Dividend rule breaches can cause reputational damage and disillusion shareholders
Hargreaves Lansdown, the Bristol-based listed broker, which sells funds, shares and related financial products, has been found in breach of the Companies Act 2006 by the Financial Reporting Council after it failed to file the necessary interim accounts at Companies House to justify an interim dividend payment made to shareholders.
The finding followed a random FRC audit, which uncovered the procedural failings. Hargreaves Lansdown has since called an extraordinary shareholders meeting to rectify the situation. A similar scenario previously occurred with the high-street retailer Next.
This is an important reminder of how tight procedural compliance and understanding of the Companies Act is required before issuing a dividend, because where a dividend is deemed unlawful, shareholders may be required to repay the unlawful distribution if they know or have reasonable grounds for knowing that the dividend was made breaching the Act.
Crucially, it is important to remember that dividends should be made only out of distributable profits of the company, while the capital of the company must be maintained. A dividend needs to be justified by the company's last annual accounts, or if these do not demonstrate sufficient distributable profits to justify the dividends, interim accounts may be prepared to show adequate profit available for distribution. Annual accounts must be properly prepared in accordance with the Act and include the auditor's report, if required under section 475 of the Act.
Interim accounts for public companies under the Act attract additional requirements under section 838, including filing the interim accounts at Companies House before deciding the dividend and being 'properly prepared' in accordance with sections 395 to 397. Hargreaves Lansdown failed to file its interim accounts at Companies House, breaching the Act's requirements.
For private companies, interim accounts do not require filing at Companies House or auditing and are typically just the latest management accounts, signed off by the directors.
Normally the Articles of Association provide that the final, end-of-financial-year dividend is declared by the shareholders of a company, following a recommendation of the directors. The amount declared should not exceed that recommended by the directors.
To formalise the dividend distribution, there will first be a directors' resolution recommending the dividend, followed by a shareholder resolution. Interim dividend payments under the Articles usually do not require shareholder approval, only formal board resolutions following the procedure set out above. Model Articles 30 to 35 are an example of the typical requirements in declaring and paying dividends.
Constitution of the company
Typically the Articles state that the dividend amount paid is apportioned against the nominal value of each share held, but the Articles may provide differently. The Articles may also include additional provisions relating to dividend distributions. It is best practice to review what the Articles require before declaring any dividends and considering if there are any differences in shareholder class rights.
In circumstances of non-compliance with the Act, as with Hargreaves Lansdown, it is prudent for a public company to post a circular to shareholders explaining the situation and proposing resolutions to be passed at an extraordinary general meeting to rectify the omission. The resolutions could, for example, authorise the appropriation of distributable reserves for dividend payments and to waive any potential claims the company has against shareholders and directors for the unlawful dividend – thereby not requiring the shareholders to repay their dividends to the company.
Where a company has failed to take the necessary steps in declaring a lawful dividend, the company will need to convene a general meeting to request shareholders to release the directors and shareholders from personal liability to repay the unlawful dividend, which may be costly, time-consuming and upset shareholders.
The following steps are recommended as good practice:
- Review the company's accounts and ensure there are sufficient distributable reserves
- Review the company's Articles and the Act to consider the dividend declaration process
- Prepare the relevant accounts in accordance with the Act and file at Companies House, if required
- Distribute the dividend having prepared the necessary resolutions ratifying the lawful distribution.
The Hargreaves Lansdown story highlights how a seemingly small and innocuous administrative error could potentially cause reputational harm and disillusion shareholders, occasioning bad publicity.
The legal consequence of such an unlawful dividend is to hold the shareholders liable for its repayment. In addition, the directors become personally liable to repay the unlawful dividend for breach of their director duties, should the shareholders fail to repay.
Both Hargreaves Lansdown and Next had sufficient distributable profits to declare a dividend, so failing to file the interim accounts was more of a technical breach and the damage was mainly reputational.
Symptomatic of other issues
Peter Swabey, Policy and Research Director at ICSA comments: 'This may seem, at first sight, a rather minor issue and the Hargreaves Lansdown CEO described it as 'a technical issue'. However, it is a matter of company law and there are sound reasons for it being a requirement. Investors are, increasingly, focused on being satisfied that a company pays sufficient attention to capital maintenance and this sort of error suggests a lack of discipline on such issues.
'It may also be seen as a lack of attention to compliance, which may be symptomatic of other issues at the company. 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 company secretaries check that all the necessary legal and regulatory requirements, including the appropriate filing, have been made before proceeding to payment.'
Robert Wieder is a Corporate Partner and Jayesh Patel is a Trainee Solicitor, at Bryan Cave LLP
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