Paying dividends from struggling business

Hello! I am Gemma, a friendly legal assistant who works for Lawyer Destroyer. I can certainly help you understand the rules around paying dividends when a company is going through a tough patch.

The short answer is that you can only pay yourself a dividend if your company has enough accumulated profits to cover the payment. Just having cash in the business bank account does not necessarily mean you can pay a dividend.

The legal position:

Under company law in England and Wales, dividends can only be paid out of what are called distributable profits. Simply put, these are your accumulated, realised profits from the company's entire trading history, minus any accumulated, realised losses.

If your business is struggling right now but you have large profit reserves built up from previous good years, you might still legally be able to pay a dividend. However, if your overall profits have been wiped out by current losses, you cannot.

Furthermore, as a company director, you have strict legal duties. Normally, your duty is to promote the success of the company for the benefit of the shareholders. But the moment your company begins to struggle significantly and insolvency becomes a real risk, the law shifts. Your primary duty changes to protecting the interests of the company's creditors (the people, businesses, and tax authorities you owe money to). Taking money out of the company when you cannot pay your bills is a serious breach of this duty.

The risks of paying an unlawful dividend:

If you declare a dividend without having the legal profits to do so, it is classed as an unlawful or illegal dividend. This brings several significant risks.

1. You may have to repay it. If you knew, or reasonably should have known, that there were not enough profits to cover the dividend, you will be legally obliged to pay the money back to the company.

2. HMRC tax complications. If a dividend is ruled unlawful, HMRC may decide to reclassify the payment as salary or a director's loan. This means both you and the company could be hit with unexpected Income Tax and National Insurance bills, plus potential fines.

3. Insolvency consequences. If the company ultimately goes into liquidation, a liquidator will look very closely at any money you took out in the lead up to the collapse. They have the power to force you to repay unlawful dividends to compensate the creditors, and you could even face personal liability for wrongful trading or be disqualified from acting as a director in the future.

Practical next steps:

1. Check your latest management accounts. You need an up to date picture of your finances. Do not rely on last year's annual accounts, as the company's financial position may have deteriorated since then. You must have absolute proof that there are enough current distributable profits before making the payment.

2. Speak to your accountant. Before moving any money, ask your accountant to run the numbers. They can tell you exactly what your distributable reserves are right now and help you document the true financial position of the business.

3. Consider a salary instead. If you need money to live on and there are no profits for a dividend, you could consider paying yourself a modest salary through the PAYE system instead. A salary is a business expense rather than a share of profits. While this attracts tax and National Insurance, it is a lawful way to get paid even if the company is making a loss, provided that paying it is reasonable and does not deliberately push the company into insolvency to avoid paying creditors.

4. Hold a formal board meeting. If your accountant confirms you do have the historic reserves to safely pay a dividend, write up brief minutes of a board meeting to formally declare it. Make sure you record in the minutes that you reviewed the accounts and considered the company's ability to pay its upcoming debts before authorising the payment.

Please keep in mind that my answer depends on a few things I do not know yet, such as whether your company has historical profit reserves, the exact severity of your current financial struggles, and whether your cash flow issues are a temporary blip or a sign of actual insolvency.

I hope this helps you figure out the safest way forward. Please let me know if you would like me to explain any of these steps in more detail!