Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect during a very active summer of 2005. This edition also examines three recent Delaware Chancery Court decisions dealing with the increasingly important statutory right to inspect books and records.

IN THE STATE LEGISLATURES

Delaware

Delaware has amended its General Corporation Law and Limited Liability Company Act. There are approximately 600,000 Delaware corporations and LLCs. On Aug. 1, amendments to the laws governing those entities went into effect. The amendments to the General Corpor-ation Law were enacted by House Bill 150. One of the key provisions of H.B. 150 is an amendment to Sec. 158 that eliminates the requirement that a corporation provide a stock certificate to a holder of uncertificated shares upon the holder's request. Sec. 271 was amended to provide that stockholder approval is not required for a sale, lease or exchange of the property and assets of a corporation to a wholly owned and controlled subsidiary, except to the extent the certificate of incorporation otherwise provides, and to clarify that for the purposes of Sec. 271 only, the property and assets of a corporation include the property and assets of a wholly owned and controlled subsidiary. (Sec. 271 provides that a corporation may, at a meeting of its board of directors sell, lease, or exchange all or substantially all of its property and assets if authorized by a resolution adopted by its stockholders.)

H.B. 150 also amended the General Corporation Law's conversion and domestication provisions. Delaware corporations may now convert to corporations and unincorporated entities formed under the laws of other states, and corporations and unincorporated entities formed under the laws of other states may now convert to a Delaware corporation. In addition, an unincorporated entity formed under the laws of a non-United States jurisdiction may domesticate as a Delaware corporation and a Delaware corporation may domesticate or continue as a non-United States unincorporated entity. (Formerly, the conversion provisions did not include non-Delaware entities and the domestication provisions did not include unincorporated entities.)

The amendments to the Delaware Limited Liability Company Act were enacted by Senate Bill 86. Highlights include an amendment to Sec. 18-101 to provide that members, managers, and assignees are bound by the LLC agreement whether or not they executed it, and to Sec. 18-106 to remove the prohibition against an LLC being in the business of granting insurance policies or assuming insurance risks.

Sec. 18-406 was amended to extend to liquidating trustees protection from liability when relying on certain reports and information. In addition, Sec. 18-703 was amended to state that to the extent a member's LLC interest has been subjected to a charging order, the judgment creditor has only the right to receive any distribution to which the judgment debtor would otherwise have been entitled in respect of that interest. Also, a new Sec. 18-806 was added allowing an LLC to revoke a dissolution under certain conditions.

Rhode Island; South Dakota

Attorneys advising companies incorporated or doing business in Rhode Island and South Dakota should be aware that on July 1, new business corporation acts went into effect in both states. The previous corporation laws were repealed as of July 1 and all domestic and foreign corporations became subject to the new laws on that date.

Rhode Island

The new Rhode Island Business Corporation Act was enacted by House Bill 7945/Senate Bill 2726 and was further amended by House Bill 5750/Senate Bill 791 and House Bill 5881/Senate Bill 822. The new law has been codified at Sec. 7-1.2-101 et seq. The new law adopts a more modern approach to the financial provisions, no longer referring to such concepts as stated capital, surplus and treasury shares. It also authorizes the issuance of shares for future consideration and provides that shareholders in corporations formed under the new law do not have preemptive rights unless the articles of incorporation so provide.

South Dakota

The new South Dakota Business Corporation Act was enacted by Senate Bill 70. The new law has been codified at Sec. 47-1A-101 et seq. The new law contains expanded provisions on indemnification, director conflict transactions, derivative suits and fundamental change transactions, and eliminates the requirement that a corporation not commence business until receiving $1000 in consideration.

Other Amendments to Business Entity Laws

Several other states recently amended their corporation and unincorporated entity laws.

Iowa

Iowa enacted the Iowa Cooperative Associations Act, providing for the formation and qualification of cooperative associations (H.B. 859, effective July 1).

Maine

Maine increased the penalty for the late filing of an annual report (H.B. 343, effective July 1).

North Dakota

North Dakota authorized corporations and other organizations to enter into statutory conversions (H.B. 1391, effective Aug. 1.)

Texas

Texas amended its Business Corporation Act to provide, among other things, that a shareholder must submit a written request to a corporation that an annual meeting be held before applying for a court-ordered meeting, that in computing the fair value of the shares of dissenting shareholders, consideration must be given to the value of the corporation as a going concern without including a control premium or minority discount, and that after the adoption of a resolution to dissolve, but before filing articles of dissolution, a corporation may continue its business for the period necessary to avoid unreasonable loss of property or business (H.B. 1507, effective Sept. 1).

Virginia

Virginia amended its Stock Corporation Act to provide, among other things, that notice by electronic transmission is allowed, that shareholders of a corporation incorporated after Dec. 31, 2005 do not have preemptive rights unless they are granted by the articles of incorporation, that the board of directors may appoint alternate committee members, and that directors have a statutory right of inspection (S.B. 1228, effective July 1).

Wyoming

Wyoming authorized annual shareholders' meetings to be held by means of remote communication (H.B. 16, effective July 1).

IN THE STATE COURTS

Delaware Chancery Court Examines and Clarifies Right to Inspect Books and Records

Since the corporate accounting scandals, the statutory right to inspect books and records has gained increased importance as a method of detecting mismanagement. In three recent decisions, the Delaware Chancery Court examined and clarified various issues involving this right.

In Deephaven Risk ARB Trading Ltd. v. UnitedGlobalCom, Inc., C.A. No. 379-N, decided July 13, 2005, a principal issue was whether a “short seller” is a stockholder for the purposes of Sec. 220 of the corporation law (the inspection section). The plaintiff traded in the defendant's stock, using several brokerage accounts. The plaintiff borrowed the defendant's shares in one of its accounts with the intention of short selling them to itself in another account. The plaintiff consistently held a long position in its brokerage account with Barclays. However, the plaintiff's net position across all of its accounts was several million shares short. According to the defendant, because of the plaintiff's net position, it did not own any of the defendant's shares and lacked standing to inspect its books and records.

The Delaware Chancery Court disagreed, finding no authority for the proposition that if an investor simultaneously holds a long position in a security and a larger short position, the investor does not own the shares held long. The court noted that once the plaintiff paid for the shares in its Barclay's account it had all the rights of ownership.

The defendant also contended that a merger it entered into on June 15, 2005 mooted the action. The Chancery Court disagreed, stating that a merger after the commencement of a Sec. 220 action does not nullify a plaintiff's standing, and also noting that the plaintiff's dispute with the defendants continued despite the merger.

In Forsythe v. CIBC Employee Private Equity Fund (U.S.) I L.P., C.A. No. 657-N, decided July 7, 2005, an inspection was sought by unitholders in a Delaware limited partnership. The LP was created by the plaintiffs' employer as a “co-invest” fund. The employer would make certain investments and then the LP could make the same investment. The plaintiffs requested certain documents created by the employer, such as copies of all materials the employer's investment committee used in making investment decisions.

The Chancery Court held that the plaintiffs could not inspect these documents. The court noted that as a general rule unitholders are only entitled to inspect the books and records of the LP in which they own units. Here, the documents sought were created by the employer, the LP was not a party to them, and the LP did not use the information contained in them. Therefore, the documents did not belong to the LP. The plaintiffs also argued that the LP was the employer's alter ego. The court disagreed, noting that the LP was run by a general partner was that independent from the employer, that they had different addresses, and that there was no showing of fraud or injustice.

In Romero v. Career Education Corporation, C.A. No. 793-N, decided July 19, 2005, a main issue was whether an action to compel an inspection of the books and records of a corporation that was the subject of a federal securities class action is preempted by the Private Securities Litigation Reform Act (PSLRA) or the Securities Litigation Uniform Standards Act (SLUSA). PSLRA provides for automatic discovery stays while a motion to dismiss a federal securities action is pending. SLUSA prevents plaintiffs from using state court actions to evade PSLRA discovery stays.

The Chancery Court held that neither act automatically preempts a shareholder's action to compel an inspection. The action may be preempted if the shareholder's intention was to evade the discovery stay. However, this must be determined on a case by case basis. In this case, where the plaintiff alleged breach of fiduciary duty claims under Delaware law that were different from the claims in the federal securities action, and where the plaintiff was not involved in the federal action, the court was not convinced that the plaintiff was seeking to evade the discovery stay in the federal action. Therefore, the defendant's motion to dismiss or stay the inspection action was denied.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT Corporation (www.CTAdvantage.com), a provider of compliance and governance workflow tools and services to corporate legal departments and the law firms that serve them; and a Wolters Kluwer company.

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect during a very active summer of 2005. This edition also examines three recent Delaware Chancery Court decisions dealing with the increasingly important statutory right to inspect books and records.

IN THE STATE LEGISLATURES

Delaware

Delaware has amended its General Corporation Law and Limited Liability Company Act. There are approximately 600,000 Delaware corporations and LLCs. On Aug. 1, amendments to the laws governing those entities went into effect. The amendments to the General Corpor-ation Law were enacted by House Bill 150. One of the key provisions of H.B. 150 is an amendment to Sec. 158 that eliminates the requirement that a corporation provide a stock certificate to a holder of uncertificated shares upon the holder's request. Sec. 271 was amended to provide that stockholder approval is not required for a sale, lease or exchange of the property and assets of a corporation to a wholly owned and controlled subsidiary, except to the extent the certificate of incorporation otherwise provides, and to clarify that for the purposes of Sec. 271 only, the property and assets of a corporation include the property and assets of a wholly owned and controlled subsidiary. (Sec. 271 provides that a corporation may, at a meeting of its board of directors sell, lease, or exchange all or substantially all of its property and assets if authorized by a resolution adopted by its stockholders.)

H.B. 150 also amended the General Corporation Law's conversion and domestication provisions. Delaware corporations may now convert to corporations and unincorporated entities formed under the laws of other states, and corporations and unincorporated entities formed under the laws of other states may now convert to a Delaware corporation. In addition, an unincorporated entity formed under the laws of a non-United States jurisdiction may domesticate as a Delaware corporation and a Delaware corporation may domesticate or continue as a non-United States unincorporated entity. (Formerly, the conversion provisions did not include non-Delaware entities and the domestication provisions did not include unincorporated entities.)

The amendments to the Delaware Limited Liability Company Act were enacted by Senate Bill 86. Highlights include an amendment to Sec. 18-101 to provide that members, managers, and assignees are bound by the LLC agreement whether or not they executed it, and to Sec. 18-106 to remove the prohibition against an LLC being in the business of granting insurance policies or assuming insurance risks.

Sec. 18-406 was amended to extend to liquidating trustees protection from liability when relying on certain reports and information. In addition, Sec. 18-703 was amended to state that to the extent a member's LLC interest has been subjected to a charging order, the judgment creditor has only the right to receive any distribution to which the judgment debtor would otherwise have been entitled in respect of that interest. Also, a new Sec. 18-806 was added allowing an LLC to revoke a dissolution under certain conditions.

Rhode Island; South Dakota

Attorneys advising companies incorporated or doing business in Rhode Island and South Dakota should be aware that on July 1, new business corporation acts went into effect in both states. The previous corporation laws were repealed as of July 1 and all domestic and foreign corporations became subject to the new laws on that date.

Rhode Island

The new Rhode Island Business Corporation Act was enacted by House Bill 7945/Senate Bill 2726 and was further amended by House Bill 5750/Senate Bill 791 and House Bill 5881/Senate Bill 822. The new law has been codified at Sec. 7-1.2-101 et seq. The new law adopts a more modern approach to the financial provisions, no longer referring to such concepts as stated capital, surplus and treasury shares. It also authorizes the issuance of shares for future consideration and provides that shareholders in corporations formed under the new law do not have preemptive rights unless the articles of incorporation so provide.

South Dakota

The new South Dakota Business Corporation Act was enacted by Senate Bill 70. The new law has been codified at Sec. 47-1A-101 et seq. The new law contains expanded provisions on indemnification, director conflict transactions, derivative suits and fundamental change transactions, and eliminates the requirement that a corporation not commence business until receiving $1000 in consideration.

Other Amendments to Business Entity Laws

Several other states recently amended their corporation and unincorporated entity laws.

Iowa

Iowa enacted the Iowa Cooperative Associations Act, providing for the formation and qualification of cooperative associations (H.B. 859, effective July 1).

Maine

Maine increased the penalty for the late filing of an annual report (H.B. 343, effective July 1).

North Dakota

North Dakota authorized corporations and other organizations to enter into statutory conversions (H.B. 1391, effective Aug. 1.)

Texas

Texas amended its Business Corporation Act to provide, among other things, that a shareholder must submit a written request to a corporation that an annual meeting be held before applying for a court-ordered meeting, that in computing the fair value of the shares of dissenting shareholders, consideration must be given to the value of the corporation as a going concern without including a control premium or minority discount, and that after the adoption of a resolution to dissolve, but before filing articles of dissolution, a corporation may continue its business for the period necessary to avoid unreasonable loss of property or business (H.B. 1507, effective Sept. 1).

Virginia

Virginia amended its Stock Corporation Act to provide, among other things, that notice by electronic transmission is allowed, that shareholders of a corporation incorporated after Dec. 31, 2005 do not have preemptive rights unless they are granted by the articles of incorporation, that the board of directors may appoint alternate committee members, and that directors have a statutory right of inspection (S.B. 1228, effective July 1).

Wyoming

Wyoming authorized annual shareholders' meetings to be held by means of remote communication (H.B. 16, effective July 1).

IN THE STATE COURTS

Delaware Chancery Court Examines and Clarifies Right to Inspect Books and Records

Since the corporate accounting scandals, the statutory right to inspect books and records has gained increased importance as a method of detecting mismanagement. In three recent decisions, the Delaware Chancery Court examined and clarified various issues involving this right.

In Deephaven Risk ARB Trading Ltd. v. UnitedGlobalCom, Inc., C.A. No. 379-N, decided July 13, 2005, a principal issue was whether a “short seller” is a stockholder for the purposes of Sec. 220 of the corporation law (the inspection section). The plaintiff traded in the defendant's stock, using several brokerage accounts. The plaintiff borrowed the defendant's shares in one of its accounts with the intention of short selling them to itself in another account. The plaintiff consistently held a long position in its brokerage account with Barclays. However, the plaintiff's net position across all of its accounts was several million shares short. According to the defendant, because of the plaintiff's net position, it did not own any of the defendant's shares and lacked standing to inspect its books and records.

The Delaware Chancery Court disagreed, finding no authority for the proposition that if an investor simultaneously holds a long position in a security and a larger short position, the investor does not own the shares held long. The court noted that once the plaintiff paid for the shares in its Barclay's account it had all the rights of ownership.

The defendant also contended that a merger it entered into on June 15, 2005 mooted the action. The Chancery Court disagreed, stating that a merger after the commencement of a Sec. 220 action does not nullify a plaintiff's standing, and also noting that the plaintiff's dispute with the defendants continued despite the merger.

In Forsythe v. CIBC Employee Private Equity Fund (U.S.) I L.P., C.A. No. 657-N, decided July 7, 2005, an inspection was sought by unitholders in a Delaware limited partnership. The LP was created by the plaintiffs' employer as a “co-invest” fund. The employer would make certain investments and then the LP could make the same investment. The plaintiffs requested certain documents created by the employer, such as copies of all materials the employer's investment committee used in making investment decisions.

The Chancery Court held that the plaintiffs could not inspect these documents. The court noted that as a general rule unitholders are only entitled to inspect the books and records of the LP in which they own units. Here, the documents sought were created by the employer, the LP was not a party to them, and the LP did not use the information contained in them. Therefore, the documents did not belong to the LP. The plaintiffs also argued that the LP was the employer's alter ego. The court disagreed, noting that the LP was run by a general partner was that independent from the employer, that they had different addresses, and that there was no showing of fraud or injustice.

In Romero v. Career Education Corporation, C.A. No. 793-N, decided July 19, 2005, a main issue was whether an action to compel an inspection of the books and records of a corporation that was the subject of a federal securities class action is preempted by the Private Securities Litigation Reform Act (PSLRA) or the Securities Litigation Uniform Standards Act (SLUSA). PSLRA provides for automatic discovery stays while a motion to dismiss a federal securities action is pending. SLUSA prevents plaintiffs from using state court actions to evade PSLRA discovery stays.

The Chancery Court held that neither act automatically preempts a shareholder's action to compel an inspection. The action may be preempted if the shareholder's intention was to evade the discovery stay. However, this must be determined on a case by case basis. In this case, where the plaintiff alleged breach of fiduciary duty claims under Delaware law that were different from the claims in the federal securities action, and where the plaintiff was not involved in the federal action, the court was not convinced that the plaintiff was seeking to evade the discovery stay in the federal action. Therefore, the defendant's motion to dismiss or stay the inspection action was denied.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT Corporation (www.CTAdvantage.com), a provider of compliance and governance workflow tools and services to corporate legal departments and the law firms that serve them; and a Wolters Kluwer company.