Dividends – knowing the law will pay dividends

Dividends are a vital aspect of company law and an essential part of many investments in small and in some cases very big companies. Payment of dividends is the main mechanism whereby shareholders get an annual return on their investment. However, there are many complexities with dividends, both from a  legal and accounting perspective. The

Home » commercial law » Dividends – knowing the law will pay dividends

Dividends are a vital aspect of company law and an essential part of many investments in small and in some cases very big companies. Payment of dividends is the main mechanism whereby shareholders get an annual return on their investment. However, there are many complexities with dividends, both from a  legal and accounting perspective. The main ones are :-

  • There is no legal requirement for a company to pay dividends and in many small companies, where the directors are also the shareholders, a decision is made to pay salaries to the directors rather than dividends. Accountancy advice is recommended in these circumstances as to which method, or combination, is best for tax.
  • Directors need to be cautious about paying dividends in circumstances where it is not clear whether the company has sufficient profits to make a payment. The formula for deciding whether a dividend might be paid, under section 830(2)the Companies Act 2006 provides that a  dividend should only be paid from ‘accumulated realised profits less ….accumulated, realised losses’. This formula is not necessarily an easy one for the average director to understand, so it may be worth getting some comfort from an accountant before deciding to declare a dividend.
  • If directors authorise a dividend to be paid in circumstances where the company may be insolvent, the directors may find themselves subject to personal liability for such sums to be clawed back which may be made by Liquidators in the future.
  • Whilst directors make the fundamental decision to declare a dividend, which has ramifications described below, it needs to be ratified by shareholders. The position on this comes from a company’s Articles of Association. Most limited companies adopt Table A standard articles and article 30 deals with the process for an ordinary resolution.
  • Dividends can also prove contentious where the directors refuse to pay a dividend. This can be a strategic decision based on an overly cautious approach  or by way of manipulating the company to create prejudice for minority shareholders. Whilst minority shareholders may apply to the court for sanctions based on such conduct, on the basis of an unfair prejudice application, this is a far from ideal situation since litigation will involve inherent cost and risk in circumstances where the shareholder may be out of pocket significantly to begin with and/or may not have the resources to take legal action. It is not always easy to demonstrate sufficient prejudice if the directors are clever, by perhaps documenting reasons, however contrived, for refusing a  dividend, or perhaps declaring a lower dividend or approving a dividend some years but not others, so as to muddy the waters.

A clear policy on dividends, either in the company’s articles or in a  shareholder agreement, is a better way to proceed. Examples of unfair prejudice may include :-

  •  establishing a bonus scheme which only benefits directors who are employees so that there is no benefit for minority shareholders
  • connected business transactions whereby other entities associated with directors and main shareholders benefit
  • agreeing excessive salaries or consultancy fees for directors

If you have any questions or concerns about dividends or want advice on protecting your interests as a minority shareholder, get in touch with me, I can help.

 

 

commercial law • David Swede • Uncategorized

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