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CALIFORNIA CORPORATE & SECURITIES LAW

Why You Should Have Read Last Week’s Posts On California’s D&O Loan Ban

I spent the better part of last week writing about California Corporations Code Section 315.  The statute general prohibits a corporation (Section 162) from making a loan of money or property to, or guaranteeing the obligation of, an officer or director without specified shareholder approval.  What happens if a prohibited loan is made?

The good news is that the California Department of Business Oversight won’t be coming after the corporation, the directors or officers.  Contrary to a common misconception, the Commissioner of Business Oversight does not administer or enforce the General Corporation Law.  The Attorney General has authority to enforce the GCL pursuant to Section 1801.  That statute authorizes the Attorney General to bring an action against any domestic corporation (Section 167) on several grounds, including that the corporation “has seriously offended against any of the statutes regulating corporations”.  The legislature has left it to the courts to figure out what might constitute a serious offense.  Chapter 22 of the GCL also includes several criminal provisions.  In contrast, the SEC has authority to, and has enforced, Section 402 of the Sarbanes-Oxley Act, which bans personal loans to directors and executive officers.  See In re Goodfellow & Molaris, (Dec. 1, 2005).

The real bite is in Section 316 which makes directors jointly and severally liable to the corporation for the benefit of the following persons who are empowered to bring suit (provided they have not consented to the loan or guarantee):

  • One or more creditors of the corporation whose debts or claims arose prior to the making of the loan or guarantee; or
  • holders of shares outstanding at the time of the making of the loan or guarantee.

Suit to enforce the liability be brought in the name of the corporation without regard to the provisions of Section 800 (governing derivative suits).  Directors sued are liable for the loss suffered by the corporation as a result of the illegal loan or guarantee.  Directors sued under Section 316 may implead all other directors and may compel contribution, either in the original action or in an independent action against the directors not joined in the original action.  The effect of these provisions is to make the directors personal guarantors of the illegal loan.

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