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[1977] HCA 59
High Court of Australia
1977-07-01
Aickin JJ, Stephen J, Mason J, Needham J
Original judgment source is linked above.
High Court of Australia Stephen, Mason, Jacobs, Murphy and Aickin JJ. Industrial Equity Ltd v Blackburn [1977] HCA 59
I have had the opportunity of reading the reasons for judgment prepared by my brother Mason. I agree with them and with his dismissal of this appeal.
On the application of the respondents who are shareholders in the appellant Industrial Equity Ltd. ("the Company") the Supreme Court of New South Wales in its Equity Division (Needham J.) [1] made a declaration that "the special distribution" declared by the Company and paid to its shareholders on or about 14th November 1975 was not authorized by its articles of association. An appeal from this decision to the New South Wales Court of Appeal failed [2] . Undeterred by their lack of success the appellants appealed to this Court.
In the notice dated 7th October 1975 of the annual general meeting of the Company to be held on 30th October 1975 the only reference to dividends was contained in the following item of business:
In the annual report of the Company dated 3rd October 1975, a copy of which was circulated to shareholders with the notice of meetings and copies of the accounts, the respondent Brierley, who was the chairman of the Company, advised that the annual dividend was being maintained at the rate of 15 per cent per annum with interim and final payments of 7½ per cent each, the interim dividend having been paid earlier in the year. The report continued:
In addition the Board proposes a special distribution of 1 ordinary share in Minerva Centre Ltd (a subsidiary of the group) for every 4 shares held in Industrial Equity Ltd. In the case of shares held by the parent company or in parcels of less than 400 there will be a cash payment instead at the rate of 35% (17½ cents per Industrial Equity share). The purpose of this distribution is to provide an immediate bonus to shareholders and to enable them to participate directly in the future development of Minerva Centre Ltd which intends to develop as an active property investor.
At a meeting of the Board of Directors of the Company on 39th October 1975 it was resolved
that a Dividend payable partly in cash and partly by the distribution of specific assets, namely, fully paid up shares of $1 each in the capital of Minerva Centre Limited, be and is hereby declared at the rate of 3¾c and one quarter share in the capital of Minerva Centre Limited for each share in the company registered in the name of each Member at 5 p.m. on the 24th October, 1975 subject to and upon the conditions following:
That such dividend be payable on 14th November, 1975.
That any entitlement to a fraction of a cent or a fraction of a share in Minerva Centre Limited shall be disregarded.
That to settle difficulties which may arise in regard to the distribution of shares in Minerva Centre Limited, the value of such shares is fixed at 70c per share.
That cash payments upon the footing of the value so fixed be made to Members holding less than 400 shares in the Company.
That a cash payment upon the footing of the value so fixed be made on shares beneficially owned by the Citizens & Graziers Life Assurance Company Limited.
Later on the same day the annual general meeting approved "The declaration of dividends on the basis adopted by a resolution of the Board of Directors".
At that time the capital of the Company was divided into shares of 50c each. Citizens & Graziers Life Assurance Co. Ltd. ("the Assurance Company") beneficially owned more than one-half of the issued capital of the Company. It was agreed that the amount required to meet the special distribution, valuing the shares in Minerva Centre Ltd. at 70c per share, was $647,500. The amount required to meet the cash dividend of 15 per cent for the year was $261,567. Yet the profit and loss account of the Company for the year ended 30th June 1975 disclosed a net profit for the year of $207,492 only, with unappropriated profits from previous years standing at $106,058, yielding total unappropriated profits from which dividends might be declared or paid of $313,550. In the profit and loss account the interim dividend of 7½ per cent and the proposed final dividend of 7½ per cent, each being part of the annual cash dividend of 15 per cent for the year, were debited against the amount of $313,550, leaving a balance of $51,983 unappropriated profits at 30th June 1975 available to meet the special distribution. The profit and loss account made no provision in respect of the proposed special distribution and it is this circumstance which has founded the suggestion that the special distribution was an interim dividend for the year ending 30th June 1976. Clause 3 (i) of the Ninth Schedule to the Companies Act, 1961 N.S.W., as amended, requires that the accounts disclose in respect of the financial year "the amount of dividends paid during the financial year and the amount of dividends proposed to be paid", excluding amounts shown in the accounts of the previous year as amounts proposed to be paid. For reasons which I shall express later, the suggestion that the special distribution was an interim dividend must be rejected.
In fact the net profit of $207,492 for the year ended 30th June 1975 had been calculated after taking into account an operating loss of $802,508 and an extraordinary item of profit amounting to $1,010,000 arising from a revaluation of investments in subsidiary companies.
The attack upon the validity of the special distribution was made on two grounds:
(a) That it involved the payment of a dividend otherwise than out of profits, contrary to art. 129 and s. 376 (1) of the Companies Act, 1961 N.S.W., as amended; and
(b) That it was not authorized by the articles of association in that it discriminated against other shareholders by providing for payment in cash to the majority beneficial shareholder, there being no authority for the making of that payment in the circumstances.
The articles of association vest in the directors, not in the Company in general meeting, the power to declare a dividend. Article 128 provides:
It is followed by arts. 129 and 130 which are in these terms:
The directors are also given a power to pay interim dividends by art. 131 which provides:
It will be noticed that this is expressed as a power to pay and not as a power to declare interim dividends. There is a well recognized distinction between a power to declare a final dividend and a power to pay an interim dividend. One consequence of the distinction is that although the declaration of a final dividend gives rise to a debt payable by the company to the shareholder immediately or from the date stipulated for payment, a resolution for the payment of an interim dividend does not create such a debt in favour of the shareholder (Potel v. Inland Revenue Commissioners [3] ). 1. [1971] 2 All E.R. 504, at pp. 511-512; (1970) 46 T.C. 658, at p. 667.
As this power is expressed to be given to the directors "when declaring a dividend" it must be taken to refer to the directors' power to "declare a dividend" under art. 128, not to their power to "pay interim dividends" under art. 131. This interpretation of art. 134 destroys the appellants' submission that the special distribution can be justified as the payment of an interim dividend. But it should not be thought that this is the only flaw in that submission. There are others. Article 137, to which I shall shortly refer, from which the appellants sought to draw authority for fixing the value for distribution of specific assets and for determining that a cash payment should be made to Minerva Centre Ltd. upon the footing of a value so fixed, does not apply to the payment of an interim dividend. Its area of application is designated by its opening words, "For the purpose of giving effect to any resolution under the three last preceding articles " They do not include art. 131.
Indeed, the facts which I have already recited show the submission to be misconceived. The resolution passed by the directors on 30th October was expressed to be for one dividend, payable as to part in cash at the rate of 3¾ cents per share and as to the balance by the special distribution. The directors did not seek to draw any distinction between the two elements in the resolution and it is acknowledged that the cash dividend of 7½ per cent was declared for the year ended 30th June 1975 and included in the profit and loss account for the year. Nor did the general meeting draw any distinction between the two when it approved by resolution on the same day. The notice convening the annual general meeting, as I have said, gave notice only in the second item of the intention to approve the payment of dividends for that year and the proposal for the special distribution as outlined in the chairman's report for the year gives no indication that it was intended to be an interim dividend for the succeeding year. And the chairman at the annual general meeting stated that the special distribution was open for discussion under the second item in the notice convening the meeting.
For all these reasons at least the special distribution cannot be sustained as the payment of an interim dividend under art. 131.
Article 134 enables the Company to distribute specific assets in entire or partial satisfaction of a dividend, subject to an appropriate resolution by the directors. There is in my view no warrant for giving it a further significance by reading it as though it authorized the directors to resolve that some shareholders should receive the dividends in cash and others in specific assets. The language of the article contains nothing to indicate that it was directed to such a situation. And we should not assume, in the absence of some indication of intention, that the articles authorize the directors to discriminate as between shareholders in paying or satisfying a dividend. The article has to be read with art. 137. So far my comments have been directed to art. 134 according to its tenor without the added operation given to it by the later provision.
Article 134 is followed by arts. 135 and 136. The first of the two articles gives power to capitalize profits and distribute them as shares or debentures. The second empowers the Company to pay up any unissued shares to be issued to members out of a capital redemption fund arising from redemption of redeemable preference shares. These two articles, together with art. 134, constitute "the last three preceding articles" referred to in art. 137 which goes on to provide:
It is an essential condition of the power conferred by this article that there should exist a difficulty in regard to the distribution. The provisions give some indications of the kinds of difficulty which are contemplated, as, for example, where on the proposed distribution a shareholder would be entitled to a fraction of a share or a debenture and where shareholders are to receive both specific assets and cash. Here the appellants' difficulty is that there was according to the terms of the special distribution no difficulty which called for the directors to settle it by resolving that the major beneficial shareholder should receive cash. All that appears is that the directors discriminated between that shareholder and other shareholders, at least those holding 400 or more shares in the Company, without assigning any reason for so doing, let alone a reason relating to difficulties inherent in or arising in connexion with the proposed distribution.
The interpretation which I have placed on arts. 134 and 137 is fatal to the special distribution considered either as a dividend for the year ended 30th June 1975 or as an interim dividend for the succeeding year.
Although this conclusion disposes of the appeal, I now turn to the question which arose in relation to art. 129 and s. 376 (1) because it was fully argued. Section 376 (1) of the Companies Act, which is similar to art. 129, provides: "No dividend shall be payable to the shareholders of any company except out of profits or pursuant to section sixty." The reference to s. 60, which relates to payments from the share premium account, may be disregarded. The consequences of a violation of the prohibition contained in sub-s. (1) of s. 376 are set out in sub-ss. (2) and (3). They provide:
(2) Every director or manager of a company who wilfully pays or permits to be paid any dividend out of what he knows is not profits except pursuant to section sixty -
(a) shall without prejudice to any other liability be guilty of an offence against this Act; and
(b) shall also be liable to the creditors of the company for the amount of the debts due by the company to them respectively to the extent by which the dividends so paid have exceeded the profits and such amount may be recovered by the creditors or the liquidator suing on behalf of the creditors.
(3) If the whole amount is recovered from one director or from the manager he may recover contribution against any other person liable who has directed or consented to such payment.
The appellants' case in this Court is that the consolidated accounts for the year ended 30th June 1975 of the group of companies of which the Company was the holding or parent company show that there were available sufficient group profits from which the dividend could be paid. According to these accounts the net profit of the group for the year after making provision for taxation and after making allowance for the proportion of profit due to outside interests and for profits earned prior to acquisition was $1,120,938, an amount well in excess of the dividends declared on 30th October 1975. Moreover, the consolidated accounts showed the existence of unappropriated group profits at the end of the financial year at $5,599,066 after making allowance for the payment of a 15 per cent dividend.
The question then is whether in ascertaining the amount of profits available for distribution by a holding company by way of dividend it is correct to look at the profit of the holding company itself or to the group profit as disclosed by the consolidated accounts. The appellants say that profits in the subsidiaries lie within the disposition of the holding company which may, by virtue of its capacity to control a general meeting of each of its subsidiaries, ensure the distribution of profits to it by declaration and payment of dividends. Consequently, the subsidiaries' profits are effectively the profits of the holding company for the purpose of computing what it may distribute by way of dividend - that is how the argument runs. The appellants also seek to enlist support from s. 162 of the Companies Act on the footing that it requires the preparation and circulation of group accounts, thereby indicating, so it is suggested, that it is to the group profits that one should look for relevant purposes.
But in the end the argument brings us back to the provisions of art. 129 and to s. 376 (1). No doubt s. 376 (1), like art. 129, operates to deny to a company power to make the prohibited payment as it is a statutory expression of a rule, often enshrined as here in the articles, which relates to the powers of a company. The issue is then whether the reference to profits in the article, and for that matter in the sub-section, is a reference to the profits of the holding company that is proposing to declare and pay a dividend or to the profits of the group of which it is a parent. Article 129, unlike s. 376 (1), speaks of "the profits of the Company". However, the appellants do not concede that this excludes the profits of the group, claiming that for relevant purposes the profits of the group are the profits of "the Company".
Although s. 376 (1) does not explicitly identify the source of the profits to which it refers, it should also be understood as referring to the profits of the company which declares and pays the dividend. The sub-section is not a recent innovation. It has a history in Australian company law dating back to s. 48 of the Companies Act 1896 Vict., long before consolidated or group accounts became a gleam in the draftsman's eye. It has no statutory counterpart in the United Kingdom, though it is but a reflection of the principle enunciated in the English courts much earlier - see, e.g., Burnes v. Pennell [4] ; In re National Funds Assurance Co. [5] . The principle, which was certainly designed to protect creditors and, I think, shareholders, more particularly where there is more than one class of shareholder in a company, inhibits the payment by way of dividends out of a company's capital. It is founded on the proposition recognized in Trevor v. Whitworth [6] that a reduction of capital can only be effected in accordance with the statutory procedure and that there can be no return of capital except in accordance with that procedure - In re Exchange Banking Co. (Flitcroft's Case) [7] . The rule is frequently expressed, as here, in the form of a prohibition against dividends being payable except out of profits.
In this case there is no reason for me to explore all the complexities which have emerged in relation to the application of the rule - whether it refers to the amount of nominal capital which has been paid up (a view on which some of the earlier cases seem to turn) or to assets in which the paid-up capital has been invested (a view on which the later cases appear to proceed), whether the obscure distinction taken between fixed and circulating capital which lies at the heart of some of the statements (Lee v. Neuchatel Asphalte Co. [8] ; Verner v. General and Commercial Investment Trust [9] ; In re National Bank of Wales Ltd. [10] : affd. sub. nom. Dovey v. Cory [11] ; Ammonia Soda Co. Ltd. v. Chamberlain [12] ) is correctly taken, and as to what precisely is meant by the word "profits" in this context (see, for example, the discussion inPalmer's Company Law, 22nd ed. (1976), pp. 794 et seq.). It is sufficient to say that in all the cases it has been assumed the principle refers exclusively to the profits of the company declaring and paying the dividend, though, so far as I am aware, in none of the decided cases did it appear that there were profits in subsidiary companies to which the article of association might have been applied. There are, I think, a number of reasons which sustain the accuracy of this assumption.
In the first place, it is a natural consequence of the recognition of the separate personality of each company, a recognition which derives from Salomon v. Salomon & Co. Ltd. [13] , and which has been confirmed by Lee v. Lee's Air Farming Ltd. [14] . It has been said that the rigours of the doctrine enunciated by Salomon v. Salomon & Co. Ltd. have been alleviated by the modern requirements as to consolidated or group accounts introduced in the United Kingdom by the Companies Act, 1948 and in New South Wales by the Companies Act, 1961 N.S.W. - see Gower, Modern Company Law, 3rd ed. (1969), pp. 198-199. But the purpose of these requirements is to ensure that the members of, and for that matter persons dealing with, a holding company are provided with accurate information as to the profit or loss and the state of affairs of that company and its subsidiary companies within the group, information which would not be forthcoming if all the shareholders received was limited to the accounts of the holding company disclosing as assets the shares which it holds in its subsidiaries. It is for this purpose that the Companies Act treats the business group as one entity and requires that its financial results be incorporated in consolidated accounts to be circulated to shareholders and laid before a general meeting (s. 162 (4), s. 164 (1)) and requires that the accounts and other documents shall accompany the annual return which shall be lodged with the Corporate Affairs Commission (s. 158; Eighth Schedule, Pt II).
However, it can scarcely be contended that the provisions of the Act operate to deny the separate legal personality of each company in a group. Thus, in the absence of contract creating some additional right, the creditors of company A, a subsidiary company within a group, can look only to that company for payment of their debts. They cannot look to company B, the holding company, for payment (see Walker v. Wimborne [15] ).
The Companies Act does not, in the case of holding companies, substitute the requirement for group accounts for the old requirement of accounts of the holding company itself. Group accounts are an additional requirement; the holding company is still obliged to lay before its shareholders in general meeting its profit and loss account and balance sheets (s. 162 (1) and (3)), containing the information prescribed by the statute and accompanied by the prescribed documents. Indeed, s. 162 in sub-s. (1) and sub-s. (4) draws a distinction between the "profit or loss of the company" and "the profit or loss of the company and its subsidiaries", thereby indicating, to my mind, that s. 376 (1) refers to the profits of the company, not those of the group. The predecessors of s. 376 (1), expressed in like terms, were in force well before the provisions as to group accounts were introduced. There are, of course, even stronger grounds for taking a similar view of art. 129 expressed, as it is, according to a time-honoured formula which originated long before group accounts or groups of companies became part of the company scene.
Underlying the rule that dividends are payable out of profits is the notion that the profits in question have already accrued in the company and that upon the declaration of a dividend by the directors or the company in general meeting there immediately springs into existence, fully armed so to speak, a debt owing by the company to each shareholder (In re Severn and Wye and Severn Bridge Railway Co. [16] ; Bond v. Barrow Haematite Steel Co. [17] ; Potel v. Inland Revenue Commissioners [18] ). However, it is accepted that a company may declare a dividend which is to be paid or payable to shareholders at some future date. This has evidently inspired the thought that the requirement as to the existence of profits is satisfied if they exist at the time stipulated for payment. It is incorrect. Both the article and the section are to be understood as stipulating that the profits in an amount necessary to sustain the dividend are in existence in the company itself at the time of the declaration of the dividend. The prohibition is not against dividends being "paid" otherwise than out of profits, but against their being "payable" otherwise than out of profits. The prohibition is certainly directed to the declaration of a dividend - though it is possible that it is also directed to payment - because it is the declaration that creates the right in the shareholder and it is the declaration that reflects the consideration by the directors or shareholders of the accounts and profit situation of the company. The rule has been expressed in the United States in these terms: " corporations can only declare dividends from earnings, which must be present when the dividend is declared. They cannot be declared in anticipation of earnings." (In re Given's Estate [19] ). It has been stated in somewhat less inflexible terms in American Jurisprudence, vol. 19, 2d, s. 826:
The theory of a dividend is that it shall be payable only from earnings which are or will be ready for actual distribution at a definite date provided for in the resolution declaring the dividend. Generally, the earnings or profits from which dividends are properly payable must be present when the dividend is declared; it cannot ordinarily be declared in anticipation of earnings or on a mere hope or expectation of profits. It would be productive of confusion and uncertainty if companies were to declare dividends against the possibility that profits not in existence at the time of declaration would or might be earned or received by the time the dividend was paid. In this instance the dividend declared by the Company was for the year ended 30th June 1975. It was therefore a dividend payable out of the accumulated profits of the Company at the end of that year. Any additional receipts by way of dividend or otherwise by the Company from its subsidiaries after the end of the financial year stood to be considered as an element in the Company's profit situation in the succeeding year. 1. [1896] 1 Ch. 559. 2. [1902] 1 Ch. 353, at p. 362. 3. [1971] 2 All E.R. 504; (1970) 46 T.C. 658. 4. (1936) 185 A. 778, at p. 780.
What I have already said disposes of the appellants' contention that the respondents should not succeed because they failed to discharge the onus of demonstrating that profits may have been received by the Company in the form of distributions by subsidiaries before the date of declaration or the date of payment of the dividend. The dividend was in my opinion declared for the year ended 30th June 1975, that is, out of the profits of the Company as they stood at that date. It has been shown that they were inadequate. Even if profits were earned after that date they were not the source of the dividend which was declared. And in any event the evidence is sufficient to justify the inference that the dividend was declared by the directors and approved by the shareholders on 30th October 1975 exclusively by reference to the materials to which I have referred and that neither the directors nor the shareholders had the advantage of more recent or up-to-date accounts reflecting the profit situation of the Company at a later date, say 30th September 1975.
It is common ground that the special distribution, which in my opinion was ultra vires for the reasons already given, is severable from the cash dividend of 15 per cent.
I am of opinion that the whole of the special distribution made in mid-November 1975 was invalid and I would dismiss the appeal.
The special distribution needed to be made out of profits earned up to a date which was either the date of the declaration of the special distribution as a dividend or the date of the making of that distribution. I do not find it necessary to decide which of these dates is the relevant one in application of s. 376 (1) of the Companies Act or art. 129 of the company's articles of association and I would prefer not to express a concluded opinion on this question.
I am satisfied that the relevant profits earned must be profits in the company itself, that undistributed profits from subsidiaries cannot as such be taken into account. I do not wish to add anything to the reasons which Mason J. has given for this conclusion.
Next, I would make it clear that the appellants expressly disclaimed any reliance upon the accumulation of profits in subsidiary companies as evidence that the shares in those subsidiaries had additional value, so that, if a revaluation of assets had taken place, there would have been disclosed capital profits with the result that such capital profits could be taken into account even without a revaluation. It was accepted before this court that the reasoning of Buckey J. in Dimbula Valley (Ceylon) Tea Co. Ltd. v. Laurie [20] correctly stated the law.
The question then is - did the respondents who bore the onus of proof establish that there were no profits sufficient to cover the amount of the special distribution? The appellants have submitted that they did not, in that the respondents relied on the accounts of the company up to 30th June 1975 and did not establish that profits had not accumulated between that date and the dates of declaration and payment (or distribution) of the dividend. It was submitted that the dividend could be regarded as an interim dividend and might have been out of profits made or disclosed after 30th June 1975. I am satisfied that the distribution could not be regarded as an interim dividend in respect of the financial year ended 30th June 1976. I agree with the reasons expressed by Mason J. for this conclusion and do not wish to add anything in this respect. Further, I am not satisfied that it would make any difference even if it were. No dividend can be paid except out of profits and the impugned dividend and distribution was in fact paid and made. The application of this requirement is not governed either by accounting periods or the accounting system.
The question is whether there were profits at the relevant time which I shall take to be the time of the payment and the making of the distribution. (If there were not profits at that date then certainly there were not profits at the date, a little earlier, when the dividend was declared and I am therefore content to examine the position at the date of payment and distribution.)
It must be borne in mind that, although the respondents bore the onus, the whole of the information upon the subject matter lay within the knowledge of the appellant company. That being so the burden of proof could be satisfied by such evidence as could support the inference that the special distribution was not a dividend in respect of profits acquired or disclosed subsequently to 30th June 1975. The appellant company could easily have cleared up the misapprehension if the drawing of such an inference was in fact a misapprehension of the true position but it did not do so. The fact that the profits had not been earned or disclosed up to 30th June 1975 carried the respondents some distance towards establishing that they had not been earned up to the time of the special distribution in mid-November. To this must be added the circumstances of the calling and holding of the annual general meeting. The notice of meeting relevantly gave as an item of business only the approval of the payment of dividends for the year ended 30th June 1975. The annual report dated 3rd October 1975 gave no hint that the special distribution which was described therein was to be made out of profits which had been earned or disclosed since the end of the last accounting period. In these circumstances the inference that they had not been earned or disclosed since the end of that period was certainly open. The failure to make any attempt to rebut it gave it greatly added strength. The course of the hearing before Needham J. when adjournment was granted to enable a revaluation of assets to be made is practically conclusive that there had not been an earlier revaluation. I am therefore of the opinion that the respondents established their case that the special distribution was contrary to s. 376 (1) of the Companies Act and art. 129 of the appellant company's articles of association.
Having come to this conclusion it is not necessary for me to express an opinion on the question whether the company had power to make a discriminatory distribution of cash in respect of the shares beneficially owned by one company only and of shares in Minerva Centre Ltd. in respect of shares held by all other shareholders. I bear in mind that the good faith of the directors and the members in general meeting was not challenged. The question turns upon the construction of arts. 134 and 137 of the articles of association. I am not satisfied that in no circumstances could directors under such articles distribute shares to some shareholder or shareholders and cash to another or others, exercising their powers under art. 137 for that purpose. That being so, I prefer to express no concluded opinion on the question.
The appeal should be dismissed for the reasons given by Mason J.
I have had the advantage of reading the reasons for judgment prepared by my brother Mason and am in agreement with them.
Industrial Equity Ltd
Blackburn