Introduction
The primary essence of conducting business is to realize financial gains that translate to the improvement of the shareholders and consumers’ well-being. In this regard, the investors should receive dividends that are proportional to their injections in a manner that observes the relevant laws. Therefore, directors should avoid instances of biased rewards in the form of dividends to the stakeholders since various laws stipulate so (McLaughlin 23). In the UK, the Companies Act 2006 is a demonstration of parliament that as of now serves as the essential wellspring of company law outlining provisions that guide business legal frameworks. For this reason, conflicts arising from issues regarding dividends can arrive at their resolution through the application of the provisions especially those included in Part 23 of the Companies Act 2006. The Re-Exchange Banking Co, Flitcroft’s Case (1882) 21 Ch. D. 519 provides a scenario of the application of general law stipulations against directors who inappropriately pay dividends to the shareholders by terming them as liable for the mismanagement of dividends (Dignam and Hicks 58). In this case, this paper seeks to provide a critical evaluation of the statutory stipulations contained in Part 23 of the CA 2006 concerning the return of capital to stakeholders.
Background to the Companies Act 2006
The Companies Act 2006 contains legal provisions that guide business practices in the UK to ensure that corporations uphold fairness in their operations. The Companies Act was established in 2006 after which the procurements were executed bit by bit in stages, with the last purchase being put into power in October 2009. The Act has the refinement of being the longest ever, containing 1,300 areas that compass more than 700 pages, with a rundown of substance that is 59 pages in length. The demonstration likewise includes 16 plans. However, those have been superseded by the Corporation Tax Act of 2009 (Kershaw 50).
Mainly, sections 593 and 597 of the Companies Act clearly outlines the terms concerning dividends with respect to the valuation of no-cash share concerns and reporting to the registrar of companies pertaining the dividends payable to stakeholders. The conditions defined underscore that companies must not partially or wholly allocate shares to the beneficiaries in any other form other than in cash unless in unique instances (Kershaw 58). Additionally, a company should submit a copy of the dividends report to the registrar of registration to depict the proposal for shares allotment (Bloomfield 39). In this regard, the two sections emphasize the significance of transparency in the allotment of shares to the shareholders to prevent cases of director’s unlawful allocation of dividends.
Failure to observe the provisions of the Companies Act 2006 about the unlawful distribution of profits implies that the directors would face the consequences. In this case, the directors who facilitated the authorization of the illegal allocation of the dividends would incur the liability of paying the money to the business entity. An exception for making the payments would consider the directors’ reliance on the accuracy of the company’s accounts that guided their regrettable decisions. The translation implies that the executives’ improper payment of the company’s assets to the stakeholders become liable and should replace them to restore a balance of the distribution of shares.
Further, section 847 of the CA 2006 stipulates that directors should pay part or the whole amount of money in the occurrence that the company experiences uneven profit distribution. In instances where the distribution was undertaken in other forms other than cash, the compensation would consider the value of the transaction at that time. Moreover, a shareholder who accepts the improper dividend would be regarded as liable, and thus required to return the asset as a constructive trustee (McLaughlin 27). In this respect, the law clearly shows that directors handle instigating illegal distribution of profits in either cash or other asset forms. Additionally, receiving an unlawful distribution of the shares prompts labeling one as a constructive trustee by returning the dividends transferred to their accounts.
The Re-Exchange Banking Co Case
The Flitcroft’s or Re-Exchange Banking Company case (1882) LR 21 Ch D 519 is a UK corporate law case concerning the installment of profits. It was chosen when the law was that profits ought to be paid out of an organization’s benefits, despite the fact that the courts conceded to organization directors to characterize their tenets for deciding when it was applicable (Dignam and Hicks 58).
The Exchange Banking Company directors presented record reports before shareholder gatherings, which were untrue. Somewhere around 1873 and 1878, they paid half-yearly dividends amounting £3,192 when they knew things in the records were terrible obligations and hence, there were no distributable benefits. The shareholders followed up on the reports and pronounced profits. The liquidator delivered summons against five previous directors of the company for the unlawful allotment of profits (Dignam and Hicks 58).
The High Court rules that the directors were liable for the acts. Thus, it was their liability to facilitate the repayment of the dividends. On procession to the Court of Appeal, it was concurred that the company’s directors must reimburse the money. The capital contributed by shareholders in the form of total offer worth, excluding offer premiums, as lawful capital is characterized by CA 2006 could not be reversed, and dividends required payments based on the profits only (Dignam and Hicks 59). Therefore, the directors were found guilty of the uneven shares distribution requiring them to account for the losses incurred through repayment.
Evaluation of the Unlawful Distributions Based on the CA 206 Statutory Provisions
Up until October 2007 when the Companies Act 2006 became fully functional, directors’ overdrawn credit accounts above £5,000 were unlawful. From that time forward, the directors’ overdrawn loan limits are legal beneath £10,000 or more of the sum if ultimately revealed and endorsed by a determination of shareholders. Then again, in SME organizations, the customs are frequently not taken after, and albeit unlawful overdrawn advance accounts are voidable, the absence of loss implies that the organization’s overdrawn credit reports are typical and routine (McLaughlin 33).
In most cases, the overdrawn loan accounts about the directors or shareholders operate in association with the declared dividends. Instead of making payments in the form of salaries or wages, some directors typically draw money over the year before the declaration of dividends at the end of the year. Afterward, the sum is usually posted to the loan accounts of the directors to keep the balance at nil for concealing the unlawful distributions. So long as the equilibrium is extinguished prior to the ninth month of the financial year, at least o £88,000 would be realized in the form of drawings and dividends per annum translating to tax and national insurance savings (Kershaw 66).
Therefore, the problem emerges when the trends are known after continued complaints from the stakeholders who usually file suits against corporates’ unlawful distribution of profits. In such instances, the company suffers from insolvency due to lack of distributable reserves. Consequently, some directors have continually foregone their remuneration creating the perception that they work for nothing thereby, owing the company significant debts while their principle income diminish.
On the off chance that the prerequisites of the CA 2006 are not fully observed by companies, the dividends distribution becomes unlawful. For this reason, directors devise remedies for the situation to ensure that the requirements are met to the latter. Further, the eventual outcomes of illegal dividends sharing the call for tax consequences that attract substantial penalties (McLaughlin 38).
The General Rules
The provisions set out in Part 23 of the Companies Act 2006 clearly underscore that it is incompatible with the expectations of the Legislature that any part of the capital should be allotted to the shareholders by disregarding the statutory requirements. In this regard, the crucial statutory provisions that directors ought to consider include those in power at the declaration date and payment of dividends.
The general rule that applies regarding the dividends issue is that companies should only distribute payable dividends emanating from distributable reserves. Therefore, business entities are supposed to make dividend payments based on the profits allocated for that purpose. In this case, directors should centrally focus on driving the organization towards profitability so that the gains would be distributed proportionately to the shareholders. Thus, the accumulated and realized profits that have not yet been utilized for capitalization or distribution would constitute the distributable reserves. Moreover, less the achieved and accumulated losses that have not affected capital reorganization or reduction would also constitute as part of the reserves for the distributable income as stipulated (“Companies Act” 429).
The Companies Act 2006 emphasizes that referencing the last annual accounts is mandatory before undertaking the distribution of profits to the shareholders. Additionally, the power of declaration lies within the shareholders’ jurisdiction through the convening a general meeting that seek the consensus of all the members. However, the dividends payable must not be in excess of the director’s recommendations (Kershaw 124). In some cases, the directors are allowed to distribute interim dividends that require subsequent approval from the stakeholders.
In this light, the aspect of cross-checking with the previous financial records is an integral feature of ensuring that the company allocates dividends to shareholders within their means thereby, ensuring that the accounts balance (McLaughlin 42). Furthermore, the reaching of a consensus among the stakeholders through the annual general meeting facilitates active participation of the investors in making their contribution regarding the dividends issue. For this reason, the directors’ accountability and responsibility would be fostered since they are answerable not only to the law but also to the stakeholders in the event of a distribution of unlawful dividends. Because the payable dividends should not exceed the recommended amount as communicated by the director, stakeholders are expected only to receive the right amount or else become liable for the excess value of dividends distributed to them. Since the stakeholders have the responsibility of monitoring the distribution of interim dividends in a subsequent manner, they foster the accountability aspect of the allotment profits among the beneficiaries (Bloomfield 54).
The directors of a particular corporate organization owe the stakeholders a fiduciary duty to perform in the best interest of the corporation. In this regard, prior to making dividend recommendations, to the shareholders, directors ought to regard the future cash flow requirements (Ferran and Ho 160). Therefore, directors are expected to picture the financial position of the company at least 12 months ahead to create a plan that would enhance the sustainability of the company in terms of profitability (Bloomfield 67). In this case, the efforts of the directors would involve the good of the company, thus discouraging their involvement in unlawful activities regarding the payable dividends. Thus, the stipulations in Part 23 of CA 2006 primarily aim at protecting the shareholders from potential losses that could be instigated by selfish interest of the directors in various firms.
Annual Accounts
The resources available for allotment among the shareholders should only consider references from the last annual accounts of the company. Interim accounts would be used in instances where annual accounts are not available or portray distributable dividend reserves that have been poorly prepared and managed. In the situation of dependence upon the last yearly records, the records act as the organization’s individual records that were last spread to stakeholders in agreement with the organization’s obligation (“Companies Act”, 423), or framed the premise of an outline budgetary explanation if it was given to individuals (“Companies Act” 426).
The accounts need to balance and arranged appropriately or arranged subject just to matters not material for figuring out if the appropriation would contravene Part 23. In the event that the records are necessary for evaluation, and they are qualified in any admiration, the inspector more likely than not expressed in composing either at the period of their report or accordingly (McLaughlin 23). Further, there is the need for the circulation of the report among the stakeholders before its submission to the registrar of registration to confirm the accounts of the company before the distribution of the dividends takes place.
Additionally, the CA 2006 stipulations provide the consideration of interim accounts in situations that the annual reports are unavailable. In this case, the reliability of such documents is questionable due to the representativeness of the organization’s financial position. However, the Act emphasizes the validity of the interim accounts based on the provision of sufficient information that fosters reasonable judgment about the distributable profits (Bloomfield 79).
Company directors are not left out from exercising judgment when relying on the annual accounts for allotment of the shares. For this reason, directors are obligated to manage processes in the best interest of the company (Kershaw 130). This aspect would be realized through the depiction of reasonable care, diligence, and skills that enhance the success of the company coupled with protecting its assets. Besides, this move would ensure that the company takes reasonable steps to ensure that the company can pay its debts as they fall due. Furthermore, “the prohibition of common law against making a distribution out of capital means that whatever position is shown by the last annual accounts, a director must re-assess the company’s financial position before making any previously recommended distribution” (Kershaw 119). Additionally, the director “would be prepared to reverse that decision if the financial position of the company has deteriorated since the date of the last annual accounts” (Kershaw 119).
Remedies of the Statutory Provisions
A shareholder who is aware or has sensible grounds to trust that a profit has been proclaimed or paid when there are inadequate distributable funds is at risk to reimburse it together with interest (“Companies Act” 447). Additionally, in the event that the company has a considerable share capital, reevaluation, or share premium reserve would require consideration until the company arrives at insolvency (Ferran and Ho 164). Therefore, the remedies provide factors that facilitate the recovery of misappropriated funds that threaten the sustainability of the company.
Where the profit is paid after an organization gets to be indebted, it might be recoverable by a liquidator or an administrator as an exchange at an underestimate according to Section 238 of the Insolvency Act 1986 (Ferran and Ho 168). Basically, this is a less demanding case to make than provided in Section 847 of the Company Act 2006 in light of the fact that an indebtedness expert only has to demonstrate that the organization was bankrupt at the period of payment and not that the shareholder knew or had sensible grounds to accept there were no distributable assets.
Conclusion
The statutory provisions cover the distribution of dividends as per Part 23 of the Companies Act 2006. An analysis of the stipulations enhances a better understanding of the considerations before a director recommends dividends to the shareholders to prevent instances of unlawful practices. The general rule of the statutory requirements underscores that companies should only pay dividends derived from profits allocated for that purpose. The last annual financial records require circulation among the stakeholders to guide the distribution of the dividends among them, and they should create the basis for a concise financial statement. The use of interim accounts should facilitate a reasonable judgment that shows the company’s financial position. In this regard, the statutory requirements emphasize that the declaration of dividends by directors should not exceed the recommended amount. Further, the requirements of CA 2006 stress that all payable dividends should be apportioned and distributed proportionately with respect to the paid up shares.
References
Bloomfield, Stephen. Theory and practice of corporate governance: an integrated approach, Cambridge: Cambridge University Press, 2013. Print.
Companies Act 2006. Web.
Dignam, Alan, and Andrew Hicks. Hicks & Goo’s cases and materials on company law, Oxford: Oxford University Press, 2011. Print.
Ferran, Eilís, and Chan Ho. Principles of corporate finance law, Oxford: Oxford University Press, 2014. Print.
Kershaw, David. Company law in context: Text and materials, Oxford, UK: Oxford University Press, 2012. Print.
McLaughlin, Sue. Unlocking Company Law, London, UK: Routledge, 2014. Print.