Shareholder funds: when can a company declare a dividend?

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Welcome to the final post in our 'Building a resilient balance sheet for 2021' series looking at solutions and opportunities for 2021 viewed through the balance sheet. We now look at dividends.  

Director shareholders of owner-managed businesses often rely on dividends in place of a salary. Investors rely on dividends to justify their deployment of capital. But if a dividend is unlawfully made the consequences can be severe.

Over recent months, deteriorating balance sheets mean that previously casual decisions to pay dividends may now be unlawful.

What are the basic requirements for a company to declare a dividend?

There are two basic requirements, set out in the Companies Act, which must be satisfied for a company to declare a dividend: 

  1. There must be "profits available" (or distributable profits) to pay the dividend; and 
  2. It must be justified by reference to "relevant accounts”.

Relevant accounts are the last audited accounts or, if they do not show distributable profits, up to date ‘interim accounts’ prepared for that purpose.

What are the directors' duties?

There is a third caveat. The directors must comply with statutory and common law duties before declaring a dividend. They must be confident that, even though there are distributable reserves, there will also be sufficient funds to continue to pay all debts thereafter. Liabilities for directors’ wrongful trading have been re-suspended until 30 April 2021 as part of COVID-19 measures, however directors remain liable for their other duties. 

What happens if there is a breach of these duties?

Directors who breach these duties could be held personally liable to repay the dividend. In addition, recipient shareholders who knew (or ought reasonably to have known) of the facts which meant a dividend is unlawful may also be personally liable to repay them. Given these serious consequences, great care must be taken if the position is at all uncertain. 

This post ends our journey through the balance sheet over the last 5 weeks. Over the coming months, those businesses that are as lean and fit as possible will be best placed to weather any storms and take the opportunities that will arise.  

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