Dividends – Directors’ Duties & Liabilities
A dividend cannot be paid in excess of a company’s distributable profits.
Under common law directors have a duty to safeguard a company’s assets and consider the company’s future financial requirements before recommending or declaring a dividend.
Directors must also consider their statutory duties under the Companies Act 2006 before recommending or declaring a dividend, specifically section 171 (duty to act within powers), section 172 (duty to promote the success of the company) and 174 (duty to exercise reasonable care, skill and diligence).
Case law has determined that directors (and a finance director if there is one), must consider the affordability of paying dividends and this must be clearly communicated to shareholders. This even extends to directors having to resign if shareholders are determined to pay themselves dividends at a level that the directors determine the company cannot afford. Directors, in fulfilling their statutory duties, must ensure that the company continues to operate on a solvent basis and in accordance with the requirements of the Companies Acts.
A director who authorises unlawful dividend payments may be in breach of their statutory and common law duties and may be personally liable to repay the company (even if the dividend has been sanctioned by the company’s shareholders). Case law has held that this will be the case:
- if the director knows or ought to have known that the payments were unlawful (whether or not the actual knowledge amounts to fraud); and
- if the director knows the facts that established the impropriety of the payments, even though they were unaware that such impropriety rendered the payment unlawful.
However, the director must have known the circumstances and all the facts that rendered the payments unlawful, and a director’s liability is fault based rather than strict. Therefore, where a director was unaware of the facts which made the dividend unlawful, then provided they have taken reasonable care to secure the preparation of accounts so as to establish the availability of sufficient profits to make the dividend lawful, they would not be personally liable if it turns out that there were in fact insufficient profits.
The High Court has also held that where a company paid dividends out of profits that would not have been available had the directors made proper provision for tax, and the directors were aware that such provision should have been made, the dividends were an unlawful distribution of profits for which the directors might be personally liable.
Note that the Companies Act 2006 does not impose criminal penalties on directors for making an unlawful distribution.
However, the directors could be liable under section 238 of the Insolvency Act 1986 (transactions at an undervalue) if, at the time of the dividend payment, the company was insolvent and there were no reasonable grounds for believing that the dividend payment would benefit the company, and the company subsequently goes into insolvent liquidation or enters administration.