Everyone knows what dividends are, but do you know the restrictions on how much you can pay as dividends and the consequences of getting it wrong?
Rules within the Companies Act 2006 place limits on how a company can distribute its profits and assets amongst its shareholders.
A distribution made in breach of the rules is unlawful and shareholders who receive an unlawful distribution can be required to repay it.
The most common form of a distribution is the dividend. However the term covers all manner of assets belonging to a company, including real property and other non-cash assets.
What are the requirements for a lawful distribution?
A distribution can only be made out of the profits which are available for the purpose (often referred to as distributable profits or reserves). The Companies Act defines these profits (in basic terms) as the company’s accumulated realised profits less its accumulated losses.
A distribution made by the directors must be justified by reference to the company’s accounts which have been prepared in accordance with generally accepted accounting principles. Individual, not group accounts must be used. It is usually the most recent annual accounts which are used to asses the extent of distributable profits. However, if the directors want to make a distribution which cannot be justified by reference to the last annual accounts, more recent interim accounts can be prepared to justify the distribution.
Directors must also consider the duties that they owe to the company when considering whether a distribution is appropriate. Directors are required to safeguard the assets of the company and to make sure that the company is able to pay its debts as they fall due.
The directors must therefore be satisfied that any distribution will not erode the profits of the company such that it will become unable to pay its liabilities (both actual and contingent).
If an unlawful distribution is made, the shareholders cannot approve it retrospectively. The shareholders might also be required to repay any dividend they have received unlawfully.
The directors may also be liable and be found in breach of their duties.
It is therefore imperative directors abide by these rules and do not pay themselves dividends without reference to the company’s accounts and profits.