Running the Corporation: When Distributions Are Allowed

One of the most exciting aspects of having a stake in an ownership is receiving dividends, or payments. Dividends, however, are not merely available just because the corporation has money in the bank. In fact, many corporations prematurely pay out dividends just because it is compelled to show its shareholders it is profitable. This is a big mistake, as it is in fact illegal for a corporation to pay out dividends when it is not allowed to. In turn, directors can be held liable, and may even be required to pay back the dividends, if a court retroactively believes that the corporation should not have paid out dividends. It is therefore important to understand when dividends are allowed in a corporation.

Generally, courts do not compel distribution absent an abuse of discretion. However, courts also do not give free reign to corporations in Florida to order distributions. In Florida, there are two tests which corporations must satisfy in order to make legal distributions to its constituents: the insolvency test and the balance sheet test.

The first such test for distributions is the insolvency test. A corporation will be allowed to make distributions only if a corporation will be able to pay its debts as they become due. In determining if a corporation meets this test, a court looks at the recurring debts that a corporation must pay. The list of recurring debts will vary with the nature of the corporation. If a corporation attempts to make distributions while being uncertain as to whether or not they can meet their usual debts, a court may find that such a distribution is illegal.

The second test for distributions is the balance sheet test. Under the balance sheet test, a corporation’s assets must be equal to or greater than total liability and dissolution preferences. Again, if a court retroactively determines that a corporation ordered dividends be distributed when their assets would not equal total liability and dissolution preferences, it may find that the distribution was illegal.

A corporations are not free to distribute dividends whenever it pleases. It must meet two important tests before it can do so: the insolvency test and the balance sheet test. If a corporation makes a distribution while failing either of these tests, a court may order that the directors who ordered the distribution be held liable for its ramifications, and reimburse the corporation. Liability for an illegal distribution can be a costly issue. Call the Trembly Law Firm at (305) 431-5678 to schedule a consultation and see if distributions for your corporation are permissible.