Learn the rules about cash dividends and how to pay them to your stockholders.
A dividend (called a distribution in some states) is a payment or other transfer made to stockholders, based on their proportional equity ownership in the company. Dividends can be made in the form of additional stock, debt, property, or other assets, but are most commonly paid in cash. While there are many legitimate reasons for declaring a cash dividend, the most common is to give stockholders (referred to as shareholders in some states) a return on their investment in the company. The required procedures for issuing a cash dividend are based on the corporate laws governing your state of incorporation. Some of this discussion will use Florida law for illustration purposes. However, for each of the steps set forth below, either you or your legal counsel should review the applicable corporations law in your state to ensure compliance.
Review Corporate Documents for any Restrictions
Responsibility for the declaration of a cash dividend typically lies with the board of directors, unless the directors have delegated such matters to a board committee or subcommittee. Initially, the board should determine whether any corporate governance documents or contracts contain any restrictions on declaring the dividend. You or your counsel should review the company's articles of incorporation (called a certificate of incorporation in some states), stockholders' agreements (if any), and loan documents (if any), together with any outstanding options, warrants, promissory notes, or other relevant contracts, for any provisions that would restrict or otherwise prohibit a cash distribution. For example, in instances where your company has different classes of stock (for example, common stock and preferred stock), one or more of these documents could provide that the superior class of stock has preferential rights with respect to any cash distributions. In other words, the articles of incorporation or a stockholders' agreement could provide that common stockholders can't receive any dividends until the preferred stockholders have received a 100% return on their capital investment.
Verify That the Dividend Meets Solvency Requirements
The next step is to determine whether or not disbursing the dividend would meet the solvency requirements of your state (if any). For example, a Florida corporation isn't permitted to pay dividends to its stockholders if the effect of doing so would either:
- prevent the corporation from paying its debts when due, in the ordinary course of its business (called an equity insolvency test), or
- cause the corporation's assets, plus (unless the corporation's articles of incorporation states otherwise) the amount needed to satisfy any preferential stockholder rights upon the company's dissolution, to be less than the company's aggregate liabilities (called a balance sheet surplus test). (Fla. Stat. Ann. § 607.06401(3).)
Your state's corporations statute might also specify permitted calculation methods for determining compliance with the solvency test. For example, a Florida company's board of directors can rely on either:
- financial statements prepared using reasonable accounting practices and principles, or
- a fair valuation or other reasonable method, based on a current valuation of assets. (Fla. Stat. Ann. § 607.06401(4).)
Take Necessary Corporate Governance Actions
Once you've determined that the dividend would satisfy any solvency or other requirements under state law, then it must be approved from a corporate governance perspective. Assuming that the directors haven't delegated responsibility for the declaration of dividends to either a board committee or subcommittee, the board can typically approve the distribution, subject to the applicable corporate laws of your state.
The board's approval of the dividend can be accomplished in various ways. The directors can do so at one of their regularly scheduled meetings, or they can call a special meeting to specifically address the matter. In either case, the meeting would have to satisfy the notice and recordkeeping requirements of your state. Alternatively, the simplest way for the board to approve the dividend could be by written consent, which must be signed unanimously in many states. In the interest of satisfying their fiduciary duties, the directors should make sure that the written consent includes detailed information regarding the methodology and reasoning underlying the approval of the dividend.
Determine Proper Sources for the Dividend
Next, the board of directors should determine the permitted sources for the dividend under state law. For example, in Florida dividends can generally be satisfied from a company's balance sheet surplus, based on a calculation set forth in the Florida Business Corporation Act. (Fla. Stat. Ann. § 607.06401(3).) Note that if your company falls within certain regulated industries (for example, natural resource exploitation), your state's laws might also have additional provisions regarding the sources from which dividends can be paid.
Notify the Stockholders
When declaring a cash dividend, the board of directors generally must:
- calculate the cash amount to be paid to the shareholders, both individually and in the aggregate
- fix a record date for determining the stockholders who will be entitled to receive the dividend (based on the laws of your state)
- determine the payment date, and
- send a notice to the stockholders.
Note that your state's corporate statute might contain requirements that the dividend be paid within a certain number of days from the board's authorization, the notice to stockholders, or the calculation of the solvency requirements. Furthermore, the notice of the dividend should include instructions for the stockholders to provide their preferred payment method (whether it be by check, wire transfer, or otherwise) and all relevant transfer details.
