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Unlawful and illegal dividends by Directors are dividends that are declared at a point when the company does not have sufficient distributable reserves.

Overview Of Unlawful Dividends

What Is A Dividend?

In order to consider what is an unlawful dividend, it is first necessary to consider what is a dividend. A dividend is a shareholder’s right or entitlement to a sum of money from a company. It is not merely the payment of that sum of money from the limited company.

Although it is common to refer to the payment of a dividend with the dividend itself, it is not the case that the payment of a dividend is the dividend.

The Companies Act 2006 enables subject to certain conditions for shareholders to receive dividends. In a nutshell, a dividend can only be paid from profits. This is to protect the company’s creditors so that a company’s wealth or money is not extracted by the shareholders at their expense.

Declaring A Dividend

If a Director wishes to pay a dividend to the limited company’s shareholders, he or she has to DECLARE the dividend otherwise it is not created.

In order to declare a dividend, the Board of Directors will need to pass a board resolution to formalise the declaration. The resolution should ensure that it refers to the accounts that are relied upon to justify the dividend. These are referred to as the RELEVANT ACCOUNTS accounts.

Why Are Dividends Declared?

Dividends are declared because the company’s shareholders that own the company will want to receive a return on their investment in the company. Such return can typically take two forms:

  1. Receipt of regular dividends.
  2. Sale of the shareholding.

Consequences Of Failing To Declare The Dividend – An Unlawful Dividend!

If payment is made to a company’s shareholders intending it to be a dividend without having been properly declared then the transaction is not a dividend. The consequence of such a failure is that the transaction may well have to be reversed and repaid to the company as Mr Belcher found out in the matter of BM Electrical Solutions Ltd & Anor v Belcher [2020] EWHC 2749 (Ch) which has featured in our post Ouch! Director Dividends, Director Loans and Director Liability.

What Are The Conditions For A Dividend?

Dividends Can Only Be Made Out Of Profits

In order to consider what is a dividend and therefore what is an illegal dividend you need to break down all the special features of dividends. Dividends can ONLY be declared out of profits. You can see from the extract of Section 830 of the Companies Act 2006 the restriction imposed.

What Are The Profits Available For A Dividend?

The profits available for a dividend are the accumulated realised profits.

Profits are not simply cash in the limited company bank account.

Profits are also not the ‘net’ profit figure shown on the last Profit and Loss Account of the company.

Consequences Of Unlawful Dividends

The consequences of unlawful and illegal dividends for an insolvent company is that the Director will be unable to ratify the breach of duty and liable to repay the dividends back to the company.

A dividend must be declared with reference to relevant accounts. This is a mandatory requirement in the Companies Act 2006. A dividend cannot be an afterthought i.e. something that is processed after the year-end for accounting purposes to justify a Director’s receipt of company money. You must declare the dividend first and then you can draw it, not backdate it into the accounts after the year-end to justify monies a Director has extracted during the year.

Director Dividends

The perils of backdating dividends should not be underestimated.

Profits made by a limited company are distributed to shareholders through the declaration of dividends. Quite often, for example in the case of owner managed businesses, the directors and shareholders of the company are the same. In such businesses, directors might take a minimum salary and pay the rest of their remuneration by way of dividend.

For some time, this has been a tax-efficient means for directors to be remunerated. However, before a company is able to pay a dividend, two main criteria must be met: sufficient distributable reserves (profits) and the reference to the ‘relevant accounts’ referred to above.

If the two main criteria are met, the company then needs to comply with certain formalities before the dividend is paid.

If companies fail to comply with the above requirements, the dividend will be unlawful.

Sometimes unlawful dividends are paid to shareholders when the directors incorrectly determine what available profits the company may have. This could be due to a mixture of poor record keeping and inaccurate accounts.

Dividends may also be paid when the company is insolvent or it may become insolvent as a result of that payment. In the event of the company’s insolvency, recovery claims inevitably will be brought by the insolvency officeholder against the shareholders and the directors.

If you have an issue with a dividend and want to discuss options, call us on 020 3925 3613 or Contact Us.

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Disclaimer: Unlawful And Illegal Dividends

This page: Unlawful And Illegal Dividends is not legal advice and should not be relied upon as such. This article Unlawful And Illegal Dividends is provided for information purposes only. You can Contact Us on the specific facts of your case to obtain relevant advice via a Free Initial Consultation.