Declaring dividends by reference to interim accounts: a potential trap for public companies

A number of ratification circulars have been published by listed companies in recent years, seeking to put right dividends which (because the necessary distributable profits did, in fact, exist) could have been lawfully made, but which were unlawful due to the failure to file “interim accounts” demonstrating those distributable profits – and thereby justifying the dividend – at Companies House.

Whilst relatively easy to fix and certainly not the worst thing that could happen to a listed company, having to convene a general meeting and ask shareholders to release the directors (and shareholders themselves) from potential personal liability to repay the dividend is time-consuming, potentially costly and may have adverse reputational consequences.

The issue: justifying dividends by reference to relevant accounts

Under sections 836 and 838 Companies Act 2006, a company can only pay a dividend out of distributable profits as shown by relevant accounts. These will be the last annual accounts circulated to members, or, if those accounts do not show sufficient distributable profits to justify the dividend, “interim accounts” showing adequate reserves.

The requirements for interim accounts for private companies are quite relaxed and usually a recent set of management accounts will be used. But, for public companies, additional requirements apply under section 838 Companies Act 2006 (see box below). These include filing the interim accounts at Companies House, and it is this filing requirement which has wrong-footed a number of listed companies.
The rules apply equally to interim dividends (dividends declared and paid by the board, usually during the course of the financial year) and final dividends (dividends recommended by the board and approved by an ordinary resolution of the shareholders – usually at the company’s AGM). Final dividends are therefore usually declared by reference to the annual accounts circulated to members prior to the company’s AGM. Whilst interim accounts are most often used in connection with interim dividends, they are sometimes also necessary for final dividends in order to capture a post-year end event which has improved the company’s distributable profit position.

The consequences of an unlawful dividend 

The procedural rules on dividends under the Companies Act are strict, and, if the dividend is justified by reference to interim accounts which have not been filed prior to the dividend being paid, the dividend will be unlawful; this is the case even if there is significant headroom in the distributable profit position. For final dividends declared by reference to interim accounts, companies will want to ensure that interim accounts are filed before the dividend is approved by shareholders (the dividend becoming a debt owing by the company once approved). 

The legal consequences of an unlawful dividend are, in theory at least, draconian. Shareholders can be pursued for repayment of the dividend, and directors can be personally liable to repay the dividend, having acted in breach of their duties. Putting it right involves the release of both shareholders and directors from the potential liability to repay the unlawful distribution (the release of the directors constituting, for companies subject to the Listing Rules, a related party transaction and requiring approval by the independent shareholders and a fair and reasonable opinion from the company’s sponsor). Ensuring that the procedural requirements of the Companies Act are followed when making both final and interim dividends will avoid these headaches.