Introduction
Dividends are the portion of profits distributed to shareholders as a return on their investment. However, companies are not always in a position to declare dividends. Legal, financial, and operational constraints may restrict dividend declarations. This article discusses various conditions under which a company cannot declare dividends.
1. Inadequate Profits or Losses
A company must have sufficient profits, either in the current year or accumulated reserves, to declare dividends. If the company incurs losses or profits are insufficient, dividend declaration may not be legally allowed.
Example: If a company reports a net loss in the financial year and has no retained earnings, it cannot pay dividends.
2. Legal Restrictions
Companies Act and other regulatory frameworks impose restrictions on dividend declarations under certain conditions:
- As per Section 123 of the Companies Act, 2013 (India), dividends can be declared only out of current year’s profits or past profits transferred to reserves.
- Dividend cannot be declared out of capital.
3. Negative Net Worth
When a company’s liabilities exceed its assets, it has negative net worth. Such firms are financially unhealthy and are prohibited from paying dividends even if they have profits in a given year.
Example: A company with negative shareholders’ equity due to past losses must retain profits to improve financial health rather than pay dividends.
4. Inadequate Cash Position
Even if a company is profitable on paper, it may not have enough cash flow to pay dividends. Liquidity constraints can restrict the company from declaring dividends.
Example: A company with profits locked in receivables or inventory may be cash-poor and unable to distribute dividends.
5. Contractual Restrictions
Loan agreements and bond covenants often impose restrictions on dividend payments to ensure that the company maintains a certain financial ratio or uses profits to repay debt.
Example: A bank loan may include a clause that prohibits dividend payments until the loan is repaid or debt-equity ratio is maintained.
6. Default in Payment of Statutory Dues
If a company defaults on statutory payments such as taxes, employee benefits, or interest to debenture holders, it may be legally restricted from declaring dividends.
7. Board or Shareholders’ Decision
The Board of Directors may decide not to declare dividends despite profits if the company needs funds for expansion, debt reduction, or other strategic purposes. Similarly, shareholders can reject a dividend recommendation in a general meeting.
8. Regulatory Orders or Court Injunctions
If the company is under investigation or subject to legal proceedings, the court or regulatory authorities may prevent dividend declarations to protect stakeholders.
Conclusion
Dividend declaration is subject to several conditions and constraints beyond profitability. Companies must comply with legal provisions, maintain financial prudence, and consider their liquidity position before distributing profits. Understanding these conditions ensures responsible financial management and protects shareholder interests.