Solvency Test
Under the new Companies Act 2016 (“CA 2016”) which had been implemented by stages on 31 January 2017, solvency test was introduced to protect and safeguard the rights of parties that doing business with companies. Directors would have the responsibility to ensure the company meets the solvency requirements when company distributes dividends, reduced share capital, giving financial assistance, redeems preference shares and buy back shares.
Directors shall inquire into company’s state of affairs and financial positions, taking into account all the liabilities of the company (including contingent liabilities) when forming the opinion on whether the company meets the solvency requirements.
Section 132 of the CA 2016: Distribution only if Company is solvent
This section defines the solvency test in 2 parts: –
- Balance Sheet Solvency: The Company’s assets must exceed its liabilities.
- Cash Flow Solvency: The Company must be able to pay its debts as and when they fall due within 12 months following distribution. (“Solvent”)
Distribution of Dividend to Shareholder
Section 131 of the CA 2016 provides that Dividend can only be distributed out of available profits of the company.
Consequences of Non-Compliance: The company, every officer and any other person or individual who contravenes this requirement commits an offence, upon conviction, be liable to imprisonment not exceeding 5 years or to a fine not exceeding RM3 million or to both.
If after a distribution is authorized and before it is made, the Directors cease to be satisfied on reasonable ground that the company will be Solvent immediately after distribution is made, the Directors shall take all necessary steps to prevent the distribution from being made.
Consequences of Non-Compliance: Every director or officer of the company who wilfully pays or permits to be paid or authorizes the payment of any improper or unlawful distribution of the dividend would be liable to imprisonment not exceeding 5 years or a fine not exceeding RM3 million or to both.
Key Considerations for Directors
Directors have a fiduciary duty to act in the best interest of the company. In the context of dividend declarations, this includes:
Acting in Good Faith: The decision to declare dividends must be made honestly and for a proper purpose.
Exercising Care, Skill, and Diligence: Directors must take reasonable steps to ensure that the company meets the solvency test. This typically involves a review of the company’s financial statements, cash flow forecasts, and other relevant information.
Consequences of Non-Compliance: A director who makes a dividend distribution without being satisfied that the company will pass the solvency test may be held personally liable to the company for the amount of the distribution that cannot be recovered from the shareholders. They may also be subject to criminal penalties, including fines and imprisonment.
Connecting for Expert Guidance
Navigating the complexities of the CA 2016, especially with critical matters like dividend declarations, is a significant responsibility. The solvency test and the legal duties of directors require careful consideration to avoid potential liabilities and penalties.
To ensure your company remains fully compliant, it is highly recommended to seek professional advice. Experts in corporate secretarial services can provide invaluable assistance with:
Pre-Declaration Analysis: to meets the solvency test.Documentation and Resolutions: Drafting and preparing all the required board and shareholder resolutions and the official solvency statement.
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