CHAPTER IX.

DIVIDENDS.

THE division of profits amongst the members of the company is determined by the articles of association.

A dividend means the aliquot portion of the net profits which each shareholder is entitled to receive.

A preferential dividend is substantially the same as interest chargeable only on profits. [Henry v. Great Northern Ry. Co., 1 De G. & J. 606.]

Preferential dividends may be cumulative, and if the profits of any year are insufficient to pay the dividend in full, the deficiency may be made good out of subsequent profits. [Webb v. Earle, 20 Eq. 556.]

Where preferential dividends are dependent upon the profits of the particular year only, these profits mean the surplus in receipts after paying expenses and restoring the capital to the position it was at the commencement of that year. Thus, where a tramway had been allowed to wear out, no reserve fund having been set aside by the ordinary shareholders, it was held that the preference shares were entitled to a dividend out of the profits of any year after setting aside a proportionate amount sufficient for the maintenance of the tramway for that year only. [Dent v. London Tramways, 16 Ch. D. 344.]

No dividend is payable except out of the net profits of the company, and the payment of any dividend out of the capital of the company is ultra vires, and may be restrained. [Guinness v. Land Corporation of Ireland, 47 L. T. 517; McDougall v. Jersey Imperial Hotel Co., 12 W. R. 1142; National Funds Assurance, 10 Ch. D. 118.]

Thus it is very doubtful how far dividends payable by contractors during construction of the company's works can be properly declared, as clearly the contractors must increase their contract price by the estimated amount of the dividends payable, thus rendering such dividends really payments out of capital. [Bloxam v. Metropolitan Ry. Co., 3 Ch. 337; James v. Eve, 6 H. L. 335.]

It is conceived that all such dividends are inadmissible, and can be made the subject of an injunction. [Fisher v. Hull and Barnsley Railway, Times, March 5, 1881. M. R.]

The net profits of a company consist of the balance remaining after deductions have been made from the gross profits in respect of current expenses of all descriptions, and a due allowance made for depreciation and bad debts. [Dent v. London Tramways, 16 Ch. D. 354.]

As yet there has been no direct decision as to how far a company which has lost part of its capital is justified in paying dividends on the nominal amount of that capital, without writing off the amount lost or replacing it out of profits.

In view of the facilities afforded by the Companies Acts for writing off lost capital, it is submitted that no company is justified in paying dividends whilst part of its capital is lost and not written off.

It has been contended where after losses in one year profits have been made in a subsequent year, that the company is entitled to distribute present profits without reference to past losses.

This can hardly be tenable, as the net result might be highly injurious to the creditors, whose knowledge of the position of a company is most frequently derived from the balance sheets published and the dividends paid. If profits earned out of working capital were to be distributed irrespective of the loss of the invested capital of a company, it would be permissible to declare dividends whilst on the brink of insolvency.

Thus, if a spinning company were to have its freehold and

uninsured mill destroyed, and were subsequently to earn profits in another mill leased for the purposes of the company, it is conceived that the company would not be justified in paying any dividend until the lost capital had been replaced or written off.

The principle is the same as that which admittedly applies to leasehold property, tramways, working machinery, or concessions for a term. In all these cases depreciation must be charged against revenue before the net profits can be arrived at. [Dent v. London Tramways Co., 16 Ch. D. 344; see, however, Lambert v. Neuchatel Asphalte Co., 47 L. T. 73.]

In cases where dividends have been declared, though not earned, the Court has summary power to order a director to repay dividends declared and paid under a delusive and fraudulent balance sheet.

But a balance sheet of a company engaged in a hazardous trade will not be considered delusive and fraudulent merely because an estimated value was put upon assets of the company which were then in jeopardy and were subsequently lost, or because the company was obliged to borrow money to pay the dividend, provided the facts fairly appeared on the balance sheet and the balance fairly represented profits. [Stringer's Case, 4 Ch. 475.]

When directors, after proper investigation of the financial position of the company declare, and the shareholders agree to, a dividend or bonus, the Court will not lightly interfere with the payment of such dividend or bonus, on the ground that the estimates on which it was founded have turned out to be

erroneous.

But when the directors declare a dividend or bonus without proper investigation or professional assistance, and it is afterwards called in question, the burden lies on them to shew that it was fairly paid out of profits; and if they are unable to do so the Court will order them to refund what they have received. [Rance's Case, 6 Ch. 104.]

F

Where directors had for several years presented to general meetings of shareholders reports and balance sheets in which various debts known by the directors to be bad were entered as assets, so that an apparent profit was shewn, though in fact there was none, it was held that, as regards each half-yearly dividend, the persons who were directors when it was paid were jointly and severally liable for the whole amount of the dividend paid for that half-year. [Flitcroft's Case, 21 Ch. D. 519.]

In the same case the shareholders had passed resolutions declaring dividends on the faith of the delusive balance sheets. It was held that even if the shareholders had known the true facts, so that their ratification of the payment of the dividends would have bound themselves individually, they could not bind the company, because the payment of dividend out of corpus was ultra vires the company, and therefore incapable of ratification by the shareholders.

The fact that the capital so improperly applied was distributed pro rata amongst all the shareholders, does not in any way protect the directors. The shareholders are not the company, and payment to them does not prevent the company, either before or after winding up, from compelling the directors to replace the money in order that it may be properly applied for the purposes of the company.

On the distribution of dividends the question arises as to the basis on which the amount is to be paid.

Where the articles adopt the 72nd section of Table A, and make the dividend payable to the members in proportion to their shares, the dividend is payable on the amount of capital subscribed, whether fully paid-up or not. [Oakbank Oil Co. v. Crum, 1882, W. N., p. 180, H. L.; Times, 13 Dec. 1882.]

The principle of the decision rests upon the assumption that the profits of the company are earned upon the credit of the uncalled capital as well as upon the capital actually paid up.

EXAMINATION OF ACCOUNTS.

In the case of dissatisfied shareholders wishing for an inquiry into the state of the affairs of the company, the Act of 1862 [sects. 56-59] provides for the appointment by the Board of Trade of one or more competent inspectors to examine into the affairs of the company and to report thereon.

Applications for an inspection under the auspices of the Board of Trade must be made as follows:

In the case of a banking company, by holders of at least

one-third of all the shares issued.

In the case of any other company limited by shares, by holders of at least one-fifth of all the shares issued.

In the case of any company not having its capital divided into shares, then by one-fifth in number of the proprietary.

To prevent vexatious and malicious applications being made, the Board of Trade, before granting such application, requires reasonable evidence of the necessity for the inquiry, and may also require the applicants to give security for payment of the costs occasioned thereby.

The inspectors, on their appointment, are invested with the fullest powers for the conduct of the examination. All books and documents of the company must be produced to them, and every information afforded to them by the officers of the company. The inspectors may examine all or any of the officers or agents of the company upon oath. A penalty of £5 each offence is imposed upon any such person who refuses to answer any question or conceals any of the transactions of the company.

On completion of their examination the inspectors must report the result to the Board of Trade, who will forward a copy of such Report to the company and to the applicants. The costs of the inquiry are to be borne by the applicants unless the Board of Trade direct the company to defray them.

Independently of the Board of Trade the shareholders may,