Dividends in Arrears
What Are Dividends in Arrears?
Dividends in arrears are missed dividend payments on cumulative preferred stock that have accrued and must be paid to preferred shareholders before any dividends can be distributed to common shareholders.
When a company issues **cumulative preferred stock**, it enters into a contract to pay a fixed dividend regularly (e.g., $1.00 per quarter). If the company runs into trouble and cannot pay, it doesn't default like a bond. Instead, the missed payment goes "into arrears." Think of it as a tab at a bar. You don't have to pay right now, but you can't buy anyone else a drink (pay common dividends) until you clear your entire tab. If a company misses 4 quarters of payments, the "arrearage" is $4.00 per share. This balance carries forward indefinitely until the company has the cash to pay it off.
Key Takeaways
- Only applies to cumulative preferred stock.
- They are a financial obligation but not a legal debt until declared.
- Disclosed in the notes to the financial statements.
- Must be cleared in full before common stock dividends resume.
- Indicates the company is facing cash flow difficulties.
How It Works
**1. Suspension:** The Board votes to omit the dividend to save cash. **2. Accumulation:** The unpaid amount is tracked. It does not usually earn interest. **3. Restriction:** The company is now banned from paying dividends to common stockholders or buying back shares. **4. Restoration:** When times get better, the Board declares a massive "catch-up" dividend to clear the arrears. Only then can normal operations resume.
Financial Reporting
Because undeclared dividends are not a legal liability (you can't sue the company for them until declared), dividends in arrears do **not** appear on the Balance Sheet as a liability. Instead, they are hidden in the **footnotes**. This is a trap for unwary investors who look at the balance sheet, see low debt, and buy the common stock, unaware that there is a massive "off-balance-sheet" obligation that must be paid before they see a dime.
Important Considerations
For **Common Shareholders**, arrears are bad news. It means your stock is effectively worthless for income purposes until the preferred holders are paid. For **Preferred Shareholders**, arrears are a safety net. It ensures you eventually get paid, assuming the company doesn't go bankrupt. For **Vulture Investors**, buying preferred stock with huge arrears at a deep discount can be a profitable strategy if they believe the company will turn around and pay the back-dividends.
Real-World Example
Company Z has 1 million shares of $100 par, 5% cumulative preferred stock. Annual dividend = $5M.
Common Beginner Mistakes
Avoid these errors:
- Assuming non-cumulative preferred stock gets arrears (it doesn't; missed payments are lost forever).
- Looking for arrears on the liabilities section of the balance sheet.
- Thinking arrears earn compound interest (they typically don't).
FAQs
Generally, no. They remain an obligation as long as the cumulative preferred stock exists. However, in a bankruptcy restructuring, they are often wiped out along with the equity.
You must read the prospectus or the "Description of Securities" in the company's SEC filings (Form S-1 or 10-K). Most preferred stock issued by REITs and banks is cumulative.
Sometimes. Many preferred stock contracts grant "contingent voting rights" if dividends are in arrears for a certain period (e.g., 6 quarters), allowing preferred holders to elect directors to the Board to force a payout.
Preferred shareholders with arrears have a claim *after* creditors but *before* common shareholders. In practice, there is rarely enough money left to pay them, so the arrears are often lost.
It is a high-risk, high-reward distressed debt strategy. If the company survives, you get a massive payout (the arrears + capital gain). If it fails, you get nothing.
The Bottom Line
Dividends in arrears represent a "IOU" from the company to its preferred shareholders. They act as a powerful protective mechanism for preferred equity but a formidable blockade for common equity. Checking the footnotes for these accumulated obligations is a mandatory step in analyzing any distressed company.
More in Dividends
At a Glance
Key Takeaways
- Only applies to cumulative preferred stock.
- They are a financial obligation but not a legal debt until declared.
- Disclosed in the notes to the financial statements.
- Must be cleared in full before common stock dividends resume.