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New California Law Eases Restrictions on Dividends

David Barton
November 2011

Effective January 1, 2012, California will adopt an important change to its law on corporate dividends and share repurchases. Under an existing California statute, the change is applicable to California corporations as well as corporations organized in other jurisdictions with substantial ties to California based on activity or ownership.

The new dividend and distribution statute replaces the current antiquated balance-sheet and liquidity test with an alternative balance-sheet test based on current asset values. At times, the antiquated test precluded healthy corporations from making distributions. The new test is consistent with more modern tests used by other states for corporate distributions as well as tests used for LLCs and limited partnerships in California and other states.

Under the new provision, a corporation’s board of directors may base its decision on reasonable methods, such as the review of financial statements based on reasonable accounting principles and practices, or a fair valuation, and the corporation may make its distribution within 120 days of board authorization. The new statute also eliminates a notice requirement and imposes a four-year statute of limitations on shareholder and creditor actions regarding a distribution.

Private equity firms and other shareholders seeking greater clarity and simplicity in the rules applicable to the upstreaming of funds will welcome this statutory change. Alternatively, shareholders, bankruptcy trustees, creditors' committees, and others seeking to recover corporate distributions for the benefit of the corporation may find themselves less able to assert technical violations of chapter 5 of the General Corporation Law as grounds for such recovery.