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Your Legal Corner - Client Alert Blog

New CA Rules Governing Corporate Dividends & Distributions

Written By: Melissa C. Marsh, Esq., California Attorney, November 2011 Add to Favorites
Effective January 1, 2012, A.B. 571 amends and greatly simplifies Chapter 5 of the California Corporations Code governing corporate distributions (dividends and share repurchases). In effect, A.B. 571 permits a solvent corporation to make a distribution to its shareholders so long as the value of the corporation's assets will exceed its liabilities after the distribution.

Prior to the adoption of AB 571, Chapter 5 of the California Corporations Code required corporations to satisfy a solvency test and either a retained earnings test, or a two-pronged balance sheet and liquidity test before making a distribution to its shareholders. AB 571 in effect makes the regulations governing distributions by California Corporations more similar to the regulations governing distributions by California limited liability companies (17254 of the Beverly-Killea Limited Liability Company Act) and partnerships (15905.08 of the Uniform Limited Partnership Act of 2008).

While the solvency test and retained earnings test remain unchanged, as of January 1, 2012 a corporation will be permitted to make a distribution so long as the corporation's Board of Directors make a good faith determination within 120 days of the distribution date that the corporation's financial statements were prepared under reasonable accounting practices and principles and show that:

  1. prior to a distribution, the corporation has retained earnings that equal or exceed the amount of the distribution, AND
  2. immediately after the distribution, the value of the corporation's total assets (excluding items like goodwill) will equal or exceed the sum of (a) its total liabilities (excluding items such as deferred taxes and income) plus (b) the value of any shares with preferential rights, if any, upon dissolution.
The test is based Board of Director's good faith determination that the above conditions are satisfied, but the standard is objective. Under Corporations Code Sections 309 and 316(a), a director can be held personal liable for willfully or negligently authorizing an illegal distribution (one that would render the corporation insolvent). With the new addition of the "good faith standard," to hold a director personally liable, the plaintiff would have to prove the Board of Directors' failed to conduct the above mentioned balance sheet tests prior to authorizing a distribution.

AB 571 also:

  • Sets a four year statute of limitations that begins to run on the date of the distribution, for a creditor or shareholder to bring a claim seeking recovery of illegal distributions; and
  • Eliminates the requirement that a corporation provide written notice of shareholder distributions that are not made in reliance on the retained earnings test.

Posted In: Corporate Client Bulletin 

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Disclaimer: The information presented on this web site was prepared by Melissa C. Marsh for general informational purposes only and does not constitute legal advice. The information provided in my articles and alerts should not be relied upon, or used as a substitute for professional legal advice from an attorney you retain to advise or represent you. Your use of this Internet site does not create an attorney- client relationship. Transmission of this article is not intended to create, and receipt of it does not constitute, an attorney-client relationship. All uses of the contents of this site, other than personal uses, are prohibited. You may print or email a copy of any information posted on this web site for your own personal, non-commercial, use, but you may not publish any of the articles or posts on this web site without the Express Written Permission of Melissa C. Marsh.

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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.