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D&O Loans: California Section 315 Versus Sarbanes-Oxley Section 402

Although both Section 315 of the California Corporations Code and Section 402 of the Sarbanes-Oxley Act purport to ban loans to directors and officers, there are significant differences between these statutes.  Below is a precis of some of the key differences.

Companies covered.  Section 315 applies to corporations.  The California General Corporation Law (GCL) defines "corporation" as only a corporation organized under the GCL and corporations made subject to the GCL pursuant to Section 102(a).  Cal. Corp. Code § 162.  In contrast, Section 402 applies to any "issuer" as defined in Section 2 of the Sarbanes-Oxley Act.  The definition of "issuer" in Section 2 is independent of the jurisdiction of organization of the company.

Persons covered.  Section 315 applies to directors and officers while Section 402 applies to directors and executive officers (or the equivalent thereof).  Thus, the California statute may prohibit a loan to non-executive officers whereas Section 402 does not.

Transactions covered.  Section 315 prohibits loans of money or property.  Section 402 prohibits extending credit or arranging an extension of credit in the form of a personal loan.  Section 402 does not directly mention loans of property.  Section 315 also prohibits guarantees of obligations of directors or officers.  Although Section 402 does not use the term "guarantee", corporate guarantees may fall within the prohibition on "arranging an extension of credit".  See RingsEnd Partners, EBIC Program no-action letter (March 4, 2013).

Shareholder approval exception.  As discussed in this post from earlier this week, Section 315 permits transactions approved by a majority of the shareholders “entitled to act thereon” (See Section 315(g) regarding the meaning of “entitled to act thereon”).  A loan or guarantee is also permitted if a majority of the shareholders "entitled to act thereon" approve an employee benefit plan that authorizes the loan or guarantee after disclosure of the right under the plan to include directors or officers.  Section 402 has no similar exceptions for loans approved by shareholders.

Bylaw exception.  Section 315 permits the board alone to approve a loan or guaranty to an officer (whether or not a director) if the board determines that the loan or guarantee may reasonably be expected to benefit the corporation and the corporation has: (i) outstanding shares held of record by more than 100 persons (determined in accordance with Section 305) on the date of the approval; and (ii) a bylaw approved by the outstanding shares (see Section 152) authorizing the board alone to approve the loan or guarantee.  Section 402 has no similar exception.

Stock purchase or option plan exception. Section 315(f)(1) excepts any transaction plan or agreement permitted by Corporations Code Section 408.  In general, Section 408 authorizes a corporation to adopt and carry out a stock purchase or stock option plan or agreement for employees or directors.  Section 408 permits the corporation to provide aid to employees and directors in paying for shares by promissory notes.  Section 402 has no similar exception.

Advancement of expenses exception. Section 315(d) expressly exempts advances for any expenses reasonably anticipated to be incurred in performance of a director's or officer's duties provided that in the absence of the advance, the director or officer would be entitled to be reimbursed by the corporation, its parent or a subsidiary.  Section 402 does not expressly except advances of travel or business expenses.  However, advances would not seem to constitute a prohibited "personal loan".  See 25 Law Firm Memo (Oct. 15, 2002).  For a discussion of advancement of litigation expenses, see yesterday's post.


Guarantee or guaranty?

Oddly, Section 315 refers to both a "guarantee" and a "guaranty".  For a discussion of which spelling is correct, see What’s With The “U” In Guarantee (Or Should That Be Guaranty)?

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30172DBAB0084D3A8F39D7AF0A8E79BC.ashx Keith Paul Bishop
Partner at Allen Matkins
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