California Corporations Code Amended to Simplify Restrictions on Distributions and Permit Waivers of Application of Section 500 to Preferences of Preferred Stock

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On September 1, 2011, California governor Jerry Brown signed Assembly Bill No. 571, which simplifies restrictions on dividends, repurchases and redemptions of shares. The restrictions are set forth in Sections 500 to 509 of the California Corporations Code, and are commonly referred to collectively as “Section 500.[1]” These provisions are designed to protect the interests of creditors and senior equity holders against transactions that might undermine their seniority in the capital structure. Section 500 applies to companies incorporated in California and to companies incorporated elsewhere but deemed subject to the same restrictions by virtue of satisfying the requirements of Section 2115 of the California Corporations Code for “pseudo-California corporations.” Section 500 uses the term “distributions” to encompass dividends of cash or property (other than shares of the corporation) and repurchases and redemptions of shares.

Section 500 has served as a trap for the unwary, a significant impediment to the ability to effect many transactions that do not intuitively threaten the interests of creditors or senior equity holders, a substantial risk for directors who face personal and potential criminal liability for distributions made in violation of Section 500, and a source of frustration to lawyers and clients who struggled to explain, apply and perform the financial gymnastics required under Section 500. In extreme cases, companies incorporated in California have had to reincorporate in other jurisdictions prior to effecting a transaction because the transaction would otherwise be prohibited under Section 500.

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Sheppard Mullin Richter & Hampton LLP on:

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