Important Changes to Rules for Payment of Dividends

1. What has changed?

Important reforms have been made to the Corporations Act 2001 and have taken effect as of 28 June 2010. The changes affect how dividends can be declared and paid by a company.

Previously, Section 254T of the Corporations Act stated that a company could only declare and pay dividends out of its “Profits” (generally taken to mean current year profits, although this has never been clearly defined by either legislation or case law).

The new legislation requires the following conditions to be satisfied before a company can declare and pay a dividend:

• the company’s assets must exceed its liabilities immediately before the dividend is declared, and the excess must be sufficient to pay the dividend;
• the dividend must be fair and reasonable for all shareholders; and
• the payment must not materially prejudice the company’s ability to pay its creditors.

Overall, the update to the legislation aims to ensure responsible behaviour by directors, with appropriate protection for creditors and shareholders who are not entitled to dividends. 

2. What does this mean for directors?

These changes are significant for all directors. Some of the key impacts are:

• Stronger links between dividend decisions and the duty to prevent insolvent trading.
• When valuing their assets and liabilities, small companies will need to consider relevant accounting standards, immediately before any dividend is declared.
• If company liabilities outweigh assets (for example, due to prior year losses), then a dividend cannot be declared, even if the company has current year profits.
• It will be prudent for all Minutes of Directors Meetings declaring dividends to state consideration of, and compliance with, Section 254T.
• The new legislation has clarified that it is possible to declare dividends out of company Reserves.
• The new legislation also technically allows for dividends to be declared out of paid-up share capital (however, careful consideration of the tax consequences is required prior to taking this step).
• Directors should review company Constitutions before applying the new law, as their actions are also governed by this document. Amendment of Constitutions may be required in some cases.

3. Further assistance

If you wish to discuss the above mentioned changes and the potential impact on your company, please contact your Lawler Partners Client Relationship Manager.