Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at some amendments to state business entity laws that went into effect, and court decisions dealing with business entities that were issued, during the last three months. Included are several amendments to New York's business entity laws, including changes to its publication requirement. Also included are Delaware Chancery Court decisions dealing with indemnification and hedge funds.

IN THE STATE LEGISLATURES

New York

Senate Bill 85-A, effective June 1, revised the publication requirement found in New York's LLC, LP and LLP laws. The bill requires publication of a copy of the formation document of a domestic entity and the registration document of a foreign entity, or a notice containing the substance thereof, once a week for 4 (formerly 6) successive weeks. The bill also provides that the notice must set forth the names of the 10 persons who are actively engaged in the business and who have the most valuable interests. If proof of publication is not filed with the Department of State within 120 days after formation or registration, the entity's authority to carry on business will be suspended. At any time after suspension, if the entity causes proof to be filed, the suspension will be annulled. (Previously, the penalty for failure to file proof of publication was that the entity could not maintain an action in the state's courts.) The suspension penalty also applies to entities formed or registered before June 1, 2006 that did not comply with the publication requirement in effect when it was formed or registered. These entities have until Dec. 1, 2007 to cure their noncompliance. Entities formed or registered before 1999 are deemed to be in compliance.

It should be noted that Senate Bill 6831 and Assembly Bill 10399 were introduced in the legislature. If enacted, these bills would make the following changes: 1) publication would be required for 6 weeks instead of 4; 2) the names of the 10 persons who have the most valuable interests would not have to be set forth; 3) the penalty for failure to comply would be personal liability for members, limited partners, and general partners of LLPs; and 4) entities formed or registered after Jan. 1, 1999 and before June 1, 2006 would have to comply by Oct. 1, 2006.

Also in New York, Assembly Bill 9558-B/Senate Bill 6458-C, effective April 12, amended the business corporation and not-for-profit corporation laws to require corporations that establish or operate child care centers to provide the office of Children and Family Services with a certified copy of their certificate of incorporation or application for authority (and certain post-incorporation or registration filings) within 30 days of filing the documents with the Department of State. Assembly Bill 9559-B/Senate Bill 6459-C extended authorization for the Department of State to offer full expedited service for business entity filings and document orders. Authorization for same day, 2 hour and most 24-hour services were scheduled to expire March 31. In addition, effective April 8, Assembly Bill 5238 amended the not-for-profit corporation law to authorize a court to dispense with quorum requirements under certain circumstances, to revise dissolution procedures, and to provide for the administrative dissolution of certain charitable corporations that fail to file financial reports.

MAINE AND SOUTH CAROLINA

In Maine, Legislative Document 2034, effective April 4, provided that a corporation without capital stock organized under Title 13 of the Maine Statutes may enter into a merger or consolidation with a corporation organized under the Maine Nonprofit Corporation Act (Title 13-B). In South Carolina, House Bill 3196, effective April 8, provided that the members of nonprofit corporations may act without a meeting if a corporation delivers either a written or an electronic ballot. (Formerly, written only).

UTAH

In Utah, several bills went into effect on May 1 that revised the state's business entity laws. House Bill 127 permitted the formation of a Series LLC. The bill provided that if certain requirements are met, none of the debts or liabilities of any series will be enforceable against the assets of another series or the LLC itself. Senate Bill 137 provided that documents filed by corporations with the Division of Corporations and Commercial Code may be signed by an attorney-in-fact. It also provided that a claim brought against a dissolved corporation that does not publish notice of its dissolution is barred unless an action is commenced within 7 years after the dissolution. Senate Bill 84 amended the nonprofit corporation law to revise the provisions governing derivative suits, to require a nonprofit corporation without voting members to hold an annual directors' meeting unless the bylaws provide otherwise, and to clarify when a director or officer may be held liable to the corporation or its members for a breach of duties.

WASHINGTON

In Washington, several bills amending the state's business entity laws were enacted. Each bill has an effective date of June 7. Senate Bill 6596 amended provisions governing the dissolution of corporations, the liability of shareholders who receive illegal distributions, and the procedures for disposing of claims. Senate Bill 6463 permitted a bank or a bank holding company to be organized as an LLC. Senate Bill 6531 provided that the dissolution of an LLC does not take away or impair any remedy available against the LLC or its managers or members unless an action is not commenced within 3 years after the effective date of dissolution.

IN THE STATE COURTS

Delaware Chancery Court Holds That Hedge Fund Is Adequate Class Representative

In Regal Entertainment Group v. Amaranth LLC, C.A. No. 1226-N (Del. Ch. Ct.), decided April 12, 2006, the plaintiff was the issuer of a series of convertible notes. The defendant, one of the largest holders of notes, publicly disputed the plaintiff's method for calculating the number of shares of common stock noteholders would receive upon conversion. The plaintiff filed suit seeking a declaration that its calculation was correct. The plaintiff moved for certification of a defendant class. The defendant refused to assent to serving as class representative.

The defendant first argued that it was not an adequate representative because, as a hedge fund, it had a fiduciary obligation to sell its notes if that was in its investors' best interests. The Delaware Chancery Court rejected that argument, stating that the fact that the defendant might sell the notes did not distinguish it from any other type of investor that serves as a class representative. The court also found that the defendant was well positioned to act as the class representative considering that it owned a large position in the notes and that the plaintiff filed the action because the defendant publicly contested its formula.

The defendant also argued that because of its complex investment position and the fact that it owned common stock in the plaintiff and swap agreements in the notes, it was not typical of the defendant class. The court disagreed, pointing out that the defendant's position regarding the conversion formula was typical and aligned with the interests of all noteholders. Thus, the motion for class certification was granted.

Delaware Chancery Court Allows Former Directors to Proceed with Indemnification Claim

In Levy v. Hayes Lemmerz International, Inc., C.A. No. 1395-N (Del. Ch. Ct.), decided April 5, 2006, former directors of a public corporation brought an action seeking indemnification of their expenses in settling an action brought against them by stockholders and bondholders after it was revealed that the corporation's financial statements contained materially misleading information.

The Delaware Chancery Court denied the corporation's motion to dismiss. One of the corporation's arguments was based on a clause in the indemnification agreement stating that the corporation would provide indemnification as permitted by law 'as soon as practicable, but in any event, no later than thirty days after written demand is presented.' According to the corporation, that clause required the plaintiffs to present it with a written demand and wait 30 days to file suit ' which they did not do. However, the court disagreed with this interpretation. Instead, it held that the clause required the corporation to respond as soon as practicable and allowed ' but did not require ' those requesting indemnification to put the corporation on the clock by issuing a written demand. According to the court, that interpretation was consistent with the way Delaware courts have interpreted similar clauses and with the indemnification agreement's stated purpose of protecting those seeking indemnification.

The court also denied the corporation's motion to stay the proceeding until the statute of limitations for actions by the S.E.C. had run. The court noted that both the bylaws and indemnification agreement promised indemnification in civil and criminal actions, thus clearly implying that a party may be indemnified for a civil action and then seek indemnification for a later criminal action if it arises.

New York Appellate Division Holds That Filing Action for Involuntary Dissolution Triggers Buyout

In Johnsen v. ACP Distribution, Inc., 2006 N.Y. Slip Op. 3176 (A.D. 1 Dept.), decided April 27, 2006, the issue was whether the filing of an action for involuntary dissolution under Sec. 1104 of the Business Corporation Law triggered a buyout clause in a stockholder agreement that provided that a stockholder may not 'donate, hypothecate, pledge, transfer or otherwise dispose of his or her stock in any manner whatsoever' without first making an offer to the corporation or other stockholders.

The New York Supreme Court, Appellate Division held that the buyout clause was triggered by filing for dissolution. The court noted that the stockholders clearly intended to cover the broadest spectrum of events that could trigger the clause by providing that stockholders could not dispose of their stock in 'any manner whatsoever' without offering it to the corporation or other stockholders. In addition, given the uncontroverted evidence that the buyout provision was intended to provide for the continuation of the business, it was reasonable to conclude that the commencement of an involuntary dissolution proceeding was within contemplation of the phrase 'any manner whatsoever.' Therefore, the court ordered the plaintiff to sell the shares in accordance with the stockholders' agreement.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for CT- and New York-based CT Corporation www.ctlegalsolutions.com), a Wolters Kluwer business that povides software and service solutions for compliance, corporate transactions, litigation management and trademark solutions.

This edition of the Quarterly State Compliance Review looks at some amendments to state business entity laws that went into effect, and court decisions dealing with business entities that were issued, during the last three months. Included are several amendments to New York's business entity laws, including changes to its publication requirement. Also included are Delaware Chancery Court decisions dealing with indemnification and hedge funds.

IN THE STATE LEGISLATURES

New York

Senate Bill 85-A, effective June 1, revised the publication requirement found in New York's LLC, LP and LLP laws. The bill requires publication of a copy of the formation document of a domestic entity and the registration document of a foreign entity, or a notice containing the substance thereof, once a week for 4 (formerly 6) successive weeks. The bill also provides that the notice must set forth the names of the 10 persons who are actively engaged in the business and who have the most valuable interests. If proof of publication is not filed with the Department of State within 120 days after formation or registration, the entity's authority to carry on business will be suspended. At any time after suspension, if the entity causes proof to be filed, the suspension will be annulled. (Previously, the penalty for failure to file proof of publication was that the entity could not maintain an action in the state's courts.) The suspension penalty also applies to entities formed or registered before June 1, 2006 that did not comply with the publication requirement in effect when it was formed or registered. These entities have until Dec. 1, 2007 to cure their noncompliance. Entities formed or registered before 1999 are deemed to be in compliance.

It should be noted that Senate Bill 6831 and Assembly Bill 10399 were introduced in the legislature. If enacted, these bills would make the following changes: 1) publication would be required for 6 weeks instead of 4; 2) the names of the 10 persons who have the most valuable interests would not have to be set forth; 3) the penalty for failure to comply would be personal liability for members, limited partners, and general partners of LLPs; and 4) entities formed or registered after Jan. 1, 1999 and before June 1, 2006 would have to comply by Oct. 1, 2006.

Also in New York, Assembly Bill 9558-B/Senate Bill 6458-C, effective April 12, amended the business corporation and not-for-profit corporation laws to require corporations that establish or operate child care centers to provide the office of Children and Family Services with a certified copy of their certificate of incorporation or application for authority (and certain post-incorporation or registration filings) within 30 days of filing the documents with the Department of State. Assembly Bill 9559-B/Senate Bill 6459-C extended authorization for the Department of State to offer full expedited service for business entity filings and document orders. Authorization for same day, 2 hour and most 24-hour services were scheduled to expire March 31. In addition, effective April 8, Assembly Bill 5238 amended the not-for-profit corporation law to authorize a court to dispense with quorum requirements under certain circumstances, to revise dissolution procedures, and to provide for the administrative dissolution of certain charitable corporations that fail to file financial reports.

MAINE AND SOUTH CAROLINA

In Maine, Legislative Document 2034, effective April 4, provided that a corporation without capital stock organized under Title 13 of the Maine Statutes may enter into a merger or consolidation with a corporation organized under the Maine Nonprofit Corporation Act (Title 13-B). In South Carolina, House Bill 3196, effective April 8, provided that the members of nonprofit corporations may act without a meeting if a corporation delivers either a written or an electronic ballot. (Formerly, written only).

UTAH

In Utah, several bills went into effect on May 1 that revised the state's business entity laws. House Bill 127 permitted the formation of a Series LLC. The bill provided that if certain requirements are met, none of the debts or liabilities of any series will be enforceable against the assets of another series or the LLC itself. Senate Bill 137 provided that documents filed by corporations with the Division of Corporations and Commercial Code may be signed by an attorney-in-fact. It also provided that a claim brought against a dissolved corporation that does not publish notice of its dissolution is barred unless an action is commenced within 7 years after the dissolution. Senate Bill 84 amended the nonprofit corporation law to revise the provisions governing derivative suits, to require a nonprofit corporation without voting members to hold an annual directors' meeting unless the bylaws provide otherwise, and to clarify when a director or officer may be held liable to the corporation or its members for a breach of duties.

WASHINGTON

In Washington, several bills amending the state's business entity laws were enacted. Each bill has an effective date of June 7. Senate Bill 6596 amended provisions governing the dissolution of corporations, the liability of shareholders who receive illegal distributions, and the procedures for disposing of claims. Senate Bill 6463 permitted a bank or a bank holding company to be organized as an LLC. Senate Bill 6531 provided that the dissolution of an LLC does not take away or impair any remedy available against the LLC or its managers or members unless an action is not commenced within 3 years after the effective date of dissolution.

IN THE STATE COURTS

Delaware Chancery Court Holds That Hedge Fund Is Adequate Class Representative

In Regal Entertainment Group v. Amaranth LLC, C.A. No. 1226-N (Del. Ch. Ct.), decided April 12, 2006, the plaintiff was the issuer of a series of convertible notes. The defendant, one of the largest holders of notes, publicly disputed the plaintiff's method for calculating the number of shares of common stock noteholders would receive upon conversion. The plaintiff filed suit seeking a declaration that its calculation was correct. The plaintiff moved for certification of a defendant class. The defendant refused to assent to serving as class representative.

The defendant first argued that it was not an adequate representative because, as a hedge fund, it had a fiduciary obligation to sell its notes if that was in its investors' best interests. The Delaware Chancery Court rejected that argument, stating that the fact that the defendant might sell the notes did not distinguish it from any other type of investor that serves as a class representative. The court also found that the defendant was well positioned to act as the class representative considering that it owned a large position in the notes and that the plaintiff filed the action because the defendant publicly contested its formula.

The defendant also argued that because of its complex investment position and the fact that it owned common stock in the plaintiff and swap agreements in the notes, it was not typical of the defendant class. The court disagreed, pointing out that the defendant's position regarding the conversion formula was typical and aligned with the interests of all noteholders. Thus, the motion for class certification was granted.

Delaware Chancery Court Allows Former Directors to Proceed with Indemnification Claim

In Levy v. Hayes Lemmerz International, Inc., C.A. No. 1395-N (Del. Ch. Ct.), decided April 5, 2006, former directors of a public corporation brought an action seeking indemnification of their expenses in settling an action brought against them by stockholders and bondholders after it was revealed that the corporation's financial statements contained materially misleading information.

The Delaware Chancery Court denied the corporation's motion to dismiss. One of the corporation's arguments was based on a clause in the indemnification agreement stating that the corporation would provide indemnification as permitted by law 'as soon as practicable, but in any event, no later than thirty days after written demand is presented.' According to the corporation, that clause required the plaintiffs to present it with a written demand and wait 30 days to file suit ' which they did not do. However, the court disagreed with this interpretation. Instead, it held that the clause required the corporation to respond as soon as practicable and allowed ' but did not require ' those requesting indemnification to put the corporation on the clock by issuing a written demand. According to the court, that interpretation was consistent with the way Delaware courts have interpreted similar clauses and with the indemnification agreement's stated purpose of protecting those seeking indemnification.

The court also denied the corporation's motion to stay the proceeding until the statute of limitations for actions by the S.E.C. had run. The court noted that both the bylaws and indemnification agreement promised indemnification in civil and criminal actions, thus clearly implying that a party may be indemnified for a civil action and then seek indemnification for a later criminal action if it arises.

New York Appellate Division Holds That Filing Action for Involuntary Dissolution Triggers Buyout

In Johnsen v. ACP Distribution, Inc. , 2006 N.Y. Slip Op. 3176 (A.D. 1 Dept.), decided April 27, 2006, the issue was whether the filing of an action for involuntary dissolution under Sec. 1104 of the Business Corporation Law triggered a buyout clause in a stockholder agreement that provided that a stockholder may not 'donate, hypothecate, pledge, transfer or otherwise dispose of his or her stock in any manner whatsoever' without first making an offer to the corporation or other stockholders.

The New York Supreme Court, Appellate Division held that the buyout clause was triggered by filing for dissolution. The court noted that the stockholders clearly intended to cover the broadest spectrum of events that could trigger the clause by providing that stockholders could not dispose of their stock in 'any manner whatsoever' without offering it to the corporation or other stockholders. In addition, given the uncontroverted evidence that the buyout provision was intended to provide for the continuation of the business, it was reasonable to conclude that the commencement of an involuntary dissolution proceeding was within contemplation of the phrase 'any manner whatsoever.' Therefore, the court ordered the plaintiff to sell the shares in accordance with the stockholders' agreement.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for CT- and New York-based CT Corporation www.ctlegalsolutions.com), a Wolters Kluwer business that povides software and service solutions for compliance, corporate transactions, litigation management and trademark solutions.