Directors of owner-managed businesses often pay a portion of their income as dividends, but directors need to be mindful of distributions made illegally where accumulated profits are eroded by provisions and asset write-offs required due to the Coronavirus pandemic.
Irrespective of the level of surplus cash, a dividend cannot be paid without the existence of distributable profits. Directors should be aware of the risk of declaring and paying illegal dividends. Whilst there may exist a history of distributable profits, directors must also consider their common law duties to take into account losses, both actual or forecasted, subsequent to the end of the financial year which may have or will erode its profits available for distribution.
Special care needs to be taken this year. Many companies have December reporting dates, and some may not have thought fully about the impact of the current situation on their balance sheet. Issues may arise, for example, due to:
- Debts due to the business falling into default
- Surplus or obsolete inventory
- Impairment of site premises which are not being used
- Early recognition of losses on contracts that will no longer be profitable
It is not unusual for directors to make judgements on accounting entries as a result of matters such as these as part of preparing their year-end financial statements. However, the pandemic will have the impact of devaluing assets for some companies. There is a risk for owner-managers of small businesses that they unintentionally pay themselves a dividend illegally, even if there is sufficient cash available.
With company dividends being an important source of income for shareholders in owner-managed businesses, directors will need to balance the needs for shareholder return alongside complying with the legal requirements for dividends above.
In time of uncertainty, an adapted capital management strategy is needed for the business that preserves sufficient cash to act as a buffer for uncertainty and bolsters the balance sheet, supports and promotes investment and capital growth and remains on the right side of directors’ fiduciary duties with respect to dividend policies that safeguard the company’s assets and take reasonable steps to ensure that the company is in a position to settle its debts as they fall due.