Paying dividends - a director's duties

If you've taken any interest in financial markets over the last year (and if you either borrow money or have some to invest, it would be a good idea - especially now - to take an interest), you'll know that a number of finance companies in New Zealand have found themselves in difficulties.

You're also likely to have heard various commentators allocating blame. Some commentators have known what they're talking about, but others we might describe, charitably, as having less than a full understanding.

I thought it might help to explain some of the basic duties of directors in these situations (remembering that I'm a company director, not a lawyer, so I'm drawing any inference as an informed layman, rather than a legal expert), so you'll be in a better position to judge the facts:

1. Dividends

In general terms, dividends are income that shareholders receive as a return on their investment, usually paid from the company's tax-paid profit. Section 52 of the Companies Act says that the Board of directors may authorise the payment of a dividend if it is 'satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test' - together with a few other conditions.

So what's the 'solvency test'? For this we look at Section 6: '... A company satisfies the solvency test if -
(a) The company is able to pay its debts as they become due in the normal course of business [my italics]; and
(b) The value of the company's assets is greater than the value of its liabilities.'

My guess would be that finance company deposits which fall due on a particular date would be classed as 'in the normal course of business'. In determining the value of the company's assets, 'the directors must have regard to the most recent financial statements of the company ... and all other circumstances that the directors know or ought to know ...' [again, my italics].

Even allowing for the tidal wave of changes in financial market conditions, and the precipitous decline in reinvestment rates (the amount of deposits that are renewed when they fall due, rather than being repaid to the investor), which has led to the liquidity difficulties of some finance companies, these provisions in the Act should prompt some searching questions of a few people who are known to have been paid large dividends in the not too distant past.

2. Reckless trading

There's another Section (135) in the Act, entitled 'Reckless trading' which may also turn out to be relevant. Under this, a director 'must not agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss ...' to the people the company owes money to.

The Act provides various defences for people charged under these Sections, so you can expect any legal actions to be lengthy, strongly contested, affairs and, naturally, to be far more complicated than this simple explanation.

But I hope that, after reading this, you will be better able to form your own view of the actions and responsibilities of various parties likely to feature in the news in coming months.