One area of law on which we are being asked to advise with increasing regularity is that relating to the circumstances in which companies lawfully can pay dividends (or "make distributions" if one is using the technically correct parlance).

The circumstances in which UK companies can make distributions are well established and enshrined in Part VIII of the Companies Act 1985 (although bear in mind that the common law rules relating to distributions also apply).

To re-cap, a company can only make a distribution out of profits available for the purpose, i.e. accumulated, realised profits (not previously distributed or capitalised) less its accumulated, realised losses (not previously written off in a reduction or reorganisation). Profits and losses means revenue and capital profits and losses.

A company decides if it has profits available for distribution by reference to its "relevant accounts". These are normally its last annual accounts. If these do not show enough distributable profits the company can prepare interim accounts, which must enable a reasonable judgment to be made inter alia about the company's profits position.

A problem we have encountered recently relates to the situation where a company has sufficient distributable reserves at the time it actually makes a distribution but the distribution cannot be justified by reference to its last audited accounts and no interim accounts have been prepared by the company. In this case, the part of the distribution that is not supported by the last audited accounts would be rendered unlawful, ultra vires and therefore incapable of shareholder ratification. A shareholder who received the dividend would also be liable to repay the unlawful part of the dividend to the company in certain circumstances.

Recent case law (Bairstow v Queens Moat Houses) is clear that this situation would not be viewed by the courts as constituting a mere procedural irregularity that can be ratified by shareholder resolution (although earlier cases suggested that it might). Companies finding themselves in this position must, therefore, take the matter very seriously.

There is, however, a solution. It is open to the company to prepare new interim accounts (as at the date the dividend was originally paid) showing the distributable reserves and the dividend (that was paid unlawfully) being recoverable as a debt from the shareholder. The company would then make a declaration of a new dividend of the same amount, expressed to be satisfied by the release of the shareholder from its obligation to repay the unlawful dividend to the company.

This may seem a rather long-winded way of regularising what one might justifiably consider to be an internal corporate housekeeping error, but it does bring home the mandatory, non-excludable nature of the rules relating to distributions set out in Part VIII of the Companies Act.

If you wish to find out more about any of these issues, please contact Glafkos Tombolis on 020 7203 5298 or click here to email him.