Professor Bob Baxt explains the importance of directors familiarising themselves with the basic rules relating to dividend declaration and payments.
The most recent corporations law legislation released by the federal government, the Corporations Legislation Amendment (the Regulatory and Other Measures) Bill 2014 (the bill), at the time of writing is being debated in parliament. While it contains important proposed amendments to the calling of general meetings and other matters, it does not deal with proposed amendments to section 245T of the Corporations Act 2001 (the Act). That section, which governs the law relating to the bases upon which dividends may be declared and paid by companies, had been the subject of considerable debate for some time. Proposed amendments were foreshadowed two years ago; these were omitted from the bill before parliament. There had apparently been difficulties in resolving certain disagreements between government departments on how the proposed amendments might work. They will have an impact, not only in the context of company law issues, but also on the revenues to be collected by the Commissioner of Taxation.
Two interesting cases in the last 12 months, which deal with questions surrounding the interpretation of the rules relating to the payment of dividends, highlight the need for reform to be moved along. I will not comment on the first of these decisions, Wambo Coal Pty Ltd v Sumiseki Materials Co Ltd  NSWCA 327. It deals with more technical questions relating to the variation of rights of shareholders through contractual arrangements, which “contradict” the constitution of the company. The New South Wales Court of Appeal made some interesting observations about dividend law in that case, which may warrant a separate note.
The decision in ICM Investments Pty Ltd v San Miguel Corporation  VSCA246 (the San Miguel case) involved more fundamental questions surrounding the operation of the rules relating to the funds from which dividends could be declared and paid. The Victorian Court of Appeal’s decision is very detailed and lengthy; it involves the interpretation of complex contractual negotiations and arrangements entered into between the relevant parties. Briefly, the facts are as follows.
The San Miguel Corporation (San Miguel) wished to purchase certain shares held by ICM Investments Pty Ltd (ICM) (together with others) in the Berri Fruit Company (Berri). The terms of the relevant agreements were complex. I do not need to go into the complexities of the drafting. Various tranches of shares which were to be sold would carry with them an obligation on the part of the purchaser of the relevant shares (San Miguel) to ensure that any dividends that had been declared but which for some reason had not been paid during the relevant period, and any entitlements to future dividends in relation to the relevant period, would be paid to ICM. In essence the language of the relevant clauses stated “the parties must procure that [Berri] pays [the relevant dividend] to the holder of the shares immediately prior to their transfer to [San Miguel] as a dividend determined in accordance with the [relevant clauses in the shareholders agreement entered into between the parties]”.
ICM argued (this was denied by both San Miguel and Berri) that, on the proper construction of the relevant documents, it had been given the right to receive dividends in respect to a period in which it was, in essence, the owner of the relevant shares, the subject of the arrangement. Further it argued that both San Miguel and Berri were contractually obliged to procure the declaration and payment of the relevant dividends to it, and that there were sufficient profits or anticipated profits to enable the payment of the relevant dividends. It further alleged that San Miguel was required to use its best endeavours to ensure that this occurred. The amount to be paid in accordance with the arrangements (and this amount was agreed to by the parties) was $3,472,198.04. (Ancillary clauses provided for the franking of dividends and the way in which these relevant amounts were to be allocated between the various parties. These are not of direct relevance to my discussion of the case.)
San Miguel and Berri disagreed with ICM’s interpretation. They argued that the proper construction of the relevant agreements meant they were relinquished of any obligation to ensure further dividends were to be paid after the cut-off date. ICM responded by reasserting that the contractual obligations remained, on the part of both San Miguel and Berri, to procure the declaration and payment of the required dividends as long as Berri had sufficient distributable profits within its funds to pay the dividend lawfully.
At first instance the trial judge, Justice Vickery, reached a number of conclusions on whether Berri had available funds to pay the required dividend. There was considerable discussion about the relevant legal rules, which applied to the determination of when dividends could be paid by a company. It was held that these rules imposed obligations on the directors in pursuing a dividend policy.
Justices Nettle, Santamaria and Beach, in the Court of Appeal, in reversing Justice Vickery’s decision held that there were certain unconditional obligations imposed on both Berri and San Miguel by the contractual arrangements. These included the need to ensure that the dividends would actually be declared and paid. The court noted that the obligation was one that applied not only in relation to direct actions to be taken, but also to “any anterior step such as declaring the relevant dividend” ( VSCA at ). This particular ruling, however, applied only to San Miguel. The court, however, ruled that only Berri had to ensure that the transaction was completed.
In reaching this conclusion, the Court of Appeal held that it was wrong for Justice Vickery to “vary the contract” as he had done to modify the nature of the contractual obligations.
There was an important discussion on the potential illegality on the part of directors of Berri in pursuing the payment of the relevant dividend. The court correctly, in my view, held that the onus to establish the suggested illegality lay squarely on the shoulders of San Miguel and Berri.
The question of alleged illegality was based on the proposition that it was not possible for the directors of Berri, acting reasonably and honestly, at the relevant time, to decide that a dividend should be recommended for payment by Berri. Justice Vickery had ruled that the declaration of an interim dividend “required the directors to form genuine opinions that there are profits from which it can be paid. In other words, the directors need to be satisfied that there are sufficient available profits. Those profits may be revenue or capital profits and may include capital profits that have been placed in a reserve” (as set out by the Court of Appeal at  VSCA at ). In reaching this view Justice Vickery had relied on the decision of the New South Wales Court of Appeal in Marra Developments Limited v BW Rofe Pty Ltd  2NSWLR 616 (Marra).
In considering this question, Justice Vickery ruled that the central question could be expressed in this way: “If [the directors] had been called upon to consider the matter on or prior [to the relevant date] would the directors of Berri have formed a genuine opinion that when the final accounts for the year were produced, they would disclose actual profits existing in the company at the time when it was proposed that the [relevant dividend] would be declared and paid (see  VSCA at ).
The Court of Appeal agreed with his interpretation of the Marra case and ruled that it was important for the directors to have formed the view as to whether the relevant dividend could honestly and reasonably be declared and that there were sufficient profits from which the dividend could be declared and paid. The court noted that the relevant shareholders agreement entered into between the parties worked on the principle that the shareholders of the company could decide the question of when dividends were to be declared and paid. The relevant shareholders agreement here had the effect of “supplanting the provisions of the constitution of Berri which would normally have regulated the payment of dividends” ( VSCA at ). In this case the power to declare and pay dividends was vested in the board of directors. But most importantly the obligation imposed on San Miguel was unconditional. It did not depend on the application of the best endeavours of the directors.
In this case the central question depended on there being sufficient profits for the declaration of the dividend. If there were insufficient profits there could be no dividends “payable” or made available under the terms of section 245T of the Act and it would have been unlawful for a declaration or payment of dividend to have been made. Such a declaration might also have amounted to a breach of section 588G of the Act which prohibits insolvent trading.
In essence for the San Miguel/Berri team to have won the case it would have been necessary to establish that “there was no way in which the directors of Berri could lawfully have paid [the relevant dividend]; and, therefore, incumbent on San Miguel to show, not just that it would have been open to the directors to take the view that there were not sufficient profits out of which to pay the dividends [as held by Justice Vickery], but also, critically, that it would have been impossible for the directors acting honestly and reasonably [at the relevant time] to have concluded that there were sufficient profits out of which to pay the dividend”  VSCA at .
In addition, the Court of Appeal also discussed whether the general reserves that were shown in the books of Berri were available for the payment of the dividends. A number of interesting cases were discussed. The court indicated that it was not necessary for Berri to recoup previous losses before the dividend was paid. The court’s discussion of these issues highlights the need for the relevant rules relating to the source of funds to be made available for the declaration and payment of dividends to be settled.
While the questions the directors face in dealing with these issues will usually be decided in conjunction with accountants, it is important that the general background against which these decisions can be taken is understood by directors. Failure of directors to familiarise themselves with these basic rules relating to when dividends may be declared and paid may amount to a breach of duty of care and diligence and may create significant problems for directors in the event of disputes arising between the relevant parties.
In conclusion, I would suggest that the decision in this case is a vital one for the members of the two teams in the federal government working on proposed amendments to section 245T of the Act. They urgently need to analyse the particular issues and the questions raised by these earlier decisions to ensure that whatever final drafting is placed before parliament for consideration, that the uncertainties, if any, which may be felt to still remain unanswered as a result of this Court of Appeal decision can be adequately dealt with by the amendments.
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