Effective January 1, 2012, A.B. 571 amends and greatly simplifies Chapter 5 of the California Corporations Code governing corporate distributions (dividends and share repurchases). In effect, A.B. 571 permits a solvent corporation to make a distribution to its shareholders so long as the value of the corporation's assets will exceed its liabilities after the distribution.

Prior to the adoption of AB 571, Chapter 5 of the California Corporations Code required corporations to satisfy a solvency test and either a retained earnings test, or a two-pronged balance sheet and liquidity test before making a distribution to its shareholders. AB 571 in effect makes the regulations governing distributions by California Corporations more similar to the regulations governing distributions by California limited liability companies (§17254 of the Beverly-Killea Limited Liability Company Act) and partnerships (§15905.08 of the Uniform Limited Partnership Act of 2008).

While the solvency test and retained earnings test remain unchanged, as of January 1, 2012 a corporation will be permitted to make a distribution so long as the corporation's Board of Directors make a good faith determination within 120 days of the distribution date that the corporation's financial statements were prepared under reasonable accounting practices and principles and show that:

1. prior to a distribution, the corporation has retained earnings that equal or exceed the amount of the distribution, AND
2. immediately after the distribution, the value of the corporation's total assets (excluding items like goodwill) will equal or exceed the sum of (a) its total liabilities (excluding items such as deferred taxes and income) plus (b) the value of any shares with preferential rights, if any, upon dissolution.

The test is based Board of Director's good faith determination that the above conditions are satisfied, but the standard is objective. Under Corporations Code Sections 309 and 316(a), a director can be held personal liable for willfully or negligently authorizing an illegal distribution (one that would render the corporation insolvent). With the new addition of the "good faith standard," to hold a director personally liable, the plaintiff would have to prove the Board of Directors' failed to conduct the above mentioned balance sheet tests prior to authorizing a distribution.

AB 571 also:

• Sets a four year statute of limitations that begins to run on the date of the distribution, for a creditor or shareholder to bring a claim seeking recovery of illegal distributions; and
• Eliminates the requirement that a corporation provide written notice of shareholder distributions that are not made in reliance on the retained earnings test.