Unlawful Dividends

Relevant to – all those working in UK public companies, especially listed companies

On 8 February 2016, we published a special Technical Briefing on the dividend payment process following the announcement by Next plc of a general meeting and proposed related party transaction in relation to four dividend payments made by the company between 3 February 2014 and 2 November 2015.

As there have recently been some more companies that have found themselves in a similar position, we thought it might be useful to remind members of the technical issue.

The Companies Act 2006 provides that a public company may pay a dividend out of its distributable profits as shown in the last accounts circulated to members or, if interim accounts are used, those that have been filed at Companies House. Section 838 of the Act deals with the requirements where interim accounts are used to justify a distribution, and sub-section (6) states very clearly that: ‘A copy of the accounts must have been delivered to the registrar’.

In all the cases that have come to light, it seems the companies concerned have always filed their statutory accounts on time in accordance with the requirements of the Act, and at all times had sufficient profits and other distributable reserves to make these payments as shown by the accounts at the relevant time. However, they had not filed the necessary accounts at Companies House to satisfy the procedural requirements of the Act before making the payments.

The requirement for the relevant accounts to have been filed applies even if the company in question has sufficient distributable profits at the relevant time. The purpose of this requirement is, presumably, so that interested shareholders can satisfy themselves that the payment is appropriate. Although this may seem to be a very technical breach of the Act requirement, it is, nonetheless, a breach of the Companies Act and deserves to be treated with appropriate seriousness as the consequences, if not ratified by shareholders, could be significant.

The result of this error is that, technically, the payments constituted unlawful distributions and so the company may have claims against past and present shareholders who received these payments and against the directors in office when the payments were made. The only other way for the company to rectify the position is for shareholders in general meeting to waive any such claims and give retrospective approval to the payments so that all concerned are returned to the position in which they would have been had the payments been made in compliance with the Act. Of course, waiving claims against the directors constitutes a relevant party transaction with the additional complexity that this entails.

As we highlighted last year, research from Manifest identified 10 companies that found themselves in this position in the year to February 2016 and in recent weeks we have seen Domino’s Pizza, Dunelm Group and Hargreaves Lansdown plc have similar issues.

In the most recent example, that of Hargreaves Lansdown, the general meeting circular identifies three different issues:

  • For five distributions, the company did not file interim accounts at Companies House before making the payments, while the previously filed accounts did not show sufficient distributable profits. 
  • For two distributions, although interim accounts had been filed, they were prepared on a consolidated basis and did not include a company stand-alone balance sheet which the circular states is permitted under the FCA Handbook, but does not satisfy the requirements of the 2006 Act as they did not specifically set out the distributable profits of the company.
  • For five distributions, the annual accounts were circulated to members after the payments had been made.

In the case of all three companies, and in all the cases identified by Manifest last year, the issue appears to have been relatively uncontentious for shareholders, with overwhelming votes in favour of the approving resolution so far. However, it would be quite wrong to dismiss it, as the chief executive of Hargreaves Lansdown was quoted as having done, as ‘not submitting a sheet of paper’. This is significant, not just for the cost to shareholders of a separate meeting in order to deal with the error, once discovered, in a prompt and transparent manner, or for the embarrassment to the company and the company secretary, whether or not they were in post when the errors were made.

The fact that a general meeting has to be called puts these issues into the public domain and each of them have attracted comment in the press. A headline in the Financial Times of ‘Hargreaves Lansdown breaks company law over dividend payments’ was probably not in the corporate communications plan.

These errors are also of significant interest to institutional investors, not because they will oppose the corrective resolution – as we have seen, these tend to receive support above 95% – but for two related reasons. First, there are a number of investors for whom capital maintenance is a major issue and who have pressed to see a clear and separate disclosure of distributable profit in annual accounts. For them, this sort of error suggests a lack of discipline on such issues. Second, there is the concern of other investors that if a company is slipshod in its compliance with basic legal requirements – and let us not forget that few, if any, companies have sought forgiveness for only one transgression – in what other areas of their business might similar carelessness apply?

Although it is usual to rely on finance colleagues and/or the auditor to confirm that a proposed dividend can be paid, it is clear that this point can be – and has been – overlooked. We therefore strongly recommend that all company secretaries check that all the necessary legal and regulatory requirements – including an appropriate filing – have been made before proceeding to payment.

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