For the distribution of a dividend at a private limited company, two tests must be performed, with positive results in both cases: the balance sheet test and an additional liquidity test.
The balance sheet or net assets test means that the distribution of a dividend must not bring the company’s net assets below zero. If a company has non-distributable equity by law or by virtue of the articles of association, no distribution may be made if the net assets have fallen or would fall as a result of the distribution to below the amount of this non-distributable equity. This test is performed on the basis of the most recently approved annual accounts or a recent statement of assets or liabilities. If a statutory auditor has been appointed, it must assess this statement and add the findings to its annual audit report.
The general meeting’s decision to pay a dividend[1] will only take effect if the management body determines by means of the liquidity test that the company, as far as may reasonably be expected, will continue to be able to pay its debts as they fall due over a period of at least 12 months from the date of the dividend payment.[2]
The management body must justify its decision on the liquidity test in a report; if a statutory auditor has been appointed, it will also explain the historical and future accounting and financial data in its report. It is advisable for the management body not to wait to carry out the liquidity test until the general meeting has decided to go ahead with a dividend distribution, but to carry it out before the general meeting takes place and before proposing a dividend distribution to the general meeting.
If dividend distributions are made without the above tests being met, the dividends paid out to the shareholders can be reclaimed by the private limited company. Moreover, the directors risk being held liable to third parties for any damage suffered by the latter as a result of the unjustified distribution, as well as to the company, as it is the directors who make the proposal for distribution to the general meeting.[3] They are therefore responsible for complying with the associated restrictions.
In a public limited company, the general meeting is authorised to allocate the profit and decide on dividend distributions, unless the articles of association provide otherwise.[4]
In a public limited company, a balance sheet or net asset test must be performed before a dividend can be distributed. No distribution may be made if the test finds that the net assets, as shown in the last approved annual accounts, would fall or have fallen below the paid-up or called-up capital plus the reserves which are non-distributable by law or according to the articles of association.
An interim dividend may only be paid out by the board of directors from the profit of the current financial year or the previous financial year (before the annual accounts for that year have been approved) minus the loss carried forward or plus the profit carried forward, without any withdrawal from the existing reserves and taking into account the reserves that must be maintained by law or according to the articles of association.
The auditor’s assessment report will be added to its annual audit report. The decision to pay out an interim dividend may be taken no more than two months after the closing of the statement of assets and liabilities. If the amount of the interim dividend is greater than the dividend determined by the general meeting, the excess will be regarded as an advance on the next dividend.
If invalid dividend distributions have been made, the shareholders will have to pay them back if the company can demonstrate that the shareholders were aware that the distributions were invalid or could not have been unaware of this in the circumstances. [5]
However, it turns out that it is not enough to meet the distribution test or tests. The Court of Cassation ruled that a proposal by a director to distribute dividends could constitute a manifestly serious error that contributed to bankruptcy, even though the net assets test was performed correctly and the results were positive.
Case study: the consequences of an incorrect dividend distribution
In this case, the dividend distribution was made with profits realised from the sale of the company’s only fixed asset in order to partially settle a current account debt of the shareholder and director; the loss-making business was then continued without the necessary buffer. Although its finding was based on the previous rulings, the Court of Cassation ruled in this case that, despite the net asset test having been satisfied a manifestly serious error had been committed, as the distribution resulted in the company’s bankruptcy.[6]
As a director, it is therefore advisable to consider the accounting and legal impact on the company when you propose a dividend distribution. As well as applying the distribution test or tests, directors must always ask themselves whether the distribution is reasonable and prudent in the company’s circumstances at that time. The Court of Cassation also emphasises the importance of documentation and justification of management decisions, so that directors can demonstrate that their decision was carefully considered and taken in the interest of the company.
If you have any further questions about a dividend distribution after reading this article or if you wish to distribute a dividend within your company and would like help with this, do not hesitate to contact your trusted advisor!
[1] Article 5:141 of the Companies and Associations Code (‘WVV’)
[2] Article 5:143 of WVV
[3] Article 5:144 of WVV
[4] Article 7:123 of WVV
[5] Article 7:214 of WVV
[6] Cass. 23 May 2024, C.23.0088,
