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Freshfields Transactions

| 6 minutes read

Audit and corporate governance in the context of corporate failures: UK Government responds to consultation on dividends and capital maintenance

On 18 March 2021, the UK Government published its white paper on restoring trust in audit and corporate governance. On 31 May 2022, the Government published its response to the consultation.

This blog post follows up from a previous blog on the aspects of the white paper relevant for restructuring and insolvency, which can be accessed here. The response outlines various planned reforms, concerning large listed and AIM-listed companies, as well as large private companies and limited partnerships where there is a public interest (see “Scope” below).

The main areas of planned reform, alongside large scale audit reforms and the establishment of a new regulator which are not covered by this blog post, include:

  • director responsibility and accountability;
  • increased transparency for so called large public interest entities; and
  • dividends and capital maintenance.

The planned reforms are important both to directors of companies within scope and its auditors and all those involved in preparing or reviewing annual reports and consideration of the legality and appropriateness of dividends. For the purposes of this restructuring and insolvency focused blog, we are focusing on the reforms to dividends.

Disclosure of distributable reserves and an accompanying narrative

The Government confirmed that it intends to require qualifying companies (see below), or, in the case of a UK group, the parent company only, to disclose in their annual report their distributable reserves as at the balance sheet date, or a “not less than” figure if determining an exact figure would be impracticable. The distributable reserves figure will be subject to audit.  This aims to provide investors with information about dividend headroom and reassure stakeholders about the legality of proposed dividends.

The response document acknowledges that the parent company position will often be incomplete and may not accurately reflect the dividend capacity of the group as a whole. Disclosure of an estimate of the dividend capacity of the whole group will therefore be encouraged through guidance to be published by the regulator. This will not however be a required element of reporting, given the cost and complexity of such an exercise and the detailed narrative that will be required in order to avoid the risk of misleading investors.

In order for the distributable reserves figure to be set in a narrative context, the Government intends to require companies to explain the board’s long-term approach to the amount and timing of returns to shareholders (including dividends, share buybacks and other capital distributions) and how this distribution policy has been applied in the reporting year. It views this narrative as essential for the reported distributable reserves figure to be of any practical use. As part of the narrative, companies will be expected to outline relevant legal and financial constraints and risks to the policy.

Confirmation statements: legality of dividends (yes) – solvency (no)

The March 2021 white paper proposed a directors’ statement confirming the legality of a dividend and that such dividend would not jeopardise the future solvency of the company over the ensuing two years. Responses to the consultation were mixed, although the proposal for a directors’ statement about the legality of dividends received support from auditors and investors.

The Government response noted that while it is implicit that directors should comply with the law and have regard to their wider duties to the long-term success of the company (and other matters) when paying dividends, there are numerous examples of dividends being paid where the necessary reserves are lacking. The Government’s view is that the requirement to make a statement on the legality of a dividend should improve focus and emphasise the importance of the capital maintenance rules. Investors backed the proposals, and companies thought it would not impose too sizeable a burden. As such, the Government intends to take forward the requirement for directors to make explicit statements confirming the legality of proposed dividends and any dividends paid in year.

Consultation responses regarding the proposed solvency statement were less positive. In particular, it was noted that this would increase complexity in an already complicated framework, and the proposed two-year coverage would need to be reconciled with the different time periods covered by existing reporting regimes and directors’ duties, particularly for multinational companies. As a result, the Government will not proceed with this proposal. However, the new Resilience Statement (as discussed below) should take into account the company’s dividend policy, which will incorporate the envisaged forward-looking element to dividend payments.

Resilience Statement

The Government intends to legislate that PIEs that meet the 750:750 size threshold should produce an annual Resilience Statement as part of the Strategic Report. In the statement, companies should set out their approach to managing risk and developing resilience over the short, medium and long term. This is a response to concerns that existing going-concern, risk and viability reporting by many companies lacks sufficient detail and specificity, and is not sufficiently long-term in outlook.

The Resilience Statement will be required to report on matters that companies consider to be a material challenge to the resilience over the short and medium term, with an explanation of how they have arrived at their judgement of “materiality”. In particular, they will be required to have regard to the following factors:

  • any materially significant financial liabilities or expected refinancing needs;
  • significant accounting judgements or estimates that are material to the company’s future solvency;
  • the sustainability of the company’s dividend policy; and
  • any significant areas of business dependency regarding suppliers, customers or markets, which may constitute a material risk.

Scope of the new disclosures, legality statement and resilience statement

The new disclosures and the legality statement will apply to companies that are Public Interest Entities (PIEs), i.e. to both listed and unlisted companies with 750 employees or more and an annual turnover of at least £750m. Companies traded on AIM or other multilateral trading facilities as well as LLPs will be PIEs if they meet this 750:750 test. Public bodies and Lloyd’s syndicates will be outside this scope. The inclusion of private companies reflects the changing nature of the UK economy, and the need for high standards of corporate governance in the most significant UK companies, whether or not they are public or private.

Next steps and timing

The Government response does not set out a precise timetable for the implementation of the planned reforms, but outlines the actions to be taken, including what the Government intends to ask of the regulator and other stakeholders. The reforms will be delivered through a variety of mechanisms including work by professional bodies, ministerial directions, changes by the regulator as well as legislation. The full suite of implementation of the reforms may therefore be some time to come yet.


The Government’s view is that the directors’ statement on the legality of dividends will not entail any significant new burden for companies, as it is something directors should already be considering. The intention of the reform is to ‘improve focus and help answer suggestions that directors sometimes pay insufficient heed to the capital maintenance rules and their wider duties with respect to dividends’. The ultimate impact will depend on precisely how confirmation statements are implemented. It will be interesting to see whether market practice develops such that companies want more comfort from auditors in relation to the payment of dividends when it comes to giving the confirmation statements. However, they are likely to attract focus from directors because directors will (quite reasonably) assume the statements will raise awareness generally that dividends follow judgements that they have made and for which they may be held accountable.     

Whilst it is not yet clear whether the confirmations will also relate to statutory duties outside the Companies Act 2006, when providing the confirmations companies that sponsor defined benefit pension schemes should be mindful of ensuring the position of any such schemes has been appropriately considered and addressed in light of the civil and criminal liabilities introduced by the Pension Schemes Act 2021.

The Government’s decision not to proceed with the proposal for a directors’ statement confirming the directors’ reasonable expectation that payment of a dividend will not threaten the solvency of the company over the next two years is significant. It is worth noting however that there is an existing common-law requirement that solvency and future prospects of a company should be at the forefront of directors’ minds when paying dividends. This common law duty to act prudently, along with the proposed Resilience Statement requirement, mean that there remains a requirement to consider actively the impact on a company of paying a dividend. It is also worth noting that the proposal has not been entirely dropped, but instead the Government has suggested that further exploration of the issue is required. 

The impact on companies of the additional requirement to disclose distributable reserves should not be substantial in terms of administrative effort and complexity, with these figures likely already being available to directors. Whether provision of an estimate of the group’s dividend-paying capacity becomes market standard or expected will determine how significant this is for companies in financial distress – if such an estimate is usually provided by a company or its peers, the failure to provide an estimate in a given year may come to be interpreted as (or may in fact be) a warning sign of underlying issues.

However, they are likely to attract focus from directors because directors will (quite reasonably) assume the statements will raise awareness generally that dividends follow judgements that they have made and for which they may be held accountable.


restructuring and insolvency