Washington law provides a board of directors discretion to make distributions to its shareholders. However, this discretion is not unfettered. This post will explore the limitations on distributions for which Boards should be aware to protect themselves from personal liability.
Limitations on Distribution
A board’s ability to make distributions to its shareholders is limited by the corporation’s articles of incorporation and the limitation imposed by RCW 23B.06.400(3). In the absence of any restriction in a corporation’s articles, Washington law provides the only restriction, which prohibits boards from making a distribution if the distribution would cause the corporation to (a) “not be able to pay its liabilities as they become due in the usual course of business” or (b) become insolvent (the total liabilities of the corporation exceed the corporation’s total liabilities). RCW 23B.06.400(3).
While both of these limitations are relatively straightforward conceptually, they can become ambiguous in practice. The statute does not provide guidance on how to determine what liabilities become due in the ordinary course or what assets and liabilities should be considered when determining whether a distribution would render a corporation insolvent. A common liability that causes confusion for purposes of determining insolvency is rental payments under a lease. Normally, the total amount of rent under a lease is not identified on a balance sheet, but rent it is certainly a liability—the corporation must pay it every month! As such, the question simply becomes how much rent qualifies as a liability for purposes of this calculation. Unfortunately, this analysis is not cut and dry, and it will differ depending on each corporation.
Relying on Experts
Fortunately, the statute provides boards with the ability to rely on experts when walking through the above analysis. Specifically, the board “may base a determination that a distribution is not prohibited … either on financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or on a fair valuation or other method that is reasonable in the circumstances.” RCW 23B.06.400(4)(a). This language in the statute indicates an intent to provide boards the protection of the business judgment rule when issuing distributions, so long as they board acts reasonably with the help of its experts.
Implications for Closely Held Entities
Boards and their members ought to care significantly about the above analysis because they will be held personally liable if they “vote for or assent to” a distribution in violation of RCW 23B.06.400. As such, it is always advisable to simply “double-check the math” before making distributions. Normally, “the math” can be done quickly and easily by a corporation’s accountant or bookkeeper, and such diligence can protect directors from personal liability and headache in the long run.
To learn more about Lawful Distributions, please contact Beresford Booth at firstname.lastname@example.org or by phone at (425) 776-4100.