May 13th, 2020 / Insight posted in Articles, Coronavirus, Legal

Payment of dividends during the Coronavirus pandemic

The current stress on the finances of many companies during the Coronavirus crisis means that directors should take the time to remind themselves of their legal obligations when declaring and paying dividends. Getting it wrong now could have serious consequences for them, the shareholders and the company.

Companies in the most affected sectors might decide to suspend dividends for a period to preserve their cash resources and the viability of their business. A company that receives loans or government assistance to ride out the pandemic, may find it particularly difficult to justify maintaining dividend payments to shareholders. Even if a company has financial capacity to maintain dividends at the same level through a temporary dip, it might decide to adopt a cautious approach, given the current level of uncertainty.

Different considerations will apply depending on the size, ownership structure and circumstances of each company. For example, in the case of many owner-managed businesses, directors regularly take a substantial part of their remuneration by way of dividend.

Where a company is part of a group, it could be necessary for a subsidiary to pay dividends to its parent company to help with the parent’s cash flow. In doing so, directors must ensure dividends are declared lawfully, and must have regard to their statutory directors’ duties.

It is important to check that the level of dividend is appropriate under the current circumstances.

What are the legal requirements relating to dividends?

In order for a company to be able to lawfully pay a dividend, there are two main requirements which must be met:

1.  It must have sufficient distributable profits available, and

2. Those distributable reserves must be justified by reference to relevant accounts.

The “relevant accounts” are normally the company’s most recent annual accounts, but if those do not show sufficient distributable profits, specific interim accounts should be prepared. The accounts relied on must show the company’s assets and liabilities, its share capital and include suitable provisions for future liabilities.

Before making any dividend, a company must consider any events that have arisen since the date of the relevant accounts.

In addition, before recommending or declaring a dividend, the company’s articles of association and any shareholders’ agreement should be checked, as they often contain express provisions regarding dividends.

Directors’ duties

Company directors are under a duty to safeguard a company’s assets. They are also under a duty to promote the success of the company “for the benefit of its members as a whole” having regard to such issues as the likely long-term consequences, employees, relationships with suppliers and customers, as well as the community and the environment. If a company is financially distressed, the directors’ usual duty to promote the company’s success is replaced by a duty to act in the best interests of the company’s creditors.

Directors should also consider the company’s future financial requirements, their other statutory duties under the Companies Act 2006, and the company’s best interests generally before recommending or declaring a dividend. Given the current uncertainty surrounding the Coronavirus pandemic, it might be necessary for directors to adopt a cautious approach to enable to the company to retain funds to meet its future liabilities.

It can often be difficult for directors to balance these competing duties, even more so in these unprecedented times.

Unlawful dividends

An unlawful dividend can be clawed back from a shareholder if at the time the shareholder knew or had reasonable grounds to believe that the dividend was unlawful (section 847 Companies Act 2006).

In addition, a director who authorises the payment of an unlawful dividend may be in breach of their statutory and common law duties and may be personally liable to repay the company, even if the director is not a shareholder.

Can a company pay dividends during the Coronavirus period?

Despite the comments above, in many circumstances it will still be appropriate to declare dividends. For example, intra-group dividends might be made to release funds to a parent company, and directors of owner-managed businesses may also wish to receive dividends, provided those dividends comply with the rules, but only after cautious and careful consideration of the company’s financial position.

For further guidance, we are here to help.