1

Reference materials relating to Lecture 9

Edited extract from Hambrook J, ‘Shares’, Australian Corporations Law: Principles

and Practice, Chapter 2.6, LexisNexis.

[2.6.0295] The nature of dividends and the rule that they are only payable from profits: s
254T

What is a "dividend"?

A dividend is a share of profits, whether at a fixed rate or otherwise, allocated by a company to

holders of its shares.10. Although the word "dividend" usually implies a share of profits periodically
payable, it may also refer to such shares of profits as are divided only occasionally and are usually
called "bonuses" or bonus dividends: Churchill International Inc v BTR Nylex Ltd (1991) 4 ACSR
693 at 695; 9 ACLC 1255 at 1258, per Beach J (reversed on other grounds, BTR Nylex Ltd v
Churchill International Inc (1992) 9 ACSR 361; 11 ACLC 58, SC(Vic) Full Ct). It is a
"replaceable rule" that the methods by which a company may pay a dividend include the payment
of cash, the issue of shares, the grant of options and the transfer of assets: s 254U(1).20. However, a
company may not pay some shareholders in cash and others in kind unless its constitution
authorises such a distribution: Industrial Equity Ltd v Blackburn (1977) 137 CLR 567; 17 ALR
575; 3 ACLR 89; (1977-78) CLC 40-370.

It is presumed that dividends are only to be paid whilst a company is a going concern: Re
Crichton's Oil Co [1902]2 Ch 86, CA; Re W Foster & Son Ltd [1942] 1 All ER 314; Re Collie
Power Co Pty Ltd (1952) 54 WALR 44; Re William Bedford Ltd (in liq) [1967] VR 490 at 493 per
Adam J. A company may borrow funds to pay a lawful dividend.30.

Who has power to declare or pay dividend?

It used to be common for a company's constitution to state that the company in general meeting
may declare a dividend which is no higher than that recommended by the directors: see, for
example, Bond v Barrow Haematite Steel Co [1902] 1 Ch 353. However, it is now more usual for a
constitution to empower the company's directors to pay a dividend without reference to a general
meeting: see, for example, Lagunas Nitrate Co Ltd v Schroeder and Co (1901) 85 LT 22; 17 LTR
625.

It is a "replaceable rule" that the directors of a company may determine that a dividend is payable
and fix (s 254U(1)):

o1 the amount;
o2 the time for payment; and
o3 the method of payment.
The methods of payment may include the payment of cash, the issue of shares, the grant of options
and the transfer of assets. As to "replaceable rules" see ss 135, 140 and 141.

Where a constitution empowers directors to ‘determine that a dividend is payable’, the directors
 2

might have the power to either declare a dividend or merely to decide that a dividend should be
paid. This may be so, for example, where the constitution, read as a whole, contain provisions
which suggest that the directors were intended to have the power to declare a dividend if they so
wished: see Bluebottle UK Limited v Deputy Commissioner of Taxation [2007] HCA 54 at [30]-
[35] .

Dividend rights

At common law, there is a rebuttable presumption that all shares issued by a company have the
same rights: see, for example, Birch v Cropper; Re Bridgewater Navigation Co Ltd (1889) 14 App
Cas 525 at 543; [1886-90] All ER Rep 628 per Lord Macnaghten, HL and [2.6.0165]. However,
under the Corporations Act, each share in a class of shares in a public company has the same
dividend rights unless there is provision in the company's constitution, or in a special resolution,
for the shares to have different dividend rights: s 254W(1). Shares which carry different dividend
rights would not be in the same class.

Section 254W(1) has nothing to say about the relative dividend rights of different classes of shares.
This makes it important to determine whether shares, which are paid up to varying amounts, but
which otherwise have the same rights and liabilities, constitute one or several classes. See the
discussion of this issue in [2.6.0165] note 10. Partly-paid shares are regarded as being in a different
class from fully-paid securities for the purposes of the ASX Listing Rules: see ASX rule 19.12
definition "class" example. It is not clear whether partly-paid shares, which are paid up to differing
amounts, constitute discrete classes for the purposes of the Listing Rules.

Dividends paid to holders of partly-paid shares in a listed company (other than a no liability
company) must be proportional to the amount of the issue price which has been paid up: ASX rule
6.11. For the purposes of this rule (which does not apply to shares issued on a pro rata basis before
1 July 1996 in accordance with the listing rules), amounts credited as having been paid, but not
actually paid, and amounts paid in advance of a call, are ignored.

In a no liability company, dividends are payable to the shareholders in proportion to the number of
shares held by them, irrespective of the amount paid up, or credited as paid up, on the shares: s
254W(4). This provision applies subject to anything in the company's constitution relating to shares
that are not ordinary shares. A shareholder in a no liability company is not entitled to a dividend on
a share if a call which is due and payable has not been paid: s 254W(3).

It is a "replaceable rule" for proprietary companies that, subject to the terms on which shares are on
issue, the directors may pay dividends as they see fit: s 254W(2). This suggests that the rebuttable
common law presumption that each share in a company has the same dividend rights no longer
applies to a proprietary company where this "replaceable rule" applies. Directors would have a
discretion as to the extent to which each shareholder participated in a dividend distribution. This
discretion would be similar to that enjoyed by trustees of a discretionary trust. The Explanatory
Memorandum to the Company Law Review Act 1998 gave no reason for the change.

It is a "replaceable rule" for companies registered on or after 1 July 1998, and for companies which
have repealed their constitutions after that date, that interest is not payable on a dividend: s
254U(2).

Rule that dividends only payable from profits

A dividend may only be paid out of profits of the company: s 254T. This statutory rule applies to
 3

all companies and not merely those with limited liability. The rule is consistent with the common
law principles that were developed before the enactment of the first Australian statutory
prohibition: see, for example, Mackie v Clough (1891) 17 VLR 493 at 495 per Webb J.40. In early
joint stock companies, investors reckoned their profits at the termination of each trading venture. A
company had to be wound up and its net assets, or profits, distributed to members. This was a
costly and generally inefficient process. Joint stock companies with terminable assets came to be
replaced by joint stock companies with permanent assets but transferable shares. The East India
Company established in 1657 was a notable example. This enterprise structure allowed profits to be
distributed as they were made without winding the company up.50. The charters of some of the early
companies limited dividends to profits in order to ensure the maintenance of sufficient capital to
carry on the enterprise. This helped to protect present and future members from fraudulent
representations of prosperity. This was important given that there was little publicly available or
reliable information about the financial affairs of companies. However, since members had
unlimited personal liability for the debts of their company, there was no objection in principle to
the members reducing the company's capital at any time. It was only in exceptional cases that the
legislature prohibited the payment of dividends from capital. One of the earliest recorded
prohibitions was in 1697. It related to the Bank of England: see 8 & 9 William III c 20 s 49. The
aim was to protect the interests of the bank's depositors.

As early as 1824, a United States court held that shareholders who received distributions from an
insolvent bank had to return them. It was thought that corporate capital was a trust fund for
creditors, and that a distribution out of capital was illegal: see Wood v Dummer (1824) 30 F Cas
435; 3 Mason 308. The Joint Stock Companies Act 1840 (UK) authorised registered companies to
declare dividends out of profits of the concern: 7 & 8 Vict c 110 s 25. This legislation was a
response to the recommendations of the Gladstone Committee. Perhaps reflecting the then state of
accounting principles, the Committee had reported that it was "doubtful ...whether the payment of
dividends out of capital was susceptible of sufficient accurate determination to be legislated upon":
First Report of Select Committee on Joint Stock Companies, British Parliamentary Papers 1844,
VII.

The Limited Liability Act 1855 (UK) s 9 (18 & 19 Vict c 133) made a company's directors
personally liable for the debts of their company if a dividend was paid when the company was
insolvent, or if the dividend payment rendered it insolvent. This provision was repealed in 1856.
However, art 64 of the optional set of articles which formed a schedule to the Joint Stock
Companies Act 1856 (UK) (19 & 20 Vict c 47) provided that "no dividend shall be declared except
from profits arising out of the business of the company". In 1862, this article was reduced to a
simple statement that "no dividend shall be declared except from profits": Companies Act 1862
(UK) (25 & 26 Vict c 89).

Even though there was no substantive statutory prohibition on a company paying dividends out of
capital, English courts held that such payments were impliedly prohibited. In Lee v Neuchatel
Asphalte Co (1889) 41 Ch D 1 and Verner v General & Commercial Investment Trust [1894] 2 Ch
239; [1891-94] All ER Rep Ext 409, the English Court of Appeal held that dividends could not be
paid out of the money subscribed for shares or out of the assets acquired with that money. As
Lindley LJ put it in Verner at 265: "when it is said, and said truly, that dividends are not to be paid
out of capital, the word 'capital' means the money subscribed pursuant to the memorandum of
association, or what is represented by that money".

The tracing of subscription moneys into particular assets had two consequences. First, if an asset
 4

was sold at a profit, that profit could be used for dividend purposes: Re National Bank of Wales
[1899] 2 Ch 629 at 669; [1895-99] All ER Rep 715 per Lindley MR, CA. Further, if an asset was
lost, the capital invested in that asset was also lost in the sense that it was impossible to say that
dividends could be paid out of that capital. As Scrutton LJ put it in Ammonia Soda Co Ltd v
Chamberlain [1918]1 Ch 266 at 296 :

... when you have lost a thing you cannot lose it for anything else, because you have lost it. You cannot pay dividends
out of a thing which you lost, because it is not there to pay dividends out of.60.

The statutory rule that dividends are only payable out of profits is not necessarily the same as the
common law rule that dividends cannot be paid out of capital. In Industrial Equity Ltd v Blackburn
(1977) 137 CLR 567 at 576; 17 ALR 575 at 583; 3 ACLR 89; (1977-78) CLC 40-370, Mason J
said:70.
In this case there is no reason for me to explore all the complexities which have emerged in relation to the application
of the rule -- whether it refers to the amount of nominal capital which has been paid up (a view on which some of the
earlier cases seem to turn) or to assets in which the paid up capital has been invested (a view on which the later cases
appear to proceed), whether the obscure distinction taken between fixed and circulating capital which lies at the heart
of some of the statements ... is correctly taken, and as to what precisely is meant by the word 'profits' in this context ...

As to applicable ASX listing rules for share cancellations by listed limited liability companies, see
ASX rules 7.26.1-7.26.3 and [2.6.0575].

Notes

10. Nature of dividends: authorities.

Churchill International Inc v BTR Nylex Ltd (1991) 4 ACSR 693 at 695; 9 ACLC 1255 at 1258, per Beach J (reversed on other
grounds BTR Nylex Ltd v Churchill International Inc (1992) 9 ACSR 361; 11 ACLC 58, SC(Vic) Full Ct). See also Re
Crichton's Oil Co [1902] 2 Ch 86 at 95 per Stirling LJ, CA; Re Chelsea Waterworks Co and Metropolitan Water Board (1904)
73 LJKB 532 at 535 per Sir Edmund Fry; Henry v Great Northern Railway Co (1857) 1 De G & J 606; 27 LJ Ch 1 at 18; 44
ER 858 per Knight-Bruce LJ.

20. Dividend may be in cash or in kind: authorities.

Archibald Howie Pty Ltd v CSD (NSW) (1948) 77 CLR 143 at 156; [1948] 2 ALR 489 per Williams J; BTR Nylex Ltd v
Churchill International Inc (1992) 9 ACSR 361 at 379; 11 ACLC 58 at 72 per Tadgell J, SC(Vic) Full Ct; Hoole v Great
Western Railway Co (1867) LR 3 Ch App 262. Companies are not usually authorised by their constitutions to pay interim
dividends in kind: compare Darvall v North Sydney Brick & Tile Co Ltd (No 4) (1988) 14 ACLR 474; 6 ACLC 1095,
SC(NSW).

30. Dividends may be paid out of borrowings: authorities.

Re Mercantile Trading Co (Stringer's case) (1869) LR 4 Ch App 475; Mills v Northern Railway of Buenos Ayres Co (1870) 5
Ch App 621; Thomas Fattorini (Lancashire) Ltd v IRC [1942] AC 643 at 652; [1942] 1 All ER 619 per Viscount Simon LC,
HL. It is improper to use loan funds for a dividend if there are no profits: Re George Newman & Co [1895] 1 Ch 674 at 686;
[1895-99] All ER Rep Ext 2160 per Lindley LJ, CA; Re Alexandra Palace Co (1882) 21 Ch D 149.

40. Common law position.

The United Kingdom common law principle was that dividends could not lawfully be paid from capital: Lee v Neuchatel
Asphalte Co (1889) 41 Ch D 1, CA; Verner v General & Commercial Investment Trust [1894] 2 Ch 239 at 265; [1891-94] All
ER Rep Ext 409 per Lindley LJ, CA. The first Australian statutory prohibition was contained in s 236 of the Companies Act
1890 (Vic), 54 Vict No 1074.

50. History of dividends.

For a useful account of the history of corporate dividends, see D Kehl, "The Origin and Early Development of American
 5

Dividend Law" (1939) 53 Harv LR 36.

60. UK rule that dividends not payable from capital.

On the meaning of "capital" for the purposes of the UK common law rule also see Re National Bank of Wales [1899]2 Ch 629
at 669; [1895-99] All ER Rep 715 per Lindley MR, CA; affirmed sub nom Dovey v Cory [1901] AC 477; [1895-99] All ER
Rep 715, HL; Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 296 per Scrutton LJ, CA. In Verner v General &
Commercial Investment Trust [1894] 2 Ch 239 at 266; [1891-94] All ER Rep Ext 409, Lindley LJ stated that a law which says
that dividends can only be paid out of profits "leads to the inference that capital must always be kept up and be represented by
assets which, if sold, would produce it ...". See also Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 475;
(1988) 4 NZCLC 64,721 at 64,750 per Tipping J, HC.

70. Is the dividend from profit rule the same as the no dividend from capital rule?
Among the High Court judgments that are relevant to this issue see, in particular, Archibald Howie Pty Ltd v Cmr of Stamp
Duties (NSW) (1948) 77 CLR 143; [1948] 2 ALR 489; Davis Investments Pty Ltd v CSD (NSW) (1958) 100 CLR 392 at 413;
58 SR (NSW) 235 per Kitto J; Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119; [1959] ALR 65; (1958) 32
ALJ 301.

[2.6.0300] The meaning of "profits"

There is no relevant statutory definition of "profits" and the term has not been comprehensively
defined by the courts.10. In Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1 at 21, Lindley LJ said:
"There is nothing at all in the Acts about how dividends are to be paid, nor how profits are to be
reckoned; all that is left, and very judiciously and properly left, to the commercial world. It is not a
subject for an Act of Parliament to say how accounts are to be kept; what is to be put into a capital
account, what into an income account, is left to men of business."

Similarly, in Dovey v Cory [1901] AC 477 at 488; [1895-99] All ER Rep 715, Lord Macnaghten
did "not think it desirable for any tribunal to do that which Parliament has abstained from doing --
that is, to formulate precise rules for the guidance or embarrassment of businessmen in the conduct
of business affairs." These high-water marks of judicial laissez-faire pronouncements on "profits"
preceded the emergence of accounting as a significant profession.

The "profits" of a company could be regarded as the amount by which its net assets exceed its net
liabilities. On incorporation, a company may only have its subscribed capital. It may have no
liability other than the contingent liability to repay that share capital on a winding up. It would be
wrong to regard the sum of the share capital as being assets available for distribution to
shareholders. Rather the sum of that capital could be treated as both an asset and a liability. Double
entry accounting involves an amount equal to the subscription moneys appearing on both sides of
the balance sheet.20. The amount appearing on the asset side can be used in the business and might
be lost. The amount on the liability side would, in the absence of a formal alteration to the
company's issued capital, remain constant. Thus a simple way of measuring profit would be to
assess the realisable value of the company's assets and then contrast that figure with the value of
the company's liabilities, including contingent liabilities such as the liability to repay share capital
in a winding up. A net surplus could be seen as the gain or the profit of the venture: Verner v
General & Commercial Investment Trust [1894] 2 Ch 239 at 266; [1891-94] All ER Rep Ext 409
per Lindley LJ.

This test is used in Canada and New Zealand for determining distributable profits: see, for
example, Business Corporations Act 1985 (Can) s 42; Companies Act 1993 (NZ) s 4(1)(b). It can
be termed the balance sheet surplus method. In both jurisdictions, the distributing company must
 6

also be solvent: Business Corporations Act 1985 (Can) s 42; Companies Act 1993 (NZ) s 4(1)(a).

A company's accounts and financial statements (in particular, its profit and loss statement) will
reveal whether it has made a profit or incurred a loss in a particular accounting period: Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 629; (1977) 3 ACLR 185; (1977-
78) CLC 40-375 per Mahoney JA, CA. See also QBE Insurance Group Ltd v ASC (1992) 38 FCR
270; 110 ALR 301; 8 ACSR 631 at 647-51; 10 ACLC 1490 at 1504-7 per Lockhart J, Fed C of A.
On the need to prepare accounts and financial statements see [3.6.0225]. A company's financial
accounts and statements must be drawn up so as to provide a fair and true view of the company's
financial position: ss 295(4)(b), 297.30. Directors have a duty to ensure that the accounts of their
company are made out in accordance with applicable accounting standards: ss 295-296. An
"accounting standard" is defined in s 9 as an instrument in force under s 334 or a provision of such
an instrument. Under s 334, the AASB is given the power to issue accounting standards: see
generally [3.6.0255].

Although "profits" are usually made from a company's business operations, or investments in fixed
assets, a company may distribute to its shareholders as a dividend a gift of money received by it:
FCT v Slater Holdings Ltd (1984) 156 CLR 447 at 461; 56 ALR 306 at 315; 15 ATR 1299; 84
ATC 4833 per Gibbs CJ.

Notes

10. No comprehensive judicial definition of profits.

See, for example, Webb v Australian Deposit and Mortgage Bank Ltd (1910) 11 CLR 223 at 241 per Higgins J; Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 628; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Mahoney
JA, CA(NSW); QBE Insurance Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR 631 at 645; 10 ACLC 1490 at
1503 per Lockhart J, Fed C of A. For illustrations of early judicial reluctance to define "profits" see Lee v Neuchatel Asphalte
Co (1889) 41 Ch D 1 at 21 per Lindley LJ, CA; Verner v General & Commercial Investment Trust [1894] 2 Ch 239 at 266;
[1891-94] All ER Rep Ext 409 per Lindley LJ; Dovey v Cory [1901] AC 477 at 488; [1895-99] All ER Rep 715 per Lord
Macnaughten, HL. See also Stevinson Hardy and Co Ltd v Smith Wylie (Aust) Ltd (1939) 39 SR (NSW) 388 at 400 per
Nicholas J. A court is entitled to critically examine the methods used by a company to calculate its distributable profits:
compare Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 629; (1977) 3 ACLR 185; (1977-78) CLC 40-
375 per Mahoney JA, CA.

20. Double entry accounting.

The double entry system was first brought to England in 1543. However, it was not until the appearance of companies with
permanent joint stocks that the system was widely adopted. During the seventeenth century, numerous accounts of the double-
entry system were published in London: see D Kehl, "The Origin and Early Development of American Dividend Law", (1939)
53 Harv LR 36 at 40.

30. Accounts must provide true and fair view.

See also QBE Insurance Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR 631 at 651; 10 ACLC 1490 at 1507
per Lockhart J, Fed C of A; Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 622; (1977) 3 ACLR 185;
(1977-78) CLC 40-375 per Hutley JA, CA; Re Mercantile Trading Co (Stringer's case) (1869) LR 4 Ch App 475 at 491-3 per
Selwyn LJ and [3.6.0175].

[2.6.0305] Trading or revenue profits

Revenue profit in particular accounting period may be used to fund dividend

Rather than adopting the balance sheet surplus technique for determining distributable profits, the
English courts focused on individual accounting periods. The term "profits" was thought to imply a
 7

comparison between the state of a business at two specific dates, with profits representing the
amount of gain, if any, between those dates: Re Spanish Prospecting Co Ltd [1911] 1 Ch 92 at 98;
[1908-10] All ER Rep 573 per Fletcher Moulton LJ, CA. See also FCT v Slater Holdings Ltd
(1984) 156 CLR 447 at 466; 56 ALR 306; 15 ATR 1299; 84 ATC 4833 per Gibbs CJ.A net trading
or revenue profit made in a particular accounting period can be used to fund a dividend.10.

Relevance of previous or subsequent revenue or trading losses

A trading loss made in a previous accounting period does not have to be made good before a
trading profit made in the most recent concluded trading period is distributed as a dividend:
Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 283 per Swinfen Eady J, CA; Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 630; (1977) 3 ACLR 185; (1977-
78) CLC 40-375 per Mahoney JA; Spassked Pty Ltd v Commissioner of Taxation [2003] FCAFC
282; BC200307488 at [16].20. However, the nature of a company's business, and the amount of a
prior loss, may be such that no honest and reasonable director would think of paying dividends
without providing for the loss. In such a case, a court could find that the payment of a dividend
constitutes a breach of the directors' duties to the company.30.

An undistributed profit may be carried forward to a subsequent accounting period and used for
dividend purposes.40. However, a trading loss in a subsequent accounting period should be offset
against accrued trading profits before a dividend can be declared for that period: compare Re John
Fulton & Co Ltd [1932] NI 35.

Relevance of capital losses to use of trading profits

A company may distribute a trading or revenue profit irrespective of whether it has lost some of its
share capital in the sense that some or all of its paid-up share capital is unrepresented by net
assets.50. The revenue and capital accounts of a company are kept separate for dividend purposes:
FCT v Miller Anderson Ltd (1946) 73 CLR 341 at 367 per Latham CJ; Glenville Pastoral Co Pty
Ltd (in liq) v FCT (1963) 109 CLR 199; [1964] ALR 225; Marra Developments Ltd v B W Rofe
Pty Ltd [1977] 2 NSWLR 616 at 631; (1977) 3 ACLR 185 at 200; (1977-78) CLC 40-375 per
Mahoney JA, CA. As Lindley LJ put it: "[T]he Companies Acts do not require the capital to be
made up if lost ... The capital may be lost and yet the company may be a very thriving concern ...
[T]here is no reason why (the company) should not go on and divide profits ... although every
shilling of the capital may be lost": Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1 at 22. However,
an insolvent company may not declare or pay a dividend.60. Nor may a company declare or pay a
dividend if to do so would render it insolvent: Peter Buchanan Ltd (in liq) v McVey [1955]AC
516n; Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 475; (1988) 4 NZCLC
64,721 per Tipping J, HC.

Notes

10. Dividends can be paid from net trading profits: authorities.

Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 629; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per
Mahoney JA, CA; Meares v Acting FCT (1918) 24 CLR 369 at 372; Webb v Australian Deposit and Mortgage Bank Ltd (1910)
11 CLR 223 at 242 per Higgins J; QBE Insurance Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR 631 at 645-
6; 10 ACLC 1490 at 1502-4 per Lockhart J, Fed C of A; Verner v General & Commercial Investment Trust [1894] 2 Ch 239 at
265; [1891-94] All ER Rep Ext 409 per Lindley LJ, CA; Re London and General Bank Ltd (1894) 72 LT 227; Ammonia Soda
Co Ltd v Chamberlain [1918] 1 Ch 266, CA. On the meaning and calculation of trading or revenue profits see, for example,
Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 286 per Swinfen Eady LJ. The Accounting Standards Review Board
has indicated what is "operating revenue" for the purposes of the trading profit and loss calculation: see AASB 1004 and
[3.6.0295].
 8

20. Should a revenue account be continuous?

In 1962, the UK Jenkins Committee recommended that the revenue account should be continuous from incorporation: Report
of the Company Law Committee, Cmnd 1749, paras 341, 351(c). However, the New Zealand Macarthur Committee disagreed:
"It is often desirable to recommence dividend payment to shareholders, especially preference shareholders, as soon as the
company returns to profitability. Such payments restore confidence in the company, and if made sensibly, do not affect the
company's liquidity. We consider that the directors' discretion should not be limited in the way suggested by the Jenkins
Committee" (Final Report of the Special Committee to Review the Companies Act (NZ), Govt Printer, Wellington, 1973, para
269).

30. Directors may breach duty if previous losses not made good: authorities.
Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 292 per Warrington LJ dicta, CA; Stevinson Hardy and Co Ltd v
Smith Wylie (Aust) Ltd (1939) 39 SR (NSW) 388 at 404 per Nicholas J dicta; Marra Developments Ltd v B W Rofe Pty Ltd
[1977] 2 NSWLR 616 at 636; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Mahoney JA dicta, CA; Re John Fulton & Co
Ltd [1932] NI 35 at 49 per Wilson J; Mosgiel Ltd v Mutual Life & Citizens Assurance Co Ltd (1992) 6 NZCLC 67,784 at
67,798 per Williamson J, HC (reversed on different grounds Mutual Life & Citizens Assurance Co Ltd v Mosgiel Ltd [1994] 1
NZLR 146; (1993) 6 NZCLC 68,534, CA).

40. Undistributed profit reserves may be used in later years: authorities.

See, for example, Glenville Pastoral Co Pty Ltd (in liq) v FCT (1963) 109 CLR 199 at 207; [1964] ALR 225; Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 630; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Mahoney
JA, CA; Re Hoare & Co Ltd [1904] 2 Ch 208 at 213 per Romer LJ; Re John Fulton & Co Ltd [1932]NI 35. Depending on a
company's constitution, retained profits may have to be held in a profit or other designated reserve account. Carrying an
amount of profits to a reserve is not enough to convert it to capital, and accordingly it continues to be distributable: Glenville
Pastoral Co Pty Ltd (in liq) v FCT (1963) 109 CLR 199 at 207; [1964] ALR 225; Stevenson v Cmr of Taxation (1936) 37 SR
(NSW) 84; Re Hoare & Co Ltd [1904] 2 Ch 208 at 213 per Romer LJ, at 217 per Vaughan Williams LJ, CA.See also Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 632; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Mahoney
JA, CA.

50. Dividends payable from profits even if capital lost: authorities.

Glenville Pastoral Co Pty Ltd (in liq) v FCT (1963) 109 CLR 199 at 207; [1964] ALR 225 per Kitto, Taylor and Owen JJ dicta;
Phillips v Melbourne and Castlemaine Soap and Candle Co Ltd (1890) 16 VLR 111 at 113 per Hood J; Marra Developments
Ltd v B W Rofe Pty Ltd [1977]2 NSWLR 616 at 630; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Mahoney JA, CA; Lee v
Neuchatel Asphalte Co (1889) 41 Ch D 1 at 15 per Cotton LJ, at 22-3 per Lindley LJ, CA; Re National Bank of Wales [1899] 2
Ch 629 at 669; [1895-99] All ER Rep 715; Verner v General & Commercial Investment Trust [1894] 2 Ch 239 at 266; [1891-
94] All ER Rep Ext 409 per Lindley LJ, at Ch 270 per Kay LJ; Bond v Barrow Haematite Steel Co [1902] 1 Ch 353 at 365 per
Farwell LJ; Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 283 per Swinfen Eady LJ, CA. For the contrary
proposition, see Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 475; (1988) 4 NZCLC 64,721 at 64,750 per
Tipping J dicta, HC.

60. Insolvent company must not pay dividends: authorities.

See, for example, Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 475; (1988) 4 NZCLC 64,721 at 64,750 per
Tipping J, HC; Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 292 per Warrington J dicta; Phillips v Melbourne and
Castlemaine Soap and Candle Co Ltd (1890) 16 VLR 111 at 113 per Hood J dicta; Mackie v Clough (1891) 17 VLR 493; ANZ
Executors and Trustee Co Ltd v Qintex Australia Ltd (recs and mgrs apptd) [1991] 2 Qd R 360; (1990) 2 ACSR 676 at 684; 8
ACLC 980 at 986, per McPherson J dicta, SC(Qld). Directors would be in breach of their duties, both statutory and under the
general law, if they caused their company to become insolvent as a result of the declaration or payment of dividends: QBE
Insurance Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR 631 at 649; 10 ACLC 1490 at 1505-6 per Lockhart J
dicta, Fed C of A. However, in Lawrence v West Somerset Mineral Railway Co [1918] 2 Ch 250, Eve J was not satisfied that
only solvent companies could lawfully pay dividends.

[2.6.0310] The use of profits or gains on fixed or capital assets

Realised capital profits

A profit realised on the sale of a capital or non-circulating asset can be used to fund a dividend
provided that all of the company's paid-up share capital would be represented by other assets
 9

immediately after its distribution. In Foster v New Trinidad Lake Asphalte Co Ltd [1901] 1 Ch 208
at 212, Byrne J said: "the question of what is profit available for dividend depends upon the results
of the whole accounts fairly taken for the year, capital, as well as profit and loss, and although
dividends may be paid out of earned profits in proper cases, although there has been a depreciation
of capital, I do not think that a realised accretion to the estimated value of one item of the capital
assets can be deemed to be profit divisible amongst the shareholders without reference to the result
of the whole accounts fairly taken." The High Court has also indicated that capital profits cannot be
used "unless upon a balance of account it appears that there has been an accretion to the paid up
capital": Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 at 133; [1959] ALR
65; (1958) 32 ALJ 301. Thus the capital account, unlike the trading and revenue account, is a
continuous account.10.

Unrealised capital profits

An unrealised profit arising from a revaluation of capital assets cannot be used for dividends
unless:

o4 all paid up capital would be represented by assets after the distribution;20.

o5 the revaluation of the assets was made in good faith by a competent valuer;
o6 the assets concerned are not of a type likely to fluctuate in value over a short term;
and
o7 the company's constitution permits the payment of dividends from unrealised capital
profits.30.
A distribution of an unrealised capital profit may be unlawful if it is based on a selective or partial
valuation of the company's assets: Blackburn v Industrial Equity Ltd (1976) 2 ACLR 8 at 16;
(1975-76) CLC 40-267 at 28,719 per Needham J dicta, SC(NSW); Australasian Oil Exploration
Ltd v Lachberg (1958) 101 CLR 119 at 133; [1959] ALR 65; (1958) 32 ALJ 301; Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 629; (1977) 3 ACLR 185; (1977-
78) CLC 40-375 per Mahoney JA, CA. All non-current assets of a particular class must be revalued
contemporaneously by a company when it is preparing its financial statements: AASB Standard
1010. The valuation of each class of non-current assets must represent its recoverable or realisable
value. As to AASB 1010 see [3.6.0325].

A company's constitution may restrict the use of capital profits for dividend purposes: see, for
example, Wall v London and Provincial Property Trust Co Ltd [1920] 1 Ch 45 (article of
investment company directed that a profit or loss arising from alteration of company's investments
was to be disregarded in estimating the company's net profits); Re Cleveland Trust Plc [1991]
BCLC 424, Scott J. However, a provision which requires dividends to be funded from the profits of
the company's business does not necessarily preclude the use of capital profits: North Sydney Brick
and Tile Co Ltd v Darvall (1989) 15 ACLR 706; 7 ACLC 1163, CA(NSW) (company entitled to
use profits realised on sale of the land on which it had conducted its brick making business).

Notes

10. Capital account is continuous account.

See also Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 630; (1977) 3 ACLR 185; (1977-78) CLC 40-
375 per Mahoney JA, CA; QBE Insurance Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR 631 at 647-8; 10
ACLC 1490 at 1504 per Lockhart J dicta, Fed C of A; Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 468;
(1988) 4 NZCLC 64,721 at 64, per Tipping J, HC; Lubbock v British Bank of South America [1892] 2 Ch 198 (capital profit on
sale of fixed assets distributable provided capital losses in same accounting period offset against profit).
 10

20. Paid up capital must be intact: authorities.

Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 at 133; [1959] ALR 65; (1958) 32 ALJ 301; QBE Insurance
Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR 631 at 648; 10 ACLC 1490 at 1504 per Lockhart J dicta, Fed
C of A; Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 630; (1977) 3 ACLR 185; (1977-78) CLC 40-
375 per Mahoney JA dicta.

30. Conditions for use of unrealised capital profits: authorities.

Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] Ch 353; [1961] 2 WLR 253; [1961] All ER 769; Blackburn v Industrial
Equity Ltd (1976) 2 ACLR 8 at 16; (1975-76) CLC 40-267 at 28,719 per Needham J, dicta, SC(NSW); Blackburn v Industrial
Equity Ltd (1977) 2 ACLR 421 at 426; (1977-78) CLC 40-324 at 29,389-90 per Glass JA dicta, CA(NSW); Industrial Equity
Ltd v Blackburn (1977) 137 CLR 567 at 580; 17 ALR 575 at 586; 3 ACLR 89; (1977-78) CLC 40-370 per Jacobs J dicta;
Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 629; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per
Mahoney JA, CA; Re New Zealand Flock & Textiles Ltd [1976] 1 NZLR 192. For the view that unrealised capital profits
cannot be used for dividends see Westburn Sugar Refineries Ltd v IRC [1960] TR 105. The (UK) Jenkins Committee
recommended that no unrealised capital profit should be used for dividends: Report of the Company Law Committee, 1962,
Cmnd 1749, para 341. The New Zealand Macarthur Committee was of the same view: Final Report of the Special Committee
to Review the Companies Act (NZ), Govt Printer, Wellington, 1973, para 268(ii). The Companies Act 1985 (UK) prohibits the
use of unrealised capital profits to pay cash dividends (s 263(2)) or to pay up amounts unpaid on issued shares: s 263(4).

[2.6.0315] Provision for depreciation in asset values

Section 294(3) of the old Corporations Law, which was repealed on 1 July 1998, required a
company's directors, when determining the company's trading profit or loss, to ensure that the
company's accounts were adjusted to reflect the amounts that the company's current assets were
likely to realise in the ordinary course of business. This suggested that directors had to make
adequate provision for any depreciation in the value of those assets.10.

A company's constitution may expressly or impliedly require directors to make adequate provision
for any depreciation in the value of its capital assets: see, for example, Davison v Gillies (1879) 16
Ch D 347n where Jessel MR indicated that a tramway company should make provision for the
annual wear and tear on its tracks even if no repairs were actually effected to them in a particular
year. See also Dent v London Tramways Co (1880) 16 Ch D 344. However, at common law, there
might not be any legal obligation to provide for depreciation20. unless a dividend is funded out of
capital profits: Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 at 133; [1959]
ALR 65; (1958) 32 ALJ 301.

Any depreciation of assets must be taken into account in determining whether all of a company's
paid up capital is represented by assets. Notwithstanding the position at common law, Australian
accounting standard AASB 1021 requires the depreciable amount of a depreciable non-current
asset (ie one that has a limited commercial or useful life) to be progressively charged against profit
and loss over its useful life. As to this standard see [3.6.0380]. As to the obligation of companies to
comply with it see [3.6.0225].

Notes

10. Directors should make provision for depreciation.

In Verner v General & Commercial Investment Trust [1894] 2 Ch 239; [1891-94] All ER Rep Ext 409, the Court of Appeal
held that a company was able to pay a dividend out of revenue received on a stock and share portfolio without first making
provision for a decline in the market value of the portfolio. The decision may, however, have been different if the portfolio had
been regarded as a circulating or current asset rather than a capital asset. On the meaning of "fixed or capital assets" and
"current or circulating assets" see Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 at 286 per Swinfen Eady LJ, CA;
Reynolds v Crompton [1950] 2 All ER 502 at 511 per Jenkins LJ, CA (affirmed sub nom Crompton v Reynolds and Gibson
 11

[1952] 1 All ER 888, HL).

20. Might be no common law obligation to depreciate fixed assets: authorities.

Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1, CA (depreciation of a wasting asset); Verner v General & Commercial
Investment Trust [1894] 2 Ch 239; [1891-94] All ER Rep Ext 409, CA; Re Kingston Cotton Mill Co (No 2) [1896] 2 Ch 279,
CA. However, compare Davison v Gillies (1879) 16 Ch D 347n; Bond v Barrow Haematite Steel Co [1902] 1 Ch 353 at 367
per Farwell J dicta.

[2.6.0320] When must distributable profits exist?

Declared dividends: s 254V(2)

If a company has a constitution which provides for the "declaration" of a dividend, the company
incurs a debt when a dividend is declared: s 254V(2).

Where a company's constitution empowers its directors to "determine" that a dividend is payable,
an inference may sometimes be drawn from other provisions of the constitution that the directors
are entitled to either ‘declare’ a dividend or decide that a dividend should be paid: see, for
example, Bluebottle UK Limited v Deputy Commissioner of Taxation [2007] HCA 54

A declared dividend becomes a debt owed to shareholders on the date it is properly declared, even
though the date of its payment may be deferred.10. Accordingly, a company may only declare a
dividend out of profits which it then has available for distribution: Industrial Equity Ltd v
Blackburn (1977) 137 CLR 567; 17 ALR 575; 3 ACLR 89; (1977-78) CLC 40-370 (company
wrongfully declared a dividend out of an anticipated, but then undeclared, dividend to be received
from a subsidiary); QBE Insurance Group Ltd v ASC (1992) 38 FCR 270; 110 ALR 301; 8 ACSR
631 at 647; 10 ACLC 1490 at 1504 per Lockhart J dicta, Fed C of A. See also Re Alexandra
Palace Co (1882) 21 Ch D 149 at 159 per Fry J.

A company must not declare a dividend out of profits which may or will arise between the date of
the declaration and the date the dividend is to be paid: Industrial Equity Ltd v Blackburn (1977)
137 CLR 567; 17 ALR 575; 3 ACLR 89; (1977-78) CLC 40-370. However, a company may
lawfully pay a dividend out of profits, which did exist at the date of its declaration, even though it
incurs a loss, equivalent to some or all of the dividend, before it is paid: Marra Developments Ltd v
B W Rofe Pty Ltd [1977] 2 NSWLR 616; (1977) 3 ACLR 185; (1977-78) CLC 40-375, CA(NSW).
See also Brookton Co-op Society Ltd v FCT (1981) 147 CLR 441; 35 ALR 293. A declared
dividend is a chose in action which can be purchased independently of the relevant share: GSH
Finance Pty Ltd v Chase Securities Ltd (1988) 4 NZCLC 64,493 at 64,503-4 per Henry J,
CA(NZ).

There is an unresolved issue as to whether a declared dividend can lawfully be paid if, between the
date of declaration and the date of payment, some or all of the profits underpinning the declaration
no longer exist. Under earlier legislation, it had been thought that a company could lawfully pay a
dividend out of profits, which did exist at the date of its declaration, even though it incurred a loss,
equivalent to some or all of the dividend, before it was paid: Marra Developments Ltd v B W Rofe
Pty Ltd [1977] 2 NSWLR 616; (1977) 3 ACLR 185; (1977-78) CLC 40-375, CA(NSW). See also
Brookton Co-op Society Ltd v FCT (1981) 147 CLR 441; 35 ALR 293; BC8100083.

The Explanatory Memorandum to the Company Law Review Act 1998 indicates that ss 254T and
254V were intended to change the law set out in Marra Developments. However, it is questionable
 12

whether such a change has been effected. On one view, because s 254T says that a dividend can
only be "paid" out of profits, the profits used must still be in existence on the payment date. Indeed,
the Explanatory Memorandum to the Company Law Review Act 1998 contains two passages
which might be taken to suggest that the decision to pay any dividend (declared or undeclared) may
be revoked at any time before it is paid. The passages are:
The Act will allow companies to avoid the problems that would arise if profits that would have been sufficient to
cover the dividend when it was declared have ceased to exist when the time comes to pay the dividend. Under the Act,
a debt will not arise until the time fixed for payment has arrived, unless the company has a constitution that provides
for the declaration of a dividend: para 11.40.

A directors' resolution to pay an interim dividend does not create a debt and may be revoked or amended before the
dividend is paid ... The effect of the Act will be to extend this rule to all dividends, not just interim dividends: para
11.42.

However, the contrary view is that because a company incurs a debt in favour of its shareholders
when it declares a dividend pursuant to its constitution, the dividend should be regarded as having
been notionally paid to them on the date of declaration. If the amounts of the declared dividends
were immediately credited to "loan" accounts of the recipient shareholders, the dividends would
necessarily be regarded as having been paid without there being any physical transfer of assets.

Further, for the purposes of s 588G (the insolvent trading provision), a company is taken to have
incurred a debt "when the dividend is paid or, if the company has a constitution that provides for
the declaration of dividends, when the dividend is declared": s 588G(1A) Table Item 1. This means
that directors could not be liable for insolvent trading where the company was solvent immediately
after the dividend was declared but became insolvent on or before the date the dividend was
physically distributed. This suggests that the relevant date for determining the legality of a declared
dividend is the time of declaration and not the time of physical transfer of the dividend.

Undeclared dividends: s 254V(1)

A company does not incur a debt merely by fixing the amount or time for payment of a dividend: s
254V(1). In such a case, where the dividend has not been "declared", the debt arises only when the
time fixed for payment arises. Until that time, the decision to pay the dividend may be revoked: s
254V(1). If a dividend is paid without having first been declared, the profits must exist at the date
of payment. This seems to follow from the reasoning in Industrial Equity Ltd v Blackburn (1977)
137 CLR 567; 17 ALR 575; 3 ACLR 89; (1977-78) CLC 40-370.

However, in the case of a decision by directors to pay an interim dividend,20. it may be sufficient for
profits to be disclosed in such accounts as enable the directors to form a genuine opinion that the
profits out of which they will be paid actually exist: Marra Developments Ltd v B W Rofe Pty Ltd
[1977] 2 NSWLR 616 at 622; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Hutley JA dicta,
CA. An interim dividend is wholly provisional and anticipates the profit to be disclosed in the
company's final accounts: Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at
622; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Hutley JA dicta, CA. Directors may properly
reconsider and reverse their decision to pay an interim dividend at any time before it is paid: see s
254V(1) and Potel v IRC [1971] 2 All ER 504 at 511 per Brightman J; Mosgiel Ltd v Mutual Life
& Citizens Assurance Co Ltd (1992) 6 NZCLC 67,784 at 67,804 per Williamson J, HC (reversed
on different grounds Mutual Life & Citizens Assurance Co Ltd v Mosgiel Ltd [1994] 1 NZLR 146;
(1993) 6 NZCLC 68,534, CA); Bluebottle UK Ltd v Deputy Commissioner of Taxation [2007]
 13

HCA 54 at [19]-[20] dicta; ABB Australia Pty Ltd v Commissioner of Taxation [2007] FCA 1063 at
[54] per Lindgren J dicta. The same principle applies where directors, who have the power to pay
but not declare an interim dividend, purport to declare an interim dividend: Lagunas Nitrate Co Ltd
v Schroeder and Co (1901) 85 LT 22; 17 LTR 625.

Shareholders cannot claim as creditors in respect of an unpaid and undeclared interim dividend
until whatever time, if any, set for its payment has elapsed and the company incurs a debt under s
254V(1) in relation to it: Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 at 572; 17 ALR
575 at 529; 3 ACLR 89; (1977-78) CLC 40-370 per Mason J; Marra Developments Ltd v B W
Rofe Pty Ltd [1977] 2 NSWLR 616 at 622; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Hutley
JA, CA; Potel v IRC [1971] 2 All ER 504 at 511 per Brightman J; Re Kidner [1929] 2 Ch 121;
[1929] All ER Rep 551.

Directors, who are merely authorised by a company's constitution to "pay" an interim dividend,
may not "declare" an interim dividend so as to make the company immediately liable for its
payment: Lagunas Nitrate Co Ltd v Schroeder and Co (1901) 85 LT 22; 17 LTR 625; Potel v IRC
[1971] 2 All ER 504 at 513 per Brightman J.

Notes

10. Company incurs debt when dividend declared: authorities.

Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 at 572; 17 ALR 575 at 584-5; 3 ACLR 89; (1977-78) CLC 40-370 per
Mason J; Re Severn and Wye and Severn Bridge Railway Co [1896] 1 Ch 559. If a declared dividend is expressed to be payable
on a stated date, a shareholder cannot seek to recover it as a creditor until the stipulated date for payment has passed: Potel v
IRC [1971] 2 All ER 504 at 511 per Brightman J; Re Kidner [1929] 2 Ch 121; [1929]All ER Rep 551; Industrial Equity Ltd v
Blackburn (1977) 137 CLR 567 at 572; 17 ALR 575 at 579; 3 ACLR 89; (1977-78) CLC 40-370 per Mason J dicta. Subject to
any applicable financial market rules, a sale of shares upon which a dividend has been declared does not entitle the buyer to the
dividend unless the contract so provides: Re Kidner [1929] 2 Ch 121; [1929]All ER Rep 551; GSH Finance Pty Ltd v Chase
Securities Ltd (1988) 4 NZCLC 64,493 at 64,498 per Somers J, at 64,501 per Casey J, at 64,503 per Henry J, CA(NZ). Shares
in a company listed on ASX are traded on a "cum" dividend basis from the time the company announces a dividend until 6
business days before the "record date" after which time they are traded on an "ex" dividend basis. A purchaser of shares "cum"
dividend will be entitled to the dividend. The "record date" is the date the company announces as the date when it will
determine who is eligible to be paid the dividend. The record date must be at least 7 days after the date the dividend is
announced: see ASX App 6A para 1.

20. Interim dividends.

There is no rule of law that a dividend must be declared by a company before it can be paid: see, for example, s 254V and
Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616; (1977) 3 ACLR 185; (1977-78) CLC 40-375, CA.

[2.6.0325] Remedies and liabilities when dividends not paid from profits: ss 254T, 588G

General

A shareholder may apply for:

o8 an injunction to restrain the payment of an unlawful dividend (see s 1324 and Marra
Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 623; (1977) 3 ACLR
185; (1977-78) CLC 40-375 per Hutley JA, CA; Lee v Neuchatel Asphalte Co [1894]
2 Ch 239, CA), or
o9 a declaration that the declaration of a dividend is void (Industrial Equity Ltd v
Blackburn (1977) 137 CLR 567; 17 ALR 575; 3 ACLR 89; (1977-78) CLC 40-370).
If a board of directors has declared, but not paid, a dividend otherwise than out of profits, the board
 14

may cause the company to seek a declaration that the dividend is void: Marra Developments Ltd v
B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 623; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per
Hutley JA, CA. However, until such an unlawful dividend declaration is declared void, the
company cannot decline to pay the dividend: Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2
NSWLR 616 at 623; (1977) 3 ACLR 185; (1977-78) CLC 40-375 per Hutley JA, CA. The penalty
for a contravention of s 254T is 100 penalty units (ie $11,000) or imprisonment for 2 years, or
both: Sch 3.

The liability of company members

A recipient of an unlawful dividend paid by a company is liable to return it if the person knew, or
ought to have known, that it was not paid out of profits.10. Such a recipient may hold the dividend as
a constructive trustee for the company.20. It is uncertain whether an innocent recipient is liable:
Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691 at 707; 8 ACLC 263 at 275-6 per Giles
J, SC(NSW). For support for the view that innocent shareholders are not liable to reimburse the
company, see Moxham v Grant [1900] 1 QB 88, particularly at 91 per A L Smith LJ dicta, CA;
Lucas v Fitzgerald (1903) 20 TLR 16; Precision Dippings Ltd v Precision Dippings Marketing Ltd
[1986] Ch 447 at 457; [1985] 3 WLR 812 at 817 per Dillon LJ, CA.

In Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691 at 707; 8 ACLC 263 at 275-6, Giles
J noted that there are at least three possible theoretical bases for shareholders being liable:

o 10 the company had paid money out on the basis of a mistake of fact (ie a mistake as to
its financial position) which was fundamental to the transaction;
o 11 the company had exceeded its statutory powers by making an illegal distribution and
was entitled to seek restitution from those of its members who had received it;
o 12 the recipient shareholders were constructive trustees of the dividend because they
paid no consideration for it, and received it pursuant to an unlawful transaction.30.
Under the Corporations Act, if a dividend is paid out of share capital and not profits, s 256B might
be contravened. However, the company would not be guilty of an offence in connection with that
contravention (s 256D(2)(b)) and the contravention would not affect the validity of the dividend
payment: s 256D(2)(a). However, s 256D(2) does not purport to ameliorate the usual consequences
of s 254T (which is a criminal provision) being contravened.

Liability of directors at common law

At common law, directors who are responsible for the payment of a dividend out of capital are
jointly and severally liable to the company for the amount of the illegal distribution plus interest.40.
No liability attaches to a blameless director who has, for example, reasonably relied on the skill
and accuracy of others: see, for example, Re National Bank of Wales [1899] 2 Ch 629; [1895-99]
All ER Rep 715 (affirmed sub nom Dovey v Cory [1901] AC 477; [1895-99] All ER Rep 715, HL);
Re Denham and Co (1884) 25 Ch D 752; Re Peruvian Guano Co; Ex parte Kemp [1894] 3 Ch 690;
Lucas v Fitzgerald (1903) 20 TLR 16.

However, the duty of directors to take reasonable steps to ascertain the financial position of a
company cannot be avoided simply by saying that a dividend was recommended by the company's
auditors or accountants: Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 476;
(1988) 4 NZCLC 64,721 at 64,751 per Tipping J, HC. See also Re National Funds Assurance Co
(1878) 10 Ch D 118 at 122 per Jessel MR dicta. This is particularly so where the auditors or
 15

accountants had not been provided with all relevant information, or been requested to ascertain the
company's financial information: Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at
476; (1988) 4 NZCLC 64,721 at 64,751 per Tipping J, HC.

Proceedings against directors may be instituted by:

o 13 the company (Re Exchange Banking Co (Flitcroft's Case) (1882) 21 Ch D 519 at 534
per Jessel MR (dicta), at 535 per Brett MR dicta, at 536 per Cotton LJ dicta. Compare
Towers v African Tug Co [1904] 1 Ch 558; [1904-7] All ER Rep Ext 1583, CA);
o 14 any of its creditors (Re National Funds Assurance Co (1878) 10 Ch D 118 at 127 per
Jessel MR dicta);50.
o 15 its liquidator (see, for example, Re National Funds Assurance Co (1878) 10 Ch D
118; Re Exchange Banking Co (Flitcroft's Case) (1882) 21 Ch D 519, CA; Re
Alexandra Palace Co (1882) 21 Ch D 149); or
o 16 members, other than those who have received and retained the dividend with
knowledge of its impropriety, bringing a derivative action (compare with Towers v
African Tug Co [1904] 1 Ch 558; [1904-7] All ER Rep Ext 1583, CA).

In a proceeding against directors by the liquidator or a creditor of a company, the directors may not
be protected from liability by any ratification of their actions by the company's shareholders: Re
National Funds Assurance Co (1878) 10 Ch D 118 at 127 per Jessel MR dicta; Re Exchange
Banking Co (Flitcroft's Case) (1882) 21 Ch D 519 at 534 per Brett LJ dicta, CA; Hilton
International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 475; (1988) 4 NZCLC 64,721 at 64,750
per Tipping J, HC. Directors are entitled to be indemnified by any person who received the
dividend with actual or constructive notice that it was illegal: Re Alexandra Palace Co (1882) 21
Ch D 149; Moxham v Grant [1900] 1 QB 88, CA; Blackburn v Industrial Equity Ltd (1980) CLC
40-604, SC(NSW), Needham J.

Statutory liability of directors

A director, who causes a dividend to be paid otherwise than out of profits, contravenes s 254T. The
director would be liable for a fine of up to $11,000 or imprisonment for 2 years or both: see s 1311
and Sch 3.

Directors contravene s 588G if they fail to prevent a company incurring a debt when they suspect,
or should suspect, that the company is insolvent, or would become insolvent, as a consequence of
incurring the debt. For the purposes of this provision, a company incurs a debt when it pays a
dividend pursuant to its constitution other than a dividend which had been previously declared: s
588G(1A). This is a curious concept. The payment of a dividend to a shareholder would usually
discharge whatever debt might then be owed to the shareholder in relation to the dividend. In the
case of a dividend declared by a company pursuant to its constitution, a debt arises immediately
and is thus regarded as being incurred immediately for the purposes of s 588G : see s 588G(1A).
The potential liability of directors under s 588G is somewhat similar to the liability briefly imposed
on directors by the Limited Liability Act 1855 (UK): see [2.6.0255].

Because insolvency is an element of a contravention of s 588G, a creditor or member could seek

injunctive relief under s 1324 in relation to an actual or imminent contravention. For the purposes
of s 1324(1), a contravention of s 588G is considered to affect the interests of a creditor or member:
s 1324(1A)(a). As to s 588G and the other insolvent trading provisions, see [5.7B.0535]-
[5.7B.0570].
 16

If an unlawful dividend is paid by a company (other than an unlimited company: see s 258A), there
could be a reduction of share capital in contravention of s 256B. While any such contravention
does not affect the validity of the reduction, or any contract or transaction connected with it (s
256D(2)), any person involved in the contravention contravenes the civil penalty provision s
256D(3). If the involvement was dishonest, a criminal offence is also committed: s 256D(4). As to
the meaning of "involvement", see s 79. Injunctive relief could be sought under s 1324 before the
unlawful distribution occurred: see s 1324(1), (1A) and Winpar Holdings Ltd v Goldfields
Kalgoorlie Ltd (2001) 40 ACSR 221; 166 FLR 144; BC200107796; [2001] NSWCA 427. In such
proceedings, the burden would be on the company to establish that there had been no contravention
of s 256B(1)(b): s 1324(1B).

Notes

10. Knowing recipient of unlawful dividend liable to return it: authorities.

Moxham v Grant [1900] 1 QB 88, CA; Re Alexandra Palace Co (1882) 21 Ch D 149 at 161 per Fry J dicta; Lucas v Fitzgerald
(1903) 20 TLR 16; Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 478; (1988) 4 NZCLC 64,721 at 64 per
Tipping J; Re Mercantile Trading Co (Stringer's case) (1869) LR 4 Ch App 475 at 488 per Selwyn LJ dicta; Blackburn v
Industrial Equity Ltd (1980) CLC 40-604, SC(NSW)..

20. Member may hold unlawful dividend as constructive trustee: authorities.

Moxham v Grant [1900] 1 QB 88 at 92 per A L Smith LJ, CA; Precision Dippings Ltd v Precision Dippings Marketing Ltd
[1986] Ch 447 at 457; [1985] 3 WLR 812 at 818 per Dillon LJ, CA; Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474
at 479 per Jessell MR; Re Cleveland Trust Plc [1991] BCLC 424 at 429 per Scott J; Blackburn v Industrial Equity Ltd (1980)
CLC 40-604, SC(NSW).

30. Recovery from members: comparative perspective.

Under the Companies Act 1993 (NZ) s 56(1), an improper dividend distribution may be recovered from a shareholder unless:

o1 the shareholder received the distribution in good faith and without knowledge of the company's failure to
satisfy the "solvency" test in s 4; and
o2 the shareholder has altered the shareholder's position in reliance on the validity of the distribution; and
o3 it would be unfair to require payment in full or at all.
If a court is satisfied that the company could have satisfied the solvency test by distributing a lesser amount, the court may
permit the shareholder to retain an amount equal to the value of any distribution that could properly have been made: s 56(5)
(a).

40. Liability of directors responsible for unlawful dividend: authorities.

Mackie v Clough (1891) 17 VLR 493; Blackburn v Industrial Equity Ltd (1980) CLC 40-604, SC(NSW); Re National Funds
Assurance Co (1878) 10 Ch D 118; Re Alexandra Palace Co (1882) 21 Ch D 149; Re Exchange Banking Co (Flitcroft's Case)
(1882) 21 Ch D 519; Re Oxford Benefit Building & Investment Society (1886) 35 Ch D 502; Leeds Estate, Building and
Investment Co v Shepherd (1887) 36 Ch D 787; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447;
[1985] 3 WLR 812; Re Mercantile Trading Co (Stringer's case) (1869) LR 4 Ch App 475 at 487 per Selwyn LJ dicta. See also
Re John Fulton & Co Ltd [1932] NI 35 at 58 per Wilson J.

50. Proceedings by creditors.

It may be that creditors can only enforce their rights in relation to an improper dividend payment by seeking a winding up
order: Re Exchange Banking Co (Flitcroft's Case) (1882) 21 Ch D 519 at 534 per Jessel MR dicta.

[2.6.0330] Liability of auditors in connection with payment of unlawful dividends

If the negligence of an auditor is responsible for directors or members of a company authorising the
payment of an unlawful dividend, the auditor is liable for the company's loss: Segenhoe Ltd v Akins
 17

(1990) 29 NSWLR 569; 1 ACSR 691; 8 ACLC 263, SC(NSW); Leeds Estate, Building and
Investment Co v Shepherd (1887) 36 Ch D 787; Re London and General Bank (No 2) [1895]2 Ch D
673; [1895-99] All ER Rep 953, CA; Re Thomas Gerrard and Son Ltd [1968] Ch 455; [1967] 2 All
ER 525. This liability may be enforced irrespective of whether the company is in liquidation:
Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691; 8 ACLC 263, SC(NSW). The
company's loss is the amount of the dividend improperly paid less any amount that is recovered
from recipients of the dividend: Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691; 8
ACLC 263, SC(NSW). The duty of a company to mitigate its loss does not require it to institute
legal actions, which would not necessarily succeed, to recover unlawful dividends from its
members: Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691; 8 ACLC 263, SC(NSW).

Statutory liability of directors

A director, who causes a dividend to be paid otherwise than out of profits, contravenes s 254T. The
director would be liable for a fine of up to $10,000 or imprisonment for 2 years or both: see s 1311
and Sch 3.

Directors contravene s 588G if they fail to prevent a company incurring a debt when they suspect,
or should suspect, that the company is insolvent, or would become insolvent, as a consequence of
incurring the debt. For the purposes of this provision, a company incurs a debt when it pays a
dividend pursuant to its constitution other than a dividend which had been previously declared: s
588G(1A). This is a curious concept. The payment of a dividend to a shareholder would usually
discharge whatever debt might then be owed to the shareholder in relation to the dividend. In the
case of a dividend declared by a company pursuant to its constitution, a debt arises immediately
and is thus regarded as being incurred immediately for the purposes of s 588G : see s 588G(1A).
The potential liability of directors under s 588G is somewhat similar to the liability briefly imposed
on directors by the Limited Liability Act 1855 (UK): see [2.6.0255].

Because insolvency is an element of a contravention of s 588G, a creditor or member could seek

injunctive relief under s 1324 in relation to an actual or imminent contravention. For the purposes
of s 1324(1), a contravention of s 588G is considered to affect the interests of a creditor or member:
s 1324(1A)(a). As to s 588G and the other insolvent trading provisions, see [5.7B.0535]-
[5.7B.0570].

If an unlawful dividend is paid by a company (other than an unlimited company: see s 258A), there
could be a reduction of share capital in contravention of s 256B. While any such contravention
does not affect the validity of the reduction, or any contract or transaction connected with it (s
256D(2)), any person involved in the contravention contravenes the civil penalty provision s
256D(3). If the involvement was dishonest, a criminal offence is also committed: s 256D(4). As to
the meaning of "involvement", see s 79. Injunctive relief could be sought under s 1324 before the
unlawful distribution occurred: see s 1324(1), (1A) and Winpar Holdings Ltd v Goldfields
Kalgoorlie Ltd (2001) 40 ACSR 221; 166 FLR 144; BC200107796; [2001] NSWCA 427. In such
proceedings, the burden would be on the company to establish that there had been no contravention
of s 256B(1)(b): s 1324(1B).

Notes

10. Knowing recipient of unlawful dividend liable to return it: authorities.

 18

Moxham v Grant [1900] 1 QB 88, CA; Re Alexandra Palace Co (1882) 21 Ch D 149 at 161 per Fry J dicta; Lucas v Fitzgerald
(1903) 20 TLR 16; Hilton International Ltd (in liq) v Hilton [1989] 1 NZLR 442 at 478; (1988) 4 NZCLC 64,721 at 64 per
Tipping J; Re Mercantile Trading Co (Stringer's case) (1869) LR 4 Ch App 475 at 488 per Selwyn LJ dicta; Blackburn v
Industrial Equity Ltd (1980) CLC 40-604, SC(NSW).

20. Member may hold unlawful dividend as constructive trustee: authorities.

Moxham v Grant [1900] 1 QB 88 at 92 per A L Smith LJ, CA; Precision Dippings Ltd v Precision Dippings Marketing Ltd
[1986] Ch 447 at 457; [1985] 3 WLR 812 at 818 per Dillon LJ, CA; Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474
at 479 per Jessell MR; Re Cleveland Trust Plc [1991] BCLC 424 at 429 per Scott J; Blackburn v Industrial Equity Ltd (1980)
CLC 40-604, SC(NSW).

30. Recovery from members: comparative perspective.

Under the Companies Act 1993 (NZ) s 56(1), an improper dividend distribution may be recovered from a shareholder unless:

o4 the shareholder received the distribution in good faith and without knowledge of the company's failure to
satisfy the "solvency" test in s 4; and
o5 the shareholder has altered the shareholder's position in reliance on the validity of the distribution; and
o6 it would be unfair to require payment in full or at all.
If a court is satisfied that the company could have satisfied the solvency test by distributing a lesser amount, the court may
permit the shareholder to retain an amount equal to the value of any distribution that could properly have been made: s 56(5)
(a).

40. Liability of directors responsible for unlawful dividend: authorities.

Mackie v Clough (1891) 17 VLR 493; Blackburn v Industrial Equity Ltd (1980) CLC 40-604, SC(NSW); Re National Funds
Assurance Co (1878) 10 Ch D 118; Re Alexandra Palace Co (1882) 21 Ch D 149; Re Exchange Banking Co (Flitcroft's Case)
(1882) 21 Ch D 519; Re Oxford Benefit Building & Investment Society (1886) 35 Ch D 502; Leeds Estate, Building and
Investment Co v Shepherd (1887) 36 Ch D 787; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447;
[1985] 3 WLR 812; Re Mercantile Trading Co (Stringer's case) (1869) LR 4 Ch App 475 at 487 per Selwyn LJ dicta. See also
Re John Fulton & Co Ltd [1932] NI 35 at 58 per Wilson J.

50. Proceedings by creditors.

It may be that creditors can only enforce their rights in relation to an improper dividend payment by seeking a winding up
order: Re Exchange Banking Co (Flitcroft's Case) (1882) 21 Ch D 519 at 534 per Jessel MR dicta.

[2.6.0330] Liability of auditors in connection with payment of unlawful dividends

If the negligence of an auditor is responsible for directors or members of a company authorising the
payment of an unlawful dividend, the auditor is liable for the company's loss: Segenhoe Ltd v Akins
(1990) 29 NSWLR 569; 1 ACSR 691; 8 ACLC 263, SC(NSW); Leeds Estate, Building and
Investment Co v Shepherd (1887) 36 Ch D 787; Re London and General Bank (No 2) [1895]2 Ch D
673; [1895-99] All ER Rep 953, CA; Re Thomas Gerrard and Son Ltd [1968] Ch 455; [1967] 2 All
ER 525. This liability may be enforced irrespective of whether the company is in liquidation:
Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691; 8 ACLC 263, SC(NSW). The
company's loss is the amount of the dividend improperly paid less any amount that is recovered
from recipients of the dividend: Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691; 8
ACLC 263, SC(NSW). The duty of a company to mitigate its loss does not require it to institute
legal actions, which would not necessarily succeed, to recover unlawful dividends from its
members: Segenhoe Ltd v Akins (1990) 29 NSWLR 569; 1 ACSR 691; 8 ACLC 263, SC(NSW).

JPH: 08/2010