Background

Swift Music Ltd (Swift) is a leading supplier of musical instruments. Swift wishes to pay a dividend to its shareholders, but Edward Wren, Swifts accountant, is concerned that a pending legal action may affect Swifts solvency. In preparing his advice to the board, Edward notes that Daisy Warbler, a well-known concert pianist, has recently started legal proceedings against Swift. Daisy claims that, by delivering a concert piano late to her recording studio, Swift was in breach of contract and caused her $200,000 in damages.

Edward calculates that if Daisys full claim were paid, Swifts liabilities would marginally exceed the value of its assets (Swift has recently prepared financial statements as required by statute).

Edward consults Fiona Eagle, Swifts solicitor, who advises him that the case against Swift has no more than an outside chance of succeeding.

Required

(a) Outline the test which applies to the payment of a dividend.

(b) Apply the test to Swifts situation.

(c) Comment on the boards ability to rely on Fionas advice.