A dividend declared by a corporation that is in violation of its charter and/or of state laws. Should such a dividend be declared, the company's board of directors can be sued by its shareholders and creditors; the company may also face prosecution. Taobiz explains Illegal Dividend Many states prohibit dividend payments from the capital surplus account. Dividends are generally paid out of net income or retained earnings. Illegal dividends may significantly weaken the financial position of the company and expose its creditors to a greater degree of risk.