I was interested to read an article in today’s Scotsman about the huge amount in dividends that UK companies are estimated to be paying their shareholders this year – over £100 billion.
This is an eye-watering sum which will be paid out mainly to the large institutional shareholders which invest in UK plcs. However, for many companies, dividends are an important source of income for their owner/manager. The overwhelming majority of companies in the UK are single shareholder/director companies. Directors of these companies often structure their remuneration so that they receive a relatively small salary which is then supplemented by periodic payment of dividends.
Whatever end of the scale you’re at, there are legal requirements which must be met before dividends can be paid out. These can be easy to forget – but if the process is not followed, the dividend will be unlawful with some potentially serious consequences e.g.:
- the shareholder who received the dividend is liable to repay the dividend to the company if he knew or had reasonable grounds for knowing it didn’t comply with the legal rules (if the shareholder is also a director, this is a big risk);
- a director who authorised the payment may be in breach of his directors’ duties (see below) and may be personally liable to repay the company, even if he is not a shareholder.
And it’s not safe to assume that any breach of the legal requirements can be “cured” by the shareholder(s) passing a resolution saying they’re happy with it. It all depends on what went wrong.
It’s far better to get it right first time so here is a short checklist for directors:
- Check what the company’s articles of association say about dividends and ensure these are complied with. The articles will commonly provide that directors can declare interim dividends (i.e. dividends paid during the company’s financial year).
- Dividends can only be paid out of available profits – accumulated realised profits less accumulated realised losses.
- Dividends must be justified by reference to properly prepared accounts showing profits, losses, assets and liabilities and provisions. Get your accountant involved in good time.
- Look at your company’s last annual accounts. If these show that there’s not enough profit to pay the dividend, arrange for interim accounts to be drawn up and see what these indicate.
- Whatever accounts you are relying on, consider whether anything has happened between the date of the accounts and now which would result in there being insufficient available profit to pay the dividend on the proposed payment date e.g. has the financial situation of the company deteriorated?
- Consider your directors’ duties before declaring a dividend. These duties include:
- to act in the way the director considers, in good faith, would be most likely to promote the company’s success for the benefit of its members as a whole;
- to exercise reasonable skill and care;
- to act within your powers;
- to declare an interest in the proposed payment – this will always be relevant if the director is also a shareholder. In that case, also check the company’s articles to see whether the director can count towards the quorum and vote on the proposed dividend payment.
- Prepare board minutes documenting the process – what accounts you have relied on, your analysis of any changes to the company’s financial position since the date of the accounts, what the company’s likely future financial needs are, etc. This may seem like unnecessary paperwork when you are an owner-managed business. However, should you bring in new directors or investors, they are likely to want to check that the company has been properly managed in the past. Worst case scenario, should the company go under, the liquidator will be trawling through the company’s paperwork (or lack of) – and repayment of any unlawful dividends would be a prime target.
Don’t hesitate to contact Brodies if you need any help!
On January 27, 2014