How do companies manipulate bonuses and dividends?

The first point to make is that directors are paid in different ways to shareholders.

Directors can be paid in two ways: by salaries or bonuses. Shareholders are paid through dividends.

Salaries are usually a fixed amount paid each month and are typically set out in a director’s service agreement.

Bonuses can be paid at any time and are usually paid after the year-end or after payment has been received from a particularly lucrative contract.

Dividends are a distribution of profits to shareholders and so can only be paid out of the profits of a company.

It is obvious from the above that the more that is paid to directors in salaries and bonuses, the less will be the profits of the company and so less will be available to pay dividends to shareholders.

The temptation is therefore there for certain directors, particularly when they jointly own the majority of shares, to pay themselves large bonuses and thus starve the minority shareholders of dividends.

So what can the minority shareholder do in this situation?

A minority shareholder who has been unfairly prejudiced by the way a company’s affairs have been conducted can apply to the court under section 994 of the Companies Act 1986. The court has a wide range of powers to resolve the situation, from ordering a buy out of the minority shareholder to making orders to regulate the company’s conduct.

Whether the minority shareholder has a good case will differ according to each situation but the main things to look for are as follows.

The first thing to consider is whether the directors had the legal authority to award themselves bonuses.

The power to award bonuses is set out in a company’s Articles. The new Model Articles state that directors can decide their own remuneration, whereas the old Articles (Table A) state that it is the shareholders who must approve directors’ remuneration.

It is necessary to examine the Articles as companies often amend them and some companies will have Table A Articles whereas others (particularly new ones) will have the new Model Articles. Any shareholders’ agreement must also be looked at.

If the Articles state that it is the shareholders who must decide on directors’ remuneration but there has been no resolution put to shareholders, then the payment of bonuses will be unlawful and a court could set them aside. Even if the decision was lawfully made by the directors, there may be a conflict of interest that would invalidate the decision in certain cases.

The next thing to consider is whether the bonuses paid were excessive. Courts do not like interfering in how a company is run but, if it can be shown that the bonuses paid to directors were excessive when compared to what is paid to directors in other companies with similar responsibilities, then the courts could come to the conclusion that the bonuses were designed to pay directors at the expense of shareholders.

The final points to consider are whether dividends should be declared at all and, if so, how much should be paid.

Unless the company’s Articles states that profits, or some of them, should be paid as dividends, there is no legal requirement for a company to distribute profits to shareholders at all; it could instead decide to retain the money.

However, the court will look at the reason that no dividend has been declared. If the company can show that it needed to retain profits for a particular reason, such as a potential investment opportunity, to improve the cash flow position or as a general cash buffer in periods of economic difficulty, then the court is unlikely to decide that dividends should have been paid.

On the other hand, if the reason for non-payment of dividends is that the money has been used to pay excessive bonuses to directors at the expense of shareholders, then the court could decide that the minority shareholder has been unfairly prejudiced.

Get Advice on Your Position

If you are a minority shareholder who is being underpaid in this way and you consider that you may want to take action, then get in touch. We can advise you on your position and what action you can take, and help you with any negotiations or court action that might be necessary.

Gary Cousins
Business Solicitor