TITLE 14 CORPORATIONS, PARTNERSHIPS, AND ASSOCIATIONS

Section 2. Business Corporations, 14-2-101 through 14-2-1703.

ARTICLE 6 SHARES AND DISTRIBUTIONS

14-2-640. Distributions to shareholders.

1. A board of directors may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles of incorporation and the limitation in subsection (c) of this Code section.
2. If the board of directors does not fix the record date for determining shareholders entitled to a distribution (other than one involving a purchase, redemption, or other reacquisition of the corporation's shares), it is the date the board of directors authorizes the distribution.
3. No distribution may be made if, after giving it effect:
   1. The corporation would not be able to pay its debts as they become due in the usual course of business; or
   2. The corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.
4. The board of directors may base a determination that a distribution is not prohibited under subsection (c) of this Code section either on financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or on a fair valuation or other method that is reasonable in the circumstances.
5. Except as provided in subsection (g) of this Code section, the effect of a distribution under subsection (c) of this Code section is measured:
   1. In the case of distribution by purchase, redemption, or other acquisition of the corporation's shares, as of the earlier of:
      1. The date money or other property is transferred or debt incurred by the corporation; or
      2. The date the shareholder ceases to be a shareholder with respect to the acquired shares;
   2. In the case of any other distribution of indebtedness, as of the date the indebtedness is distributed; and
   3. In all other cases, as of:
      1. The date the distribution is authorized if payment occurs within 120 days after the date of authorization; or
      2. The date the payment is made if it occurs more than 120 days after the date of authorization.
6. A corporation's indebtedness to a shareholder incurred by reason of a distribution made in accordance with this Code section is at parity with the corporation's indebtedness to its general, unsecured creditors except to the extent subordinated by agreement or except to the extent secured.
7. Indebtedness of a corporation, including indebtedness issued as a distribution, is not considered a liability for purposes of determinations under subsection (c) of this Code section if its terms provide that payment of principal and interest are to be made only if and to the extent that payment of a distribution to shareholders could then be made under this Code section. If the indebtedness is issued as a distribution, each payment of principal or interest is treated as a distribution, the effect of which is measured on the date the payment is actually made.

(Code 1981, §14-2-640, enacted by Ga. L. 1988, p. 1070, § 1.)

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 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.