What is a dividend?

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“Distribution” is the general term used to describe a payment made by a company to its shareholders based on their shareholding. A “dividend” is a distribution of a portion of the company’s earnings to a class of its shareholders. Usually, in smaller companies in which the shareholders are also the directors, a regular dividend is paid, because dividends can be more tax-efficient for both the company and the recipient. In larger companies, however, shareholders expect to be able to participate in the company’s profits. In this article I will outline the different types of dividends and will answer the most frequently asked questions.

Do I have a right to a dividend?

Generally, shareholders do not have a right to a dividend. The company is not required to declare dividends unless its articles oblige it to do so or it has made a contractual commitment to pay dividends, for instance, in a shareholders’ agreement. Thus, in unlisted companies, especially in smaller ones, it is largely dependent on the directors to decide whether a dividend will be paid or not. By contrast, the dividend policy of a listed company has a direct impact upon its share value and therefore requires the payment of regular adequate dividends.

The failure of a company to pay dividends or the payment of low dividends usually causes shareholders’ discontent. In such situations shareholders’ legal rights are very limited. The court does not have the power to interfere with a company’s dividend policy because it is a matter of internal company management. Nonetheless, if there was some sort of understanding that dividends would be declared on a particular basis, the situation may be different. That said, if the dividend policy is irrational or if the shareholders have a legitimate expectation to receive a dividend, the withholding of dividends may give rise to a claim of unfair prejudice.

Usually, when a dividend is paid, the shareholders are entitled to profit in proportion to the nominal value of their shareholding in the company. This may lead to unfairness between the holders of fully-paid and partly-paid shares. For example, an ordinary shareholder who holds 50 fully-paid £1 shares will be entitled to the same amount of profit as an ordinary shareholder who holds 50 partly-paid £1 shares. This is not an issue for private companies governed by the Model Articles as their shares must be fully paid on issue.

What are the types of dividend payouts?

The general rule is that a dividend must be paid to the registered holder of the relevant shares as of the date of the shareholder’s declaration. In large companies the articles sometimes provide for payment to be made to shareholders registered on a particular date, known as the “record date”.
Cash
Dividends are usually paid in cash. This is the most common way of distribution. Generally, the articles will provide that a company can pay dividends by cheque, and the dispatch of a correctly made out cheque to the correct address will discharge the company’s payment obligation. Other methods of payment may be allowed as well, for example, electronic transfers to a bank account or any other means agreed with the shareholder.
Assets
Most articles also provide that the shareholders’ declaration of assets can be wholly or partly satisfied by a distribution of assets. This is known as a “distribution in specie”. It is important to consider the tax advantages and disadvantages before opting for this option. For example, depending on the nature of the asset, stamp duty or stamp duty land tax may be payable. Particular legal formalities should also be observed. For example, if the asset being distributed is shares in another company, a stock transfer has to be executed.
Stock
Another common alternative is for a company to give the shareholders the option to take a dividend of shares in the distributing company rather than cash. This is known as a “stock dividend”. The payment of a stock dividend amounts to a bonus issue of fully-paid shares funded by a company’s distributable profits. The only difference between a bonus issue and a stock dividend is that the company does not know how many shares will be issued under the stock dividend until all of the options have either been taken up or declined.

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