A company may decide to pass on its after-tax profits through a distribution to shareholders. A distribution can take the form of a cash payment (a dividend) or shares instead of a dividend.
Satisfying the solvency test
A company can authorise a distribution at any time and for any amount, but directors must:
- be satisfied that the company will be able to satisfy the solvency test after the distribution is made, and
- ensure the distribution doesn't breach any provision in the company's constitution, or section 53 of the Companies Act 1993.
A company satisfies the solvency test if, after the distribution is made:
- it's able to pay its debts as they become due, and
- the value of its assets is greater than the value of its liabilities, including contingent liabilities.
In approving a distribution to shareholders, directors must sign a certificate confirming that, in their opinion, the company can satisfy the solvency test and explain why they've formed that opinion.
If a company becomes insolvent
If it is later apparent that the company should not have made the distribution, as it could not satisfy the solvency test, the company can ask shareholders to repay the distribution.
If the company goes into liquidation after the distribution has been made, a liquidator may also demand repayment.