Question

Question 1 [10 marks]

The five directors of Fly-By-Night Pty Ltd (‘FBN’) decided that at their next board meeting they would discuss paying a dividend of 15 cents per share. As FBN’s accountant, you have previously identified a potential cash flow issue due to the company’s loss of a business contract with a key customer. FBN is presently able to cover this loss in revenue because of its positive net asset position. However, you think that cash flow problems will start to arise during the next quarter. You have advised all of this in writing in a letter to FBN’s board. Two directors have called you just before commencing their board meeting (the other three directors are overseas and un-contactable). The two directors tell you: ‘We want your confirmation that there is nothing to stop two out of the five directors resolving to pay the proposed dividend. The company’s net asset position will remain positive after the dividend is paid, so we think it is fine.’

What is your advice to the two directors under Corporation Act 2001 (Cth)?

This is a Corporation Law related question from the chapter Dividends. use s 254 U, 254 T, 256B, 588 G

Answer 1

In the given scenario, the two directors seem to be adamant to their decision about dividend distribution and are less likely to change their decision. In such a situation, the Corporation Act 2001 requires to determine the feasibility and legality of the dividend decision.

Section 254T of the act requires three basic criterions to be met, if a company wishes to announce a dividend. The criterions are:

(i) The company must have a positive net asset position, which Fly-By-Night Pty Ltd meets.
(ii) The payment of dividends should be fair and feasible from the company’s shareholders’ perspective as a whole. Proposed dividend of $0.15 seems quite in-line with fairness.
(iii) The payment of dividend should not impact company’s ability to pay its creditors. This is a concern for the company as its cash positions are expected to weaken. Hence, this point needs to be taken care.

Section 254U of the act scribes the provisions about dividends payment. This sections states that directors of a company has right to determine payment of dividends, its amount, time for payment and method of payment. The method of dividend payment includes cash dividends, bonus shares, the grant of option and transfer of assets.

In the given situation, since the company is facing cash-crunch and a cash-dividend may impact its capacity to pay its creditors, Section 254T requires the company to pay the dividends, if any, in a form other than cash. Under Section 254U, the directors are allowed to announce dividends in many methods. The most suitable method here is bonus shares or grant of options. So, the directors can go for announcing a bonus share dividend or grant of option dividend.