Board reviews financial statements, would payment of dividends make it difficult to pay debts of corporation when due?
Usually, look at current assets and current liabilities (due in next year). Judgment call, protected by business judgment rule. • Balance Sheet Test: can’t pay dividend if total assets is less than total liabilities plus all amounts due to preferred shareholders. • Don’t need to use GAAP financials • From standpoint of creditor, whether company pays dividend or repurchases share, same effect. Assets are being paid out to shareholders, diminishing available assets for repayment of liabilities. Corporation statutes treat them the same. • If shareholders who received dividends or repurchase knew that payment was improper, Board can sue shareholders for contribution. • Decisions to pay or not to pay dividends is protected by business judgment rule, thus usually fraud, self-dealing, or bad faith are needed to overcome business judgment rule. In small closely held companies, sometimes courts will intervene in equity.
