Corporate and Business Law (Global) · Capital maintenance and dividend law

Unlawful Dividends and Recovery: Member and Director Liability

Updated 11 October 2026 · Fact-checked

An unlawful dividend is a distribution paid when the company has insufficient distributable profits. A member who knew, or had reasonable grounds to know, of the breach must repay it. Directors who authorised it are usually liable to restore the money to the company. Innocent members generally keep what they received.

Understand Unlawful Dividends and Recovery

A company may pay dividends only out of distributable profits. These are accumulated realised profits less accumulated realised losses. This rule protects creditors. Share capital and other non-distributable reserves act as a cushion for them, so they must not be paid out to members.

A dividend paid when profits are insufficient is unlawful. The usual question is who must put the money back. The answer depends on who knew what.

First, the members. A member who received the dividend must repay it if, at the time of payment, they knew or had reasonable grounds to believe it was paid in breach of the rules. This is a test of knowledge. A member who honestly had no reason to suspect a problem is not required to repay under this rule. Do not treat all shareholders alike. Check each person's knowledge.

Second, the directors. Directors who authorise or approve an unlawful dividend are in breach of their duties to the company. They can be required to repay the company the amount unlawfully paid. A director cannot usually escape by saying they did not know that the accounts were wrong. Directors are expected to check that profits support the payment. Where they relied on properly prepared accounts, the position can differ, so read the facts carefully.

The case often linked to this area is Precision Dippings v Precision Dippings Marketing. It concerned a distribution made in breach of the rules, and the point is that a recipient who knows of the breach holds the money as a liability to the company. Remember it for the principle that knowing recipients must repay, and do not rely on its detailed facts in answers.

The company is the party that recovers. Creditors do not sue shareholders directly for the dividend. The money goes back to the company, and a liquidator may also pursue it if the company fails.

Key formulas to remember

Distributable profits: Accumulated realised profits − accumulated realised losses; Dividends may be paid only out of this amount. Unrealised profits and share capital are not available.
Member liability rule: Member must repay if they knew, or had reasonable grounds to believe, the distribution was unlawful; Test knowledge at the date of payment. Innocent members are generally not liable.
Director liability rule: Directors who authorise an unlawful dividend can be required to restore it to the company; Liability is for breach of duty to the company. The company or its liquidator enforces it.
Amount of unlawful dividend: Dividend paid − distributable profits available; Use this to find the excess if the dividend is only partly unlawful.

How to solve Unlawful Dividends and Recovery questions

Use this order for any scenario question on unlawful dividends.

1Find the distributable profits: accumulated realised profits less accumulated realised losses. Ignore share capital and unrealised gains.
2Compare the dividend paid with that figure. If it is higher, the dividend (or the excess) is unlawful.
3Identify each person who received it and what they knew when it was paid.
4Apply the member rule. Knew or had reasonable grounds to know means repay. Honestly unaware means no liability.
5Apply the director rule. Directors who authorised it are liable to restore it to the company.
6Say who recovers: the company, or a liquidator if it is being wound up.
7State a clear conclusion for each person named in the question.

Quickest way: Three-check shortcut for objective questions

When to use it: Use in Section A or B objective questions where you must pick the correct statement about liability.

Check the profit figure: is the dividend above distributable profits? If not, nothing is unlawful.
Check the member's knowledge. No knowledge, no duty to repay.
Check the director's role. Authorised it means liable to the company.
Reject any option saying creditors sue shareholders directly or that all members must repay regardless of knowledge.

Common mistakes in Unlawful Dividends and Recovery

Saying every shareholder must repay an unlawful dividend.
Students focus on the breach and forget that the member rule depends on knowledge.
Fix: Always ask what the member knew or had reasonable grounds to know at payment.
Counting share capital or unrealised profits as distributable.
Students think any positive reserve can be paid out.
Fix: Only accumulated realised profits less realised losses are distributable.
Saying creditors can recover the dividend from members directly.
Students link the rule to creditor protection and assume creditors enforce it.
Fix: Recovery is by the company, or its liquidator. The money is returned to the company.
Ignoring the directors.
The question focuses on the shareholders who received money.
Fix: Always discuss directors who authorised the payment and their liability to restore it.
Treating the whole dividend as unlawful when only part exceeds profits.
Students do not calculate the excess.
Fix: Compare the dividend with distributable profits and identify the excess.

Worked examples

Example 1

Zeta Ltd has accumulated realised profits of ₹8,00,000 and accumulated realised losses of ₹3,00,000. Its directors declare and pay a dividend of ₹7,00,000. Is the dividend lawful, and by how much is it unlawful?

Show the solution

Distributable profits = ₹8,00,000 − ₹3,00,000 = ₹5,00,000.
The dividend paid is ₹7,00,000, which is more than ₹5,00,000.
The excess = ₹7,00,000 − ₹5,00,000 = ₹2,00,000.
The dividend is therefore not fully lawful. The unlawful element is ₹2,00,000.

Answer: The dividend is unlawful to the extent of ₹2,00,000, because distributable profits are only ₹5,00,000.

Example 2

Omar owns shares in Delta Ltd. The company pays an unlawful dividend. Omar is a director and helped prepare accounts he knew showed a loss. Priya, a shareholder, saw only a notice of dividend and believed the company was profitable. Advise who is liable to repay.

Show the solution

The dividend is unlawful, so consider liability for each person.
Omar received the dividend and knew of the loss, so he knew or had reasonable grounds to know of the breach. He must repay as a member.
Omar also authorised the dividend as a director, so he is liable to restore it to the company for breach of duty.
Priya had no knowledge and no reasonable grounds to suspect a breach. She is not required to repay under the member rule.
Recovery is by Delta Ltd, or its liquidator if it is wound up.

Answer: Omar is liable both as a knowing member and as a director. Priya, who was innocent, is generally not liable to repay.

Exam tips

In objective questions, the word knew or reasonable grounds decides whether a member repays. Look for it.
Calculate distributable profits first. Many scenarios give figures that require a quick subtraction.
For a written task, give a separate conclusion for the members, the directors and who recovers the money.
Use Precision Dippings only for the principle that a knowing recipient must repay. Do not invent facts about the case.
Watch for options saying creditors sue shareholders directly. These are usually wrong.

Practice questions from Capital maintenance and dividend law

Unlawful Dividends and Recovery: frequently asked questions

Can a company recover an unlawful dividend from shareholders?

Yes, from a member who knew or had reasonable grounds to believe the dividend was unlawful when paid. An innocent member is generally not required to repay. The company, or its liquidator, brings the claim.

Are directors liable for an unlawful dividend?

Directors who authorise an unlawful dividend can be required to restore the amount to the company. This arises from their duty to the company. Check the facts, including what accounts they relied on.

What are distributable profits?

They are accumulated realised profits less accumulated realised losses. Share capital and unrealised profits are not included.

What is the point of Re Precision Dippings in exams?

Use it for the principle that a recipient who knows of the breach must account to the company for the unlawful distribution. Keep the answer focused on the rule rather than detailed facts.