Directors who authorise a dividend the company could not lawfully pay can be made to repay it personally, usually by a liquidator bringing a misfeasance claim. Shareholders who knew, or had reasonable grounds to believe, the payment was unlawful must also repay under section 847 of the Companies Act 2006, and the members cannot approve the problem away.

When is a dividend unlawful?

Section 830 allows a company to make a distribution only out of profits available for the purpose: accumulated realised profits not previously distributed or capitalised, less accumulated realised losses not previously written off in a proper capital reduction. “Distribution” in section 829 covers every distribution of assets to members, in cash or otherwise, so a transfer of an asset at an undervalue to a shareholder can also be caught.

Whether there are enough profits is judged by reference to the “relevant accounts” (section 836). Normally these are the last annual accounts circulated to members, which must have been properly prepared and, if the company is audited, reported on by the auditor, with an auditor’s statement if the report was qualified (section 837). If those accounts do not support the payment, interim accounts can be used, and they must enable a reasonable judgment to be made of profits, losses, assets, liabilities, provisions and reserves (section 838(1)). If the procedural requirements are not met, section 836(4) treats the distribution as unlawful even if the profits were there.

ICAEW and ICAS guidance in TECH 02/17BL says reliable management accounts will often meet the interim accounts test for a private company, but adjustments may be needed, for example for tax. A detailed checklist for paying dividends properly is in our guide to paying dividends legally.

Does it help that the company was solvent and had cash?

No. The Insolvency Service’s technical guidance for official receivers states that solvency at the time of the distribution is irrelevant to whether it was unlawful, citing Bairstow v Queen’s Moat Houses plc, and that ignorance of the law is no defence, citing It’s a Wrap (UK) Ltd v Gula. The test is reserves, not bank balance. A company with £80,000 in the bank and a deficit on its profit and loss reserve cannot pay a dividend.

How are directors made personally liable?

The liability arises from general law rather than a single section of the Companies Act. Directors are treated as trustees of company property under their control, and a director who misapplies it must make good the loss, as the official receivers’ guidance explains at paragraph 32.40. At paragraph 32.64 it says that where directors authorise or fail to stop an unlawful dividend, this is misfeasance for which a civil recovery may be made.

In a winding up, section 212 of the Insolvency Act 1986 gives a summary procedure: on the application of the official receiver, the liquidator, a creditor or a contributory, the court can examine the conduct of an officer who has misapplied company money or been guilty of misfeasance or breach of duty, and order repayment. ICAEW’s guidance on paying dividends puts it plainly: directors can be personally liable for the amount paid if they pay dividends unlawfully.

The government’s director information hub lists the consequences if a company later becomes insolvent as being required to repay dividends received, personal liability for losses suffered by the company, and director disqualification proceedings. Liability is typically pursued against every director who authorised the payment, not only those who received it.

When do shareholders have to repay?

Section 847 makes a member liable to repay a distribution, or the unlawful part, if at the time they knew or had reasonable grounds for believing it was made in contravention of the rules. ICAEW notes that what counts is knowing the facts that made it unlawful, even without appreciating that those facts made it unlawful, and that a shareholder who is also a director is fixed with what they know as a director.

HMRC’s Company Taxation Manual at CTM15205 says that in private companies controlled by director shareholders, it expects section 847 to apply in the majority of cases. A genuinely innocent recipient, such as an outside investor, is not liable under section 847. That does not let the directors off: their liability for authorising the payment remains.

Can the shareholders ratify an unlawful dividend?

No. CTM15205 records that shareholders cannot agree to waive the requirements of the Companies Act, citing Precision Dippings Ltd v Precision Dippings Marketing Ltd. This is different from the ordinary position on many breaches of duty, covered in ratifying directors’ breaches. The practical fix while the company is solvent is repayment by the recipients, or a properly supported fresh dividend once profits exist, with the error documented.

What defences do directors have?

  • The dividend was lawful when paid. Lawfulness is tested when the dividend becomes a binding liability: on declaration for a final dividend, and on payment for an interim dividend (ICAEW). ICAEW’s helpsheet notes that where profits later deteriorate after an interim dividend that the directors had properly substantiated, liability to repay would not normally arise. Evidence is everything here: the relevant accounts, interim figures and minutes.
  • Relief under section 1157. The court may relieve an officer, wholly or partly, if they acted honestly and reasonably and ought fairly to be excused. Section 1157(2) allows an application before any claim is made.
  • Errors in earlier accounts. TECH 02/17BL says it is the error, not its later correction, that may make a past distribution unlawful, and that the legal effect raises complex issues. Directors who relied in good faith on accounts later restated should take advice rather than assume either outcome.
  • Time limits. Section 21 of the Limitation Act 1980 sets a six year period for most claims for breach of trust, but no period for claims involving fraud by the trustee or to recover trust property the trustee received or converted to their own use. Directors who received the dividend themselves should not assume a claim is time barred.

The company cannot validly indemnify a director against liability to the company for breach of duty; see indemnifying directors. Sums ordered against a director also cannot be set off against money the company owes them, according to paragraph 32.41 of the official receivers’ guidance.

What happens for tax?

CTM15205 explains that where the recipient knew or had reasonable grounds to believe the dividend was unlawful, they hold it as constructive trustee and it is void for income tax purposes, so it is not dividend income. For a close company, HMRC regards the company as having made a loan to the participator, triggering the section 455 charge under the Corporation Tax Act 2010, with relief under section 458 when the money is repaid, by cash or through the loan account. The director information hub also says insufficiently covered dividends will usually be treated as a director’s loan that must be repaid. See director’s loan accounts. For an innocent recipient, the payment remains a distribution.

How might a claim look?

Illustration only. A company’s last circulated accounts show £20,000 of distributable reserves. During the next year, without preparing interim accounts, the two director shareholders pay themselves interim dividends of £50,000 because the bank balance is healthy. Trading losses mean the year ends with negative reserves, and the company enters liquidation the following year.

  • £30,000 was paid without any profits to support it, and arguably more if losses had already eroded the £20,000 by the payment dates.
  • The liquidator can claim that sum from the directors as recipients under section 847 and as directors for misfeasance under section 212.
  • Any repayment ordered cannot be set off against the directors’ own unpaid loans to the company.

What mistakes cause unlawful dividends?

  • Paying by reference to cash rather than realised reserves.
  • Relying on old annual accounts when losses have arisen since.
  • Treating revaluation gains as distributable, when unrealised profits are not.
  • Paying monthly “dividends” with no board minutes or supporting figures.
  • Assuming a parent can pay out because the group is profitable, when the test applies company by company (ICAEW).

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.