Giving a company the ability to pay different rates of dividend to different shareholders can be a useful tool.
One way to achieve this is to give the founders different classes of share, one founder having “A shares” and the other “B shares”. Provided this is done correctly it provides flexibility that can be very valuable for certain situations; but there are two required elements to set up these structures, and several have crossed our desks recently that failed on one or both fronts.
The intention of creating distinct share classes is that the founders’ other share rights do not have to be compromised in order to give the desired economic result. The founders could, for example, hold one A share and one B respectively so that the founders’ rights to vote or receive capital on an exit will be 50/50. Profits, however, can be paid out in any proportions that the company wishes – for example to maximise the post-tax position for the founder group as a whole, where the founders are related.
Payment of an unlawful dividend is a potentially serious issue – any director involved in paying it may be in breach of their duties and (along with the recipients) find themselves having to repay the company out of their own pocket. Taking it as read that the company is able to pay the amount of the dividend, so this isn’t an unlawful distribution on that basis, there are two key issues around paying it unevenly to shares of different classes.
First, there must actually be different classes of share. That means that the shares have rights which are not wholly the same – issuing new shares with identical rights and calling them something different doesn’t create a new class. Ideally this would be done by amending the company’s articles, but failing that the rights of the new class can be set out in a shareholders’ resolution or, if the company’s articles allow it, a board resolution. Note, however, that the SH01 form that is filed at Companies House following an allotment of shares is not an operative document – only a report. Rights reported in that form must first appear elsewhere, the report will not function to create a new share class.
Second, the company must have the ability to pay different dividends on different classes of share – that is not automatic. The rule established in Birch v Cropper (1889) 14 App Cas 525 still holds in 2017; a dividend must be paid out to each share (regardless of class) pro rata, unless the company’s articles of association provide for something different. That can be something specific in the dividend rights attached to each class, or it can be a discretion. The Model Articles, which many companies use by default, by implication give a wide discretion to directors; whether that would be sufficient has not been tested in a court, so far as we know – and in any event, it never hurts to be more explicit.
Taking both points together, in adopting these schemes companies should give serious consideration to amending their articles. This will allow the company to implement specific and distinct share rights to ensure that there are different classes, and a clear discretion to pay different dividends to each of them, so as to make sure that declaring dividends in this way is lawful.