In our blog “Coronavirus COVID-19: how your business can weather the storm”, we laid out some aspects for businesses to consider and additionally provided some guidance as to how company officers can prepare during these uncertain times amidst the outbreak of the coronavirus. In this blog, we discuss the impact of the coronavirus crisis on dividend distribution. Given the fact that the coronavirus crisis may have an impact on your company, it may be advisable to take caution when deciding to make new resolutions to distribute dividends that have not been executed yet.
Balance sheet test and distribution test for dividend distribution
During a general meeting of shareholders, shareholders have the power to make decisions regarding profit sharing arrangements and may decide to make interim distributions to the shareholders. The company's articles of association may contain specific provisions on how this is conducted. It is important to remember that every resolution from the general meeting of shareholders aimed at distribution in inconsequential if the resolution is not approved by the board.
The board must perform (i) a balance sheet test and (ii) a distribution test to decide if dividends may be distributed.
Balance sheet test: the company may only make distributions if shareholders’ equity exceeds the reserves required by law and the articles of association (such as the revaluation surplus and the reserve for participating interests). In theory, excess distributable reserves and capital surplus may be distributed.
Distribution test: the company must be able to continue to pay its outstanding obligations after the distribution.
In other words: the board must test whether business continuity is put at risk within the foreseeable future (as a rule: one year) as a result of the distribution. The decisive factor here is the actual time of distribution, and not the time of the resolution and only the board may perform this assessment. If the board's opinion is that the company can no longer meet its obligations after the distribution, it will have to refrain from making the distribution, and the resolution to distribute dividends will not have an legal consequences.
The key factors for assessing the balance sheet test and the distribution test are: (i) liquidity, (ii) solvency, and (iii) profitability. The board must assess the financial status of a company based on its specific features.
If it later emerges that, at the time of the distribution, the board knew or could reasonably have known that the company would no longer be able to pay its debts following distribution, the board is jointly and severally liable. The relevant board members must then pay to the company the deficit caused by the distribution.
Recent developments and the coronavirus
If the company's business is affected by the coronavirus crisis, board members should be very careful when executing dividend distributions. Resolutions made prior to the outbreak of the coronavirus need to to be revaluated and the board must make careful assessments as to whether the company's business continuity is at risk if a distribution is made. Companies are now busy closing the previous financial year (2019), and dividend resolutions may already have been made. If the resolutions have not yet been executed, board members are advised to be very careful given the current circumstances. The time at which the actual distribution is made is a crucial factor in assessing business continuity and therefore also determines the directors' liability.
If you have any questions on this topic, or reservations about the execution of a dividend distribution resolution, please feel free to contact us.