Changes to the method of payment of dividends

This is part of Lavan Legal’s continual series on corporate governance updates.

The Corporations Amendment (Corporate Reporting Reform) Act 2010 (Cth) (Amendment Act) has made important changes to section 254T of the Corporations Act 2001 (Cth) (Act) which deals with the payment of dividends.

Historically, companies can only pay dividends out of profits.  The law in this area changed on 28 June 2010, and dividends can now be paid not out of profits where the balance sheet solvency test is satisfied.

The balance sheet solvency test

The balance sheet solvency test provides more flexibility in the payment of dividends.  A company may now pay dividends when:

• the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend;
  
  
• it is fair and reasonable to the company’s shareholders as a whole; and
  
  
• it does not materially prejudice the company’s ability to pay its creditors.

The Amendment Act must be considered with the overriding duty of directors to prevent insolvent trading in mind, as even if the above requirements are satisfied, directors are prohibited from declaring and paying a dividend when the company is insolvent.

The move away from the ‘profits test’ is being welcomed as it will hopefully eliminate restrictions on the payment of dividends by companies with sufficient cash flows to do so but are unable to as their accounting profits have been minimised due to non-cash expenses.

Lavan Legal comment

In the light of changes, we suggest that companies review their constitutions to ensure that there are no limitations in regard to paying dividends from profits only and if there are, seek advice on how to amend the constitution to incorporate these latest legislative changes. 

For further information please contact Partner, Tony Chong on 08 9288 6843 / tony.chong@lavanlegal.com.au