Paying no dividends – the dangers of withholding profit from shareholders

Government reform

At the end of August, the government shone a light on companies that pay their management teams excessive salaries or bonuses, announcing the introduction of a public register that would include the names of listed companies that face regular shareholder opposition to management remuneration levels. A voluntary code for large private companies that face pressure from shareholders in relation to pay is also proposed.

The proposals, although watered down from the reforms that had been mooted by the government last year, are aimed at deterring companies from paying large amounts to directors while shareholders are left with little or no return, despite collectively owning the company.

A case heard earlier this year in the Companies Court, known as Re CF Booth Limited [2017] EWHC 45 (Ch), epitomised the type of behaviour that the government is aiming to target with its reforms.

Paying no dividend

In Re CF Booth Limited [2017] EWHC 45 (Ch), the minority shareholders of CF Booth Limited petitioned the court alleging unfair prejudice resulting from the fact that no dividend had been paid to them since 1986.

Under company law, a dividend can only be paid where a company has sufficient distributable profits to do so, and often a company’s dividend policy will be set out in its constitutional documents. Final dividends, which are calculated at the end of a company’s financial year, are usually recommended by directors and declared by shareholders. Shareholders cannot, however, pay themselves a final dividend that exceeds the amount of the dividend recommended by directors.

After CF Booth Limited, which manufactures, imports and exports a variety of materials worldwide, made a loss in 1986, its board decided that it would adopt a ’no dividend’ policy. This policy was maintained thereafter, despite the company returning to profit the following year and remaining profitable during most of the years that followed.

Not only did this mean that shareholders lost out on any potential entitlement to a share of the company’s profits in the short term; it also meant that the value of their shares inevitably decreased as would-be purchasers had no prospect of receiving a dividend on the shares.

The directors, meanwhile, received remuneration from the company which the court described as ‘excessive’. Although the directors claimed during the proceedings that the reason dividends had not been declared was that all the profits of the company were required for the continued running of the business, the court dismissed this argument by pointing to the level of their remuneration.

Director duties

The Companies Act 2006 sets out the duties to which company directors are subject, including duties to promote the success of the company and to exercise independent judgment. An offence is committed by any officer of a company that does not satisfy these duties. In Re CF Booth Limited, the court held that, by failing to declare any dividends and by paying themselves excessive remuneration, the directors had failed on both counts.

In addition to their excessive remuneration, the directors also enjoyed the benefit of a yacht and a fleet of luxury cars owned by the company. Although the directors tried to justify the purchase and maintenance of these luxury vehicles by virtue of the fact that the company’s products were used on the yacht and could thereby be shown to customers, the court held that the use of the vehicles was inconsistent with the directors’ duty to act in the best interests of the company’s shareholders as a whole and could not be reconciled with the decision not to pay shareholders a dividend since 1986.

The court also found that the directors had intended to acquire the shares from the minority shareholders and must have known that the value of the shares was weakened as a result of the ‘no dividend’ policy, in breach of their duty to exercise independent judgment.

Conclusion

Directors who decide not to pay a dividend to shareholders will not always be in breach of their statutory duties, nor will shareholders who do not receive a dividend necessarily be unfairly prejudiced as a result. It may be that the relevant company does not have sufficient distributable profits to declare a dividend, or it may be in the long-term interests of the shareholders as a whole to plough profits back into the business.

There is a danger, however, that directors who receive healthy salaries while withholding dividends from shareholders will find themselves on the wrong side of their duties and of company law. Acting in shareholders’ best interests is key to the role of every director and the decision as to whether dividends are to be declared should, therefore, be carefully considered and, where appropriate, advice should be sought.

The transgression highlighted in Re CF Booth Limited would not have been caught by the government’s new proposals as the proposed public register would only name listed companies subject to shareholder revolt over director pay, and would not be imposed on private companies. By highlighting the importance of ensuring that shareholders are treated fairly, however, the reforms may have a ‘trickle down’ effect, improving those standards to which all companies strive to attain. Critics will, nevertheless, argue that the reforms do not go far enough and that further reform is required to help ensure that directors do not benefit at the expense of shareholders.

For more information on adopting a clear and fair dividend policy for your company, please contact a member of our corporate team who will be happy to assist.