A company pays an interim dividend to its shareholders in June. Several months later, it emerges that the company did not have sufficient distributable profits to justify the payment, or that the accounts relied upon by the directors were inaccurate. Can the company recover the dividend from its shareholders?
While the question may appear unusual, it raises important issues concerning creditor protection, directors' duties and shareholder rights. Interim dividends occupy a unique position in company law because they are declared on the basis of financial information available at the time, rather than audited annual accounts. Their flexibility makes them commercially attractive but also raises important questions regarding their lawfulness and the circumstances in which shareholders may be required to return amounts received.
Under Maltese law, interim dividends can, in certain circumstances, be clawed back. However, repayment is not triggered simply because a company's fortunes subsequently deteriorate. Rather, recovery generally depends on whether the dividend was unlawful when it was paid and whether the recipient knew, or ought reasonably to have known, that this was the case.
Why Interim Dividends are different
Dividends represent the most common form of distributions of a company's profits to its shareholders. Under Article 192 of the Companies Act, a company may only make a distribution out of profits available for that purpose, being accumulated realised profits less accumulated realised losses determined in accordance with generally accepted accounting principles.
The model articles of association contained in the First Schedule to the Companies Act recognise a largely procedural distinction between final and interim dividends, principally in terms of the manner in which they are authorised. A final dividend is typically recommended by the directors and approved by shareholders at the annual general meeting on the basis of the company's audited financial statements for the preceding financial year. Once properly declared, a final dividend generally becomes a debt due by the company to the shareholder. This principle was recognised by the Maltese courts in Gaetano Bonnici et v. Age Concern Company Limited (23 July 2017).
Interim dividends, by contrast, are generally declared by the board during the financial year before the annual accounts have been finalised and audited. Unlike a final dividend which has been duly declared by shareholders, an interim dividend may generally be revoked by the directors at any time prior to payment.
This distinction is significant. Directors must determine whether sufficient distributable profits exist at a time when the financial year remains ongoing and the figures have not yet been tested through an audit process. Lord Alverstone C.J. observed in Lucas v. Fitzgerald [1903] 20 T.L.R. 16 that: "The declaration of interim dividend depends much more upon estimates and opinions than the declaration of a final dividend, which is made upon the information contained in a formal balance sheet." It is this reliance on current financial information, in respect of an incomplete financial year, that may later give rise to disputes concerning whether the directors were justified in concluding that sufficient distributable profits existed to support the payment of the interim dividend.
A change in fortune does not make a dividend unlawful
A common misconception is that an interim dividend can be reclaimed simply because, by the end of the financial year, the company's financial position has deteriorated and the profits available when the dividend was paid have since disappeared. This is not the case. The legality of an interim dividend is generally assessed by reference to the circumstances prevailing at the time of payment, rather than by reference to subsequent events.
A company that lawfully distributes an interim dividend in June does not render that payment unlawful simply because market conditions deteriorate in September or because it ultimately records a loss by year-end.
The real question is therefore not whether circumstances later changed but whether the dividend was lawful when it was paid.
When does a clawback become possible?
The rules governing distributions form part of the wider capital maintenance regime underpinning Maltese company law, which is designed to protect creditors and safeguard the company's capital. At the heart of this regime is Article 192 of the Companies Act, which prohibits distributions except out of profits available for the purpose. In the case of public companies, Article 193 imposes an additional safeguard by requiring that the company's net assets remain at or above the aggregate of its called-up share capital and undistributable reserves both before and after the distribution. Together, these provisions seek to ensure that value is not improperly extracted from the company to the detriment of creditors.
The rationale behind these rules is straightforward. Every dividend involves a transfer of value from the company to its shareholders. Creditors, however, rely on the company's assets as a source of repayment. The law therefore seeks to ensure that shareholders are rewarded only where the company genuinely possesses sufficient distributable profits to justify the payment.
Where the statutory conditions are not satisfied, the payment of a dividend may constitute an unlawful distribution, opening the door to recovery proceedings.
Can shareholders be forced to repay an interim dividend?
The short answer is yes. Article 204 of the Companies Act provides that where a distribution is made in contravention of the relevant statutory provisions, a shareholder is liable to repay it if that shareholder knew, or had reasonable grounds to believe, that the distribution was unlawful. This provision strikes a balance between competing interests. Ordinary shareholders should generally be entitled to rely on the company's governance structures and the directors' assessment of the company's financial position. Most shareholders are not involved in preparing management accounts or assessing distributable reserves.
At the same time, the law does not permit individuals to retain an unlawful benefit where they knew, or ought reasonably to have known, that the dividend should never have been paid.
The knowledge requirement is therefore critical. It protects innocent shareholders while ensuring that those who knowingly participate in an unlawful distribution cannot simply hide behind their status as shareholders.
This distinction becomes particularly important in closely-held companies, where shareholders and directors are often the same individuals. In such circumstances, it may be considerably easier to establish that the recipient possessed the requisite knowledge of the company's financial position and the unlawfulness of the distribution (vide SSF Realisations Ltd (in liquidation) v. Loch Fyne Oysters Ltd [2020]).
It should nevertheless be noted that Article 204 discussed above may not provide the only basis upon which an unlawful distribution may be recovered. This issue is considered further below under the section 'Recovery beyond the Companies Act'.
Directors' liability: The real risk?
Although discussions concerning clawbacks often focus on shareholders, directors frequently face the greater legal risk.
Article 136A of the Companies Act requires directors to act honestly, in good faith and in the best interests of the company, while exercising reasonable care, skill and diligence in the discharge of their functions. Accordingly, an unlawful distribution may expose directors to liability where they have failed to comply with these duties or have otherwise authorised a distribution in circumstances where the statutory requirements were not satisfied.
The courts have repeatedly emphasised that directors cannot justify an unlawful dividend merely because they believed sufficient profits existed. In the English case, Bairstow v. Queens Moat Houses plc [2001] EWCA Civ 712, directors were held liable for unlawful dividends paid on the basis of accounts that failed properly to reflect the company's true financial position. Similarly, in Re AG (Manchester) Ltd [2003] EWHC 1339 (Ch), the English court highlighted the responsibility of directors to ensure that dividends are supported by reliable financial information.
The practical lesson is clear. Before approving an interim dividend, directors must satisfy themselves that sufficient distributable profits exist, that the supporting accounts provide a true and fair view of the company's financial position and that all statutory requirements have been met.
Recovery beyond the Companies Act
The Companies Act is not the only potential basis upon which a company may seek restitution.
Indeed, Article 205 of the Companies Act provides that Article 204 applies without prejudice to any obligation imposed apart from that article on a member to repay an unlawful distribution. In the author's view, this suggests that Article 204 was not intended to constitute an exhaustive code governing the recovery of unlawful distributions and that obligations to repay may, depending on the circumstances, arise from other sources of law. Such obligations may potentially derive from the Civil Code (including the doctrine of indebiti solutio under Article 1023), restitutionary principles (to the extent recognised under Maltese law), contractual arrangements or provisions contained in the company's memorandum or articles of association.
The doctrine of indebiti solutio under Article 1023 of the Civil Code is of particular relevance in this context, permitting the recovery of payments made without legal cause.
While the interaction between corporate law and restitutionary principles can be complex, the existence of this remedy reinforces the broader concept that recipients should not retain benefits to which they were not legally entitled.
Conclusion
Can interim dividends be clawed back? Yes, but only in limited circumstances. A subsequent decline in the company's fortunes will not, of itself, require shareholders to repay an interim dividend that was lawfully declared and paid. The critical question is whether the dividend complied with the Companies Act at the time it was distributed.
Where the payment was unlawful, Article 204 of the Companies Act provides an important mechanism for recovery, only where shareholders knew or ought reasonably to have known of the unlawfulness. In the author's view, Article 204 is not necessarily the final word on the recovery of unlawful distributions. As explained above, Article 205 may preserve additional remedies which may (depending on the legal basis invoked) operate independently of the knowledge requirement contained in Article 204.
The potential consequences are not necessarily confined to shareholders. Directors who authorise unlawful distributions may also face personal liability where they fail to comply with their duties under company law.
The possibility of a clawback is therefore best understood not as a penalty for commercial misfortune, but as a safeguard against distributions that should never have been made in the first place.
The author would like to thank Dr. Nadia Cassar, Of Counsel at Ganado Advocates for her valuable contribution to this article and Ms. Martina Naudi and Ms. Nicole Mamo for their research assistance.
This article is for informational purposes only and does not contain or convey legal advice. The information contained in this article should not be used or relied upon in regard to any particular facts or circumstances without first obtaining legal advice.