The legal rules for shareholder dividend distributions

16 December 2019 

Directors need to know they can make dividend distributions to shareholders, but those distributions cannot jeapordise the company’s ability to pay debts.

The guidance in this article is based on the Corporations Act 2001 (Cth) (Corporations Act).

In a hurry? Jump ahead below.

Payments to comply with constitution & laws

Shareholders can take money out of the company in a number of ways, but only if the company complies with its constitution (if any), the Corporations Act and all other applicable laws.

If a company pays out money in a way that results in the company being unable to pay its debts as they fall due, its directors may be liable:

  • to pay compensation; and
  • for criminal and civil penalties.

Consequences of non compliance

There are consequences of making payments e.g. to shareholder’s in a ways that results in a company being unable to pay its debts. 

Sections 588G, 1317E, 1317G, 1317H, 1317P of the Corporations Act deal with those consequences. 

Briefly here’s a breakdown of those sections and what they allow: 

  • 588G - directors have a duty to prevent insolvent; trading by a company, there are civil and criminal penalties; 
  • 1317E - court may order a civil penalty for contravention; 
  • 1317G & 1317H - the court may order compensation for damage e.g. for profits, diminished value of property; and
  • 1317P - criminal proceedings may be commenced after civil proceedings.

What are dividends?

Dividends are payments to shareholders. They can only be paid if:

  • the company's assets are sufficiently in excess of its liabilities immediately before the dividend is declared; and
  • the payment of the dividend is fair and reasonable to the company's shareholders as a whole and does not materially prejudice the company's ability to pay its creditors.

Replaceable rule (non mandatory) and mandatory rules

Non mandatory

It is a replaceable rule that the directors decide whether the company should pay a dividend. This means that paying a dividend is not mandatory under the Corporations Act.

Section 254U has the replaceable (non mandatory) rule that can be adopted in a company’s constitution: 

  • 254U - directors may determine a dividend is payable and fix the amount, time for payment and method of payment.

Mandatory

However, if the company is paying a dividend, these are the rules and they are mandatory: 

  • 254T - the company’s assets must exceed liabilities before the dividend is declared and the excess must be sufficient to pay the dividend, the payment is fair to shareholders as a whole, and finally - the payment does not materially prejudice the ability to pay creditors. 

Buy-back of shares

A company can buy back shares from shareholders, the Corporations Act has some rules around this from section 257A through to 257J inclusive.

Similar to the above sections, the company’s act of buying back shares cannot prejudice creditors and must comply with any constitution

Sections 257B through 257J inclusive describe the buy back process, which we won’t go through in this article.

Distribution of surplus assets on winding up

If a company is wound up and there are any assets left over after all the company's debts have been paid, the surplus is distributed to shareholders in accordance with the rights attaching to their shares.

Key takeaways

Any distribution to shareholders or share buy back must comply with any company constitution, applicable laws and not prejudice creditors. 

As always, if you are in doubt, get advice. 

I wish you success in your ventures! 

Got questions or comments about dividend distributions? Be sure to leave them below. 


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Vivian Michael
 

Vivian Michael is a lawyer and founder of Michael Law Group. Vivian's mission is to deliver the best quality business legal services to entrepreneurs launching an Australian business, wherever they are in the globe.

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