Avoid making unlawful dividends

The most common mistake we see directors of financially stretched companies making is to carry on paying dividends (usually to themselves) long after the distributable reserves have been exhausted and when creditors are not being paid when they fall due. If the company were to fail this can lead to the money having to be handed back to a liquidator – adding insult to the injury of seeing your company go to the wall.

Also often director/shareholder overdrawn loan accounts operate in conjunction with declaring dividends. Rather than paying monthly salary typically directors will draw sums in “lieu of salary” and at the year end a dividend is declared and posted to the directors’ loan accounts bringing the balance down to nil. This works fine until the company becomes insolvent and dividends can no longer be declared leaving the loan accounts on the balance sheet which have to be repaid.

In effect the directors have foregone salary, worked for nothing and owe the company a substantial debt exactly at the same time their principal source of income has or is in danger of drying up. An invidious position. Accordingly, if there are doubts about your company’s ability to continue as a going concern the following simple steps taken in time could significantly improve your position in the event of an insolvency:

  • Obtain shareholder approval for any loans to directors above £10,000 to make them lawful
  • Ensure you do not continue to unwittingly build up loan accounts based on previous advice received given when the company was solvent
  • Consider paying directors by way of salary rather than through monthly drawings and dividends. Directors are entitled to reasonable remuneration just like any other employee. Minute the reasons for doing this
  • Ensure that you have a written contract of employment in the event of any insolvency of the company as if the directors are employees then statutory pay in lieu of notice, redundancy, arrears of wages/holiday pay claims currently up to £450 per week will usually be paid by the Redundancy Payment Service. For a director with over five years service (even if most of this was below the national insurance level) this could be worth over £10,000!

See our briefing sheet on this subject. If you are concerned that you have received unlawful dividends that might have to be returned, think you should move on to being paid by salary or have any other business rescue and insolvency related query please call 0800 331 7417 for advice.

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