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PrintDividend Distributions
A small business owner has a number of withdrawal methods available when seeking to minimize the amount of vulnerable assets within an entity by withdrawing funds from the business. One way is to distribute earnings among the owners based on their ownership interests. But there are some statutory restrictions on how this must be done.
By definition, a distribution of a corporation's income (i.e., a dividend) or in redemption of an owner's interest (i.e., a stock redemption) will be for no return consideration. Thus, the first criterion under the constructive fraud test again really is irrelevant, and the only issue involves the solvency of the corporation, under the cash flow test and the balance sheet test.
The cash flow test, under the corporation statutes, is identical to the cash flow test under the Uniform Fraudulent Transfers Act (UFTA). Thus, if a distribution to an owner on account of his ownership interest is made when a corporation is unable to pay its debts as they come due, the distribution automatically is deemed to be fraudulent.
State corporation statutes also impose a balance sheet test. However, the balance sheet test under the corporation statutes, which is limited to distributions of earnings (i.e., dividends) and stock redemptions, is much more restrictive than the balance sheet test imposed by the UFTA.
The actual balance sheet test applied to dividends and stock redemptions varies, to a certain degree, from state to state, and is based on the capital structure of the corporation.
Finally, distributions for dividends and stock redemptions by a corporation also will be restricted by the earned surplus test.
