The payment of dividends
The payment of dividends used to be a matter to be decided by commercial prudence and the company’s constitution.
In a company’s articles of association it is generally provided that the basic power to pay dividends lies with the company in general meeting. It is granted the power to pay a dividend up to the amount recommended by the directors.
A typical provision would provide that the company may by ordinary resolution declare dividends in accordance with the respective rights of the members, but no dividend shall exceed the amount recommended by the directors.
Generally, directors will be granted the power to declare interim dividends. For example, it may be provided that:
Subject to the provisions of the Act, the directors may pay interim dividends if it appears to them that they are justified by the profits of the company available for distribution.
If the dividends are to be paid otherwise than in cash, express authority is required. This point was at issue in Wood v Odessa Waterworks Co (1889) 42 ChD 636, where the company’s articles empowered dividends ‘to be paid’ by directors. This was interpreted as meaning ‘paid in money’. A member was then able to rely on this article in challenging a distribution that was made in a non-cash form by the issue of bonus debentures.
Dividends are payable, in the absence of any provision to the contrary, to those members who are on the register at the time the dividend is declared.
Another question that needs to be considered in relation to provisions in the articles is from which profits are dividends payable. Some articles, for example, specify ‘the profits of the business’, which is taken to mean that dividends can only be paid out of trading profits and not out of capital profits.
As has been noted previously, preference shareholders are only entitled to a preferential dividend when the dividend is actually declared. However, a preferential dividend is presumed to be cumulative. This means that if the dividend is not paid in one year it must be paid in a later year (see section 4.2.1).
In addition to the requirements set out in the company’s constitution, the Stock Exchange provides rules for companies that are listed or are dealt with on the Alternative Investment Market. The Stock Exchange requires that the date of any board meeting at which the declaration or recommendation of payment of a dividend is expected to be decided must be notified to the Stock Exchange in advance; it will then publish the information. The Stock Exchange issues a schedule of suitable dates to assist in settlement of transactions and to permit securities to be traded ‘ex-dividend’ from a convenient date.
If the regime relating to the payment of dividends used to be somewhat lenient, that changed with the Companies Act 1980. Amendments were made by the Companies Act 1981 and the provisions are now contained in the Companies Act 2006.
A company may not make a distribution that includes paying a cash dividend except out of the profits available for distribution (s 830 of the Companies Act 2006).
The statutory provisions of the Companies Act 2006 apply to distributions. These are defined in s 829(1) to include any distribution of the company’s assets to its members. The definition is an extremely wide one and covers any benefits in cash or in kind.
However, the following are expressly excluded:
(a) an issue of fully or partly paid bonus shares;
(b) reductions of capital;
(c) the redemption or purchase of any of the company’s shares out of capital or out of unrealised profits; and
(d) distributions of assets to members of the company on its winding up (s 829(2)).
The profits available for distribution in both private and public companies are ‘accumulated, realised profits not previously distributed or capitalised, less accumulated, realised losses not previously written off in a reduction or reorganisation of capital’ (s 830(2)). Two key points about this provision should be noted:
(a) The use of the word ‘accumulated’ in relation to profits and losses applies to a continuous account. In particular, directors should ensure that previous years’ losses are made good before a distribution is made. This reverses the position in Ammonia Soda Co Ltd v Chamberlain  1 Ch 266. In this case, a distribution of revenue profits was made in a trading year even though there was an accumulated deficit from earlier years which had not been made good. The claimant company, which had been incorporated for the purpose of acquiring, developing and working as brineland an estate in Cheshire, sued to recover dividends that the company alleged had been wrongly paid. The Court of Appeal held that there was no law that prohibited a company from distributing the clear net profit of its trading in any year without making good trading losses of previous years. The Court of Appeal considered it was legitimate for companies not to make good past trading losses. Swinfen Eady LJ said: ‘The Companies Acts do not impose any obligation upon a limited company, nor does the law require, that it shall not distribute as dividend the clear net profits of its trading unless its paid-up capital is intact or until it has made good all losses incurred in previous years.’ This is therefore no longer the case.
(b) Profits must be realised. Directors should ensure that any income whether from trading or from capital must have actually been received by the company. This reverses the decision in Dimbula Valley (Ceylon) Tea Co Ltd v Laurie  Ch 353, which permitted the distribution of unrealised capital profits. Article 5 of the company’s articles in its constitution permitted the company to pay a divided to shareholders from an excess of assets on capital account. Buckley J held that this provision was valid and hence the company could pay a dividend based on an unrealised profit. (It is perhaps worth noting that, in a Scottish decision, the opposite result had been reached: see Westburn Sugar Refineries Ltd v IRC  AC 625.)
A further restriction in s 831 CA 2006 only applies to public companies. Distributions may only be made so long as the value of the company’s net assets does not fall below the aggregate of its called-up share capital plus its undistributable reserves. This requires public companies to maintain the value of their capital.
Undistributable reserves are defined in s 831(4) as:
(a) the share premium account;
(b) the capital redemption reserve;