Unlawful dividends: clawback risk for directors and shareholders

The CA 2006 distribution regime requires distributable reserves. A dividend declared without sufficient reserves is unlawful in substance regardless of the formal record. Accountants who post dividends retrospectively to balance director remuneration packages frequently create exposure that surfaces only at insolvency — by which time the funds have been spent.

1. Salary-plus-dividend structures in owner-managed companies

A typical small company pays directors a basic salary and tops up via dividends declared monthly or quarterly. Where trading deteriorates and profits do not in fact materialise, dividends declared during the year are paid out of capital, not profits. The annual accounts produced months later reveal the shortfall.

2. Dividends declared without proper interim accounts

Distributions made between annual accounting reference dates require properly prepared interim accounts where the last annual accounts do not show sufficient reserves. Many owner-managed companies pay dividends without preparing interim accounts at all, relying on management estimates that subsequently prove wrong.

Where a member receives a distribution knowing or having reasonable grounds to believe it was made in contravention of Part 23, the member is liable to repay it (or its value) to the company. For director-shareholders of owner-managed companies, this knowledge requirement is easily satisfied — they are deemed to know the company's financial position.

Where the recipient is a non-director shareholder without involvement in management, the position is more nuanced — but the burden of demonstrating lack of knowledge falls on the recipient.

Directors who authorised the unlawful dividend face liability on three independent footings (see card above).

Liability is joint and several. A director who personally received no dividend can still face liability for distributions to other shareholders that they sanctioned.

Section 1157 gives the court a discretion to relieve a director from liability wholly or in part where the director acted honestly and reasonably, and having regard to all the circumstances ought fairly to be excused. The relief is exceptional, not routine. Evidence typically required:

• ›The director relied on accountancy advice that the company had sufficient reserves.
• ›Management accounts were prepared regularly and reviewed before each dividend declaration.
• ›The dividend was declared on the basis of figures that subsequently proved wrong for reasons outside the director's reasonable contemplation.

Relief is rarely granted in pure owner-managed company scenarios where the director controlled both the accounting and the distribution.

An unlawful dividend remains a dividend for tax purposes unless and until it is repaid or recharacterised:

• ›Repayment to the company may reopen the original income tax charge on the shareholder, with interest and penalties on the recovered amount.
• ›Recharacterisation as a director loan engages s.455 CTA 2010 — a 33.75% charge on outstanding balances (rising to 35.75% from 6 April 2026), payable nine months after year-end and refundable on repayment.
• ›Where the dividend forms part of a director loan account written off on liquidation, the write-off may be treated as employment income subject to PAYE and NICs.

Tax treatment should be assessed alongside the insolvency analysis — the two regimes do not always align and double exposure is possible.

• ›Quantify the exposure: which dividends, in which periods, against which reserves.
• ›Distinguish dividends from genuine remuneration — a payment recorded as a dividend that lacked the required reserves may sometimes be recharacterised as salary, with PAYE/NICs implications but no clawback liability.
• ›Assess available defences: s.1157 relief; lack of knowledge on the part of recipient shareholders; reliance on professional advice.
• ›Negotiate early with the officeholder where exposure is clear — settlement before litigation costs accrue protects directors from the additional indemnity costs award if claims succeed.

For transactions at undervalue, see transactions at undervalue (s.238). For wrongful trading exposure, see wrongful trading. For the DLA dimension that frequently interacts with dividend analysis, see director's loan account & s455.

At IQ Insolvency, every engagement is led by a licensed insolvency practitioner from the first conversation. Simon Renshaw's chartered-accountancy background allows the dividend, tax, and insolvency dimensions to be assessed as a single problem rather than across separate advisers. If you are concerned about historic dividends, or an officeholder has raised clawback concerns, call 020 8153 1270 for a confidential same-day conversation. No call centres. No handoffs.