Looking forward – UK Government proposes new focus on dividends in light of major corporate failures

On 18 March 2021, the UK Government published its long-awaited white paper on restoring trust in audit and corporate governance.

This follows a series of high-profile audit errors and major corporate collapses, including those of BHS in 2016 and Carillion in 2018, which led the Government to commission three independent reviews into different aspects of the UK’s audit, reporting and corporate governance systems.

The white paper targets large listed and AIM-listed companies, and large private companies where there is a public interest, and primarily focuses on:

• directors’ accountability;
• audits and corporate reporting; and
• dividends and capital maintenance.

Focus for restructuring and insolvency: dividends

The white paper is a long document (232 pages) and the vast bulk of it focuses on general corporate issues around audits, corporate reporting and auditors. Most relevant from a restructuring and insolvency perspective are the proposals on dividends and capital maintenance. The white paper raises concerns about the robustness of the existing legal framework and the extent to which it is both respected and enforced, in light of recent examples of companies paying out significant dividends shortly before profit warnings and, in some cases, insolvency.

One particular area of concern is the focus of the current statutory regime on realised profits and distributable reserves in determining whether a company can pay a dividend to its shareholders. This current test on distributable reserves is backward looking and does not require any assessment of the future performance of the company or its future financial requirements. However, this is not the only test and directors also owe common-law duties to consider the consequences of decisions and the company’s future financial needs, including an express requirement to consider that the payment of a dividend will not result in the company becoming cash-flow insolvent.

The proposals: confirmation statements

The white paper proposes a new requirement that directors of listed and AIM-listed companies (and potentially other large public-interest entities) should, in proposing any interim or final dividend, make a statement:

• confirming that they have: 
  • satisfied themselves that the dividend is within known distributable reserves; and 
  • had regard to their general duties under section 172(1) of the Companies Act 2006 (including the need to have regard to the likely consequences of any decision in the long term) and their wider common-law and fiduciary duties; and
• confirming that it is the directors’ reasonable expectation that payment of the dividend will not threaten the solvency of the company over the next two years in the light of the risk analysis undertaken and the directors’ knowledge of the company’s position at the date the dividend is proposed.

What is the standard required? 

The proposal reinforces the current common-law requirement that solvency and future prospects of a company should be at the forefront of directors’ minds when reducing cash reserves through payments to shareholders.

The proposal requires only that directors have a reasonable expectation as to solvency and to have properly applied their minds to the issue at the time they are making the decision. Directors do not have a crystal ball, so will need to be judged on the facts and knowledge that they have on the date of making the decision, rather than with the benefit of hindsight. Further, while acknowledging that the statement may make it easier to pursue directors for breach of duty, the white paper does not propose a new limb of director liability, but suggests that this would be captured as a breach of an existing duty.

So what could this mean in practice? 

• Directors will have an express requirement to make a public statement that they have considered the future solvency of the company over a two-year period. In practice, this should be something that they are already considering where declaring substantial dividends so the actual practical effect may be limited.
• Directors will need to evidence that they have in fact applied their mind to the new confirmation (and the reasonable expectation of the company’s continued solvency).
• Recent events have shown that even companies appearing to have strong balance sheets can very quickly collapse. Directors should therefore give proper consideration to forming and evidencing their reasonable expectation even if they have no concerns as to solvency.
• The COVID-19 pandemic continues to have severe effects on some industries and the full fallout is unlikely to be clear for some time. Many businesses are struggling to prepare accurate forecasts, meaning an assessment of long-term prospects is currently difficult (although it might be said that a company struggling to forecast is exactly the type of company this proposal is intended to capture).
• The proposal will capture some but not all large companies – potentially only those that are listed, though the Government is looking wider. We will have to see to what degree directors of large privately owned companies are bound or will feel influenced by the proposals in the white paper.

What’s missing?

The white paper does not include any proposals regarding liability for directors in relation to sales of subsidiaries that subsequently become insolvent, as had previously been suggested in government consultations. This is not surprising as the Government has set out an intention to include this as part of the directors’ disqualification regime rather than a new actionable tort. 

Potential impact

The degree to which directors of privately owned companies will be caught by the new regime or will feel the need to follow suit, even when not bound by a confirmation statement, will remain to be seen.

The two-year look forward does not address all concerns. For example, although this two-year period would have captured dividends paid out by Carillion prior to its collapse, it would not have caught the dividends paid by BHS, which remain controversial despite being made over 10 years prior to its insolvency. However the approach should reinforce the existing requirement to consider impact on solvency when considering the declaration of a dividend.