A dividend is an optional payment that a company makes to its shareholders when it has excess profits that it chooses not to reinvest in the company. The company’s board of directors determines whether or not to pay dividends to its shareholders based on the company’s financial position. Company shareholders will often own different classes of shares. Within each class, a company must distribute dividends proportionately. However, there may be situations where the directors do not wish to pay dividends based on the percentage of the company that each shareholder holds. This article will explore how your company can pay out unequal dividends to shareholders.
How Are Dividends Declared?
In some shareholder agreements, one shareholder might not have the right to a dividend or should get a reduced dividend for different reasons. This situation can cause problems because dividends on shares must be distributed equally to every shareholder within that category. However, your company has the option to pay different dividends to its shareholders each fiscal year.
Typically, the company’s board of directors is responsible for declaring and paying dividends, following the company’s dividend policy. Moreover, the directors also make decisions regarding the dividend policy. To determine any specific rules about distributing dividends, you should check your company’s shareholders agreement and constitution.
Under the law, a company can pay a dividend only if it meets certain circumstances. A company must not pay a dividend unless:
- the company’s assets are more significant than its liabilities when it declares the dividend, and the difference is enough to pay the dividend;
- the payment of the dividend is fair and reasonable to the shareholders as a whole; and
- the payment of the dividend does not affect the company’s ability to pay its debts (for example, paying a dividend should not cause the company to become insolvent).
A dividend policy is a document governing how a board of directors can distribute dividends, considering the various share classes in the company.
Classes of Shares
Most incorporated companies have shareholders who own ordinary shares. However, a company can choose to establish different classes of shares. For example, a company might create and issue preference shares to investors when considering investment opportunities. Preference shares are a class of shares that give priority over ordinary shares. In other words, preference shares receive preferential treatment, and a company must pay anyone with preference shares before holders of ordinary shares.
If your company has a constitution, it should specify the:
- types of shares that the company can issue; and
- rights attached to each class of shares.
In order to pay your shareholders unequal dividends, your shareholders will need to hold different classes of shares. The directors will then declare:
- a certain dividend on one class of share; and
- a different dividend (or no dividend at all) on the other class or classes.
If the dividend distribution is the only thing, you want to be different between the classes of shares. In that case, you must follow the process to convert a shareholder’s shares to a different class with the appropriate rights as set out in your company’s constitution. Whilst considering this process, be aware of the risks of oppression if you convert the shares solely to reduce the dividends of shareholders who would otherwise be entitled to more.
If you want to declare a different dividend for a shareholder who currently holds 500 ordinary shares in your company, you can convert those 500 ordinary shares into 500 ‘Class A’ shares. However, your constitution must grant the ‘Class A’ shares the appropriate rights. If your company’s constitution already includes a class with the relevant rights and the ability to convert one class of shares to another, you can convert the shareholder’s shares into that class. If an appropriate class of shares does not exist, you may need to amend your constitution.
Continue reading this article below the formHow to Amend your Constitution
Under the Corporations Act, a company may amend its constitution by special resolution of its members (i.e. 75% approval by a meeting of members). However, the company’s constitution and/or shareholders agreement may impose further requirements to approve any constitutional amendments. Accordingly, it is critical to consider what approvals are necessary when amending your constitution to convert a shareholder’s shares into another class.
How to Convert to a New Class of Share
To convert the shares of your shareholders into a new class, you need to take a number of steps. The specific requirements will depend on your company’s shareholders agreement and constitution, as these documents will outline any particular approvals or steps you must undertake.
Generally, converting shares into a new class will require:
- a shareholder or board resolution to approve the conversion;
- cancelling any existing share certificates and preparing a new share certificates;
- updating the company’s register of members; and
- completing and lodging the relevant ASIC Form within 14 days.
Once the shareholders hold a different class of shares, the directors can declare a different dividend as appropriate for each class of share.
Issues with Paying Uneven Dividends
When distributing unequal dividends, it is important to consider the risk of shareholder disputes and any tax implications.
1. Possible Shareholder Disputes
Proper documentation is crucial when issuing unequal dividend payments. These distributions must align with your company’s constitution and/or be backed by specific shareholder resolutions. Failing to adhere to these requirements may expose your company to potential legal or otherwise disputes from dissatisfied shareholders or invite closer examination from regulatory bodies.
2. Tax Implications
The tax treatment can vary based on several factors, including the type of shares, the shareholders’ residency status, and the specific tax regulations in the relevant jurisdiction. As a result, different dividend payments may be subject to distinct tax rates or rules, potentially impacting the company’s and its shareholders’ overall financial outcome.
If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.
Key Takeaways
If your company wants to pay its shareholders some of its profits, you can declare a dividend on a certain class (or classes) of shares and pay it per share. If you wish to pay different dividends to different shareholders, you will need to convert the relevant shares held by the shareholder into a new class. You should check your company’s shareholders agreement and constitution regarding your company’s particular requirements in respect of:
- paying dividends;
- the types of share classes your company’s shareholders can hold; and
- the process for converting shares into a new class.
You should distribute dividends equally and transparently. Avoid using them to discriminate against shareholders or deviate from your constitution, shareholders agreement, or dividend policy. Moreover, you must adhere to legal guidelines, ensuring that the company’s assets exceed its liabilities and that dividend payments are fair and reasonable to shareholders.
If you need help determining your company’s requirements to pay out unequal dividends, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Your company’s constitution is a legal document that sets out the rules and regulations for its internal management. The constitution typically includes provisions regarding the company’s objectives, powers, share capital, governance structure, decision-making processes, and other operational procedures. It also provides a framework for resolving disputes and ensuring that the company operates transparently and accountable.
A share class is a designation that identifies a specific type of share in a company. Different share classes can have different rights and privileges attached to them, such as voting rights, dividend payments, or liquidation preferences.
The different share classes may also have different names or codes to distinguish them from each other, such as Class A, Class B, or Class C shares. The characteristics of each share class are usually set out in the company’s constitution.
Your company’s dividend policy dictates how to divide dividends. In addition, the dividend policy will set out how your company can pay dividends to its shareholders. The payment will typically be in accordance with the particular share classes in your company.
To pay unequal dividends to shareholders, you will need to ensure that those shareholders hold different classes of shares. If they currently hold the same classes of shares, you can convert the classes held by the shareholders into a different class.
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