Unlawful and illegal dividends
Unlawful and illegal dividends by Directors are dividends that are declared at a point when the company does not have sufficient distributable reserves. The consequences of this 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 after thought 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.
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.