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Paying dividends during the COVID-19 crisis

14 April 2020: companies considering whether to pay a dividend during these turbulent times should take a range of factors into account, cautions ICAEW’s Head of Business Law Charles Worth.

The last annual accounts of a company may show sufficient distributable profits to meet the Companies Act 2006’s statutory test to pay a dividend. However, there are other legal tests and other factors to consider before a company decides to pay a dividend. 
 Perhaps most importantly in turbulent times such as these is that the financial position of a company may have deteriorated significantly from that shown in its last annual accounts, as may its prospects for the immediate future.  Two key tests are noted below, but companies should also consider the possible application of insolvency or other laws as appropriate.

Capital maintenance law

First, the effect of case law on capital maintenance is to require a company to update its consideration of the financial position from the balance sheet date of the last annual accounts to the date of the proposed dividend. Directors should consider whether the company’s distributable profits shown in its last annual accounts have subsequently – ie, up to the date of the proposed dividend – been lost or eroded. 
If they have, then it would be unlawful to make a distribution out of such lost, now non-existent profits. That is because the dividend would instead, as a matter of fact, now be out of capital. This is explained in paragraphs 2.2, 2.10-10A of TECH 02/17BL. 
Distributable profits could have been subsequently lost through, for example, impairment of investments in subsidiaries or associates; write-downs of stock (inventory); provisions against trade debts; loan loss provisions by banks; losses on financial investments; impairment of non-financial assets, including deferred tax assets; onerous contract provisions; or insurer’s claims provisions on travel, business interruption etc policies. The previous examples are not exhaustive.

Duties of directors

Second, the effect of the law of directors’ duties is to require directors of a company to look forward from the date of the would-be dividend. Before recommending or paying a dividend, directors should consider whether the company will, following the payment of the proposed dividend, be solvent and be able to continue to pay its debts as they fall due. 

That decision needs to be made in light of the current and likely future financial position and needs of the company. For example, the fact that cash and liquidity needs during a period in which all or a part of the company’s business may, for an uncertain period, be shut down by public health restrictions or be operating at reduced levels through reduced customer demand or supply-chain disruption should be considered. In these circumstances, for many companies, the preservation of cash has become the top priority. 

Law applies to individual companies, not groups

The law operates at the level of the individual company and not the group. The assessments referred to above must be carried out at individual company level. Note, however, that there can be some legal arrangements that may spread adverse consequences directly from company to company – eg, cross-guarantees of bank debt amongst group members could make all such companies in the group subject to the same liquidity issues. 

Purchase of own shares

The considerations outlined above will also be relevant where a company intends to purchase its own shares out of distributable profits. 

Reversing or cancelling dividends

Ordinarily, if a dividend is declared by shareholders it becomes a debt due to the shareholders and therefore cannot be simply reversed or cancelled. Directors, therefore, need to consider carefully whether a dividend can and should be paid before recommending that shareholders give their approval. If a company has declared a dividend which has not been paid and the directors now wish to cancel it, they should seek legal advice based on the specific facts and circumstances.