Unlawful dividends director liability arises when a company pays a dividend it did not have the distributable profits to cover, and a director who authorised or received that payment can be made to repay it personally. This applies whether the company later enters liquidation or not, though a liquidator is usually the one who raises it. Understanding the rules now can save a difficult conversation with an insolvency practitioner later.
Many directors treat dividends as a flexible way to draw money from a company, especially in the early or lean years of trading. The problem is that dividends are not simply "profit you can see in the bank" — they follow strict rules under company law, and getting it wrong can leave a director personally exposed years after the payment was made.
What makes a dividend unlawful (no distributable profits)
A dividend is only lawful if the company has enough distributable profits — accumulated realised profits, less accumulated realised losses — to cover it at the time it is declared. This rule comes from section 830 of the Companies Act 2006, and it applies to every UK limited company, regardless of size.
If a company pays a dividend when its accounts do not show sufficient distributable reserves, that dividend is unlawful — sometimes called an illegal dividend — even if the directors believed the company was doing well. Common causes include:
- Relying on management figures rather than proper accounts
- Paying dividends based on turnover or cash in the bank, not retained profit
- Forgetting to account for tax liabilities, including Corporation Tax and VAT, before declaring a dividend
- Declaring dividends every month without checking reserves each time
Each dividend payment must be judged against the reserves available at the time it was declared — a healthy year cannot retrospectively justify a dividend paid when the company was, in fact, loss-making.
How this differs from salary and from a directors' loan
Salary, dividends and directors' loans are taxed and treated very differently, and confusing them is a frequent source of trouble.
Salary
Salary is a company expense, paid through PAYE, and it can be paid regardless of whether the company has made a profit. It reduces the company's taxable profit and is not subject to the distributable profits test.
Directors' loan
A directors' loan is money drawn from the company that the director owes back. It is not profit, has its own tax consequences if left outstanding, and does not need distributable profits to be advanced — but it does need to be repaid or properly accounted for.
Dividend
A dividend is a distribution of genuine, realised profit to shareholders. It is the only one of the three that is legally conditional on the company actually having the profit to distribute — which is exactly why unlawful dividends director liability becomes an issue.
How a liquidator identifies and challenges unlawful dividends
When a company enters liquidation, the appointed insolvency practitioner reviews the company's financial history, usually going back several years. Dividend payments are checked against the accounts in place at the time each one was declared.
A liquidator will typically look at:
- Whether interim or annual accounts existed to justify the dividend, and what they actually showed
- Whether the company had genuine distributable reserves, once tax and other liabilities are properly accounted for
- The pattern of dividends over time, particularly if they continued after the company was known to be struggling
- Whether the dividend was recorded correctly in the company's books, or simply drawn as cash
If the liquidator concludes a dividend was unlawful, they can pursue the director, and sometimes the recipient shareholder, to recover the money for the benefit of creditors.
Unlawful dividends director liability under the Companies Act
Under the Companies Act 2006, a shareholder who receives a dividend knowing (or having reasonable grounds to believe) that it was paid unlawfully must repay it. Directors face a wider exposure: a director who authorised an unlawful dividend can be held personally liable to repay the full amount to the company, separately from any liability as a shareholder.
This liability is not capped by the value of the director's own shareholding — it relates to the loss the unlawful payment caused the company, and by extension, its creditors. In many small companies, the director is also the sole shareholder, so both routes to liability can apply to the same person for the same payment.
A liquidator does not need to prove dishonesty to pursue repayment; showing the dividend was not properly covered by distributable profits, and that the director knew or ought reasonably to have known the company's financial position, is generally enough.
The overlap with an overdrawn directors' loan account
In practice, unlawful dividends and an overdrawn directors' loan account often appear together. If a "dividend" was declared without proper paperwork or without sufficient reserves, a liquidator may argue it was never a valid dividend at all — in which case the money drawn is instead treated as a loan from the company to the director.
That reclassification matters because an overdrawn directors' loan account — explained in HMRC's guidance on directors' loans — is one of the most common things a liquidator pursues directors for repaying, and it sits alongside, or instead of, an unlawful dividend claim, depending on how the paperwork stacks up.
Reclassification and how HMRC and the liquidator view it
HMRC and an insolvency practitioner can each take their own view of a payment that was labelled a dividend but does not meet the legal test. If HMRC decides a dividend was not validly paid, it may be reclassified as employment income or as a loan, with different tax consequences — potentially including additional Income Tax, National Insurance, or a Corporation Tax charge on an outstanding loan balance.
Separately, and regardless of HMRC's tax treatment, a liquidator can still pursue the same payment as an unlawful dividend or an overdrawn loan for the purposes of returning money to creditors. Directors sometimes assume that because HMRC has "accepted" a dividend for tax purposes, it must have been lawful — this is not the case; the two processes are independent.
Fixing it early: interim accounts and taking advice
The clearest way to avoid unlawful dividends director liability is to check distributable profits properly before every dividend is declared, using up-to-date interim accounts if the last annual accounts do not reflect the current position. This is particularly important if trading has slowed, costs have risen, or a significant tax bill is due.
Where dividends have already been paid and a director is unsure whether they were properly covered, options can include:
- Getting the company's accounts brought up to date so the true position is clear
- Reviewing whether some or all of a dividend should be reclassified, with proper professional advice
- Addressing the position with the company's accountant before annual accounts are finalised
- Speaking to a regulated insolvency practitioner or solicitor if the company is showing signs of financial distress, so the position can be reviewed before creditors or a liquidator do it first
If you're also concerned about wider exposure as a director, our article on Am I Personally Liable for Company Debts? sets out the broader picture of when a director's personal assets can be at risk.
Frequently asked questions
Can a liquidator really claw back dividends paid years ago?
Yes. There is no fixed time limit specific to unlawful dividend claims in the way there is for some other insolvency claims, so a liquidator can look back over several years of dividend history if needed.
What happens if I can't repay an unlawful dividend?
If a director cannot repay, the liquidator may still obtain a court judgment against them personally, which can affect the director's own finances and credit position, separately from the company's insolvency.
Does it matter if the dividend was small?
The legal test is the same regardless of size, though a liquidator will usually weigh up the cost of pursuing recovery against the amount involved when deciding whether to act.
Is an unlawful dividend the same as an overdrawn director's loan?
Not always, but they overlap. A dividend without proper distributable profits or documentation can be reclassified as a loan, which is why the two issues are often assessed together.
Will this affect my ability to be a director again?
Unlawful dividends alone do not automatically lead to disqualification, but conduct around them can form part of a wider review of a director's conduct under the rules set out in gov.uk's guidance on being disqualified as a company director if the company enters insolvency.
This article is general information, not legal, financial or insolvency advice. Every company's position is different, and directors should speak to a regulated specialist about their own circumstances.
If you'd like to talk it through, Harbourfirst can introduce you to a regulated insolvency specialist — start an enquiry.