A legal dividend is a distribution of a share of profits of a Limited Company amongst the shareholders. It is governed by Part 23 of the Companies House Act 2006 which sets out the requirements. If the criteria are not met, then a dividend is unlawful.
The case of BM Electrical Solutions Ltd* has set out the consequences of dividends not being paid in accordance with the rules of the Companies Act.
The company had one sole shareholder who was also a Director (Michael Belcher). He took a salary from the company of £11,702.00 and the remaining income was by way of dividends. However, the company ran into financial difficulties and a large tax bill was due to HMRC. HMRC commenced a successful winding up an application against the company in 2015. Following this, the Liquidator reviewed the company and found that £220,000 of transfers had been paid to the sole shareholder without valid reasons. It was also noted that the company had only ever filed one set of Accounts.
At the trial, the shareholder indicated that these payments were recorded as dividends on the accounting software.
The court’s view was that the money paid to Mr Belcher should not be classed as dividends but as director’s loans. There were two main reasons for this: –
- A dividend must be declared so that it can thereafter be legally paid to a shareholder. The shareholder in this company could not prove that the declaration had been made and therefore there was no confirmation that it was a legal dividend.
- Part 23 of the Companies Act 2006 states that a dividend can only be paid out of profits available and those profits can only be determined by profits, loss and liabilities consistent with accounts. As the company had not filed accounts, (even though dividends had been declared) it was unknown how these ‘dividends’ were calculated.
The court, therefore, found that the payments to the shareholder were a director’s loan and must be repaid to the company. This amounted to £288,000.
This case highlights that it is important for all companies to ensure that dividends are declared in accordance with the rules and regulations set down by law. Failure to do so can have a drastic effect.
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*BM Electricals Ltd (in liquidation)  EWHC 2749 (Ch) (14th October 2020).
A copy of the judgment can be found here: BM Electrical Solutions Ltd & Anor v Belcher  EWHC 2749 (Ch) (14 October 2020) (bailii.org)