The Comprehensive Guide to

Passive Income Investing

SIGN UP FOR PAUL’S NEWSLETTER

Learn the secrets of how Paul Tracy generates over $XXX,XXX per month in passive income!

How to Become Financially Independent Through Passive Income Investing

What is an Illegal Dividend?

An illegal dividend is a dividend declared in violation of a company's charter or state laws.

How Does an Illegal Dividend Work?

For example, let's say Company XYZ has $20,000,000 of retained earnings. It recently raised $20,000,000 of new capital from a bank loan.

The company decides to declare a $0.05 per share dividend. It pays the dividend out of the $20,000,000 it got from the bank loan. Because many states prohibit companies from paying dividends out of their capital accounts, Company XYZ is paying an illegal dividend. It should've paid the dividend out of retained earnings.

Why Does an Illegal Dividend Matter?

Illegal dividends invite shareholder suits and action from lenders, and in many cases the company making the illegal dividend must rescind the dividend (i.e., get it back). Both parties become concerned very quickly that the company's managers are using cash in nonapproved ways. For lenders, this could mean the companies are jeopardizing their ability to make loan payments or using funds for purposes other than what was agreed to in the loan agreement.

Ask an Expert about Illegal Dividend

All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Illegal Dividend.

Be the first to ask a question

If you have a question about Illegal Dividend, then please ask Paul.

Ask a question
Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.