MBE Rules · Business Associations
Distributions to Shareholders
Cal. Corp. Code §§ 500-501
The rule
A corporation may make a distribution only if (1) the amount does not exceed the greater of retained earnings or a two-part solvency test (assets ≥ 1.25x liabilities and current assets ≥ current liabilities), and (2) after the distribution the corporation is able to meet its liabilities as they mature.
In plain English
A corporation can only distribute money or assets to its shareholders if it has enough retained earnings or passes a solvency test, which checks if its assets are significantly greater than its liabilities. Additionally, the corporation must still be able to pay off its debts after making the distribution.
Worked example
Company A has $1 million in retained earnings and liabilities of $600,000. It wants to distribute $500,000 to its shareholders. After the distribution, Company A will have $500,000 in assets and $600,000 in liabilities, failing the solvency test. Therefore, the distribution cannot be made.
Memory hook
No cash for shareholders if the company can't pay its bills!
The trap
Exams often present scenarios where a corporation appears to have enough retained earnings but fails the solvency test, tricking students into thinking a distribution is permissible.
How examiners test it
Questions typically involve a fact pattern where a corporation's financials are presented, requiring candidates to analyze both retained earnings and solvency before determining if a distribution is valid.
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