When running a company, the main purpose of directors is to ensure the company is successful. The primary aim is to deliver distributable profit to the company’s shareholders, which for a majority of companies are also its directors. But great care needs to be taken when drawing dividends. Failure to do so properly might lead to a number of claims.
Whilst a company could be successful when selling its products and services, generating large amounts of turnover, it is the balance remaining after deduction of all costs, i.e. the net profit, which is the true mark of success.
Where a company is unprofitable and is then profitable (as occurs with a lot of start-ups, who need a high degree of investment in the early stages of their life) it may be that the company remains unprofitable on a balance sheet basis, as the loss and profit each year accumulates in a reserve account, as a retained profit of loss.
However, for most profitable companies and their owner-managers, it remains the case that it is more tax efficient to draw a majority of your remuneration as dividends (although, as of writing, the tax difference is slowly closing).
Income and paying dividends
Directors and employees of a company are entitled to be rewarded for their involvement in a company, which for employees is usually by way of their salary. Directors likewise are entitled to a salary, or remuneration, for the provision of their services.
Shareholders, alternatively, are usually only permitted to draw funds from a company by way of dividends, which can only be paid out of available “distributable profit”, which in summary is the retained profit described above.
Such dividends cannot exceed the amount of retained profit, as this is the only distributable income that the company has, and it must be “available”.
Formalities for a dividend
A dividend cannot simply be drawn by a director (who may also be a shareholder) unless it is on an interim basis. Generally, for full year accounts, dividends are required to be recommended by directors and then shareholders must agree that such dividends be paid.
Some of the steps required to declare a dividend on either an interim or final basis include:
- having available management accounts (for interim dividends) or year-end detailed accounts (for final dividends) showing a retained distributable profit;
- for interim dividends, a requirement for directors to meet and agree the payment of a dividend;
- for final dividends, the requirement for shareholders to approve the distribution;
- the requirement for dividends to be paid equally to all shareholders, in accordance with the classification of their shareholding; and
- the requirement for the funds to be available.
For small companies it is not unusual for the above steps not to be followed, although there is provision in certain circumstances for some steps to be retrospectively amended.
Issues for directors
- where retained profits exist but the physical funds are not available; or
- the company is having trading or solvency difficulties, but the last set of accounts provide sufficient distributable profits to declare and pay a dividend and there are available funds; or
- where directors draw monies as directors loans and intend to convert this to a dividend at the year-end (between which the company may be placed into insolvency proceedings).
Whilst the above circumstances are not always likely to lead to a finding of misconduct in disqualification proceedings, they may cause severe problems for directors who may have to repay any dividends drawn in the event the company is wound-up and a liquidator appointed.
Misconduct leading to the disqualification of a director may arise where dividends are declared and paid but where there are insufficient distributable, insufficient available funds (see above) or where the formalities are not followed.
We commonly see directors drawing monies from a company as a loan and then seeking to avoid payment by stating they are dividends (and recording them as such either during the company’s trading life or shortly afterwards).
For the above reasons, these may be void dividends and therefore the director considered to have abused his/her position by declaring them as such (presumably to avoid having to repay such sums).
Dependent on your background and circumstances, there are a number of defences to any of the above allegations and at Francis Wilks & Jones we have considerable experience of dealing with the minutiae of any allegation that a dividend was illegal or constitutes misconduct by a director. Contact the experts today.