Directors of Limited companies take care when paying Dividends

Illegal Dividends – Misfeasance Claims and Director Disqualification can be the outcome for Directors of Liquidated Companies

Hundreds of thousands of directors, often of small companies, pay themselves with a mixture of salary (usually up to the thresholds when National Insurance and/or income tax kick in) and dividends. They do so because dividends are not subject to National Insurance Contributions and attract a lower rate of income tax, resulting in a reduced personal tax bill.

This is fine, of course, when a company is making sufficient profits to pay the dividends but is illegal when the profits are not there. The problem is that, as insolvency practitioners, we find that the law on the payment of dividends is often not widely known or understood by company directors. Nor are the potentially serious consequences of paying illegal dividends, even if the payment was accidental or unintentional, which can include misfeasance claims and director disqualification.

With company insolvencies at the highest level since 2009, this will likely lead to more directors of liquidated companies being investigated for the payment of illegal dividends. In this article, we look at what illegal dividends are, how they arise and how we can help concerned directors avoid the risk of paying them.

What are illegal dividends?

The rules regarding the payment of dividends are laid down in the Companies Act, 2006 which states:

“a dividend or distribution to shareholders may only be made out of profits available for the purpose.”

In addition, a dividend is also likely to be deemed illegal if:

In the event of an insolvency, shareholders and directors are legally required to repay illegal dividends received if they knew or ought to have known that the dividends were paid unlawfully. As insolvency practitioners, when we are appointed as liquidators, it is a statutory requirement that we investigate the status of dividend payments.

Only profits that have been realised are available for dividends

This is another area that is not widely understood by directors, but it is a highly important one. By law, only those profits that have been ‘realised’ are available for distribution as a Dividend. Profits from normal trading activity are typically realised profits, as opposed to unrealised profits from, for example, a revaluation of the company’s property, which are not automatically available for distribution until the revaluation is realised.

Further issues may arise if the company is subject to an audit, and additional considerations apply where the auditor’s report is qualified. Under the Companies Act 2006, an auditor’s statement will be required, confirming that the qualification does not affect the proposed Dividend.

A dividend is still illegal even if it has arisen due to a miscalculation of profits, poor record keeping or even “bad advice” from an accountant or other professional advisor. Claiming lack of knowledge or awareness of the rules surrounding dividend payments does not exclude you from being forced to repay an illegal dividend.

Directors should also be mindful of the future financial position of the company; as this must also be a clear consideration when deciding to declare a Dividend. If you cannot evidence that you carefully considered the future financial impact of declaring a Dividend, any defence to a claim against you is likely to be compromised.

How is available profit determined?

To determine profit available, the first port of call is usually the last set of annual Accounts. However, the financial position of a company can change and deteriorate very quickly. This means that Directors must consider the company’s position carefully at all times, as any deterioration since the date of the last Annual Accounts will reduce the reserves from which a Dividend may be paid. Indeed, on-going losses can quickly eliminate the potential for legitimate Dividends to be paid.

Talk to us if your company is facing Financial Difficulties and you are concerned about Illegal Dividends

We can offer guidance in this area to help ensure directors remain compliant with regulations and are not at risk of personal liability. This is important because what might look like a healthy cash flow and strong existing profits can sometimes lead to a mistaken sense of security, especially in the current difficult financial environment.

Directors working under a genuine belief that their company is solvent, may find upon further investigation that a future liability such as Corporation Tax or a BounceBack Loan gives a quite different picture and places the company into an insolvent position. Under these circumstances, what were thought to be lawful dividends become unlawful very quickly.

Antony Batty, Licensed Insolvency Practitioner and Partner points out that:

“Directors will face huge pressure to justify their actions when insolvency is combined with the payment of unlawful dividends. For that reason, it is vital that Licensed Insolvency Practitioners are approached for advice if insolvency and the issue of illegal dividends looms.

We offer guidance in situations such as this, and the sooner we are consulted on such matters the more we can do to help directors avoid the illegal dividend trap.”

Please contact us or call any of our offices, below, for a FREE initial discussion with our insolvency practitioners on the phone or over a coffee.

Also, K&W Recovery, trading as Antony Batty and Company, Thames Valley: