Online Reporter
Godknows Hofisi
Business Law
Many investors invest in companies to get a financial return in the form of a dividend on the shares they hold.
In this article, I look at the law on the determination of dividends, focusing on the solvency and liquidity tests.
Applicable laws
The main applicable laws are:
Companies and Other Business Entities Act (Chapter 24:31), “the COBE Act”.
Articles of Association (“Articles”) of the company, which may vary from company to company.
Key considerations on dividend
There are several considerations necessary in determining dividend distribution, the main of which are the following:
Whether or not the company is making profits.
Any dividend policy by the company.
Legal requirements per the COBE Act and the company’s Articles, particularly on solvency and liquidity tests.
Distribution of dividends must be authorised
The normal approval process for dividends requires a reading of the COBE Act together with a company’s Articles. Ordinarily, the directors recommend the dividend and the shareholders approve in a general meeting.
A general meeting is either an annual general meeting (AGM) or an extraordinary general meeting (EGM).
Section 138 of the COBE Act applies. According to section 138(1) a company must not make any proposed distribution unless:-
a) the distribution is pursuant to an existing legal obligation of the company, or a court order; or the board of the company, by resolution, has authorised the distribution, and
b) it reasonably appears that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution; and
c) The board of the company, by resolution, has acknowledged that it has applied the solvency and liquidity test, as set out in section 102 (Solvency and liquidity test), and reasonably concluded that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution.
According to section 138(2) and (3), when the board has adopted the resolution in section 138(1), the relevant distribution must be fully carried out.
If the distribution is not completed within 120 days after the board has made the acknowledgement required in section 138(1) (c) (“solvency and liquidity test”) or after a fresh acknowledgement being made, as the case may be:
The board must reapply the solvency and liquidity test with respect to the remaining distribution.
Despite any law, order or agreement to the contrary, the company must not proceed with or continue with any such distribution unless the board adopts a further resolution on the solvency and liquidity test.
According to section 138(5), if after applying the solvency and liquidity test, it appears to the company that the section prohibits its immediate compliance with a court order contemplated in section 138(1) (a)(i):
the company may apply to a court for an order varying the original order; and the court may make an order that is just and equitable, having regard to the financial circumstances of the company, and ensures that the person to whom the company is required to make a payment in terms of the original order is paid at the earliest possible date compatible with the company satisfying its other financial obligations as they fall due and payable.
Solvency and liquidity test
Section 102 of the COBE Act applies. According to section 102, a company satisfies the solvency and liquidity test at a particular time if, considering all reasonably foreseeable financial circumstances of the company at that time:-
a) the assets of the company as fairly valued, equal or exceed the liabilities of the company as fairly valued, and
b) It appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of:-
(i) twelve (12) months after the date on which the test is applied; or
(ii) in the case of a distribution contemplated in paragraph (a) of the definition of ‘distribution’ in section 2 (Interpretation), twelve (12) months following that distribution.
According to section 102(2), for the purposes contemplated in section 102(1):-
Any financial information to be considered concerning the company must be based on financial records that satisfy the requirements of section 182 (keeping of financial records) and financial statements that satisfy the requirements of section 184 (General provisions as to contents and form of financial statements).
The board of directors or any other person applying the solvency and liquidity test to a company must consider a fair valuation of the company’s assets and liabilities, including any reasonably foreseeable contingent assets and liabilities, irrespective of whether or not arising as a result of the proposed distribution, or otherwise and may consider any other valuation of the company’s assets and liabilities that is reasonable in the circumstances.
Conclusion
The key considerations in dividends include profitability, solvency and liquidity. The COBE Act and Articles are key to refer to.
Disclaimer
This simplified article is for general information purposes only and does not constitute the writer’s professional advice.
Godknows (GK) Hofisi, LLB(UNISA), B.Acc(UZ), Hons B.Compt (UNISA), CA(Z), ACCA (Business Valuations), MBA(EBS, Heriot-Watt, UK) is the Managing Partner of Hofisi & Partners Commercial Attorneys, chartered accountant, insolvency practitioner, commercial arbitrator, registered tax accountant and advises on deals and transactions. He has extensive experience from industry and commerce and is a former World Bank staffer in the Resource Management Unit. He was recently appointed to sit on the Council of Estate Administrators in Zimbabwe. He writes in his personal capacity. He can be contacted on +263 772 246 900 or ghofisi@ hofisilaw.com or gohofisi@ gmail.com. Visit www//:hofisilaw.com for more articles.
