Illegal Dividends and Insolvency: The Implications of Unlawful Dividends
The distribution of dividends is a common practice in businesses, rewarding shareholders for their investment in the company… But in this guide, we explain the difference between legal and illegal dividends.
Dividends can be deemed unlawful if they’re paid out without consideration of a company’s financial situation or disregard the legal regulations governing them.
Also known as unlawful dividends, illegal dividends are profits distributed by a company to shareholders when it doesn’t have the right to do so.
The Companies Act 2006 states that dividends must solely be paid out of an organisation’s distributable profits.
Distributable profits are realised after a company accounts for all its liabilities, such as debts, taxes and other expenses.
Dividends are illegal if paid out of a company’s capital reserves, or money is borrowed to fund them.
Paying out unlawful dividends can lead to severe legal and financial consequences, particularly if the company is struggling financially or is on the brink of insolvency.
In this article, we discuss what defines illegal or unlawful dividends and the implications of them.
Dividends and the law
The Companies Act 2006 provides a clear legal framework for the distribution of dividends.
The Act makes clear that a company needs sufficient distributable profits before distributing dividends.
Financial prudence underpins the Act, which is designed to protect creditors and ensure financial stability.
Responsibility for ensuring sufficient profits are available to declare a dividend falls to company directors.
Directors must carefully examine the company’s financial statements and ensure that there are sufficient profits available after meeting all financial obligations.
Businesses must use the most current and accurate financial data when making dividend decisions.
If dividends are based on overly optimistic projections or misrepresented accounts, this can lead to legal challenges.
The impact of unlawful dividends
Paying out illegal dividends can have a severe impact on both a company and its directors.
- Strained relationships between the company and its investors are common, as dividend repayments may be demanded of shareholders.
- Directors may be held personally liable for the repayment of unlawful dividends. This is especially likely if it is decided that they acted negligently or deceptively when it came to the declaration of dividends.
- As well as significant, personal, financial impact, a director may be disqualified from acting as a director in the future.
More seriously still… If it is determined that the payment of illegal dividends has contributed to a company’s insolvency, directors may be accused of wrongful trading. This can lead to potential criminal charges in some cases.
Insolvency and unlawful dividends
When a company is facing insolvency, the distribution of dividends becomes a particularly sensitive issue.
- Insolvency happens when a company or individual is unable to pay their debts on the due dates, or has insufficient assets to cover their debts.
- It’s the directors’ responsibility to know when a company has become insolvent, and they can be held legally responsible for continuing to trade if this is the case.
In such a situation, the interests of creditors come ahead of those of shareholders.
Directors can be disqualified for up to 15 years if it is discovered that they failed to fulfil their fiduciary duties and did not act in the best interest of the creditors, under the Company Directors Disqualification Act 1986.
Prevention is always better than cure, and this is especially true when it comes to unlawful dividends.
By maintaining up-to-date and accurate financial records, directors can identify potentially serious issues before they arise.
Regular audits and reviews should be an integral part of a company’s day-to-day operations. This allows directors to make dividend decisions from an informed position.
Illegal dividends and insolvency: The implications of unlawful dividends
The significant risks to both companies and directors from the paying of illegal dividends should not be taken lightly.
The consequences can be severe. They could include personal liability for directors and damage to the company’s reputation as well as possible criminal charges.
By understanding the legal framework governing dividends, recognising the signs of unlawful dividends, and taking proactive steps to prevent them… Directors can protect their companies and themselves from the pitfalls.
The team of highly qualified chartered accountants and chartered insolvency practitioners here at Hudson Weir can provide valuable guidance on managing your company’s financial affairs.
As well as being insolvency experts, the Hudson Weir team possesses a wealth of business knowledge to help your company finances remain healthy.
It’s always preferable to seek advice at the earliest stage, so don’t hesitate to reach out. We would be delighted to help guide you to a financially secure and stable future.
For more information about illegal dividends and insolvency, don’t hesitate to get in touch with the Hudson Weir team today.
