Declaring a Cash Dividend: Remember the Solvency Tests!

June 10, 2019


While the board of directors of a corporation governed by the Business Corporations Act (Ontario) (the “OBCA”) has the power to declare dividends, its authority to declare and pay cash dividends is subject to compliance with two statutory solvency tests.

Solvency Tests

Cash dividends are subject to two statutory solvency tests set out in Section 38(3) of the OBCA, each of which must be met at both the time of declaration of a dividend as well as at the time of its payment. Section 38(3) of the OBCA reads as follows:

“38(3) When dividend not to be declared — The directors shall not declare and the corporation shall not pay a dividend if there are reasonable grounds for believing that,

  • the corporation is or, after the payment, would be unable to pay its liabilities as they become due [the ‘cash-flow test‘]; or
  • the realizable value of the corporation’s assets would thereby be less than the aggregate of
    • its liabilities, and
    • its stated capital of all classes [the ‘net realizable assets test‘].”

The OBCA, the Canada Business Corporations Act (the “CBCA“) and the other provincial corporate statutes containing substantially the same solvency tests do not provide a bright line test as to what constitutes a liability, nor do they define “realizable value”.

The courts have provided some guidance, particularly concerning contingent liabilities, however, the decisions are dependent upon the unique fact situations of each case.

While the cash-flow test is used to assess a corporation’s ability to pay its short term liabilities, directors should also take into account any long term liabilities which could become accelerated and become payable if a default is or will be triggered, for example, as a result of non-compliance with required ratios in a corporation’s banking arrangements.

In considering contingent liabilities, the courts have held that directors must form a reasonable opinion based on the facts of each case to see what the likelihood would be of the contingency arising in the future so as to constitute it a “liability” which must be paid as part of the “liabilities as they become due” under the cash-flow test. (Clarke v. Technical Marketing Associates Ltd. (Trustee of), 1992 Carswell Ont. 1110 (Ont. Gen. Div.) (“Clarke“)) So, for example, tax liabilities arising from the disposition of property were required to be included in liabilities falling due under the cash-flow test even though the exact amount had not yet been confirmed by an assessment or reassessment, and a corporate guarantee was determined to be properly excluded from liabilities, as it was only a contingent liability, unless there was a likelihood that the guarantee will be called. (R. v. Sands Motor Hotel Ltd., 1984 Carswell Sask 217 (Sask. Q.B.))

The Quebec Court of Appeal, in the context of interpreting a similar provision in the Quebec Companies Act, adopted the Canadian Institute of Chartered Accountants Handbook approach to contingent liabilities, which looks at the probability or likelihood of a contingency occurring and whether the monetary value of the liability can be determined with sufficient precision. The court also recognized that a corporation may need to include liabilities which do not appear on its financial statements. (Gestion Michel Noël ltée c. 2323-0220 Québec inc., 1998 Carswell Que 539 (C.A. Que.)) In that case, it was held that the unexpired term of a lease should be excluded from the calculation of liabilities of a sublandlord, as there was a likelihood that the subtenant would continue to meet its payment obligations, thus rendering the sub-landlord’s obligation to pay rent under its lease only a contingent liability.

In some cases there might be reason to look to collateral evidence, beyond the financial statements, as indicative of the realizable value of assets. For example, where a subscriber had agreed to subscribe for shares in a corporation and payment of the subscription price was fully secured by a letter of credit, it was held that the corporation could include the subscription proceeds in the calculation of its realizable assets. (North American Trust Co. v. Hospitality Equity Corp., 1998 Carswell Alta 559 (Alta. C.A.))

Mr. Justice Farley, in interpreting the expression “realizable value” (contained in a since-repealed provision of the CBCA dealing with the provision of financial assistance), provided the most helpful decision on what constitutes “realizable value”:

“Quite clearly this is not an historical balance sheet exercise. Nor is it one, in my view, which contemplates that the corporation’s assets should be valued on a liquidation scenario (in the sense of putting them on the distress auction block) unless at the time of giving the financial assistance that was the reasonable expectation. There does not seem to me any reason why the traditional sense of value should not be incorporated into this interpretative exercise — that is, what price a willing and knowledgeable vendor and purchaser, neither acting under compulsion, would agree to. This is a value which is to be determined at the time of giving of the financial assistance. Implicit in this analysis is that the assets would be valued as if sold on a going concern basis if that would maximize the price; on the other hand they would be valued as if sold on a piece-meal or break-up basis if the going concern approach were shown to conceal undervalued or redundant assets. “Distress” liquidation values would only come into play if the storm clouds were on the horizon — e.g., years of losses with no hope of turnaround, or a material hit that was shattering a concern that did not have enough financial resources pushing to see it through, or major creditors in a pressing mode with no white knight in the wings.”(Clarke)


An improper declaration of a dividend in violation of the solvency tests can typically give rise to a claim of oppression by creditors or other shareholders pursuant to Section 248 of the OBCA, or be subject to a court determination under Section 101 of the Bankruptcy and Insolvency Act (Canada) (the “BIA“).

Section 101(1) of the BIA provides for a “look back”, where a corporation that is bankrupt has paid a dividend within one year preceding the initial bankruptcy event (typically, filing an assignment in bankruptcy or a notice of intention or proposal under Part III of the BIA). Under Section 101(2) of the BIA, the court can hold the directors of the corporation jointly and severally liable for the amount of the dividend, with interest, if the court finds that (i) the transaction occurred when the corporation was insolvent or the transaction rendered the corporation insolvent; and (ii) the directors had no reasonable grounds to believe that the corporation (x) was solvent at the time of the transaction; or (y) would remain solvent if the transaction were to occur.

In determining whether the directors had no such reasonable grounds, the court is required to consider whether the directors acted as prudent and diligent persons would have acted in the same circumstances, and whether the directors in good faith relied on (a) financial or other statements of the corporation represented to them by officers of the corporation or the auditor of the corporation, as the case may be, or by written reports of the auditor to fairly reflect the financial condition of the corporation; or (b) a report relating to the corporation’s affairs prepared pursuant to a contract with the corporation by a lawyer, notary, accountant, engineer, appraiser or other person whose profession gave credibility to the statements made in the report.


The decision to declare cash dividends is not simply an accounting or tax-planning exercise. The failure to consider and comply with the statutory solvency tests of the OBCA could lead to directors’ personal liability to repay the amount of the dividend.