What Are Advanced Dividends And Why Might They Have To Be Repaid?

What Are Advanced Dividends?

Many small owners managed companies can operate with a degree of informality and this can result in transactions such as advanced dividends.

An advanced dividend is in effect an anticipated dividend. The problem with such an approach is then proving at a later date what a transaction was if there was no record at the relevant time to properly explain and evidence it.

Why Do Advanced Dividends Happen?

The day to day pressures of running a company can mean that the recording of transactions may arise after the event and in some cases long afterward. However, attempting to record transactions long after their event risks a Director failing to adequately keep proper company records.

Advanced dividends can arise because of the separation between a dividend that is declared on the one hand and the payment of the liability that arises from the dividend on the other hand. The liability resulting from the dividend is sometimes referred to as the dividend payment.

Such transactions may be entered into without the benefit of considering the consequences that can flow from them, particularly if they are not properly determined when they are processed.

Dividend Rules

Dividends can be troublesome because there are strict and mandatory procedures set out in Part 23 of the Companies Act 2006 that must be followed in order to declare a dividend. Failure to follow those rules can result in a dividend being an unlawful dividend and needing to be repaid.

Two fundamental dividend rules are that dividends can only be declared if a company has sufficient distributable profits. To ensure that is the case the dividend declaration must be made with reference to what is known as relevant accounts.

Advanced dividends will typically not comply with these dividend rules because money may be paid over to the owners of the business (so they can meet their personal expenditure desiderata) without a proper review of a company’s ability to declare the dividend.

Advanced Dividends In First Global Media Group Limited v Larkin

The case of First Global Media Group Limited v Larkin [2003] EWCA Civ 1765 highlighted the concept of advanced dividends when the Court of Appeal rejected Mr Larkin’s appeal against an earlier Court order when his defence was struck out and he had to pay £164,952.

The Directors of First Global Media Group Limited (“the Company”) took out money as drawings which were recorded as part of their Directors’ Loan Account.

Over a number of years between 1995 to 1999 the liability on the Directors’ loan accounts was in effect cleared by way of dividends being declared.

When the Company went into Liquidation the Liquidator required Mr Larkin to repay the balance on his Director’s account. However, Mr Larkin’s primary disagreement was not that he had not received the monies from the Company recorded in his Director’s loan account but the categorisation of the receipts and payments referred to therein.

The judge of first instance, Jacob J, decided the monies in question were loans not dividends, thereby recoverable from Mr Larkin.

The Court Of Appeal’s View

When the matter came before the Court of Appeal it said it was clear that when the drawings were made no dividends had been declared and as a result that in taking the money the Directors were taking a risk that ultimately arose:

The drawings were debited to the director’s account and the corresponding dividends as and when they were declared were credited to that account. It is simply not possible to assert and satisfy any court on the basis of the evidence we have seen, that the advanced dividends, as they were called, as representing the debit items on the account were, in fact, sums of money to which the director was entitled, either because they were dividends or because they were remuneration

…

what is not acceptable is the evidence of Mr Larkin to the effect that the amounts he drew were justified from time to time when drawn by the then profits available to the company for distribution by way of dividend. We were shown the amounts drawn in January and February 1999 by way of example. In each case there were substantial sums drawn and in each case the management accounts indicated that in that month substantial losses had been incurred. It is simply not the case, therefore, that sums of money were withdrawn from time to time in recognition of profits made during the same period.

…

It is true that there had been a previous practice of declaring dividends after the event, but the fact is that to conduct the affairs of the company in the way that Mr Feeny and Mr Larkin did meant that they were putting the monies of the company at risk by taking it for themselves in advance of the declaration of the dividend which, in the event, might not be justified under ss 263 to 277 of the Companies Act 1985. They put the company’s money at risk. The risk matured, and I think it would be wholly unreasonable and fanciful to suggest that they should be relieved thereby prejudicing the creditors who have been done out of their money.