Unlawful Dividends, Capital Maintenance, and Revaluation Reserves
BlueSky Airlines Ltd is a private company with share capital of €2,000,000 and accumulated realised profits of €1,000,000. It also has an unrealised revaluation reserve of €500,000 arising from a property revaluation. In December 2023, the directors declared a dividend of €1,200,000, relying on the revaluation reserve as part of distributable profits. The dividend was paid to shareholders in January 2024, including a €100,000 payment to Helena, a 10% shareholder. By June 2024, the company became insolvent and was wound up. The liquidator now seeks to recover the dividend from the directors and shareholders. The directors argue that the revaluation reserve should be treated as a realised profit because the property was sold in February 2024 for €500,000 above its original cost. The sale occurred after the dividend but before the liquidation.
1. Was the dividend of €1,200,000 lawful under company law? Consider the rules on distributable profits and the revaluation reserve.
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No, the dividend was not lawful. Under s.830 UK CA 2006 (Irish s.117), a company may only make a distribution out of profits available for the purpose, meaning accumulated realised profits less accumulated realised losses. Unrealised revaluation reserves are not distributable unless they have been realised. At the time the dividend was declared in December 2023, the property revaluation of €500,000 was unrealised. The company had only €1,000,000 of realised profits. Therefore, the maximum lawful dividend was €1,000,000. The declaration of €1,200,000 exceeded distributable profits by €200,000. The directors cannot rely on the subsequent sale in February 2024, because the lawfulness of a dividend is assessed at the time it is declared or paid. The sale after the declaration cannot retrospectively convert the unrealised reserve into realised profits for the purpose of the December dividend. The directors' argument fails. The dividend was unlawful to the extent of €200,000.
2. What are the consequences for the directors and for Helena as a shareholder who received €100,000?
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The directors may be personally liable to repay the unlawful portion of the dividend. Under s.847 UK CA 2006 (Irish s.118), directors who authorise an unlawful distribution are liable to repay it to the company if they knew or had reasonable grounds to believe that it was unlawful. Here, the directors relied on an unrealised revaluation reserve, which is a clear error; they had reasonable grounds to know it was unlawful. They may also be liable for breach of fiduciary duty and for wrongful trading if they continued to trade while insolvent. Helena, as a shareholder, must repay the €100,000 she received if she knew or had reasonable grounds to believe that the dividend was unlawful. The test is objective: would a reasonable person in her position have known? As a 10% shareholder, she may not have had access to the accounts, but the excessive dividend relative to profits might put her on inquiry. If she received the dividend in good faith without knowledge, she may not be liable, but the liquidator can still pursue the directors. The company can also recover the unlawful distribution from any recipient who knew or had reasonable grounds to believe. Helena should consider whether she had notice.
3. How does the subsequent sale of the property affect the analysis? Could the directors argue that the dividend was effectively paid out of the proceeds?
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The subsequent sale of the property in February 2024 does not retroactively validate the December 2023 dividend. The lawfulness of a distribution is determined at the time it is made. The sale realised the revaluation reserve after the dividend had already been declared and paid. The directors cannot recharacterise the dividend as having been paid out of later profits. However, the sale proceeds may be relevant to the company's financial position and to whether the directors can argue that the unlawful distribution should be set off against subsequent realised profits. Under UK CA 2006 s.847(5), a shareholder who has repaid an unlawful distribution may have a right to be indemnified by the company for any subsequent lawful distribution that could have been made. But that does not cure the original unlawfulness. The directors might argue that the company could have declared a lawful dividend after the sale, and that the shareholders would have received the same amount. That argument may reduce the loss to the company if the sale proceeds were sufficient, but it does not make the December dividend lawful. The liquidator can still recover the unlawful portion from the directors and knowledgeable shareholders. The sale may also strengthen a claim that the directors breached their duty by declaring a dividend before the sale was complete.