18 September 2019
This guide is one in a series of 'Collas Crill explains...' in which we examine areas of Jersey law that frequently arise in practice. Further guides will be released weekly, click here to subscribe to receive the rest of the guides in this series to your inbox.
Jersey is a popular place to establish an asset holding company because the Law is modern, flexible and modelled on English companies legislation.
This guide looks at the key things you need to know about the payment of distributions by a company.
Words in bold text are defined at the end of this guide.
Dividends and distributions
Being modelled on English companies legislation, the Law previously included provisions which implemented the maintenance of capital rule. This rule required a company to maintain its paid up share capital for the benefit of its creditors and limited the sources from which dividends could be paid to shareholders.
As a result, dividends could only be paid from profits (whether earned in the current financial year or previous ones) or distributable reserves.
Today, the maintenance of capital rule has been considerably relaxed and the Law allows dividends to be paid from a far wider range of sources. Consequently, the Law now uses the term distribution rather than dividend to describe a payment from a company to its shareholders. Despite this, the term dividend is still commonly used, including in the M&A of many companies.
What is a distribution?
The Law defines a distribution as any distribution (whether in cash or otherwise) of a company's assets to its shareholders, in their capacity as shareholders, other than any:
- issue of bonus shares;
- redemption or buyback of shares;
- reduction of capital; or
- distribution of assets on a winding up.
A distribution that is made in accordance with the Law does not amount to a reduction of capital under the Law.
Requirements of Law
Unlike legislation in other countries, the Law is not very prescriptive and allows a company considerable flexibility to make distributions. The Law has two main requirements.
The Law states that a company may only make a distribution if the directors who authorise it make a statement that they have formed the opinion that:
immediately following the date on which the distribution is proposed to be made, the company will be able to discharge its liabilities as they fall due; and
- having regard to:
- the prospects of the company and to the intentions of the directors with respect to the management of the company's business; and
- the amount and character of the financial resources that will in their view be available to the company,
the company will be able to:
- continue to carry on business; and
- discharge its liabilities as they fall due,
until the first to occur of the expiry of the period of 12 months immediately following the date on which the distribution is proposed to be made, or the company is wound up on a solvent basis.
The solvency statement is normally included in the minutes of meetings of directors, which approves the distribution, or in a separate document that is signed by each director who authorised it.
Source of payment
The Law states a distribution may be debited to any account of the company other than:
- its nominal capital account if it is a par value company; or
- any capital redemption reserve.
Therefore, the Law does not require a distribution to be paid from profits or distributable reserves or (in fact) that the company have any profits or distributable reserves as long as the directors have reasonable grounds for making the solvency statement. Consequently, a company may pay a distribution from its:
- share premium account if it is a par value company; or
- stated capital account if it is a no par value company.
Ratification of distributions
- a company makes a distribution; and
- the directors who authorised the distribution did not make a solvency statement,
the company will have breached the Law and the distribution will be unlawful.
Where this happens, the Law allows the company to apply to the Jersey court for an order that the distribution be treated as having been made in accordance with the Law.
The court may make the order if it is satisfied that:
- immediately after the distribution was made, the company was able to discharge its liabilities as they fell due;
- at the time the application is made, the company is able to discharge its liabilities as they fall due;
- (if the distribution was made less than 12 months before the application was made) the company will be able to:
- carry on business; and
- discharge its liabilities as they fall due,
until the end of the 12 month period beginning on the date on which the distribution was made; and
- it would not be contrary to the interests of justice to do so.
In addition, to the requirements in the Law, a company's M&A will normally contain provisions relating to the payment of distributions. The directors of the company must make sure they are familiar with these provisions and comply with them.
Sometimes the distribution provisions in the company's M&A will be more restrictive than the requirements of the Law, especially if the M&A have not kept pace with changes to the Law. Where this is the case, the directors may want to amend these provisions so the company can enjoy the flexibility allowed by the Law.
Interim and final distributions
The Law does not distinguish between interim and final distributions, however, the M&A of most companies continue to do so.
A final distribution is recommended by the directors and declared by the shareholders after the company's financial statements have been prepared. Once a final distribution is declared, it is a debt due by the company to its shareholders.
In contrast, an interim distribution is declared and paid by the directors during a financial period before the company's financial performance for that financial period is known. Unlike a final distribution, the declaration of an interim distribution does not create a debt that may be enforced against the company because it may be rescinded by the directors before the payment date.
Distributions in kind
A company will generally pay distributions in cash, however, if its M&A allow it to do so, it may also pay a distribution (in whole or part) by transferring specific assets (eg shares or bonds) to its shareholders. This is called a distribution in kind or an in specie distribution.
Where a company's M&A allow it pay distributions in kind, they normally require the shareholders to approve the distribution in kind.
Typical distribution provisions in M&A
A company's M&A typically have provisions relating to distributions which address the following points.
- Subject to the Law, the:
- shareholders may declare a final distribution and the amount may not exceed the amount recommended by the directors; and
- directors may pay an interim dividend at any time in an amount they think appropriate.
- A distribution is to be paid proportionately according to the amount paid up on shares. Some M&A state that a distribution is to be paid proportionately according to the number of shares held.
- The shareholders may, on the recommendation of the directors, direct that a distribution is to be satisfied in assets rather than cash (ie a distribution in kind).
Potential liability of directors
A director who makes a solvency statement without having reasonable grounds for the opinion expressed in it is guilty of an offence and, upon conviction, is liable to a fine, imprisonment for up to two years or both.
Breach of duty
- a director authorises a distribution;
- the company subsequently becomes insolvent; and
- the Jersey court finds that the director breached the director's duties to act in the best interests of the company and to exercise the necessary care, diligence and skill,
the director will be liable to the company for any damage suffered by it.
If an action is brought against a director alleging a breach of the director's duties to the company, the director may apply to the Jersey court to be relieved from any liability.
The Law allows the court to relieve the director (in whole or part) from liability for negligence, default or breach of duty, or trust on any terms the court thinks fit if it appears to the court that:
- the director acted honestly; and
- having regard to all the circumstances, the director ought fairly to be excused from liability.
In practice, however, the court is only likely to exercise these powers in favour of a director in rare cases.
Potential liability of shareholders
- a company makes a distribution to a shareholder;
- at the time the distribution is made, the shareholder knows, or has reasonable grounds for believing, that the distribution (or part of it) is made in breach of the Law; and
- the company has not applied to the Jersey court for an order that the distribution be treated as having been made in accordance with the Law,
the shareholder is liable to repay the distribution (or part of it) to the company.
If the distribution was a non-cash distribution, the shareholder is liable to pay to the company a sum equal to the value of distribution (or part of it) at the time at which the unlawful distribution was made.
Law means the Companies (Jersey) Law 1991.
company means a Jersey company that is not an open ended investment company.
M&A means a company's memorandum and articles of association.
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About this guide
This guide gives a general overview of this topic. It is not legal advice and you may not rely on it. If you would like legal advice on this topic, please get in touch with one of the authors or your usual Collas Crill contacts.