Corporate and Business Law (Global) · Share capital

Dividends and Distributions: Distributable Profits and Unlawful Payments

Updated 11 October 2026 · Fact-checked

A distribution is any payment of a company's assets to its members, usually a dividend. It is lawful only if made from distributable profits: accumulated realised profits less accumulated realised losses. An unlawful distribution can be recovered from members who knew, or had reason to know, it was unlawful.

Understand Dividends and Distributions

A company is a separate legal person. Its capital is a fund that creditors rely on. If members could take that fund out as dividends, creditors would be left with nothing. So the law limits what a company can pay to its members.

A distribution is any transfer of company assets to members, in cash or in kind. The usual example is a dividend. The key rule is that a company may make a distribution only out of distributable profits. These are its accumulated, realised profits not already distributed or capitalised, less its accumulated, realised losses not already written off. Both revenue and capital items count if they are realised.

This is a rule about the company's position as a whole, not just this year's result. Past losses must be covered first. Unrealised profits, such as a revaluation surplus on property, are not normally distributable. Share capital and the share premium account can never be paid out as dividends.

Public companies face an extra test. A public company may distribute only if, after the distribution, its net assets are not less than the total of its called-up share capital and undistributable reserves. This stops a public company from paying out so much that it eats into its capital base.

If a distribution breaks the rules, it is unlawful. Members who received it, and knew or had reasonable grounds to know it was unlawful, must repay it. Directors who authorised it may also be liable to the company. Many legal systems follow this pattern, though the exact wording varies. Answer from the general principle unless the question names a jurisdiction.

Dividends are normally recommended by the directors and approved by the members. Under typical articles, the members cannot declare more than the directors recommend. Once a dividend is declared, it becomes a debt owed to the members.

Key formulas to remember

Distributable profits: Accumulated realised profits − accumulated realised losses; Both measured to date, not just for the current year. Amounts already distributed or capitalised are excluded.
Public company extra test: Net assets after distribution ≥ called-up share capital + undistributable reserves; Applies in addition to the distributable profits test. A private company does not need to meet it.
Never distributable: Share capital and share premium cannot be paid out as dividends; Only a formal capital reduction or buyback procedure can return capital to members.
Recovery rule: Member liable if they knew, or had reasonable grounds to believe, the distribution was unlawful; Directors who authorised it may also be liable to repay the company.

How to solve Dividends and Distributions questions

Use the same sequence for any dividend or distribution question.

1Identify whether the payment is a distribution: any transfer of company assets to members, except permitted items such as a lawful capital reduction or buyback.
2Find the company's accumulated realised profits and subtract accumulated realised losses. Ignore unrealised gains.
3Check the amount of the proposed dividend against the result. If it is higher, it is unlawful.
4If the company is public, apply the net assets test after the distribution, using called-up share capital plus undistributable reserves.
5Decide who is affected. Look at what each member knew or should have known.
6State the consequence: recovery from members with knowledge, and possible director liability.
7Give a clear conclusion in one sentence.

Quickest way: Three-check shortcut for objective questions

When to use it: Use it for Section A questions and multi-task questions where you must pick the correct statement quickly.

Check 1: are profits realised and accumulated, after deducting past losses?
Check 2: is the company public? If so, run the net assets test.
Check 3: did the member know or have reason to know? If not, no recovery from that member.
Eliminate options that say share capital or unrealised gains can be distributed.

Common mistakes in Dividends and Distributions

Looking only at this year's profit.
Students treat a dividend like an annual bonus tied to the year's result.
Fix: Always use accumulated realised profits less accumulated realised losses.
Treating a revaluation surplus as distributable.
The asset value has risen, so it feels like profit.
Fix: A surplus is unrealised until the asset is sold. Do not count it.
Applying the net assets test to private companies.
Students blend the two rules.
Fix: The extra net assets test applies only to public companies.
Saying every member must repay an unlawful dividend.
Students forget the knowledge condition.
Fix: Only members who knew or had reasonable grounds to know must repay.
Forgetting directors' liability.
Focus stays on the shareholders who received the money.
Fix: Add that directors who authorised an unlawful distribution can be liable to the company.

Worked examples

Example 1

Alpha Ltd, a private company, has accumulated realised profits of $500,000 and accumulated realised losses of $180,000. It also has an unrealised revaluation surplus of $200,000. The directors want to pay a dividend of $350,000. Is it lawful?

Show the solution

Distributable profits = 500,000 − 180,000 = $320,000.
The revaluation surplus is unrealised, so it is excluded.
Proposed dividend $350,000 exceeds $320,000 by $30,000.
Alpha Ltd is private, so no net assets test applies.

Answer: The dividend is unlawful because it exceeds distributable profits of $320,000. The most that can lawfully be paid is $320,000.

Example 2

Beta plc paid an unlawful dividend. Mia, a shareholder, received $4,000. She is not a director and knew only that the company had reported strong sales. Can the company recover the money from her?

Show the solution

Recovery from a member depends on knowledge.
The test is whether she knew, or had reasonable grounds to believe, the distribution was unlawful.
Knowing the company had strong sales does not show she knew about the lack of distributable profits.
Unless she had access to facts showing the breach, she lacks the required knowledge.

Answer: The company is unlikely to recover the $4,000 from Mia, since nothing shows she knew or had reasonable grounds to know the dividend was unlawful. The directors who authorised it may still be liable to the company.

Exam tips

Read for the words realised, accumulated and public. They decide the answer.
In objective questions, reject any option allowing payment out of share capital or share premium.
Always calculate distributable profits before judging the dividend. Write the arithmetic in your rough work.
For recovery questions, look for facts on what the member knew, and name directors as a second group who may be liable.

Practice questions from Share capital

Dividends and Distributions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Dividends and Distributions: frequently asked questions

What are distributable profits?

They are accumulated realised profits not yet distributed or capitalised, less accumulated realised losses. They are measured to date, not for one year only.

Can a company pay a dividend out of share capital?

No. Share capital and share premium are not distributable. Capital can be returned only through a lawful capital reduction or buyback.

What happens if a company pays an unlawful dividend?

Members who knew or had reasonable grounds to know it was unlawful must repay it. Directors who authorised it may also be liable to the company.

Is there a special rule for public companies?

Yes. A public company must also have net assets, after the distribution, at least equal to its called-up share capital plus undistributable reserves.