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Dividends in bankruptcy

Companies sometimes declare dividends but do not actually pay them out, instead leaving the funds in the business for additional working capital. Recent changes to the Bankruptcy and Insolvency Act can spell bad news for such unpaid dividends in the event of an insolvency.

Previously, such amounts owing by a company were generally-speaking regarded as a debt like any other. Once the dividend was declared due and owing, it became simply another amount owing by the company, entitled to be paid the same as any other debt of the company. New section 140.1 of the Bankruptcy and Insolvency Act changes that. Now, all such "equity claims" are postponed until all other claims have been paid in full (in other words, postponed to never). An equity claim includes a dividend or a share retraction or redemption.

"But my company is not bankrupt, so none of this applies to me". No one plans to have their company go bankrupt, and yet thousands of companies end up in bankruptcy every year. If a creditor with a non-paying customer sees an advantage in bankrupting their customer, that might be reason enough to push the customer into bankruptcy.

How to avoid this potential problem? Where the intention is to declare dividends but leave the funds in the company, the documents should carefully and fully reflect two separate transactions. First, a dividend declared and paid, and then - happening a moment later - a loan advanced by the shareholder back to the company.

How "carefully and fully" should the documentation be? In one case that made its way to the BC Court of Appeal, the company had been so careful as to actually make a deposit by cheque into the bank account of the shareholder; the next transaction on the shareholder account was the advance of the same funds back to the company by a second cheque. As well, the proper director's resolutions, financial statement entries, etc. were also made. More commonly in such transactions, exchanges of promissory notes, or offsetting cheques, are deemed to be sufficient.

We are presuming here that the company is otherwise in a position to make a dividend. No company should pay dividends while insolvent, or if doing so would make the company insolvent.

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