Corporate Finance Assignment

A listed company might easily and quite lawfully return surplus profits to its

shareholders.

It is generally understood that a company is a legal business enterprise with the aim of

making a profit. The Trinidad and Tobago Companies Act states that a company means

means a body corporate that is incorporated or continued under this Act. 1 It furthers in

Section 155(5) that a listed company is one admitted to the official list of the Trinidad and

Tobago Stock Exchange2 and that only public companies can be listed. 3 Furthermore, given

that a listing on the stock exchange is a private contractual agreement between a public

company and the stock exchange to gain access to a market for its shares, only public

companies that have made this agreement will be listed. Ordinarily the payment of dividends

is the way in which a company distributes a share of profits among the shareholders. Under

the TT Companies Act Sections 54 to 55 are detailed statutory rules as to the distribution of

dividends, and it is submitted that under the Act a company can only issue dividends out of

surplus profits if statutorily specified conditions are satisfied, namely that after the issue of

the dividends the company is will be able to meet its liabilities.

A shareholder in relation to a company, can be defined as any person who agrees to become a

member of the company and whose name is entered in the company’s register of members 4 or

a person in whose favour a transfer of shares has been executed and delivered but whose

name has not been entered in the register of members of the company. 5 The shareholders of

1
Trinidad and Tobago Companies Act Section 4
2
TT Companies Act S 155 (5)
3
TT Companies Act s 4 “public company” means a company any of whose issued shares or
debentures are or were part of a distribution to the public.
4
TT Companies Act s 4; 107 (1); 349 (3)
5
TT Companies Act s 107 (1) (c)
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listed companies are known as institutional investors. Shareholders are entitled to receive

dividends. A dividend is a payment made by a company by the rate of payout approved by

the board of directors or that is apportioned among the shareholders.6

The general rule is that a company can only pay a dividend if it satisfies the dual insolvency

test under the TT Companies Act7 and not whether or not there are surplus profits. There are

two tests that can be used to determine this. The first test is found under Section 54 which

provides that “a company shall not declare or pay a dividend if there are reasonable grounds

for believing that— (a) the company is unable, or would, after the payment, be unable, to pay

its liabilities as they become due.”8 An example of the application of this test is seen In

Standal’s Patents Ltd v 160000 Canada Inc 9 and Re Central Capital Corp10 where it was

held that the company cannot be insolvent at the time of the dividend or the issue of the

dividend render the company insolvent.

The second test is found the under the Section 54 (b) which provides that the company should

not declare a dividend “if the realisable value of the company’s assets would thereby be less

than the aggregate of its liabilities and stated capital of all classes.” 11 A specific example of

6
Black’s Law Dictionary
7
TT Companies Act s 54 A company shall not declare or pay a dividend if there
are reasonable grounds for believing that—
(a) the company is unable, or would, after the payment, be unable, to pay its liabilities as they
become due; or
(b) the realisable value of the company’s assets would thereby be less than the aggregate of
its liabilities and stated capital of all classes.
8
TT Companies Act s 54
9
(19993) 53 ACWS (3d) 425 Que SC
10
(1996) 26 BLR (2d) 88 Ont CA
11
TT Companies Act s 54 (b)
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this is seen in the Canadian case of Sparling v Javelin International LTD12 where the

Canadian Court in examining legislation in pari materia to TT Companies Act held that the

second test prohibits the payment of a dividend where there is every reason to believe that

upon a liquidation and realisation of assets, the company would be unable to fully reimburse

the capital contributions of shareholders. Additionally, this test prohibits the declaration of a

dividend at a time when the amount for the dividend exceeds the difference between the

assets and liabilities and stated capital as reflected in the most recent unaudited financial

statements of the company.13

The task of ensuring that a company is able to manage its debts belongs to the directors.

Directors are charged with the duty to manage the company’s affairs 14 and act with in the best

interest of the company15. It is therefore the directors who have the responsibility to take

reasonable steps to ensure that the company is able to pay its debts as they become due. The

current industry practice is that in a public company, directors recommend a dividend at the

Annual General Meeting based on the profits made in the full year, and the AGM then passes

a resolution declaring that dividend.16 Each director is required to sign a solvency statement

stating the company’s current financial position at the time the statement is made, to the

effect that there is no ground on which the company could be found unable to pay its debts.

This statement of solvency must also be applicable to the future and so must cover a period of

1 year after the date of the statement. 17 It is thus incumbent on a director to re-assess the

12
(1987) 37 BLR 265 Que SC
13
Trustee of 633746 Ont Inc. V Salvati (1990) 73 OR (2d) 774 Ont SC.
14
TT Companies Act s 60
15
TT Companies Act s 99.
16
Company Law Solutions Limited, 'Dividends ' (Company Law Club )
<http://www.companylawclub.co.uk/topics/dividends.shtml> accessed 2 March 2014
17

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company’s financial position before approving any previously recommended distribution. He

must be prepared to reverse a decision to distribute funds if the financial position of the

company has deteriorated since the date of the last annual accounts.

The capital maintenance rule is intrinsic to these provisions. Share capital falls under equity

financing, and strictly speaking, refers to that part of capital generated from the sale of shares.

Capital maintenance is concerned with the preservation of certain reserves or share capital,

currently designated as not normally distributable to members. 18 Section 54 and 55 thus

assert the preservation of the capital maintenance rule. In other words, the purpose of the

capital maintenance rule is to restrict a debtor firm's ability to take value-reducing actions that

would increase the risk of default for creditors and to ensure that the company’s share capital

is not dissipated on activities which the company was not incorporated for. 19 This principle

was evident in The Court of Appeal decision taken in It's a Wrap (UK) Limited v Gula 20,

where Lord Arden stated, that there was an inherent risk in the payment of dividends where

the capital maintenance rule may be offended through the distribution of the company’s

capital to shareholders in the form of payments of capital masquerading as dividends. 21 In this

particular case, a company had made trading losses, and there were no retained realised

profits. A director had deliberately classified as dividends, certain amounts taken by him as

salary, during the year, in order to gain a tax advantage. This action was taken even though he

was fully aware that the company had only made losses. Thus, even though Section 48 of the

TT Companies Act outlines instances in which a company may reduce its capital, the purpose

18
Company Law Review's Strategic Framework [DTI (1999: 81
19
Ceffins, Brian R. (1997), Company Law: Theory, Structure and Operation
(Oxford: Oxford University Press)
20
[2006] EWCA Civ 544
21
It’s a Wrap UK Limited v Gula at 641 per Arden LJ
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of Section 54 is to preserve the capital maintenance rule, by providing that a company cannot

pay dividends if it is unable to meet its liabilities.

That the capital maintenance rule is integral to the protection of a company is evident in the

Re Exchange Banking Co, Fitcroft’s Case. In this case, the directors of the Exchange

Banking Company through statements of accounts, misrepresented the company’s state of

finances to the shareholders. For several years profits were overstated. Uncollected debts that

the directors knew to be bad were stated as profits. The incorrect information was fed into

reports that the shareholders subsequently relied on and declared dividends. The matter went

to the court of appeal where it was held, that the directors were liable to repay the unlawful

dividends. In his delivery of the judgment, Lord Jessel stated, that the rules on the payment of

dividends were an aspect of the capital rule. He held that when a creditor

gives credit to the company on the faith of the representation that the capital shall be
applied only for the purposes of the business, and he has therefore a right to say that the
corporation shall keep its capital and not return it to the shareholders. It follows then that
if directors who are quasi trustees for the company improperly pay away the assets to the
shareholders, they are liable to replace them. 22

But the capital maintenance rule is not the only consideration for the declaration of

dividends. Another relevant statutory provision that must be considered is found under

Section 55(2). Under this section, the company is prohibited from issuing dividends out of

unrealized profits, where unrealized profits are profits which have not been made but are not

yet realized through a completed transaction. Professor Burgess posits, that the wording of

the provision strongly supports the view that the section relates not only to the unrealized

capital accretions - but also to any profits which are not realised. This is a marked difference

from the position at common law that dividends can only be paid out of distributable profits.

22
Re Exchange Banking Co at 533-534
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The rule in Dimbula Valley23 must also be taken into account which asserts that a company

can declare dividends on unrealized profits occurring on the reevaluation of assets.

It would seem therefore, that a company can pay dividends out of surplus profits, but this also

raises the concern of whether or not this should be the case. In general terms, the Act avoids

any reference to the term “profits”; however at common law the rule is that dividends must

only be paid out of distributable profits. A similar stance is taken in the Companies Act of

Guyana and Jamaica.24 This is exemplified in the case of Re Exchange Banking Co,

Fitcroft’s Case,25where it was pointed out that common law says that dividends should be

paid on distributable profits. This was later followed in the case In Bairstow v Queens Moat

Houses Plc,26 which was concerned with a distribution to which the UK Companies Act

1985(and section 277 of that Act) applies. Here, the court held, that if dividends were paid

out of surplus profits - improperly - directors may be liable to compensate the company for

loss caused. At the Court of Appeal the court also furthered that a shareholder should be

required to return a distribution if he knew or ought reasonably to have known that the

distribution contravened the requirements of the Companies Act.

Again, in the case of Precision Dippings Ltd v Precision Dippings Marketing Ltd 27 Justice

Dillon held that where a dividend is paid and it is unlawful in whole or in part, and the

recipient knew - or had reasonable grounds to believe- that it was unlawful, then that

shareholder holds the dividend (or part) as constructive trustee. 28 This was again reaffirmed in

23
Dimbula Valley Celyon Tea Co ltd v Laurie [1961} Ch 353
24
Guyana Companies Act s 50(3); Jamaica Companies Act s 158(3)
25
(1882) 21 CH D
26
[2001] EWCA Civ 712
27
[1986] 1Ch447
28
[1986] 1Ch447 at 457
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the It's a Wrap (UK) Limited where the court made the point that the shareholder’s ignorance

was no defense - so if the shareholders were of the view that they were honestly entitled to

the money, they still were deemed to be holding it as constructive trustee. In Aveling Barford

Ltd v Perion Ltd29the court also held that the director was liable as a constructive trustee

when he failed to obtain the full resalable value of a company’s asset he had sold to himself.

Lord Hoffman thus reiterated, that the rule that capital may not be returned to shareholders is

a rule for the protection of creditors.

In addition, it appears that at the common law the court is also skeptical as to dividends paid

out of surplus profits because these may be disguised as gifts out of capital. In Re Halt

Garage (1964) Ltd30 the court held that where directors of the company were also

shareholders, their remuneration could be construed as a disguised gift of capital which in

turn amounts to an illegal return of capital. This is not to say that a company cannot reward

its directors, but if it wishes to do so there are specific forms that the remuneration may take.

The remuneration can be in the form of a bonus but it must be genuine and not recognized as

a gift providing the company can meet its liabilities thereafter.

The reality is however, that a company may choose other methods to distribute surplus profits

rather than return them in the form of dividends to shareholders. This is because directors in

determining the best interest of the company have to consider all of its other stakeholders. 31

As such, the board can determine that instead of paying dividends, it can appropriate the

money in other ways such as to raise employees’ salaries, improve customer service or work

toward a lower debt-equity ratio for creditors.32Furthermore, there are two significant

disadvantages that the company would incur if it returns surplus profit to shareholders.
29
[1989] BCLC 626
30
Re Halt Garage (1964) Ltd [1982] 3 All ER 1016
31
TT Companies Act s 99 (2)
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Firstly, the payment of dividends reduces the company’s retained earnings, meaning it now

has less money to invest in the company’s growth. Secondly, the issued dividends are taxed

and this tax creates an additional cost to the company.

It is noteworthy that when the UK Companies Act and the TT Companies Act are compared

there is an important contrast. The UK Companies Act has established more statutorily

defined rules for the payment of dividends as opposed to the TT Companies Act. Under the

UK Companies Act, a company must take into consideration the following information as

stated in its relevant accounts, before it can issue a dividend: (a) Profits, losses, assets and

liabilities; (b) Various provisions33; and (c) Share capital and reserves (including

undistributable reserves), together understood as “the Accounting Factors”. The ‘relevant

accounts’ are defined as the company’s last annual accounts. 34 It is submitted that this wider

test would be more beneficial to Trinidad and Tobago ensure that the company remains in the

best financial position and commercially viable.

Thus it is evident that whilst a company may lawfully declare dividends out of surplus profits

under the TT Companies Act, once the dual solvency test is satisfied, the situation is different

under the common law. Under the common law it is stated that dividends must only be issued

out of distributable profits. To do otherwise would be unlawful and the directors are liable to

repay the company in such an instance. The reality is that directors can explore other

alternatives for surplus profits rather than declare dividends. Generally speaking the TT

Companies Act is silent on the terms to profits, capital or solvency in relation to dividends.

32
Lynn A. Stout, 'Shareholders as Owners: Legal Reality Or Urban Legend?' (National
Association of Corporate Directors 2010) <http://www.directorship.com/stout-shareholders-
as-owners/> accessed 6 March 2014
33
Section 396 Companies Act 2006
34
Section 836(2) Companies Act 2006
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As Burgess argues, the only enquiry relevant to the declaration of a dividend under the Act is

whether the insolvency test laid down in the Acts is or will be offended.

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