Dividends During COVID-19 – A Potential Trap For The Unwitting Director

The effects of the Coronavirus pandemic are having a dramatic effect on the global economy. Many businesses are suspending or reducing trading activities due to decreased demand, inability to trade safely in the current environment or being unable to source materials/products. This in turn will have a knock-on effect on both profitability and cash flows within businesses, along with the ability to declare and pay dividends.

Already a number of listed companies and financial institutions have indicated that in the light of the impact to their businesses and current uncertainty they will not be paying dividends in 2020. This will of course impact their investors, including pension funds.

However, there are also implications for a large number of owner managed UK companies that typically, to optimize their tax position, remunerate their shareholders/directors with a mixture of a modest salary and the remaining remuneration package paid through dividends. It has been reported that over 90% of the profits of owner managed businesses are distributed as dividends. A modest sum may be drawn annually as salary with the balance taken, perhaps monthly or quarterly, as dividends. Historically, it may have been sufficient to rely on the financial position shown in the previous annual accounts.

The declaring of dividends is still allowable through these turbulent times, subject to the company having distributable reserves (profits) available to declare. However, with many companies uncertain about their future performance and ability to continue as a going concern at present, this could result in some dividends being unlawful. It is essential that directors do not unwittingly pay an unlawful dividend which might result in a claim on them by a liquidator should the company fail. The liquidator can claim to recover the unlawful dividend and interest. The director could also face disqualification from acting as a director.

In addition, if the unlawful dividend is not repaid, HMRC may treat the dividend as salary and claim tax and national insurance from the shareholder.

Before declaring a dividend, the directors must consider  1) if there is sufficient distributable reserves and 2) whether, following the payment of the dividend, the company will continue to be solvent and able to meet its debts as they fall due.

It simply isn’t sufficient to look at the last filed accounts to see if there are distributable reserves available, directors also need to reflect on the following:

– Any events (example: COVID-19) that have arisen and the effects of the events since the date of the last filed accounts;

– At the date directors consider declaring a dividend they must also have reviewed trading since the last filed accounts and the movement on the distributable reserves to ensure there are sufficient distributable reserves for a dividend to be declared (distributable profits could be reduced since the last accounts in areas such as stock write downs, onerous contract provisions, irrecoverable trade debts and other impairments of assets); and

– Directors must also review the company’s position as a going concern and take into account latest forecasts from both a profitability and cash flow perspective to ensure the business remains a going concern and solvent post declaring and paying of the dividend.

On reflection of the above points, if a director believes or has reasonable grounds to know that their company either does not or is unlikely to have sufficient available profits as a result of the COVID-19 restrictions or in the normal course of business to continue then no dividend should be declared.

The law on dividends applies to individual companies. However, in relation to connected and group companies, the directors also need to consider the impact of cross guarantees.

If there is any hesitation, directors should act with caution, consider taking advice from their accountant or other qualified adviser and look to change their remuneration methods to salary only.

If a director has unwittingly paid a dividend which they now consider may be unlawful, legal advice should be sought before cancelling or reversing the dividend.

The recently announced temporary relaxation to the “wrongful trading” rules will not prevent an action for recovery of an unlawful dividend.

Please do not hesitate to contact the JDC team if you would like to discuss further.