Paying different dividends on shares in the same class

Introduction

It is commonly thought that dividends paid by Australian companies must be paid equally across all shares within the same class. Because of this, if shareholders and directors wish to allow for payment of different dividends (per share) to different shareholders, they generally have created a separate class of shares with specified dividend rights (often preference shares), to be held by the persons meant to receive a specific stream of distributions separate to other classes of shareholders.

Creating a separate class of shares to allow for a different dividend to be paid to some shareholders is not necessary, however. Under the Corporations Act, Australian companies may, in fact, pay different dividends per share on shares within the same class (referred to here as Differential Dividends).  The most obvious avenue for paying Differential Dividends would be to distinguish between different shareholders holding the same class of shares.

Section 254W of the Corporations Act

Under s254W of the Corporations Act:

• the directors of a proprietary company may pay a dividend as they see fit, including paying a Differential Dividend, provided the terms on which the shares were issued do not expressly provide for equal dividend rights; and
• the directors of a public company may pay a Differential Dividend if different dividend rights are provided for in the constitution of, or by a special resolution passed by shareholders of, the company.

Section 254W as it applies to proprietary companies is a replaceable rule. If the replaceable rules have been replaced by a constitution (the more common position for proprietary companies), then the constitution, and any other agreement between shareholders and the company, will need to not prohibit payment of Differential Dividends for a Differential Dividend to be possible.

The directors of both proprietary and public companies also need to ensure that, prior to paying any dividend (differential or not), the requirements of s254T of the Corporations Act are met. Those requirements are:

• balance sheet test: for the company’s assets to exceed its liabilities, as calculated immediately before the dividend is declared or paid (if not declared) and for the excess to be sufficient for the payment;
• fair and reasonable test: for the payment of the dividend to be fair and reasonable to the company’s shareholders as a whole; and
• prejudice test: for the payment of a dividend to not materially prejudice the company’s ability to pay its creditors.

Clearly the fair and reasonable test will be the requirement most particularly relevant to the payment of Differential Dividends.

Fair and reasonable test

Guidance on when a dividend will fail to meet the fair and reasonable test is limited but it was introduced into the Corporations Act for the stated purpose of aligning the prerequisites for the payment of dividends with a similar test of fairness and reasonableness in relation to capital reductions under s256B of the Corporations Act.[1]

The meaning of “fair and reasonable to shareholders as a whole” has yet to be tested by the superior courts at a Federal level, or in New South Wales, in either context.

It is likely that a Differential Dividend can be paid without breaching the fair and reasonable test if:

• for a proprietary company: there is an agreement between the shareholders and the company which either provides the company with the power to pay a Differential Dividend on specific terms or in specific circumstances or in accordance with a dividend policy which it adopts from time-to-time.
• for a public company: there is a rule in the constitution of the company which allows for the payment of a Differential Dividend, which is more practical than seeking the agreement of a large number of shareholders.

The Pepper Group scheme

There is at least one good market precedent for paying Differential Dividends in the public company context (where the Corporations Act is more restrictive than for proprietary companies). In 2017, when KKR took ASX-listed Pepper Group private via members’ scheme of arrangement, the special dividend that was permitted to be paid by Pepper was only paid to those shareholders who received cash (instead of scrip) under the scheme.  This required a change to Pepper’s constitution, as it had originally required that dividends be paid equally on all shares within a class.

The general meeting to change the constitution was held adjacent to the scheme meeting, and the scheme was approved by shareholders and the Court, and implemented in accordance with its terms, with the special dividend paid only on those shares for which cash was being paid to acquire them under the scheme. Furthermore, the tax adviser’s report in the Scheme Booklet suggested no adverse tax outcome (with respect to franking credits etc) for shareholders who received the special dividend.  That this arrangement was also subject to scrutiny by both ASIC and the Court should provide a high level of comfort of its permissibility.

How to pay Differential Dividends

Where Differential Dividends are proposed after a public company is established, it is advisable to avoid relying on the ‘special resolution’ limb for public companies in s254W – passage of a special resolution under that section will not infer agreement from dissentients or abstainers. Conversely, a constitutional amendment will constitute an agreement between all shareholders and the company (per s140 of the Corporations Act), and would bind them even if the relevant constitutional provision came into force after the shareholder first became a member.  A constitutional provision allowing for Differential Dividends may also assist with satisfying the fair and reasonable test, as paying a dividend as permitted under the constitution may prima facie be considered fair and reasonable to shareholders as a whole (though this is unlikely to be determinative where there is clearly oppressive conduct).

For proprietary companies, to preserve the flexibility for Differential Dividends, the constitution should not prohibit dividends being paid unequally on the same class of shares. A separate shareholders agreement may also be put in place that lays out a dividend policy that differentiates between shareholders, if that is what is desired.

Having said that, depending on the commercial situation among shareholders, it may be considered appropriate to hard-wire into the constitution a requirement for dividends to be paid equally within a class, as this will avoid any temptation amongst directors or majority shareholders to favour certain shareholders over others (perhaps oppressively) in terms of dividend payments. Whether Differential Dividends should be permitted ought to be determined on a case-by-case basis depending on the commercial understanding between the parties.

Key Takeaways

Directors, and their advisors, may not appreciate the ability of a company to pay different dividends on shares in the same class. This may allow for different dividends to be paid to different shareholders holding the same class of shares, while maintaining a simpler capital structure.

Subject to the company satisfying the general requirements for payment of dividends under s254T of the Corporations Act, directors of proprietary and public companies can pay Differential Dividends without breaching the Corporations Act if the Differential Dividend is contemplated or permitted under the governing documents of the company.

Tax matters are beyond the scope of this article. However, companies and their directors should be aware of the dividend anti-streaming rules in the Australian tax legislation, which are designed to prevent streaming of franked dividends to those shareholders who can most benefit from the franking credits to the exclusion of other shareholders (often foreign shareholders).  While these rules may also apply in respect of dividends paid on different classes of shares, companies should nevertheless consult their Australian tax advisers if they are considering pursuing a Differential Dividend.

[1] Corporations Amendment (Corporate Reporting Reform) Bill 2010 (Cth)