Corporations - Distributions

Question 1

What are the 3 types of DISTRIBUTIONS?

Answer 1

these are payments by the corporation to shareholders - there are three types:

(1) Dividend or
(2) Payment to repurchase shares or
(3) to REDEEM shares [forced sale to corporation at price set in certificate]

Question 2

When do shareholders have a right to distribution?

Answer 2

When the board declares it, this is in board’s discretion

Distributions are declared in the Board’s Discretion.

A court will interfere with the Board’s discreton and order a distribution ONLY IF there is a showing of BAD FAITH or DISHONEST PURPOSE

Question 3

Stock Splits

Answer 3

A stock split gives a shareholder more shares than she now has but reduces the value of each share.

e.g. Sally owns 100 shares of XYC Inc. The shares are selling at $40/share. If the stock splits 2-for-1, Sally will end up with 200 shares worth $20/share. So the economic effect is nothing, she has $4,000 worth of stock

Question 4

Which shares get DIVIDENDS??

Answer 4

e.g. board of directors of C Corp. declare a dividend of $400,000. Who receives what if the outstanding stock is:

100,000 shares of common stock = $4/share

100,000 shares of common and 20,000 shares of PREFERRED with $2 dividend preference –
preference means “pay first” so $40,000 would go to the preferred shares ($2/share) and then each common share would get $3.60/share

100,000 shares of common, 20,000 shares of $2 preferred that is PARTICIPATING
= participating means they get paid as a regular share, along with getting paid the preferred share rate so
(i) participating preferred would get $2 for its preferred portion and then $3 as part of the regular dividend to common and participating - so $5 overall
(ii) common gets $3/share (100,000 common _ 20,000 participating preferred gives you 120,000 shares to split up $360,000 left after paying out the $40,000 for the preferred dividend)

100,000 shares of common and 20,000 shares of $2 CUMULATIVE preferred (and no dividends have been paid in the prior three years)
(i) the 20,000 cumulative preferred would get $2/share for each of the 4 years (the 3 prior years and this year) so they would each get $8/share

this leaves $240,000 left for distribution to the 100,000 common shares
(ii) so each common share receives $2.40/share

Question 5

Which funds may be used for any distribution? (dividend, repurchase, redemption)

Answer 5

DISTRIBUTIONS (which include: dividends, repurchases, and redemptions) must be paid from SURPLUS

SURPLUS = Assets - Liabilities - Stated Capital

STATED CAPITAL = the amount contributed at issuance ABOVE par value
-e.g. C Corp issues 10,000 shares of $2 par stock for $50,000
$20,000 = stated capital
$30,000 - SURPLUS

IF there were NO PAR issuance, within 60 days of the issuance, the board can allocate any part, but not ALL to SURPLUS

Question 6

Can a corporation make distributions even though it lost money last year? what are limitations on making distributions?

Answer 6

YES, a corporation CAN make distributions even though it lost money last year

However, a corporation cannot make distributions if it is INSOLVENT or of the distribution would RENDER it INSOLVENT

“Insolvent” means the company is unable to pay its debts as they come due in the ordinary course of debtor’s business

as mentioned before, can’t use STATED CAPITAL to issue dividends either

Question 7

Who is liable for unlawful distributions?

Answer 7

DIRECTORS are PERSONALLY liable for unlawful distributions. So are shareholders who KNEW the distribution was unlawful when they received it

Who could sue to recover?
It is the corporation’s claim, so the corporation could sue, or shareholder could bring as a DERIVATIVE suit

remember though, officers have a DEFENSE for GOOD FAITH RELIANCE

Question 8

What are REDEMPTIONS?

Answer 8

Redemptions are set in the certificate and must be done proportionately within each class of stock. Repurchases are individually negotiated. Can the corporation discriminate in repurchases? (ie repurchase some shareholder’s stock and not others?)

YES, you can discriminate with repurchases

Exception: might have to give equal opportunity to all shareholders in a CLOSE CORPORATION (bc of freeze out problem since there is no market for the stock)

Note: INSOLVENCY - the corporation may not repurchase or redeem shares if it is insolvent or the repurchase or redemption would cause insolvency