Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at some of the legislative enactments and court decisions of interest to corporate lawyers that occurred over the last 3 months. Included is a look at three new limited partnership acts, a Delaware decision granting shareholders access to a corporation's privileged communications, and an Illinois decision holding that an internal corporate memo could be the basis of a defamation action.

IN THE STATE LEGISLATURES

New Limited Partnership Laws in Illinois, Iowa, and Minnesota

Attorneys who form and advise limited partnerships should be aware that on Jan. 1, 2005, new limited partnership acts went into effect in Illinois, Iowa, and Minnesota. The Illinois limited partnership act was enacted by Senate Bill 2982, Iowa's by House File 2347 and Minnesota's by Senate Bill 1803. All three laws are based on the Uniform Limited Partnership Act of 2001 and govern such issues as formation, rights and liabilities of partners, contributions and distributions, transfers of interests, dissociation and dissolution, foreign limited partnerships, and mergers and conversions.

In all three states the new laws apply to limited partnerships formed on or after Jan. 1, 2005. However, as to existing limited partnerships, the Illinois law does not apply until Jan. 1, 2008, the Iowa law does not apply until Jan. 1, 2006, and the Minnesota law does not apply until Jan. 1, 2007. However, each state provides that an existing limited partnership may elect to be governed by the new law before those dates. Consequently, attorneys may wish to review these new laws to determine if it will benefit their clients to make such an election. This is particularly true if the client is one of the two types of limited partnerships the drafters of the Uniform Act targeted — sophisticated, manager-entrenched commercial deals whose participants commit for the long term, and family limited partnerships.

Other Amendments to Unincorporated Entity Laws

There were several other changes of interest to unincorporated entity laws effective on Jan. 1. Mississippi enacted the Uniform Partnership Act to govern its general and limited liability partnerships (Senate Bill 2504). Maryland imposed a $300 annual report fee on business trusts (Senate Bill 508). And Tennessee enacted the Tennessee Processing Cooperative Law, authorizing the formation of cooperatives to market and process agricultural products (Senate Bill 1161).

In addition, in California, Assembly Bill 3073 authorized a limited liability company to engage in not-for-profit activities and Assembly Bill 1859 allowed an LLC to file a certificate of cancellation without obtaining a tax clearance if it had not conducted business and the filing was made within 12 months of formation.

California and Kansas Amend Their Corporation Laws

There were also several bills amending corporation laws that went into effect on Jan. 1. One is California Senate Bill 1306. This bill authorized certain transactions and communications to be conducted by electronic transmission, including permitting shareholder meetings to be conducted by electronic transmission if the corporation provides shareholders with a reasonable opportunity to participate and vote and maintains a record of votes or actions taken.

In Kansas, Senate Bill 29 extensively revised that state's corporation law. The bill provided, among things, that a corporation has the power to renounce its interest, expectancy, or opportunity to participate in specified business opportunities, that a corporation may submit a matter to a stockholder vote even if the board of directors later determines that the matter is not advisable, that the board may authorize officers to designate officers and employees to receive rights or options, and that the board of directors may determine that a stockholder meeting will be held by means of remote communication.

2005 Legislative Sessions Begin

Another recent, notable legislative event is the 2005 legislative sessions beginning. A number of significant bills affecting business entities have already been introduced. One of these is New York Assembly Bill 2105, introduced on Jan. 24, which would impose penalties on corporations and other entities that issue audited financial statements in connection with which the auditor engaged in professional misconduct. Others include Michigan Senate Bills 114 and 115, introduced Feb. 1, which would permit conversions involving corporations and LLCs, and South Dakota Senate Bill 70, introduced Jan. 13, which would enact a new business corporation act. Also of interest is the fact that New York Senate Bill 5902, which would have required public disclosure of the names of the holders of the 10 most valuable interests in LLCs, LPs, and LLPs, was pocket vetoed on Jan. 30.

IN THE STATE COURTS

Delaware Court Compels Production of Privileged Documents

In In re Freeport-McMoRan Sulphur, Inc. Shareholder Litigation, C.A. No. 16729 (Del. Ch., decided Jan. 26, 2005) former shareholders of a corporation filed suit against the corporation and its former directors, alleging that the directors breached their fiduciary duties in approving a merger. The shareholders sought to compel production of documents contained in the defendants' privilege log. Most of the documents related to a previous lawsuit involving the corporation's parent. One document related to the corporation's shareholder repurchase plan. The shareholders sought production under the fiduciary duty exception to the attorney-client privilege. Under this exception, shareholders who enjoy a mutuality of interest with a corporation may obtain access to its confidential communications with counsel, if the shareholders can show good cause.

The Delaware Chancery Court held that the shareholders met their burden as to the documents related to the previous litigation because the shareholders showed that their fiduciary duty claim was colorable and that the documents were unavailable from other sources. They also identified the specific documents needed and explained how the documents related to their lawsuit. However, the court denied the motion to compel production of the document related to the shareholder repurchase plan because that document was created before the corporation issued public stock and before there was a fiduciary duty owed to the shareholders.

Delaware Court Upholds Subject Matter Jurisdiction in Suit Against Purported Officer

In Jacobson v. Ronsdorf, C.A. No. 518-N (Del. Ch., decided Jan. 6, 2005) a Delaware corporation and its largest shareholder filed an action in the Delaware Chancery Court seeking a declaratory judgment that the defendant was not an officer or director of the corporation, an injunction to prevent the defendant from acting on the corporation's behalf, specific performance of an agreement that required the defendant to sell his shares, and money damages. The defendant moved to dismiss claiming that the Chancery Court, as a court of equity, lacked subject matter jurisdiction.

The Delaware Chancery Court found that it had jurisdiction. The court noted that it has inherent and statutory authority to determine whether someone is an officer or director of a Delaware corporation, that injunctions and specific performance are equitable remedies, that money damages would not remedy the harm done, and that it has subject matter jurisdiction over equitable claims even if money damages are sought in addition to equitable remedies.

Illinois Court Upholds Defamation Claim Based on Internal Corporate Memo

In Popko v. Continental Casualty Company, No. 1-03-3389 (Ill. App., decided Jan. 21, 2005) the plaintiff worked as an attorney for the defendant corporation. Following a negative performance review, his supervisor sent a written memorandum to a corporate vice president indicating that the attorney engaged in a pattern of unacceptable conduct. The attorney was then fired. After his termination, he brought suit for defamation. The jury found for the attorney. The defendants appealed, contending that intracorporate communications made during an internal employee evaluation and disciplinary process do not constitute a publication sufficient to support a defamation claim. According to the defendants, this was merely the corporation “communicating with itself.”

The Illinois Appellate Court affirmed the judgment against the corporation. While acknowledging that the states are split on this issue, the court stated that in Illinois a communication to any third party may constitute a publication for defamation purposes. This includes a communication by a corporation to its agent, employee or officer. Therefore, the termination memo sent to the vice president satisfied the element of publication. Furthermore, the fact that it was published in the course of an evaluation and disciplinary process did not change that fact.

North Carolina Court Reverses Award of Attorney's Fees to Shareholders

In In re Wachovia Shareholders' Litigation, No. COA04-402 (N.C. App., decided January 18, 2005) shareholders of a North Carolina corporation brought a class action seeking to block a merger by challenging two deal protection devices. The action was heard by the Special Superior Court for Complex Business Cases (the business court). The business court issued an order holding one of the devices invalid. The court also awarded the shareholders attorneys' fees based on the corporate benefit theory. That theory awards attorneys' fees where a common benefit is conferred upon an ascertainable shareholder class. The corporate benefit theory had been adopted by Delaware and some other states, but had not been previously adopted by North Carolina.

The North Carolina Court of Appeals reversed. The court pointed out that in a 1987 decision it denied an award of attorney's fees under the corporate benefit theory. The business court found that case distinguishable because it did not involve a class action or deal protection devices. The Court of Appeals, however, held that the 1987 decision was not distinguishable as the common benefit theory can be applied regardless of whether there is a class action and regardless of how the benefit was conferred. Thus, the appellate court held that despite the business court's reasoned arguments in favor of adopting this theory, it did not have the power to extend equitable exceptions to the state's jurisprudence when a prior panel had chosen not to do so.

This edition of the Quarterly State Compliance Review looks at some of the legislative enactments and court decisions of interest to corporate lawyers that occurred over the last 3 months. Included is a look at three new limited partnership acts, a Delaware decision granting shareholders access to a corporation's privileged communications, and an Illinois decision holding that an internal corporate memo could be the basis of a defamation action.

IN THE STATE LEGISLATURES

New Limited Partnership Laws in Illinois, Iowa, and Minnesota

Attorneys who form and advise limited partnerships should be aware that on Jan. 1, 2005, new limited partnership acts went into effect in Illinois, Iowa, and Minnesota. The Illinois limited partnership act was enacted by Senate Bill 2982, Iowa's by House File 2347 and Minnesota's by Senate Bill 1803. All three laws are based on the Uniform Limited Partnership Act of 2001 and govern such issues as formation, rights and liabilities of partners, contributions and distributions, transfers of interests, dissociation and dissolution, foreign limited partnerships, and mergers and conversions.

In all three states the new laws apply to limited partnerships formed on or after Jan. 1, 2005. However, as to existing limited partnerships, the Illinois law does not apply until Jan. 1, 2008, the Iowa law does not apply until Jan. 1, 2006, and the Minnesota law does not apply until Jan. 1, 2007. However, each state provides that an existing limited partnership may elect to be governed by the new law before those dates. Consequently, attorneys may wish to review these new laws to determine if it will benefit their clients to make such an election. This is particularly true if the client is one of the two types of limited partnerships the drafters of the Uniform Act targeted — sophisticated, manager-entrenched commercial deals whose participants commit for the long term, and family limited partnerships.

Other Amendments to Unincorporated Entity Laws

There were several other changes of interest to unincorporated entity laws effective on Jan. 1. Mississippi enacted the Uniform Partnership Act to govern its general and limited liability partnerships (Senate Bill 2504). Maryland imposed a $300 annual report fee on business trusts (Senate Bill 508). And Tennessee enacted the Tennessee Processing Cooperative Law, authorizing the formation of cooperatives to market and process agricultural products (Senate Bill 1161).

In addition, in California, Assembly Bill 3073 authorized a limited liability company to engage in not-for-profit activities and Assembly Bill 1859 allowed an LLC to file a certificate of cancellation without obtaining a tax clearance if it had not conducted business and the filing was made within 12 months of formation.

California and Kansas Amend Their Corporation Laws

There were also several bills amending corporation laws that went into effect on Jan. 1. One is California Senate Bill 1306. This bill authorized certain transactions and communications to be conducted by electronic transmission, including permitting shareholder meetings to be conducted by electronic transmission if the corporation provides shareholders with a reasonable opportunity to participate and vote and maintains a record of votes or actions taken.

In Kansas, Senate Bill 29 extensively revised that state's corporation law. The bill provided, among things, that a corporation has the power to renounce its interest, expectancy, or opportunity to participate in specified business opportunities, that a corporation may submit a matter to a stockholder vote even if the board of directors later determines that the matter is not advisable, that the board may authorize officers to designate officers and employees to receive rights or options, and that the board of directors may determine that a stockholder meeting will be held by means of remote communication.

2005 Legislative Sessions Begin

Another recent, notable legislative event is the 2005 legislative sessions beginning. A number of significant bills affecting business entities have already been introduced. One of these is New York Assembly Bill 2105, introduced on Jan. 24, which would impose penalties on corporations and other entities that issue audited financial statements in connection with which the auditor engaged in professional misconduct. Others include Michigan Senate Bills 114 and 115, introduced Feb. 1, which would permit conversions involving corporations and LLCs, and South Dakota Senate Bill 70, introduced Jan. 13, which would enact a new business corporation act. Also of interest is the fact that New York Senate Bill 5902, which would have required public disclosure of the names of the holders of the 10 most valuable interests in LLCs, LPs, and LLPs, was pocket vetoed on Jan. 30.

IN THE STATE COURTS

Delaware Court Compels Production of Privileged Documents

In In re Freeport-McMoRan Sulphur, Inc. Shareholder Litigation, C.A. No. 16729 (Del. Ch., decided Jan. 26, 2005) former shareholders of a corporation filed suit against the corporation and its former directors, alleging that the directors breached their fiduciary duties in approving a merger. The shareholders sought to compel production of documents contained in the defendants' privilege log. Most of the documents related to a previous lawsuit involving the corporation's parent. One document related to the corporation's shareholder repurchase plan. The shareholders sought production under the fiduciary duty exception to the attorney-client privilege. Under this exception, shareholders who enjoy a mutuality of interest with a corporation may obtain access to its confidential communications with counsel, if the shareholders can show good cause.

The Delaware Chancery Court held that the shareholders met their burden as to the documents related to the previous litigation because the shareholders showed that their fiduciary duty claim was colorable and that the documents were unavailable from other sources. They also identified the specific documents needed and explained how the documents related to their lawsuit. However, the court denied the motion to compel production of the document related to the shareholder repurchase plan because that document was created before the corporation issued public stock and before there was a fiduciary duty owed to the shareholders.

Delaware Court Upholds Subject Matter Jurisdiction in Suit Against Purported Officer

In Jacobson v. Ronsdorf, C.A. No. 518-N (Del. Ch., decided Jan. 6, 2005) a Delaware corporation and its largest shareholder filed an action in the Delaware Chancery Court seeking a declaratory judgment that the defendant was not an officer or director of the corporation, an injunction to prevent the defendant from acting on the corporation's behalf, specific performance of an agreement that required the defendant to sell his shares, and money damages. The defendant moved to dismiss claiming that the Chancery Court, as a court of equity, lacked subject matter jurisdiction.

The Delaware Chancery Court found that it had jurisdiction. The court noted that it has inherent and statutory authority to determine whether someone is an officer or director of a Delaware corporation, that injunctions and specific performance are equitable remedies, that money damages would not remedy the harm done, and that it has subject matter jurisdiction over equitable claims even if money damages are sought in addition to equitable remedies.

Illinois Court Upholds Defamation Claim Based on Internal Corporate Memo

In Popko v. Continental Casualty Company, No. 1-03-3389 (Ill. App., decided Jan. 21, 2005) the plaintiff worked as an attorney for the defendant corporation. Following a negative performance review, his supervisor sent a written memorandum to a corporate vice president indicating that the attorney engaged in a pattern of unacceptable conduct. The attorney was then fired. After his termination, he brought suit for defamation. The jury found for the attorney. The defendants appealed, contending that intracorporate communications made during an internal employee evaluation and disciplinary process do not constitute a publication sufficient to support a defamation claim. According to the defendants, this was merely the corporation “communicating with itself.”

The Illinois Appellate Court affirmed the judgment against the corporation. While acknowledging that the states are split on this issue, the court stated that in Illinois a communication to any third party may constitute a publication for defamation purposes. This includes a communication by a corporation to its agent, employee or officer. Therefore, the termination memo sent to the vice president satisfied the element of publication. Furthermore, the fact that it was published in the course of an evaluation and disciplinary process did not change that fact.

North Carolina Court Reverses Award of Attorney's Fees to Shareholders

In In re Wachovia Shareholders' Litigation, No. COA04-402 (N.C. App., decided January 18, 2005) shareholders of a North Carolina corporation brought a class action seeking to block a merger by challenging two deal protection devices. The action was heard by the Special Superior Court for Complex Business Cases (the business court). The business court issued an order holding one of the devices invalid. The court also awarded the shareholders attorneys' fees based on the corporate benefit theory. That theory awards attorneys' fees where a common benefit is conferred upon an ascertainable shareholder class. The corporate benefit theory had been adopted by Delaware and some other states, but had not been previously adopted by North Carolina.

The North Carolina Court of Appeals reversed. The court pointed out that in a 1987 decision it denied an award of attorney's fees under the corporate benefit theory. The business court found that case distinguishable because it did not involve a class action or deal protection devices. The Court of Appeals, however, held that the 1987 decision was not distinguishable as the common benefit theory can be applied regardless of whether there is a class action and regardless of how the benefit was conferred. Thus, the appellate court held that despite the business court's reasoned arguments in favor of adopting this theory, it did not have the power to extend equitable exceptions to the state's jurisprudence when a prior panel had chosen not to do so.