Dividend Declared Out of Revaluation Reserve
Padma Ceramics Ltd has share capital of BDT 50 million and accumulated realised profits of BDT 20 million. Last year the company revalued its factory land, creating an unrealised revaluation surplus of BDT 80 million. The board, facing pressure from a private equity investor, declares a dividend of BDT 60 million, sourced partly from the revaluation surplus. The auditors qualify the financial statements, noting that the dividend exceeds distributable profits. The company secretary is asked to advise the board before the dividend is paid. Two directors argue that the surplus is shown in the balance sheet as a reserve, so it must be available for distribution. A shareholder has threatened to sue the directors personally if the dividend is paid and the company later becomes insolvent.
1. Advise whether the dividend can lawfully be paid out of the revaluation surplus.
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A dividend may be paid only out of profits available for distribution. Unrealised revaluation surpluses are not distributable profits. They arise from a change in the carrying value of an asset and have not been realised in cash or in a realised profit. The fact that the surplus appears as a reserve in the balance sheet does not make it distributable; reserves are of different kinds, and only realised profits are available.
On the figures, realised profits are BDT 20 million. The proposed dividend is BDT 60 million. Even if the whole of the realised profits were distributed, the company would be BDT 40 million short. The dividend cannot lawfully be paid in that amount.
The directors who argue that the reserve is available are confusing the accounting presentation with the legal test. The legal test is whether the company has profits available for distribution, and the revaluation surplus fails that test.
The board should reduce the dividend to no more than the realised profits available, after making proper provision for known liabilities, and should record the basis of the calculation in the minutes.
2. Explain the personal exposure of the directors if the dividend is paid as declared.
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If a dividend is paid out of capital or out of unrealised reserves, the directors who authorised it may be personally liable to repay the amount to the company. The liability arises because the payment is an unlawful return of capital, and the directors are treated as having misapplied company funds.
The exposure has several dimensions:
Repayment. Each director who voted for the dividend may be ordered to repay the shortfall, jointly and severally with the others.
Fraudulent or wrongful trading. If the company later becomes insolvent and the directors knew or ought to have known that there was no reasonable prospect of avoiding insolvency, they may face wrongful trading liability. The payment of an unlawful dividend is evidence of that knowledge.
Disqualification. Persistent unlawful distributions can support an application to disqualify the directors from management.
Shareholder action. A shareholder may bring a derivative claim on behalf of the company to recover the unlawful distribution.
The directors who voted against the dividend should ensure their dissent is recorded in the minutes. The company secretary should advise the board to obtain written legal advice before payment and to consider whether the dividend can be reduced to a lawful amount.
3. Describe how the company secretary should document the corrected dividend decision.
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The company secretary should prepare a board minute that:
- Records the original declaration and the audit qualification.
- States the realised profits figure of BDT 20 million and confirms that the revaluation surplus of BDT 80 million is unrealised and not distributable.
- Records the legal advice received.
- Sets out the revised dividend, not exceeding the realised profits available after provision for liabilities.
- Records the votes for and against, and the dissent of any director.
- Notes that the shareholder threat has been considered and that the revised dividend removes the risk of an unlawful distribution.
The company secretary should also update the dividend register, issue a revised dividend notice to shareholders explaining the reduction, and ensure the financial statements disclose the correction. If any part of the original dividend was already paid, the board should consider recovery from the recipients and record that decision.