Alpha Corporation has outstanding four hundred shares of $100 par value common stock, which has been issued and sold at $105 per share for a total of $42,000. Alpha is incorporated in State X, which has adopted the earned surplus test for all distributions. At a time when the assets of the corporation amount to $65,000 and the liabilities to
creditors total $10,000, the directors learn that Rachel, who
holds one hundred of the four hundred shares of stock, is
planning to sell her shares on the open market for $10,500.
Believing that this will not be in the best interest of the corporation, the directors enter into an agreement with Rachel
to buy the shares from her for $10,500. About six months
later, when the assets of the corporation have decreased to
$50,000 and its liabilities, not including its liability to Rachel,
have increased to $20,000, the directors use $10,000 to pay
a dividend to all of the shareholders. The corporation later
becomes insolvent.
a. Does Rachel have any liability to the corporation or its
creditors in connection with the corporation’s reacquisition of the one hundred shares? Explain.
b. Was the payment of the $10,000 dividend proper? Explain.