that knowledge of the latter kind is required in the context of section 217(1)(b) of the Insolvency Act 1986 (“Personal liability for debts, following contravention of s. 216”) – (ibid, 645f-g and 646g-h 641). But, as it seems to me, those observations were made obiter - in that the defendant’s liability in that case turned on section 217(1)(a) of the 1986 Act and not on section 217(1)(b) – and, as Lady Justice Arden has pointed out, were made in relation to a statutory provision which is not based on Community law. We were referred, also, to the decision of this Court in Swain v Puri [1996] PIQR P442. But, for my part, I find no assistance in that case on the question which I am addressing at this stage: whether knowledge of the facts alone is sufficient. Swain v Puri, as it seems to me, is a decision on the different and distinct question: what is meant by the phrase “has reasonable grounds for believing that”.[47]The question which I am addressing at this stage – whether knowledge of the facts alone is sufficient – does not arise in a purely domestic context. As Lady Justice Arden has explained, the question arises in the context of a provision which was first enacted in domestic law (as section 44(1) of the Companies Act 1980) in order to give effect to obligations imposed on the United Kingdom by the Second Council Directive of 13 December 1976 on the co-ordination of safeguards which are required (inter alia) in respect of the maintenance of capital (77/91/EEC). For the reasons which she has given, section 277(1) of the 1985 Act – which re-enacts section 44(1) of the 1980 Act – must be interpreted in conformity with article 16 of the Second Directive.[48]Article 16 of the Second Directive is in these terms:
“Any distribution made contrary to article 15 must be returned by shareholders who have received it if the company proves that these shareholders knew of the irregularity of the distributions made to them, or could not in the circumstances have been unaware of it.”
As Lady Justice Arden has pointed out, “the irregularity”, in that context, must mean the fact that the distribution has been made contrary to article 15.[49]Lady Justice Arden has pointed out that article 16 has to be interpreted in accordance with the general principles of Community law; and she has pointed out that those principles include the principle that a person is to be taken to know the content of Community law when published in the Official Journal unless the directive contains a contrary indication. Further, she has drawn attention to the need to interpret article 16 with regard to the recitals to the directive; and, in particular to the fourth recital:
“Whereas the Community provisions should be adopted for maintaining the capital, which constitutes the creditors’ security, in particular by prohibiting any reduction thereof by distribution to shareholders where the latter are not entitled to it . . .”
I respectfully agree with her conclusion that, as a matter of Community law, the effect of article 16 of the Second Directive is that a shareholder who has received a distribution made contrary to article 15 and knew of the facts which gave rise to “the irregularity” must return it. It is sufficient that the shareholder knew of the facts which, when viewed in the light of the provisions in article 15, make the distribution one which the Second Directive seeks to prohibit. It is not necessary for the company to prove that the shareholder knew of the provisions of article 15: he is taken to know the content of Community law.[50]I agree, also, that – if that is the effect of article 16 of the Second Directive as a matter of Community law – then section 277(1) of the Companies Act 1985, which must be construed in accordance with the principle of conformity, is to be given a meaning which is consistent with that effect. So, in construing section 277(1) of the 1985 Act, the meaning to be given to the words “he knows . . . that it is so made” is that it is enough that the member has the relevant knowledge of facts which, if they exist, lead to the conclusion that the distribution does contravene the statutory provisions; it is not necessary that the member has the relevant knowledge of the legal rules and the consequences of those rules when properly applied to the facts.[51]That is a sufficient basis upon which to allow this appeal. It is not in dispute that the respondents had actual knowledge, at the time of the distributions made to them, that the distributions were made otherwise than out of profits available for the purpose. They knew that there had been no profits. That knowledge was sufficient to satisfy the condition that they knew that the distributions were made in contravention of section 263(1) of the 1985 Act.[52]It follows that I take the view that it is unnecessary, on the facts of this case, to decide what meaning should be given to the words “has reasonable grounds for believing that”. Those words, plainly, do enable the second (or knowledge) condition in section 277(1) to be established without proof of actual knowledge. But, to my mind, it is by no means self-evident that they are to be equated with “constructive knowledge” if by that expression is meant knowledge which a person would have but for his negligence. I do not think that the composite phrase “knows or has reasonable grounds for believing” has the same meaning as “knows or ought to know”.[53]In Swain v Puri [1996] PIQR P442 this Court rejected the contention that the words “has reasonable grounds to believe” in section 1(3) of the Occupiers Liability Act 1984 were equivalent to “ought to have known”. As

Lord Justice Pill put it, (ibid, P446):

“. . . the expression ‘has reasonable grounds to believe’ does not include constructive knowledge. Actual knowledge or reasonable grounds to believe must be established. That does not permit an occupier to turn a blind eye. There are some facts which, on the evidence, an occupier cannot deny. For example, the presence of footholds in the perimeter wall . . .”
And, in the words of

Lord Justice Evans (ibid, P448):

“It is not sufficient for the plaintiff to prove that [the defendants] ought to have known those or any other facts. That would imply that a negligent lack of knowledge was enough. They must be proved either to have had actual knowledge of the relevant fact or to have known facts which gave reasonable grounds for the relevant belief.”
[54]The phrase used in article 16 of the Second Directive is “could not in view of the circumstances have been unaware of … ”. My present, and provisional, view is that the meaning given to the words “has reasonable grounds to believe” in Swain v Puri is a meaning which is more likely to be consistent with the meaning to be given to the phrase in the Community instrument than “ought to know”. The knowledge which the legislature has sought to describe in section 277(1) of the 1985 Act is, I think, knowledge which the member has and knowledge which the member “must be taken to have” or, perhaps, “may reasonably be taken to have”. But, as I have said, it is unnecessary, in this case, to decide between those alternatives and I do not do so.

Cited in 6 later judgments