Companies, and their directors, need to be very careful about how and when they make distributions to their shareholders as there are a number of strict rules and regulations which need to be adhered to for the payment to be legal and valid. There may also be internal constitutional rules for that particular company which should also be checked and considered. These might include the company’s articles of association and any shareholders agreement.
Failure to adhere to the rules could potentially have significant consequences for the individual directors and the shareholders.
What is a “distribution”?
A distribution is described very widely under the Companies Act 2006 and includes “every description of distribution of a company’s assets to its members, whether in cash or otherwise”. As such, interim and final dividends are classed as “distributions” for the purposes of company law.
For a distribution to be lawfully paid the company must have sufficient profits which are available for distribution (called “distributable profits”), and it must be justified with reference to the company’s accounts. A distribution made out of capital or declared in excess of the company’s distributable profits is unlawful. The company’s solvency status should also be considered carefully as a distribution (even if otherwise lawful) may be classed as a transaction at an undervalue if the company is insolvent. Failure to consider the company’s financial position could have significant consequences for the directors who authorise the distribution and the shareholder who receives it.
Can I distribute assets, other than cash, from a company?
There are a number of different ways in which the profits of a company may be distributed to its shareholders. For example, a “dividend in specie” or “distribution in specie” is sometimes used. A dividend in specie is where a dividend is first declared and then satisfied by the transfer of a non-cash asset (such as a property). Whereas a distribution in specie occurs when a company makes a distribution of a non-cash asset without first declaring an amount in monetary terms.
The terms dividend in specie and distribution in specie are sometimes used interchangeably, but they may have different treatment from a tax perspective and so specific tax advice should be taken first.
What are the consequences of the distribution being unlawful?
If a director authorises the payment of an unlawful dividend, they may find themselves in breach of their directors’ duties. In some circumstances that director may be found personally liable to repay the company, or even worse be disqualified as a director. It is therefore important that directors take due care and consideration when making decisions to pay a distribution, and importantly always consider the financial position of the company first.
A shareholder who knows, or has reasonable grounds to believe, that a distribution is unlawful is liable to repay it (or the part which is unlawful).
It is important that directors making, or shareholders receiving, a distribution from their company ensure that it is lawful and has been properly recorded. Advice should always be considered given the potentially significant consequences of unlawful distributions.
For further information or advice, please contact BHW’s corporate team on 0116 289 7000 or email info@bhwsolicitors.com.