The Model Business Corporation Act Financial Provisions: A Historical Snapshot

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I

INTRODUCTION

In 1980, the Committee on Corporate Laws (Committee) adopted sweeping amendments to the financial provisions of the Model Business Corporation Act (MBCA). (1) What these changes did, the forces that contributed to them, and the process of formulating them are excellent illustrations of how the Committee has worked over the years. These changes, which remain in the MBCA largely unchanged today, evolved during the decade of the 1970s and took effect in 1980, the midpoint in the existence of the MBCA from its inception in 1950 to its sixtieth anniversary this year.

During the life of the MBCA, many important changes have been made, usually involving multiple years of deliberation, debate, and refinement by committee members. (2) Most of the highly significant changes have involved making the MBCA's statutory provisions more detailed and lengthy than the existing ones. Examples of this are found in the provisions dealing with indemnification of directors and officers, (3) conflicting interest transactions, (4) fundamental changes, (5) and appraisal. (6) Another major addition to the MBCA, one of the most significant, actually had no counterpart at all in the then existing MBCA: that was the introduction in 1998 of stated standards of liability of directors (7) as a companion to the stated standards of conduct for directors. (8) Interestingly, on the one hand, the process of formulating the sweeping 1980 changes to the financial provisions of the MBCA, which were developed over more than half a decade, is typical of the way the Committee works. On the other hand, the end result of the process was different from most other major changes in their outcome when considered from the point of view of simplicity versus complexity. The changes eliminated a complex series of provisions that were out of date and, in the view of the Committee and other observers, largely obsolete and ineffective. The new provisions, which are essentially the same today, were simpler and clearer, even though they address fundamental elements of corporation finance and policy that are complex and ever changing.

II

FINANCIAL PROVISIONS BEFORE THE 1980 AMENDMENTS

Before the 1980 amendments, the MBCA financial provisions had remained largely unchanged from the inception of the MBCA in 1950. The structure of the financial provisions was grounded in the concepts of "net assets," "stated capital," "capital surplus," and "earned surplus." Dividends could be paid only out of "unrestricted and unreserved" earned surplus, subject to exceptions added in later for natural resource or "wasting asset" businesses and "nimble dividends," and a few exceptions such as elimination of preferred-stock dividend arrearages. Deficits in earned surplus could be eliminated or mitigated by procedures to reduce capital surplus. Capital surplus could be used to make distributions in "partial liquidation." (9) Of importance, the MBCA provided, as it provides today, that if dividends were declared and paid in violation of the requirements of the statute, directors had liability. (10)

When shares were issued, the consideration received was stated capital to the extent of par value, and the excess, if any, of the amount received over the par value was capital surplus; or, if the shares were of no par value, the entire consideration was stated capital, except that the directors were empowered to allocate amounts received for no par value shares to capital surplus prior to the time of issuance. (11)

Two developments in financial accounting posed serious issues under the MBCA's provisions relating to the issuance of shares and of determining the amount of earned surplus.

A. Pooling of Interests

One was the evolution of "pooling of interests" accounting in business combinations. (12) This accounting treatment, frequently employed in the 1960s and 1970s, brought forward, in the financial statements of the resulting entity in a merger or similar transaction that qualified for the pooling of interests treatment, the assets, liabilities, and earned surplus accounts of the constituent entities. …