6.5 Liability for Improper Distributions

• Library: Corporations and Partnerships in Virginia (Virginia CLE) (2016 Ed.)

6.5 LIABILITY FOR IMPROPER DISTRIBUTIONS

6.501 In General. A director may be held personally liable to the corporation or its creditors if the director votes for or assents to a distribution of corporate assets that is contrary to provisions of the Act or the corporation's articles of incorporation. ⁹⁷ The measure of liability for improper distributions is the amount by which the actual distribution exceeds what could have been properly distributed without violating the Act or articles of incorporation. The statute has a two-year limitations period. ⁹⁸ Under the Act:

"Distribution" means a direct or indirect transfer of money or other property, except its own shares, or incurrence of indebtedness by a corporation to or for the benefit of its shareholders in respect of any of its shares. A distribution may be in the form of a declaration or payment of a dividend;

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a purchase, redemption, or other acquisition of shares; a distribution of indebtedness of the corporation; or otherwise. ⁹⁹

Because of this inclusive definition, a "distribution" may be involved in almost any specialized corporate transaction, including a corporation's acquisition of its own shares, ¹⁰⁰ merger and share exchange, ¹⁰¹ sale of assets, ¹⁰² affiliated transactions, ¹⁰³ dissenters' rights, ¹⁰⁴ and dissolutions. ¹⁰⁵ Officers and directors should be aware of the foregoing statutory provisions for these types of transactions. The focus of the following discussion will, however, be on the central provision for personal liability ¹⁰⁶ and the primary statutory limitation on distributions. ¹⁰⁷

6.502 Distribution to Shareholders. Section 13.1-653 of the Virginia Code authorizes the board of directors to make distributions to shareholders and places limits on those distributions. The limitations are set out in section 13.1-653(C):

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

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dissolution of shareholders whose preferential rights are superior to those receiving the distribution. ¹⁰⁸

The equity solvency test of section 13.1-653(C)(1) requires the corporation to be able to pay its debts as they come due in the ordinary course of business. This involves a subjective judgment as to liquidity and the future course of the corporation's business. Analytical projections should consider cash flow, business forecast, and budget for a sufficient period to determine whether obligations can reasonably be expected to be satisfied as they mature.

The balance sheet solvency test of section 13.1-653(C)(2) requires that, after the proposed distribution, the corporation's assets at least equal its liabilities plus the dissolution preferences of senior equity securities which, for purposes of the test, are deemed liabilities.

For purposes of section 13.1-653(C), the indebtedness of a corporation is not considered a liability of the corporation where its repayment is expressly conditioned upon whether the repayment...