O.C.G.A. § 14-2-640 (2019)

Annotations

Cross references. - Criminal responsibility of corporations, § 16-2-22. Personal liability of corporate officer or employee for tax delinquency, § 48-2-52.

Law reviews. - For article discussing distributions from capital surplus to

shareholders, see 3 Ga. L. Rev. 11 (1968). For article discussing ‘‘earned’’ surplus and ‘‘capital’’ surplus concepts under Georgia Business Corporation Code, see 3 Ga. L. Rev. 11 (1968). For article discussing corporation director’s liability for im-

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proper payments to shareholders, see 3 Ga. L. Rev. 11 (1968). For article discussing liability of corporate directors, officers, and shareholders under the Georgia Business Corporation Code, and as affected by

provisions of the Georgia Civil Practice Act, see 7 Ga. St. B.J. 277 (1971). For note discussing effect of Georgia law on dividend restrictions, see 24 Ga. B. J. 254 (1961).

COMMENT Source: Model Act, § 6.40. This replaces former §§ 14-2-90, 14-2-91, 14-2-92(e), & 14-2-154(c). Former rules limiting dividends to earned surplus or current earnings, and limiting distributions in partial liquidation to capital surplus, thus preserving stated capital as a ‘‘fund’’ (unless stated capital was reduced by the shareholders) have been entirely eliminated in the Code. It has long been recognized that the traditional ‘‘par value’’ and ‘‘stated capital’’ statutes do not provide significant protection against distributions of capital to shareholders. The financial provisions of the Code sweep away all the distinctions among the various types of surplus but retain restrictions on distributions built around the traditional equity insolvency test of earlier statutes, and adds a balance sheet test designed to give protection to long-term creditors. Former law did impose an equity insolvency test on distributions that prohibited distributions of assets if the corporation was insolvent or if the distribution had the effect of making the corporation insolvent or unable to meet its obligations as they were projected to arise. See former §§ 14-2-90(a), 91(a)(1) and 92(e). Subsection (a) imposes a single, uniform test on all distributions. It eliminates the former distinctions between dividends (§ 14-2-90) (payable only from earned surplus or current earnings, except in the case of wasting asset corporations), distributions in partial liquidation (§ 14-2-91) (payable from capital surplus), and share repurchases (§ 14-2-92) (payable from earned surplus, and from capital surplus if permitted in the articles or approved by the shareholders). Subsection (b) provides a default rule for determining the record date for distributions, in the absence of specification by the board of directors. Subsection (c) restricts ‘‘distributions’’ (the new generic term defined in § 14-2-140(6) to cover any transfer of money or property, or incurrence of indebtedness to shareholders, thus covering repurchases, dividends and returns of capital) with two basic tests: (1) an equity insolvency test (inability to pay debts as they become due in the usual course of business, which preserves the rule formerly found in §§ 14-2-90(a), 91(a)(1) and 92(e). (2) a balance sheet test that requires remaining assets to be sufficient to cover all creditors plus preferences on senior securities on liquidation. This is similar to the limitation on distributions in partial liquidation contained in former § 14-2-91(a)(4), where no earned surplus was available, and in § 14-2-92(e), governing share repurchases. Under former law, dividends were also governed by a surplus test under § 14-2-90(a)(1). In most cases involving a corporation operating as a going concern in the normal course, information generally available will make it quite apparent that no particular inquiry concerning the equity insolvency test is needed. It is only when circumstances indicate that the corporation is encountering difficulties or is in an uncertain position concerning its liquidity and operations that the board of

directors or, more commonly, the officers or others upon whom they may place reliance under Section 14-2-830(b), may need to address the issue. Subsection (c)(2) requires that, after giving effect to any distribution, the corporation’s assets equal or exceed its liabilities plus (with some exceptions) the dissolution preferences of senior equity securities. Subsection (c)(2) provides that a distribution may not be made unless the total assets of the corporation exceed its liabilities plus the amount that would be needed to satisfy any shareholder’s superior preferential rights upon dissolution if the corporation were to be dissolved at the time of the distribution. The treatment of preferential rights mandated by this section may always be eliminated by an appropriate provision in the articles of incorporation. The provisions of former § 14-2-91(a)(3), prohibiting distributions to common unless all cumulative dividends on preferred have been paid are not contained in the Model Act. This is a matter of contract rather than corporate law. Subsection (d) authorizes asset and liability determinations to be made for this purpose on the basis of either (1) financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or (2) a fair valuation or other method that is reasonable in the circumstances. This is similar to the language of former § 14-2-154(c) governing liability of directors for dividends) which excused directors who rely on financial statements, except that § 154(c) permitted a director in good faith to consider the assets to be worth their book value. The concept of ‘‘reappraisal surplus’’ in § 14-2-2(4) of the former law, which was designed to alleviate the formalism of the old legal capital requirements, was eliminated as unnecessary, with the abandonment of the other categories of surplus. This leaves boards free to revalue assets to their current values at the time of a proposed distribution. See, e.g., the leading ‘‘balance sheet’’ case of Randall v. Bailey, 288 N.Y. 280, 43 N.E.2d 43 (1942). In a corporation with subsidiaries, the board of directors may rely on unconsolidated statements prepared on the basis of the equity method of accounting (see American Institute of Certified Public Accountants, APB Opinion No. 18 (1971)) as to the corporation’s investee corporations, including corporate joint ventures and subsidiaries, although other evidence would be relevant in the total determination. While a board is expressly permitted to rely upon unconsolidated statements, it may, in its discretion, continue to rely upon consolidated statements, in accordance with former law under § 14-2-97. Subsection (e) sets out rules for testing the legality of distributions involving delayed or deferred payments, such as executory agreements to repurchase shares, or the issuance of corporate debt as consideration for share repurchases. Former § 14-2-92(e) provided that an executory agreement to purchase was permitted only when ‘‘such purchase or payment would not violate the insolvency or net assets tests,’’ and 92(f ) forgave a violation only if, at the time payment was required, the corporation would not violate those tests. Commentary indicated that the repurchasing corporation must be solvent both at the time of an agreement to repurchase and at the time of each payment. Herwitz, ‘‘Installment Repurchase of Stock: Surplus Limitations,’’ 79 Harv. L. Rev. 303, 322 (1965). See Hullender v. Acts II, 153 Ga. App. 119 (1980) (refusing to enforce a corporate note given in a buy-back because of insolvency at time note was given. Uncertainty thus surrounded the enforceability of executory repurchase agreements until each installment payment was made. The provisions of subsection (e) clarify this area. Subsection (e)(1) provides that compliance with the insolvency and net asset tests shall be measured at the earlier of (1) the payment date or (2) the date the

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shareholder ceases to be a shareholder, except as provided in subsection (g). Distribution of indebtedness is defined as a payment for purpose of share repurchases. Subsection (e)(2) provides that the time for measuring the effect of a distribution of indebtedness is the date the indebtedness is distributed. Subsection (e)(3) provides that the time for measuring the effect of a distribution for compliance with the equity insolvency and balance sheet tests for all distributions not involving the reacquisition of shares or the distribution of indebtedness is the date of authorization, if the payment occurs within 120 days following the authorization; if the payment occurs more than 120 days after the authorization, however, the date of payment must be used. If the corporation elects to make a distribution in the form of its own indebtedness under subsection (e)(2), the validity of that distribution must be measured as of the time of distribution, unless the indebtedness qualifies under subsection (g). Subsection (f ) provides that indebtedness created to acquire the corporation’s shares or issued as a distribution is on a parity with the indebtedness of the corporation to its general, unsecured creditors, except to the extent subordinated by agreement. Subsection (f ) of the Model Act was amended by adding the second exception, ‘‘or except to the extent secured,’’ which is intended to be clarifying. Subsection (g) provides that indebtedness need not be taken into account as a liability in determining whether the tests of subsection (c) have been met if the terms of the indebtedness provide that payments of principal or interest can be made only if and to the extent that payment of a distribution could then be made under Section 14-2-640. This has the effect of making the holder of the indebtedness junior to all other creditors but senior to the holders of all classes of shares, not only during the time the corporation is operating but also upon dissolution and liquidation. Although subsection (g) is applicable to all indebtedness meeting its tests, regardless of the circumstances of its issuance, it is anticipated that it will be applicable most frequently to permit the reacquisition of shares of the corporation at a time when the deferred purchase price exceeds the net worth of the corporation. In such situations, it is anticipated that net worth will grow over time from operations so that when payments in respect of the indebtedness are to be made the two insolvency tests will be satisfied. In the meantime, the fact that the indebtedness is outstanding will not prevent distributions that could be made under subsection (c) if the indebtedness were not counted in making the determination. Cross-References Director standards of conduct, see § 14-2-830 et seq. ‘‘Distribution’’ defined, see § 14-2-140. Failure to present certificates for redemption or cancellation, see § 14-2-641. Liability for unlawful distributions, see § 14-2-831. Record date, see § 14-2-707. Redemption, see §§ 14-2-601 & 14-2-631. Share dividends, see § 14-2-623. JUDICIAL DECISIONS Editor’s notes. - In light of the similarity of the statutory provisions, a decision under former Code 1933, § 22-512 and former Code Section 14-2-91, which were repealed by Ga. L. 1988, p. 1070, § 1,

effective July 1, 1989, is included in the annotations for this Code section. Arrangements for payment of debts must first be made. - One cannot withdraw capital from a corporation without

first arranging for payment of its valid debts. Nicholson v. Core (In re Carolee’s Combine, Inc.), 3 Bankr. 324 (Bankr. N.D. Ga. 1980) (decided under former Code 1933, § 22-512). Leverage buy out transaction. - Georgia’s stock distribution and repurchase statutes applied to a leverage acquisition of a corporation. Munford v. Valuation Research Corp., 97 F.3d 456 (11th Cir. 1996). Effect of guarantee of corporation’s obligation upon buyout of shareholder. - Since the defendant guarantors had insisted on structuring the buyout of a former shareholder’s interest as a purchase of stock by the corporation and guarantee of the corporation’s obligation, the guarantors could not contend that the entire transaction was void on the ground that the transaction rendered the corporation insolvent. Morris & Manning Ins. Agency, Inc. v. Morris, 211 Ga. App. 433, 439 S.E.2d 660 (1994). Payment for stock. - Payment for

capital stock made to former employee/ shareholders of a professional corporation was not a distribution in violation of O.C.G.A. § 14-2-640 since, under the terms of a termination agreement, the corporation was required to pay the purchase price of the stock, and the former employees were no longer shareholders. Dougherty, McKinnon & Luby v. Greenwald, 225 Ga. App. 762, 484 S.E.2d 722 (1997). When the creditor first made a demand on the debtor to pay the creditor $900,000 in exchange for the creditor’s stock, the debtor would not have been able to pay its debts as they came due in the usual course of its business, whether or not it paid the creditor. Therefore, the debtor was not permitted by O.C.G.A. § 14-2-640 to convert the creditor’s equity to debt and hence was not obligated to pay $900,000 to the creditor; thus, the creditor’s claim had to be disallowed. Vista Eyecare, Inc. v. Neumann (In re Vista Eyecare, Inc.), 283 B.R. 613 (Bankr. N.D. Ga. 2002).

RESEARCH REFERENCES Am. Jur. 2d. - 18B Am. Jur. 2d, Corporations, § 1709 et seq. C.J.S. - 18 C.J.S., Corporations, § 360 et seq. 19 C.J.S., Corporations, §§ 571, 575, 576, 586, 637. ALR. - Insolvency of corporation as barring stockholder’s right to rescind subscription on ground of fraud, 41 ALR 674; 46 ALR 484. Reduction of capital stock and distribution of capital assets upon reduction, 44 ALR 11; 35 ALR2d 1149. Trademark or tradename as asset in case of bankruptcy, insolvency, or assignment for benefit of creditors, 44 ALR 706. Right or duty of corporation to pay dividends, and liability for wrongful payment, 55 ALR 8; 76 ALR 885; 109 ALR 1381. Right as between seller and purchaser of stock to dividends declared thereon, 60 ALR 703. Right of pledgee of corporate stock in respect of dividends declared thereon, 67 ALR 485; 103 ALR 849. Rights of holders of preferred stock in

respect of dividends, 67 ALR 765; 98 ALR 1526; 133 ALR 653. Duty and remedy as regards deferring payment of dividends from assets of insolvent bank or other insolvent corporation while there are undetermined claims or preferences, 88 ALR 1301. Constitutionality of tax upon corporate dividends, or the transfer thereof, in respect of stock owned by nonresident, 104 ALR 1491. Failure of purchaser of stock from existing corporation, or of subscriber thereto, to pay for same as affecting his right to dividends, 122 ALR 1048. Right as between life beneficiaries and remaindermen, or successive life beneficiaries, in corporate dividends or distributions during the life interest, 130 ALR 492; 44 ALR2d 1277. Validity and construction of state statutes as applied to the taxation of income derived from dividends on stock of foreign corporations, 143 ALR 147. When dividends on corporate stock become taxable as income, 143 ALR 596; 158 ALR 1432; 167 ALR 303.

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Validity of cancellation of accrued dividends on preferred corporate stock, 8 ALR2d 893. Parties defendant to stockholder’s suit to compel declaration of dividend, 15 ALR2d 1124. Preferred stockholders’ rights, upon liquidation or dissolution to dividends, 25 ALR2d 788. Dividend rights in surplus of new consolidated corporation resulting from reduction of capital stock of former constituent corporations, 28 ALR2d 1177.

Corporation’s right to interplead claimants to dividends, 46 ALR2d 980. Construction of ‘‘net profits,’’ ‘‘earnings,’’ or the like, in provision for profit-sharing bonus for corporate officers or employees, 49 ALR2d 1129. Negligence, nonfeasance, or ratification of wrongdoing as excusing demand on directors as prerequisite to bringing of stockholder’s derivative action on behalf of corporation, 99 ALR3d 1034.