Quarterly State Compliance Review

At one time corporate attorneys had one type of statutory business entity to worry about — the corporation. Now there is also the LLC, LP, LLP, LLLP and others. The statutes authorizing and governing these business entities are continually being amended by the state legislatures and interpreted by the courts. This edition of the Quarterly State Compliance Review looks at some amendments that went into effect, and court decisions that were issued, during the last 3 months.

IN THE STATE LEGISLATURES

A significant number of amendments to business entity laws went into effect on Jan. 1, 2006. They include the following:

California

Senate Bill 119 amended the section of the California corporation law that allows an action to be taken by the board of directors without a meeting if all members of the board consent in writing. The bill stated that “all members of the board” includes an interested or common director who abstains in writing if a disclosure of the conflict is made to the noninterested or noncommon directors, who then approve the action by a vote that is sufficient for approval without counting the votes of the interested or common directors. The bill also provided that this amendment is repealed Jan. 1, 2011.

Senate Bill 702 added provisions to the California statutes relating to the governance of unincorporated associations. The new provisions deal with the termination or suspension of membership, member voting, amendments, merger and dissolution.

Assembly Bill 241 specified that upon a merger, the surviving business entity is deemed to have assumed the tax liability of the disappearing business entity, and authorized the Secretary of State to file the certificate of merger without a certificate of satisfaction from the Franchise Tax Board if the survivor is a corporation, LLC, or LLP. Formerly, the law referred to surviving and disappearing corporations, rather than to any business entity.

Illinois

Senate Bill 468 amended the reinstatement provisions of Illinois' corporation and LLC laws to repeal the 5-years-from-the-date-of-dissolution limitation on when administratively dissolved corporations and LLCs may apply for reinstatement.

New York

Assembly Bill 1794 amended the New York laws governing business corporations, not for profit corporations, LLCs, and LPs to prohibit the names of those entities from containing certain specified words that imply an education related purpose, unless the consent of the Commissioner of Education is endorsed on or annexed to the formation document.

Texas

House Bill 1156, Laws of 2003, as amended by House Bill 1319, Laws of 2005 enacted the Business Organi-zations Code (BOC). The BOC governs all entities formed and registered in Texas including corporations, LLCs, LPs, LLPs, LLLPs, non-profit and professional entities. The legislature's main intent in enacting the BOC was to rearrange the business entity statutes in a more logical order and eliminate duplicative, obsolete or ineffective provisions. There were also some substantive changes made, mainly dealing with filings, foreign registrations, and reinstatement. Entities formed or registered on or after Jan. 1, 2006, are subject to and must comply with the BOC. Entities formed or registered before Jan. 1, 2006 are not subject to the BOC until Jan. 1, 2010 unless they voluntarily elect to adopt the BOC.

Other Amendments to State Business Entity Laws

In Florida, Senate Bill 1056 enacted a new LP Act, based on the Uniform Limited Partnership Act (2001). The new LP Act applies to LPs formed or registered on or after Jan. 1, 2006 and to existing LPs that elect to be governed by the Act. It applies to all LPs on Jan. 1, 2007. In Tennessee, House Bill 1121 enacted a Revised LLC Act, reorganizing and simplifying the state's LLC law and enacting various substantive changes including allowing oral operating agreements, series LLCs, and family LLCs. In Oregon, House Bill 3324 provided that an Oregon bank or trust company may be organized as an LLC, and that a corporate bank or trust company may convert to an LLC. And in Michigan, Senate Bills 298 and 664 revised the fees payable by corporations upon organization and upon an increase in authorized shares and revised the expedited fees for filing corporate documents.

IN THE STATE COURTS

DE Chancery Court Interprets LLC Agreement As Not Requiring Arbitration

In Willie Gary LLC v. James & Jackson LLC, C.A. No. 1781, decided Jan. 10, 2006, the plaintiff, a member of a Delaware LLC, brought suit against the defendant, the other member, seeking an injunction to remedy an alleged breach of the LLC agreement and specific performance of an alleged promise to guarantee a debt. In the alternative, the plaintiff sought dissolution of the LLC. The defendant moved to dismiss on the grounds that the LLC agreement required arbitration of the plaintiff's claims.

The Delaware Chancery Court denied the motion to dismiss, holding that the LLC agreement contemplated the arbitration of claims while reserving to members the opportunity to seek judicial relief. The court first held that the issue of whether the claims had to be arbitrated had to be decided by the Chancery Court, and not the arbitrator, as the LLC agreement did not contain language reflecting a clear and unmistakable intent to have disputes about arbitrability thus arbitrated. The court then pointed out that the LLC agreement stated that a member shall be entitled to injunctive relief to prevent breaches of the agreement and to enforce any of its terms in any action instituted in any court with subject matter jurisdiction. In addition, the LLC agreement clearly contemplated judicial involvement in the dissolution process. Thus, the plaintiff was merely doing what the LLC agreement gave it the right to do by pressing its claims in the Chancery Court.

CA Appellate Court Holds That Insurer May Not Defend Action on Suspended Corporation's Behalf

In Kaufman & Broad Communities, Inc. v. Performance Plastering, Inc., CO49391 (3d A.D.) decided Jan. 31, 2006, a complaint was filed against a California corporation whose corporate powers had been suspended for failure to pay taxes. The corporation's insurer hired a law firm to answer the complaint. The answer designated the responding party as the corporation. The complaint was voluntarily dismissed and the law firm sought attorney's fees and costs. The trial court denied its request on the grounds that neither the insurer nor the corporation had standing. The law firm filed a notice of appeal.

The California Court of Appeal dismissed the appeal. The court noted that under California law a suspended corporation may not sue or defend a lawsuit. In addition, an insurer may not use the name of a suspended corporation to continue litigation. The court rejected the insurer's argument that it could defend the action based on a section of law that exempted insurers from the penalty imposed on anyone attempting to exercise the powers or rights of a suspended corporation. The court held that this section was not intended to authorize insurers to defend litigation in the name of the suspended corporation. Instead, it allows the insurers to intervene in the lawsuit and assert any defenses on behalf of the suspended insured corporation.

NV Supreme Court Holds That Buyout Was Not an Appropriate Remedy

In Bedore v. Familian, 122 Nev. Adv. Rep. 2, decided Jan. 19, 2006, the plaintiff, a shareholder in a Nevada corporation, brought a lawsuit against the corporation's other shareholders and directors, alleging that they breached their fiduciary duties by taking excessive salaries and usurping a corporate opportunity. The trial court ordered the return of the excessive salaries, issued an injunction to prevent the defendants from taking the corporate opportunity and ordered a corporate buyout. The court also denied the plaintiff's motion for an order directing the defendants to reimburse the corporation for the costs and attorney's fees paid for the defendants' defense.

The Nevada Supreme Court held that although a trial court has the power to order a corporate buyout even in the absence of statutory authority, this power was not appropriately exercised in this case. The reasons included that: 1) the defendants' conduct was not found to amount to fraud or gross mismanagement; 2) the trial court's order of the return of the excess salaries and the injunction were sufficient to protect the corporation; 3) the dissension among the shareholders did not threaten irreparable harm to the corporation; and 4) the plaintiff did not request dissolution. However, the court also held that because the defendants' actions constituted bad faith and intentional misconduct, they were not entitled to indemnification under either the Nevada corporation law, the corporation's articles of incorporation or its bylaws.

At one time corporate attorneys had one type of statutory business entity to worry about — the corporation. Now there is also the LLC, LP, LLP, LLLP and others. The statutes authorizing and governing these business entities are continually being amended by the state legislatures and interpreted by the courts. This edition of the Quarterly State Compliance Review looks at some amendments that went into effect, and court decisions that were issued, during the last 3 months.

IN THE STATE LEGISLATURES

A significant number of amendments to business entity laws went into effect on Jan. 1, 2006. They include the following:

California

Senate Bill 119 amended the section of the California corporation law that allows an action to be taken by the board of directors without a meeting if all members of the board consent in writing. The bill stated that “all members of the board” includes an interested or common director who abstains in writing if a disclosure of the conflict is made to the noninterested or noncommon directors, who then approve the action by a vote that is sufficient for approval without counting the votes of the interested or common directors. The bill also provided that this amendment is repealed Jan. 1, 2011.

Senate Bill 702 added provisions to the California statutes relating to the governance of unincorporated associations. The new provisions deal with the termination or suspension of membership, member voting, amendments, merger and dissolution.

Assembly Bill 241 specified that upon a merger, the surviving business entity is deemed to have assumed the tax liability of the disappearing business entity, and authorized the Secretary of State to file the certificate of merger without a certificate of satisfaction from the Franchise Tax Board if the survivor is a corporation, LLC, or LLP. Formerly, the law referred to surviving and disappearing corporations, rather than to any business entity.

Illinois

Senate Bill 468 amended the reinstatement provisions of Illinois' corporation and LLC laws to repeal the 5-years-from-the-date-of-dissolution limitation on when administratively dissolved corporations and LLCs may apply for reinstatement.

New York

Assembly Bill 1794 amended the New York laws governing business corporations, not for profit corporations, LLCs, and LPs to prohibit the names of those entities from containing certain specified words that imply an education related purpose, unless the consent of the Commissioner of Education is endorsed on or annexed to the formation document.

Texas

House Bill 1156, Laws of 2003, as amended by House Bill 1319, Laws of 2005 enacted the Business Organi-zations Code (BOC). The BOC governs all entities formed and registered in Texas including corporations, LLCs, LPs, LLPs, LLLPs, non-profit and professional entities. The legislature's main intent in enacting the BOC was to rearrange the business entity statutes in a more logical order and eliminate duplicative, obsolete or ineffective provisions. There were also some substantive changes made, mainly dealing with filings, foreign registrations, and reinstatement. Entities formed or registered on or after Jan. 1, 2006, are subject to and must comply with the BOC. Entities formed or registered before Jan. 1, 2006 are not subject to the BOC until Jan. 1, 2010 unless they voluntarily elect to adopt the BOC.

Other Amendments to State Business Entity Laws

In Florida, Senate Bill 1056 enacted a new LP Act, based on the Uniform Limited Partnership Act (2001). The new LP Act applies to LPs formed or registered on or after Jan. 1, 2006 and to existing LPs that elect to be governed by the Act. It applies to all LPs on Jan. 1, 2007. In Tennessee, House Bill 1121 enacted a Revised LLC Act, reorganizing and simplifying the state's LLC law and enacting various substantive changes including allowing oral operating agreements, series LLCs, and family LLCs. In Oregon, House Bill 3324 provided that an Oregon bank or trust company may be organized as an LLC, and that a corporate bank or trust company may convert to an LLC. And in Michigan, Senate Bills 298 and 664 revised the fees payable by corporations upon organization and upon an increase in authorized shares and revised the expedited fees for filing corporate documents.

IN THE STATE COURTS

DE Chancery Court Interprets LLC Agreement As Not Requiring Arbitration

In Willie Gary LLC v. James & Jackson LLC, C.A. No. 1781, decided Jan. 10, 2006, the plaintiff, a member of a Delaware LLC, brought suit against the defendant, the other member, seeking an injunction to remedy an alleged breach of the LLC agreement and specific performance of an alleged promise to guarantee a debt. In the alternative, the plaintiff sought dissolution of the LLC. The defendant moved to dismiss on the grounds that the LLC agreement required arbitration of the plaintiff's claims.

The Delaware Chancery Court denied the motion to dismiss, holding that the LLC agreement contemplated the arbitration of claims while reserving to members the opportunity to seek judicial relief. The court first held that the issue of whether the claims had to be arbitrated had to be decided by the Chancery Court, and not the arbitrator, as the LLC agreement did not contain language reflecting a clear and unmistakable intent to have disputes about arbitrability thus arbitrated. The court then pointed out that the LLC agreement stated that a member shall be entitled to injunctive relief to prevent breaches of the agreement and to enforce any of its terms in any action instituted in any court with subject matter jurisdiction. In addition, the LLC agreement clearly contemplated judicial involvement in the dissolution process. Thus, the plaintiff was merely doing what the LLC agreement gave it the right to do by pressing its claims in the Chancery Court.

CA Appellate Court Holds That Insurer May Not Defend Action on Suspended Corporation's Behalf

In Kaufman & Broad Communities, Inc. v. Performance Plastering, Inc., CO49391 (3d A.D.) decided Jan. 31, 2006, a complaint was filed against a California corporation whose corporate powers had been suspended for failure to pay taxes. The corporation's insurer hired a law firm to answer the complaint. The answer designated the responding party as the corporation. The complaint was voluntarily dismissed and the law firm sought attorney's fees and costs. The trial court denied its request on the grounds that neither the insurer nor the corporation had standing. The law firm filed a notice of appeal.

The California Court of Appeal dismissed the appeal. The court noted that under California law a suspended corporation may not sue or defend a lawsuit. In addition, an insurer may not use the name of a suspended corporation to continue litigation. The court rejected the insurer's argument that it could defend the action based on a section of law that exempted insurers from the penalty imposed on anyone attempting to exercise the powers or rights of a suspended corporation. The court held that this section was not intended to authorize insurers to defend litigation in the name of the suspended corporation. Instead, it allows the insurers to intervene in the lawsuit and assert any defenses on behalf of the suspended insured corporation.

NV Supreme Court Holds That Buyout Was Not an Appropriate Remedy

In Bedore v. Familian , 122 Nev. Adv. Rep. 2, decided Jan. 19, 2006, the plaintiff, a shareholder in a Nevada corporation, brought a lawsuit against the corporation's other shareholders and directors, alleging that they breached their fiduciary duties by taking excessive salaries and usurping a corporate opportunity. The trial court ordered the return of the excessive salaries, issued an injunction to prevent the defendants from taking the corporate opportunity and ordered a corporate buyout. The court also denied the plaintiff's motion for an order directing the defendants to reimburse the corporation for the costs and attorney's fees paid for the defendants' defense.

The Nevada Supreme Court held that although a trial court has the power to order a corporate buyout even in the absence of statutory authority, this power was not appropriately exercised in this case. The reasons included that: 1) the defendants' conduct was not found to amount to fraud or gross mismanagement; 2) the trial court's order of the return of the excess salaries and the injunction were sufficient to protect the corporation; 3) the dissension among the shareholders did not threaten irreparable harm to the corporation; and 4) the plaintiff did not request dissolution. However, the court also held that because the defendants' actions constituted bad faith and intentional misconduct, they were not entitled to indemnification under either the Nevada corporation law, the corporation's articles of incorporation or its bylaws.