Impact of COVID-19 on dividends: Modifying dividends after the decision to pay is made

In brief - Due to COVID-19, the environment in which companies have decided to pay dividends may be vastly different from the environment in which dividends are due to be paid to shareholders. As a result, many companies will want to cancel, defer or change dividend payments. However, if a company modifies a dividend when it is not entitled to do so, shareholders may have a cause of action against the company. 

Following up from our article, Impact of COVID-19 on dividends: What are the legal requirements for payment of dividends?, this article explores the ways in which dividends can be modified and the legal issues associated with doing so.

Given the volatile effects of COVID-19 on the economy, many companies have already modified dividends to mitigate the effects of the pandemic on their business activities. For example, the Super Retail Group Ltd has cancelled its previous dividend announcement to maintain liquidity and shareholder value. In addition, drops in travel demand have seen Qantas Group defer dividend payments that were scheduled for March 2020 until September 2020. 

Cancelling or deferring dividend payments 

Whether a company is able to cancel or defer dividend payments depends on when it incurs the debt to pay the dividend to each shareholder. If the company incurs a debt to pay the dividend, any decision to cancel or defer the date of a dividend payment without shareholder approval after the debt has been incurred may cause the shareholders to have a cause of action against the company. 

Dividends can only be paid in accordance with a company's constitution. Historically, constitutions distinguished between interim and final dividends. The directors could resolve to pay interim dividends while final dividends had to be declared, and in some cases approved by shareholders, before they became payable.

More recently, constitutions have removed the distinction between interim and final dividends and authorise the directors to determine that a dividend is payable, and fix the amount and time for payment and method of payment. This is reflected in a replaceable rule in section 254V of the Corporations Act 2001. Other constitutions give the directors the choice of declaring or determining to pay a dividend.

The choice between declaring or determining to pay a dividend determines when the company incurs the debt to pay the dividend.

According to section 254V(1) of the Corporations Act, a company does not incur a debt merely by fixing the amount or time for payment of a dividend. The debt arises only when the time fixed for payment arrives, and the decision to pay the dividend may be revoked at any time before that time. But if the constitution authorises the declaration of dividends, the company incurs the debt when the dividend is declared. This may even be the case where the constitution does not expressly authorise the declaration of dividends.

In Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598, the constitution authorised the directors to determine to pay a dividend and to fix the amount, time for payment and method of payment. Although the constitution did not expressly authorise the directors to declare a dividend, the directors still took that action. The High Court decided that the constitution authorised the directors to choose to determine to pay or declare the dividend. This was because there were several articles in the constitution where the word "determine" was used simply to mean "decide" and "declare" was used interchangeably with "determine".

A company is only able to cancel or defer the date of a dividend payment without shareholder approval if there is no debt at the time it decides to take this action. 

To ensure no debt is incurred at the time the decision to pay the dividend is made:

• the constitution must authorise the directors to determine to pay a dividend, instead of declaring a dividend, or give the directors a choice to undertake either action, and

• the directors must determine to pay the dividend 

If the constitution does not permit the directors to determine to pay a dividend, it should be amended by special resolution before the decision to pay the dividend is made.

The decision to determine to pay a dividend will give the company maximum flexibility if its financial position deteriorates after the decision is made and before the time fixed for payment. For this reason, where directors have a choice between determining to pay a dividend or declaring a dividend, directors should choose to determine to pay the dividend instead of declaring the dividend. 

Modifying a dividend reinvestment plan (DRP)

Some companies have introduced DRPs where shareholders can receive new shares instead of cash dividends. 

In light of COVID-19, some companies may be looking to reprice shares to be issued under DRPs, or suspend or cancel DRPs. Many DRP rules will allow companies to undertake these actions. However, it is important to review the rules to work out what can be done. 

If a DRP is suspended or cancelled and the directors have declared the dividend, the company may be required to pay the dividend in cash. 

ASX listed companies should consult with ASX before modifying a DRP. If the DRP rules are varied to reprice shares, or the DRP is suspended or cancelled, the listed company must give ASX a copy of the variation (if the rules are varied) or a copy of the rules (if the DRP is suspended or cancelled). Likewise, if a DRP is reinstated after a suspension, a copy of the rules must be given to ASX.