Coronavirus: Risk of paying unlawful dividends

Partner David Few, in Blandy & Blandy’s corporate and commercial team, explains why business owners and shareholders should consider whether to declare a dividend given the Coronavirus (COVID-19) pandemic and the legal requirements that must be followed if doing so.

It goes without saying that the current situation represents a very difficult and unpredictable time for many businesses and for the economy.

From placing staff on furlough leave to taking advantage of the various government schemes aiming to protect jobs and to conserve cash flow, companies and their owners are faced with making vitally important but hard decisions, with a growing number of businesses closing and trading conditions becoming increasingly challenging.

It is therefore important that before owner managers consider whether or not to declare a dividend they should remember that certain legal requirements must be followed. There are three major conditions.

  • Firstly, the company must have sufficient distributable reserves out of which to pay the dividend.
  • Secondly, the directors must have regard to the cash reserves and working capital requirements of the business.
  • Lastly, the dividend must be declared by reference to the company’s relevant accounts.

It is not possible to decide at a later date that what should have been paid as a salary had been wrongly paid as a dividend. The risk is that if a dividend is wrongly paid, any shareholder who receives a dividend may be liable to repay the sum as it will represent an unlawful return on capital. Further, if the company goes into liquidation, the liquidator will almost certainly consider whether to seek to recover the dividend from the shareholders for the benefit of the unsecured creditors.

Against this background, the issues of dividends requires some thought and a decisions as to whether it is right and proper for companies to be declaring dividend during this time

In many cases with SME businesses, the owners and managers of the company are the same people and there has always been a temptation for directors to pay themselves by way of dividend as opposed to a salary or bonus to benefit from the tax benefits that follow. Such a course has always been required to be followed with care but particularly now in these unprecedented times.

For the present, directors should therefore be careful before declaring dividends and be asking themselves as to whether they should be remunerated through salary and pay income tax and national insurance.

For further information or legal advice, visit www.blandy.co.uk, contact law@blandy.co.uk or call 0118 951 6800.