First Published in The Royal Gazette, Legally Speaking, April 2020
As Covid-19 sweeps across the globe, many companies are choosing to retract, suspend or reduce dividends to preserve cash and ensure liquidity.
Dividend payments are a method of returning value to shareholders, the propriety of which, apart from questions of legality, are a matter for director discretion.
The Companies Act 1981, a company's bye-laws, regulatory pronouncements and listing rules, if applicable, govern Bermuda companies.
The Act provides that a company shall not declare or pay a dividend, or make a distribution out of contributed surplus, if there are reasonable grounds for believing that the company is, or would after the payment be, unable to pay its liabilities as they become due; or if the realisable value of the company's assets would thereby be less than its liabilities.
The Act imposes a combined "solvency" and "net asset" test that makes no reference to profits. The tests must be met on both the date of declaration and payment. Boards must monitor the company's financial position to ensure there are no impediments that may adversely impact compliance with the tests on the payment date.
Bye-law provisions regulating dividends should be consulted including whether dividends can be satisfied in whole or part by transferring non-cash assets of equivalent value, which is appealing from a cash preservation standpoint. Absent express authority to pay a dividend-in-kind, dividends must be paid in cash.
Directors often ask what to consider in order to conclude that they have reasonable grounds to make a solvency statement. The Act provides no guidance on what constitutes reasonable grounds.
Answers will be case specific and will likely be influenced by: the state of the global economy, the duration and severity of the Covid-19 impact on the macroeconomic environment, changes to the regulatory landscape, the company's financial health, prospects of the company (e.g. mandated closures of non-essential businesses, shifts in consumer demand and fragility of supply chains), key stakeholders (e.g. insurance companies must take prudent measures to protect policyholders) and the complexity of a company's trading position.
It will also likely be influenced by the amount and character of the financial resources available to the company to manage in these turbulent times (including the ability to secure financing on favourable terms), future cash requirements of the business (e.g for redundancy payments), the intentions of the board with respect to the management of the business (including strategically positioning itself to rebound once the pandemic subsides) and any actual and contingent liabilities.
Dividends must be justified by reference to the company's accounts including annual unconsolidated accounts, interim management accounts, 12-month projections and other financial data deemed relevant. To avoid accusation that there were not reasonable grounds for making a solvency statement, directors should carefully scrutinise the financial information in light of the circumstances affecting the company's business. Professional advice may be sought.
Outstanding guarantees or indemnities should be examined and "risk rated", especially those contingent liabilities that can be called within 12 months of the dividend. Where creditor pressure is known, the possibility of a payment demand foreseeable and the anticipated impact of crystallisation significant, a cautious approach should be adopted, provisions made, and assets retained as appropriate.
Most directors will not have faced a crisis of this magnitude and their stewardship will no doubt be tested.
Directors must also have regard to their common law and statutory duties to act in the company's best interest and be mindful of their personal exposure from a wrongful trading perspective.
Boards must ask thoughtful questions, test underlying assumptions, make principled decisions and document their reasoning for concluding that the aforementioned tests will be met at the relevant times. Failure to rationalise on reasonable grounds could result in arguments of recklessness being advanced in any formal insolvency process.
Directors may be exonerated for breach of duty if they rely in good faith upon reports or financial statements presented by an accountant or other credible professional.
Companies may exempt and indemnify directors from liability arising from "negligence, default, breach of duty or breach of trust" not involving dishonesty or fraud. This may cover liabilities incurred in defending proceedings where relief is granted to a director, where he is acquitted, or where a favourable judgement is granted.
Companies may take out insurance policies against liability incurred for a director's failure to exercise the "care, diligence and skill" of a reasonably prudent person or to cover the aforementioned director liabilities.
The court may relieve director liabilities where a director acted honestly or reasonably and that, having regard to all the circumstances, he ought fairly to be excused.
As market uncertainty persists, boards may reassess dividend policies to cope with actual or anticipated losses and otherwise safeguard the company's long-term viability.
There are risks in a company taking the unusual step of cancelling an already announced dividend. Companies should consider, among other things, whether the declaration of the dividend has created an enforceable debt against the company, potential claims of misleading conduct/disclosures, and breaches of listing rules, especially where a dividend is cancelled after its "ex" entitlement date.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
