The Companies Act 1985 section 263 states 'a company shall not make a distribution except out of profits available for the purpose'. A company’s profits available for distribution are its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital.
Further restrictions are placed on public limited companies.
Under section 277 of the Companies Act 1985 where a shareholder knows or has reasonable grounds for believing that a dividend was improperly paid, he is liable to repay it to the company.
Sections 829 to 853 of the Companies Act 2006 which relate to 'distributions' become effective on 6 April 2008 and replace sections 263 to 281 of the Companies Act 1985.
The Companies Act 2006 section 830 states 'a company may only make a distribution out of profits available for the purpose'. The company’s profits available for distribution are as stated above.
Section 831 of the Companies Act 2006 imposes further restrictions on public companies and section 832 places conditions on investment companies.
Under section 847 of the Companies Act 2006 if at the time of the distribution the member knows or has reasonable grounds for believing that a distribution was unlawful he is liable to repay it (or that part of it, as the case may be) to the company.
Procedure for Paying Dividends
A shareholder cannot insist on the company declaring a dividend. Directors can declare and pay a dividend or propose a dividend to be approved by the shareholders in general meeting. The shareholders in general meeting may confirm a dividend already paid out or declare a dividend to be paid out, the directors having set the amount. The Articles may put in place additional restrictions in addition to those in the Companies Acts.
Effect on the Accounts of Illegal Dividends
In the accounts of private companies the directors may include an explanation within the dividend note that either:
- The dividend was not illegal as it was based on interim accounts which showed there were sufficient profits available for distribution at the time the dividend was paid, or
- An explanation of the illegal dividend payment and reasons why the event occurred. For example 'The directors acknowledge illegal dividends were declared and paid. No further distributions have been made and the directors are seeking to recover monies from the shareholders'. Another example is 'At the time the dividend was paid the directors were not aware that there were insufficient profits available for distribution and the directors acknowledge that no further distributions can be made until there are sufficient profits available for that purpose'.
The note should explain the situation to readers of the accounts and therefore should be appropriately tailored to fit the circumstances.
If the accounts are audited and there is a material uncertainty or disagreement of disclosure the auditor will need to consider the impact on the audit report.
In the accounts of public limited companies there are additional requirements both in relation to the accounts and the auditors. In such situations reference should be made to the Companies Act 1985 or 2006.