1. The 3 Sources of Dividend Restriction

A) Statutory / Corporate Law Restriction:
You cannot pay if no distributable profits, legal reserve not covered, net assets < capital, or interim accounts don't show liquidity.

B) Contractual Restriction:
Loan agreement covenant, bond indenture, shareholder agreement. e.g. No dividend if DSCR <1.2x, or Event of Default continuing.

C) Regulatory / Prudential Restriction - For Banks:
You cannot pay if you breach Combined Buffer Requirement - CBR. This triggers Maximum Distributable Amount - MDA under Art 141 CRD IV / Art 48 Spanish Law 10/2014 and ECB SREP letter.

This is automatic. ECB has no discretion to waive it. Once bank dips into CBR, distributions of CET1, AT1 coupons, variable pay are capped by MDA formula.

ECB Working Papers confirm: When banks reach MDA limits, their discretion in payouts is overridden by regulatory rules. MDA comes into effect when banks utilise combined buffers - it is not a breach stricto sensu but restriction.

2. How Enforcement Works - 4 Tracks

Track 1: Corporate Law - Enforcement by Company / Liquidator vs Directors

This is the most litigated.

Legal principle from English law - adopted in Spain, India, Commonwealth:

Directors are treated as trustees of company funds. If they authorize unlawful dividend, they are liable for breach of trust to repay.

Leading case law:

a) Bairstow v Queens Moat Houses plc - England
Directors authorized dividends based on accounts that overstated profits due to accounting errors. No fraud. Court held directors must repay unlawful dividend personally. Intent irrelevant. Must take reasonable care to verify sufficient distributable profits.[2000]

b) Burnden Holdings (UK) Ltd v Fielding EWHC 1566 (Ch) + Supreme Court on limitation
Supreme Court clarified:

• Liability is fault-based but low threshold - if directors knew the facts that constituted unlawful dividend, they are liable even if they did not know it was unlawful as a matter of law.[2019]
• They are entitled to rely on auditors, but must make reasonable inquiries.
• Claim for unlawful dividend is NOT subject to 6-year limitation under Limitation Act - it is breach of trust, no limitation while company in liquidation.
  Enforcement: Liquidator sues directors.

c) SSF Realisations Ltd v Loch Fyne Oysters Ltd EWHC 3521 (Ch)
High Court clarified extent: Liability limited to amount of excess over distributable profits, not entire dividend, if part was lawful. Both directors and shareholders liable.[2020]

d) Re Exchange Banking Co (1882) - Flitcroft's case
Oldest authority: Directors liable for paying dividends out of capital. Dividend must be from profits only. Paying out of capital = misapplication.

e) Spanish LSC enforcement - Art 273, 275:
Action de responsabilidad social. Shareholders 5% can bring derivative action if company does not. Administrator who distributes against LSC must return with legal interest.
Practical case: Spanish Mercantile Courts void capital reductions where auditor statement invalid - Lexology case - reduction and dividend following it unlawful, directors liable up to €21m.

Track 2: Contractual Restriction - Enforcement by Lender / Bondholder

Mechanism:

• Negative covenant breach = Event of Default.
• Lender can accelerate loan, block dividend account, enforce DSRA.
• Bond trustee can sue for injunction.

Case law: US - Credit Agreement Dividend Baskets

• In re Tronox Inc. (Bankr S.D.N.Y. 2009) - leveraged buyout dividends paid while insolvent were avoidable as fraudulent conveyance under §548. Dividend paid when company had unreasonably small capital.

Enforcement is via clawback - if company paid dividend in breach of covenant and later goes insolvent, liquidator can claim transaction at undervalue / preference.

Spanish banks example: In syndicated loans, dividend stopper clause: If borrower pays dividend in breach, Agent can freeze further drawdowns and demand prepayment.

Track 3: Regulatory Restriction - Enforcement by ECB / Banco de España

This is strongest for banks.

Step 1: Automatic MDA restriction
Art 48 Ley 10/2014: If institution fails to comply with combined buffer, it will be prohibited from discretionary payments until it calculates MDA and communicates to Banco de España.

Step 2: Supervisory enforcement

• ECB SREP decision can impose P2R add-on and explicitly prohibit dividends - Art 104 CRD.
• If bank pays despite MDA=0, ECB can:
  • Impose administrative penalty up to 10% annual turnover
  • Remove board members - fit and proper
  • Declare breach of capital requirements and trigger early intervention

COVID case - ECB Recommendation ECB/2020/35, extended to ECB/2020/62
ECB asked all banks to refrain from dividends until 30 Sept 2021, limit <15% of cumulative 2019-20 profit. Banks that paid in breach faced higher Pillar 2 guidance and public naming. Banco de España Economic Bulletin 1/2021 studied impact - banks that ignored had credit flow penalized.

System-wide restriction evidence: ECB Working Paper Nov 2023 - In adverse stress test, 53 banks needed to restrict dividends for at least 1 year due to MDA trigger.

Enforcement is ex-ante: JST must approve dividend before AGM for significant banks. No approval = cannot pay.

Track 4: Enforcement Against Shareholders Who Received Unlawful Dividend

Shareholder who knew or had reasonable grounds to know dividend was unlawful must return it - Art 275 LSC in Spain, Sec 830 Companies Act 2006 UK, Sec 123 Companies Act 2013 India.

Test: Knowledge of facts, not knowledge of law. If accounts showed no profits, shareholder deemed to know.

Case: Walker Morris - Dangers of unlawful dividend - courts show marked reluctance to relieve directors even if honest. Shareholder recipient also liable to repay if bad faith.

3. Defences and Safe Harbors

1. Reliance on Auditors: Directors can rely on audited accounts and professional advice if they had no reason to doubt - Burnden principle.
2. Business Judgment: Not available for unlawful dividend - strict liability once facts known.
3. Shareholder ratification: Cannot ratify unlawful dividend - void ab initio.
4. Limitation: No limitation for breach of trust claim in liquidation - Burnden.
5. Rectification: If company later makes profits, can retroactively legalize? No - English and Spanish law - dividend legality judged at time of payment.

4. Practical Enforcement Checklist - If You Suspect Breach

For Creditor:

1. Review covenant definition of Restricted Payment
2. Check compliance certificate - was distributable profit certified?
3. Issue Reservation of Rights + block
4. If insolvent, file avoidance action as transaction at undervalue

For Regulator:

1. Calculate CET1 vs MDA trigger daily
2. If breach, demand capital conservation plan within 5 days
3. Impose distribution ban

For Liquidator / New Board:

1. Reconstruct distributable profits per Circular 4/2017 / PGC
2. Compare to dividends paid
3. Sue directors for excess + interest under Art 236 LSC / Sec 212 Companies Act 2006