Assembly Bill 571, which was signed into law in California in the Fall of 2011, significantly amends California law governing distributions to shareholders by California corporations.
Pursuant to the solvency test contained in Section 501 of the California Corporations Code, a corporation may not make a distribution if the corporation is unable to meet its liabilities as they mature.
The provisions that were in place prior to AB 571 allowed a corporation to make distributions only if the corporation satisfied a general solvency test AND either a retained earnings test or a two-pronged balance sheet and liquidity test.
The newly enacted law permits a solvent corporation to make a distribution to its shareholders so long as the value of the corporation’s assets would exceed its liabilities after the distribution is made.
AB 571 maintains the existing retained earnings test but replaces the existing balance sheet and liquidity test with a more flexible balance sheet test.
Under the retained earning test, a corporation may make a distribution from retained earnings to the extent that its retained earnings exceed (a) the amount of the distribution; and, (b) the amount, if any, of dividends in arrears on shares with preferential dividend rights.
The balance sheet test provides that a corporation may make distributions if, immediately after the distribution, the value of the corporation’s assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution.
The amendments to Chapter 5 of the California Corporations Code as a result of the passage of AB 571 modernize the guidelines and eliminate unnecessary regulatory prohibitions, making it more efficient for corporations to determine the viability of distributions.
AB 571 – Dividends and Distributions of Corporations