In a heartening display of collective sanity, the California legislature passed, and the governor signed, a highly sensible revision of the law regulating shareholder distributions by California corporations.
By way of background, a shareholder distribution is simply a distribution of corporate funds to its shareholders in proportion to their wnership interests—i.e., a dividend. Along with compensation for services actually rendered and repayment of a loan, a shareholder distribution is one of the three avenues for a shareholder who wants to withdraw corporate assets for personal use.
Before January 1, 2012, a California corporation could not make a shareholder distribution unless (1) the corporation had enough retained earnings to cover the distribution, or (2) the corporation could satisfy a rigid, complicated and confusing balance sheet and liquidity test. The purpose of these restrictions was to limit the ability of shareholders to drain the corporation of the assets needed to pay its debts. Unfortunately, the test also made it difficult for a corporation without an earnings history to make a shareholder distribution, even if the corporation’s assets exceeded its liabilities.
The new revision injects a refreshing element of common sense into the shareholder distribution rules. A corporation is still allowed to make a shareholder distribution out of its retained earnings. However, a corporation without retained earnings may make a shareholder distribution of the value of the corporation’s assets immediately after the distribution will equal or exceed the sum of its total liabilities (and, if applicable, preferred stock preference). The statute allows the board to determine the asset to liability ratio by any method that is reasonable under the circumstances. Finally, as before, the corporation may not make a distribution that would cause it to become insolvent, even if the distribution would somehow satisfy one of the other tests.
This is a general summary of the law and should not be taken as legal advice specific to your situation. If you would like to schedule a 30-minute free consultation, please email me at jcw@eastbaybusinesslawyer.com or call 925-327-1019.
