Many companies are choosing to suspend dividend payments given the uncertainties caused by COVID-19, but it may be necessary to move funds through a group by way of dividends from a subsidiary to its parent company to help with cashflow during these uncertain times. In doing so, directors must ensure dividends are declared lawfully, and must have regard to their duties to the company and its stakeholders (including its creditors).
When declaring a dividend, directors must ensure not only that the subsidiary company has the reserves available to meet the dividend itself, but also must retain sufficient resources to continue to meet the subsidiary’s operational and capital needs. We take a brief look at the legal framework.
The law relating to declaring dividends is set out in Part 23 of the Companies Act 2006 (CA 2006), and the following key sections apply:
s.830: “A company may only make a distribution to shareholders out of profits available for the purpose”
s.836: “Whether a distribution may be made is determined by reference to the company’s accounts, taking into account profit, losses, assets & liabilities and share capital & reserves”
It follows that there are two types of unlawful dividend:
- Where there were insufficient distributable profits to make the dividend; and/or
- The directors failed to have regard to proper accounts or interim accounts.
Dividends that are found to have been made unlawfully could be clawed back from the parent, if at the time the parent knew or had reasonable grounds to believe that the dividend was unlawful (section 847 CA 2006). Personal liability for unrecoverable dividends could potentially also be attached to directors, if they are found to have breached their fiduciary or other duties in declaring a dividend.
Directors must ensure that they fulfil their duties to each company in relation to which they are director – and not only is there often tension between the best interests of different entities within a company group, but also directors’ duties will change if a particular company’s fortunes deteriorate.
The general duties required of directors are set out in sections 171 to 177 CA 2006. Section 172 CA 2006 requires directors, among other things “… to promote the success of the company for the benefit of its members as a whole…”. That stands to reason – a company is usually set up and run for the benefit of its owners.
However, directors should be wary of section 172(3) CA 2006 which requires them, in certain circumstances, “to consider or act in the interests of creditors of the company”. Acting in the interests of creditors is a whole different ballgame – the Insolvency Act 1986 sets out a framework for the preservation of value of the company and for creditors to be treated equably.
The directors’ duty to act in the best interests of the subsidiary’s creditors switches from the parent when they know (or ought to know), that the subsidiary is likely to become insolvent – a test considered by the Court of Appeal 2019 in BTI v Sequana, but which is far from straightforward. Getting it wrong could again result in directors being ordered to make a personal contribution towards a deficit to creditors.
Can dividends be declared during the COVID-19 crisis?
Despite the strong words of caution touched on above, it will still be appropriate to declare intra-group dividends to release cash to other parts of the group that vitally need it, in cases where there is robust and conservative consideration of the subsidiary’s present and future financial position.
That won’t be easy – forecasting without knowing how long this situation will continue and quite what the impact will be – but the UK government’s rapidly evolving measures in response to the coronavirus pandemic emphasise its support for business and for directors taking difficult decisions. An example of government’s attempts to protect directors from some of their personal risk (thus encouraging them to be braver in weathering the storm of the crisis) is the proposed relaxation of wrongful trading provisions, announced over the weekend. Further details of that and the accompanying restructuring moratorium proposals are eagerly awaited in the coming weeks.