Paying dividends is one of the ways companies "share the wealth" generated from operating their businesses. A company can distribute the profits it makes from the capital invested by shareholders. They are usually cash payments to company investors, but other forms of settlement may also be used. Dividends are usually paid annually, but sometimes a company may decide to distribute profits more than once.
However, paying dividends to shareholders will leave the company with less assets to pay off debts to creditors. Accordingly, the Companies Act 2016 makes provisions for directors to ensure that a company is solvent before such distributions can be made. Even if solvency is met, the company must comply with other legal considerations.
The CA 2016 dividend rule has two principles – namely (1) dividends will be paid out of company profits; (2) dividends should not be paid if payment of dividends would render the company insolvent. Since the directors are the ones who authorize payment of the dividend, they must be satisfied that the company will be solvent after the distribution.
The CA 2016 lays down the liability of directors and managers who knowingly pay or allow dividends to be paid out of which they know are not profits. They are liable to the company for the amount exceeding value of any dividends that would have been properly distributed.
CA 2016 also sets out the responsibilities imposed on members. The Act provides that a company may recover distributions received by a shareholder in excess of the amount that would have been properly distributed unless the shareholder (1) received the distribution in good faith; (2) was not aware that the company failed the solvency test.
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