Section 166 of the California Corporations Code defines “distribution to its shareholders." Knowing what constitutes a distribution to shareholders is important because Chapter 5 of the General Corporation Law imposes various restrictions on such distributions.  Shareholders and directors may be liable when these restrictions are violated.  Cal. Corp. Code §§ 316 & 506.  Under Section 166, a corporation will generally be considered to have made a distribution to its shareholders when it repurchases or redeems its shares.

Although the rescission of a share issuance may be considered to be the economic equivalent of a share repurchase or redemption, not all rescissions constitute a distribution under Section 166.  The statute excludes a rescission by a corporation of the issuance of its shares if the board of directors determines all of the following:

• it is reasonably likely that the holder or holders of the shares in question could legally enforce a claim for the rescission,

• the rescission is in the best interests of the corporation, and

• the corporation is likely to be able to meet its liabilities (except those for which payment is otherwise adequately provided) as they mature.

In a further wrinkle, the statute a director who is, or would be a party to the transaction, is not entitled to vote.