A new section 254T has been inserted in the Corporations Act
2001 ("Act") to make changes to the
way dividends can be declared. The new section took effect from 28
The previous "profits test" which used to govern the
way dividends can be declared and paid has now been replaced with a
"solvency test". The solvency test requires the company
to meet ALL of the following criteria before the declaration and
payment of dividends:
Assets must exceed liabilities immediately before the dividend
is declared and the excess must be sufficient to pay the
The payment of the dividend must be fair and reasonable to the
company‟s shareholders as a whole; and
The payment of the dividend does not materially prejudice the
company‟s ability to pay its creditors.
The requirements of section 254T are to be applied alongside a
director‟s duty under the Act to prevent insolvency.
As a result of the solvency test:
Valuation of assets and liabilities: must be
done by reference to Accounting Standards as recorded in the
company‟s balance sheet. As a result, directors cannot
rely on reasonable market valuations to determine the value of the
company‟s assets. The outcome may be that assets are
valued lower on the balance sheet than market reality, which may
lead to a company being unable to pay dividends, or able to pay
much lower dividends than if market values had been the basis of
the asset valuation.
Preparation of "special purpose" financial
statements: Since dividends can‟t be declared
and paid unless assets exceed liabilities by reference to
Accounting Standards, even if the company is not usually required
to apply Accounting Standards (such as small proprietary
companies), in future financial statements applying Accounting
Standards will need to be prepared to substantiate a decision to
pay dividends. The likely result is that companies not normally
required to apply Accounting Standards will have to incur
additional expense to prepare special purpose financial
"Point in time" test: The
"solvency test" must be satisfied at the time the
dividend is declared. This "point in time" test means
that assets must exceed liabilities as shown on financial
statements that show the position at the time the dividend is
declared. So to pay a dividend for 1 July, companies that
don‟t normally declare that dividend until after
preparation of the end of year financial statements will need to
ensure that not only on 1 July, but also on the date of declaration
of the dividend (for example, 30 August), the solvency
test‟ is satisfied. As a practical matter, it may be
difficult to prepare financial statements in time to make a
declaration, or alternatively special purpose financial statements
may have to be prepared.
"Fair and Reasonable": Historically,
the term fair and reasonable‟ requires determination of
each shareholder‟s rights in relation to each of the
other shareholders in different classes, and the adequacy of the
dividend paid. These are not simple matters to determine, and it is
likely that directors will need guidance from lawyers reviewing
decided cases to assist them in making this determination. There is
potential for shareholder disputes to arise even within companies
with few shareholders, or actions against the Board, on the basis
that dividends paid to shareholders with different class rights is
not fair and reasonable‟, or that the dividend paid to
all shareholders is not adequate.
"Materially Prejudice Creditors":
Section 254T of the Act now requires an assessment of whether the
payment of dividends will materially prejudice‟
creditors. This will require an increased level of investigation
and use of resources for directors to determine whether, at the
time that dividends are declared, creditors might be materially
prejudiced‟ by the payment. Boards often manage the risk
of getting this test wrong in the context of share capital
reductions and share buy-backs by engaging expert accountant
reports to guide them.
What needs to be done?
Companies should urgently review their constitutions and
dividend payment policies as most company constitutions and
dividend payment policies provide that dividends can only be paid
out of profits.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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