Quick read

What happens when dividends to shareholders are unlawful?

Article by

Strict statutory rules govern the payment of dividends by a company. But what happens when a company doesn’t stick to the rules?

Red faces at Next plc

Next plc recently admitted that due to “a technical infringement of the Companies Act 2006” a number of its dividends to shareholders were in fact unlawful.

Rules for dividends

A company can only pay a dividend to its shareholders out of profits available for distribution (broadly, its accumulated, realised profits less its accumulated, realised losses).

Any dividend has to be justified by reference to relevant accounts. The company’s last annual accounts will usually be used for this but, where those accounts don’t show sufficient distributable profits to cover the dividend payment, the company can rely on interim accounts. Those interim accounts must enable a reasonable judgment to be made of the company’s profits available for distribution.

Crucially, where a public company (like Next plc) relies on interim accounts, those accounts must be filed at Companies House before the dividend is paid. In Next’s case, although the company did have distributable profits from which the various dividends could lawfully have been paid, it had not filed the interim accounts on which it was relying to justify the dividend payments. This resulted in that “technical infringement of the Companies Act” and meant that the four dividends paid between February 2014 and November 2015 were unlawful.

What are the consequences?

An unlawful dividend is not void – the payment still stands – but any shareholder who received the unlawful dividend can be required to pay it back to the company if the shareholder knew (or had reasonable grounds for believing) that it was unlawful.

In addition, any director who authorised the unlawful dividend could face a claim for breach of fiduciary duty (particularly the duty to act with reasonable care, skill and diligence) which could result in the director having to make a payment to the company equal to the amount of the unlawful dividend. The four dividends paid by Next totalled more than £300 million so the potential liabilities faced by the directors were not insignificant.

How can you fix it?

To rectify the problems with its dividends, Next asked its shareholders to approve both the use of distributable profits to pay the dividends and the waiver of any claims which the company may have against the shareholders who received the dividend and the directors who authorised it.

The resolutions were duly passed (and no doubt Next’s directors slept a little more soundly that night).