In our previous post we explained the different ways in which a company may decide to return surplus cash to its shareholders. The simplest method involves the payment of a cash dividend but are there any restrictions on a company’s ability to do this and what happens if those restrictions are breached?
Board or shareholder consent?
The general rules are that:
- A final dividend, paid after the end of a company’s financial year by reference to its annual accounts, must be approved by the shareholders.
- An interim dividend, paid during a financial year before final accounts have been drawn up, must be approved by the board.
In each case, however, the company’s articles of association should be checked to see if these general rules are varied or if any other consent is required before a dividend can be paid.
The main restriction which could prevent a company from paying a dividend is that any such payment must be made from a company’s distributable profits. This is defined as its “accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made“.
The amount of distributable profits must be justified by reference to “relevant accounts”. These will typically be the company’s last annual accounts but may be more recent management accounts where events have occurred since the last annual accounts which need to be taken into consideration (for example, a profit realised on a disposal made after the accounts date).
Paying an unlawful dividend: the consequences
Perhaps surprisingly, if a company pays a dividend at a time when it does not have sufficient distributable profits available, the dividend is not void and the payment still stands. However, the payment is an unlawful one and therefore any shareholder can be required to repay the amount received back to the company if (and only if) the shareholder knew or ought to have known that there were no distributable profits available to fund the dividend.
In addition, any director who authorised payment of the unlawful dividend may be liable to compensate the company for the amount of the dividend as a result of that director having breached their statutory and common law duties by declaring and paying an unlawful dividend (in particular their duty to exercise reasonable care, skill and diligence).
In either case, the claim (against either the shareholders or the directors) would be brought by the company.
What if the company has no distributable profits?
So, can anything be done to enable a profit-making company to pay dividends where accumulated historical losses mean it has negative distributable profits? Yes, but you’ll have to read our next post to find out….