Quarterly State Compliance Review

In California, Assembly Bill 2341, effective Sept. 29, amended one of the compliance requirements found in California's business entity laws ' the need for a terminating or merging business entity to obtain a Tax Clearance Certificate from the Franchise Tax Board. A.B. 2341 eliminated the need to obtain a Tax Clearance Certificate for a terminating corporation, LLC, or LLP, and a merging corporation, LLC, LP or LLP. The bill does require various dissolution and cancellation documents to state that a final franchise tax return or annual tax return has been filed with the FTB. A.B. 2341 also allows corporations, LLCs, LPs, and LLPs to avoid the minimum franchise tax or annual tax for the current taxable year if the entity filed a final tax return, did not thereafter do business in California and the dissolution, surrender, or cancellation of the entity was completed before the end of the 12 month period following the date the final tax return was filed.

Connecticut

In Connecticut, Senate Bill 547, effective Oct. 1, amended various sections of the corporation law dealing with directors. A new term, 'qualified director,' was added to the definition section, generally replacing the term 'independent director.' Amendments were made to the sections governing derivative suits and indemnification to set forth the power of qualified directors to have a derivative suit dismissed and to authorize the advance or reimbursement of funds in connection with certain proceedings against a director. In addition, amendments were made to the section governing conflict of interest transactions and a new section was added limiting the liability of a director for taking advantage of a corporate business opportunity if the director brought the opportunity to the corporation's attention and directors or shareholders disclaimed an interest in compliance with the corporation law.

Ohio

In Ohio, House Bill 301, effective Oct. 12, amended the state's business entity laws to create procedures whereby corporations, LLCs, GPs, LPs, and LLPs may enter into statutory conversions. The corporation law was further amended to provide, among other things, that directors may delegate to officers the authority to issue, offer or sell stock options to employees, that consideration for shares may now include promissory notes or other binding obligations to contribute cash or property or perform services, that a committee of directors may create subcommittees, and to provide for the reorganization and restructuring of holding companies.

Oklahoma

In Oklahoma, Senate Bill 1556, effective Nov. 1, amended the LLC Act to revise one of the Act's principal compliance requirements – the requirement that an LLC file an annual certificate with the Secretary of State. The amendment provided that the annual certificate will be due on the anniversary date of filing the original certificate, rather than on July 1.

IN THE STATE COURTS

Delaware Supreme Court Clarifies Standard for Pleading Demand Futility in Director Oversight Cases

In Stone v. Ritter, No. 93, 2006 (Del. Supr.) decided Nov. 6, 2006, the plaintiffs filed a derivative complaint against the directors of a corporation. The corporation had paid $50 million in fines and penalties based on the failure of its employees to file suspicious activity reports as required by the Bank Secrecy Act and various anti-money laundering regulations. The complaint alleged that the defendant directors failed to implement any sort of statutorily required monitoring, reporting or information controls that would have enabled them to learn of problems requiring their attention. The plaintiffs did not make a pre-suit demand and the Chancery Court dismissed the complaint for failure to adequately plead demand futility. The plaintiffs' argument that demand was excused was based on their contention that the directors breached their oversight duty and that, as a result, they faced a substantial likelihood of personal liability. In determining that the directors did not face personal liability, the Chancery Court applied the standard set forth in In re Caremark Int'l Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996).

On appeal, the Delaware Supreme Court held that the Chancery Court properly applied Caremark in this case. The Delaware Supreme Court further noted that under Caremark, to establish the lack of good faith that is a necessary condition to the imposition of director oversight liability, the plaintiff must show either that the directors utterly failed to implement any reporting or information system or controls or, having implemented such a system or controls, consciously failed to monitor or oversee its operations. The court then applied that standard to this case and noted that an independent consultant's report showed that the board dedicated considerable resources to its compliance program, that the system was designed to permit the directors to periodically monitor compliance, and that the board did exercise oversight by relying on periodic reports on compliance from employees. Thus, the Chancery Court properly dismissed the complaint for failure to excuse demand by alleging particularized facts that created a reason to doubt whether the directors had acted in good faith in exercising their oversight responsibilities.

Delaware Supreme Court Reaffirms 'Credible Basis' Pleading Burden in Stockholder Inspection Actions

In Seinfeld v. Verizon Communi-cations, Inc., No. 624, 2005 (Del. Supr.) decided Sept. 25, 2006, the plaintiff, a minority stockholder in a public corporation, brought suit under Sec. 220 of the General Corporation Law to compel the inspection of certain books and records. The plaintiff's stated purpose was to investigate mismanagement and waste regarding the executive compensation paid by the corporation. The Chancery Court granted the defendant's motion for summary judgment, finding that the plaintiff did not carry his burden of showing a credible basis from which the court could infer that the corporation's board of directors committed waste or mismanagement in compensating its executives. The plaintiff acknowledged that he had no factual support for his claims. Instead, he claimed that the 'credible basis' burden of proof erected an insurmountable barrier for minority stockholders in public corporations and requested that the burden on such stockholders be reduced.

The Delaware Supreme Court af-firmed the Chancery Court's application of the credible basis standard. The court stated that the credible basis standard does not erect an insurmountable burden on minority stockholders in public corporations. The court also stated that this standard achieves an appropriate balance between providing stockholders who can offer some evidence of possible wrongdoing with access to corporate records and safeguarding the right of corporations to deny inspection requests based on suspicion or curiosity.

Delaware Chancery Court Rejects Hedge Fund's Request For Inspection

In Polygon Global Opportunities Master Fund v. West Corporation, C.A. No. 2313-N (Del. Ch.) decided Oct. 12, 2006, the plaintiff was a hedge fund that bought stock in a corporation following the announcement of the corporation's going private recapitalization transaction. The plaintiff sought to inspect the corporation's books and records pursuant to Sec. 220 for the stated purposes of valuing its stock to determine whether to seek an appraisal, to investigate alleged breaches of fiduciary duty and to communicate with other stockholders.

The Chancery Court dismissed the complaint. The court found that the plaintiff's motive of valuing its stock in order to make a decision on whether to seek an appraisal was proper. However, the corporation, through its public SEC filings, disclosed all material information necessary for the plaintiff to determine whether to seek an appraisal. The court also rejected the plaintiff's argument that it should be given access to the same information it would receive in an appraisal action, as the argument misapprehended the significant difference in scope between a Sec. 220 action and discovery under Rule 34. The Chancery Court also held that the plaintiff's purpose of determining whether the board breached its fiduciary duties in approving the recapitalization was not proper as the transaction occurred before the hedge fund purchased the stock and it would not have standing to pursue a claim based on the breaches. The purpose of communicating with the other stockholders about the information the plaintiff received was moot as it was derivative of and dependent on the other two rejected purposes.

California Appellate Court Holds That Suspended Corporation May Defend Action Upon Revival

In The Cadle Company v. World Wide Hospitality Furniture, Inc., No. B183821 (Cal. App., 2 Dept.) decided October 31, 2006, the defendant was a corporation whose powers had been suspended by the Secretary of State for failing to file the statutorily mandated information statement. The plaintiff, upon learning of the suspension, moved to preclude the corporation from defending the action. The trial court granted the motion and after the trial entered judgment against the corporation. Two days after the trial, the corporation filed the information statement and obtained a Notice of Revivor. The corporation then appealed the judgment.

On appeal, the California Court of Appeal held that the trial court abused its discretion in entering judgment against the corporation.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT (www.ctlegalsolutions.com), a Wolters Kluwer business.

All corporations and other statutory business entities must comply with the provisions of their home states' business entity law. This edition of the Quarterly State Compliance Review looks at some amendments to these business entity laws that went into effect during the last three months and will review some recent court cases interpreting these statutes. Included are Delaware decisions dealing with a director's duty of oversight and a corporation's need to comply with a request for inspection of books and records.

IN THE STATE LEGISLATURES

California

In California, Assembly Bill 2341, effective Sept. 29, amended one of the compliance requirements found in California's business entity laws ' the need for a terminating or merging business entity to obtain a Tax Clearance Certificate from the Franchise Tax Board. A.B. 2341 eliminated the need to obtain a Tax Clearance Certificate for a terminating corporation, LLC, or LLP, and a merging corporation, LLC, LP or LLP. The bill does require various dissolution and cancellation documents to state that a final franchise tax return or annual tax return has been filed with the FTB. A.B. 2341 also allows corporations, LLCs, LPs, and LLPs to avoid the minimum franchise tax or annual tax for the current taxable year if the entity filed a final tax return, did not thereafter do business in California and the dissolution, surrender, or cancellation of the entity was completed before the end of the 12 month period following the date the final tax return was filed.

Connecticut

In Connecticut, Senate Bill 547, effective Oct. 1, amended various sections of the corporation law dealing with directors. A new term, 'qualified director,' was added to the definition section, generally replacing the term 'independent director.' Amendments were made to the sections governing derivative suits and indemnification to set forth the power of qualified directors to have a derivative suit dismissed and to authorize the advance or reimbursement of funds in connection with certain proceedings against a director. In addition, amendments were made to the section governing conflict of interest transactions and a new section was added limiting the liability of a director for taking advantage of a corporate business opportunity if the director brought the opportunity to the corporation's attention and directors or shareholders disclaimed an interest in compliance with the corporation law.

Ohio

In Ohio, House Bill 301, effective Oct. 12, amended the state's business entity laws to create procedures whereby corporations, LLCs, GPs, LPs, and LLPs may enter into statutory conversions. The corporation law was further amended to provide, among other things, that directors may delegate to officers the authority to issue, offer or sell stock options to employees, that consideration for shares may now include promissory notes or other binding obligations to contribute cash or property or perform services, that a committee of directors may create subcommittees, and to provide for the reorganization and restructuring of holding companies.

Oklahoma

In Oklahoma, Senate Bill 1556, effective Nov. 1, amended the LLC Act to revise one of the Act's principal compliance requirements – the requirement that an LLC file an annual certificate with the Secretary of State. The amendment provided that the annual certificate will be due on the anniversary date of filing the original certificate, rather than on July 1.

IN THE STATE COURTS

Delaware Supreme Court Clarifies Standard for Pleading Demand Futility in Director Oversight Cases

In Stone v. Ritter, No. 93, 2006 (Del. Supr.) decided Nov. 6, 2006, the plaintiffs filed a derivative complaint against the directors of a corporation. The corporation had paid $50 million in fines and penalties based on the failure of its employees to file suspicious activity reports as required by the Bank Secrecy Act and various anti-money laundering regulations. The complaint alleged that the defendant directors failed to implement any sort of statutorily required monitoring, reporting or information controls that would have enabled them to learn of problems requiring their attention. The plaintiffs did not make a pre-suit demand and the Chancery Court dismissed the complaint for failure to adequately plead demand futility. The plaintiffs' argument that demand was excused was based on their contention that the directors breached their oversight duty and that, as a result, they faced a substantial likelihood of personal liability. In determining that the directors did not face personal liability, the Chancery Court applied the standard set forth in In re Caremark Int'l Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996).

On appeal, the Delaware Supreme Court held that the Chancery Court properly applied Caremark in this case. The Delaware Supreme Court further noted that under Caremark, to establish the lack of good faith that is a necessary condition to the imposition of director oversight liability, the plaintiff must show either that the directors utterly failed to implement any reporting or information system or controls or, having implemented such a system or controls, consciously failed to monitor or oversee its operations. The court then applied that standard to this case and noted that an independent consultant's report showed that the board dedicated considerable resources to its compliance program, that the system was designed to permit the directors to periodically monitor compliance, and that the board did exercise oversight by relying on periodic reports on compliance from employees. Thus, the Chancery Court properly dismissed the complaint for failure to excuse demand by alleging particularized facts that created a reason to doubt whether the directors had acted in good faith in exercising their oversight responsibilities.

Delaware Supreme Court Reaffirms 'Credible Basis' Pleading Burden in Stockholder Inspection Actions

In Seinfeld v. Verizon Communi-cations, Inc., No. 624, 2005 (Del. Supr.) decided Sept. 25, 2006, the plaintiff, a minority stockholder in a public corporation, brought suit under Sec. 220 of the General Corporation Law to compel the inspection of certain books and records. The plaintiff's stated purpose was to investigate mismanagement and waste regarding the executive compensation paid by the corporation. The Chancery Court granted the defendant's motion for summary judgment, finding that the plaintiff did not carry his burden of showing a credible basis from which the court could infer that the corporation's board of directors committed waste or mismanagement in compensating its executives. The plaintiff acknowledged that he had no factual support for his claims. Instead, he claimed that the 'credible basis' burden of proof erected an insurmountable barrier for minority stockholders in public corporations and requested that the burden on such stockholders be reduced.

The Delaware Supreme Court af-firmed the Chancery Court's application of the credible basis standard. The court stated that the credible basis standard does not erect an insurmountable burden on minority stockholders in public corporations. The court also stated that this standard achieves an appropriate balance between providing stockholders who can offer some evidence of possible wrongdoing with access to corporate records and safeguarding the right of corporations to deny inspection requests based on suspicion or curiosity.

Delaware Chancery Court Rejects Hedge Fund's Request For Inspection

In Polygon Global Opportunities Master Fund v. West Corporation, C.A. No. 2313-N (Del. Ch.) decided Oct. 12, 2006, the plaintiff was a hedge fund that bought stock in a corporation following the announcement of the corporation's going private recapitalization transaction. The plaintiff sought to inspect the corporation's books and records pursuant to Sec. 220 for the stated purposes of valuing its stock to determine whether to seek an appraisal, to investigate alleged breaches of fiduciary duty and to communicate with other stockholders.

The Chancery Court dismissed the complaint. The court found that the plaintiff's motive of valuing its stock in order to make a decision on whether to seek an appraisal was proper. However, the corporation, through its public SEC filings, disclosed all material information necessary for the plaintiff to determine whether to seek an appraisal. The court also rejected the plaintiff's argument that it should be given access to the same information it would receive in an appraisal action, as the argument misapprehended the significant difference in scope between a Sec. 220 action and discovery under Rule 34. The Chancery Court also held that the plaintiff's purpose of determining whether the board breached its fiduciary duties in approving the recapitalization was not proper as the transaction occurred before the hedge fund purchased the stock and it would not have standing to pursue a claim based on the breaches. The purpose of communicating with the other stockholders about the information the plaintiff received was moot as it was derivative of and dependent on the other two rejected purposes.

California Appellate Court Holds That Suspended Corporation May Defend Action Upon Revival

In The Cadle Company v. World Wide Hospitality Furniture, Inc., No. B183821 (Cal. App., 2 Dept.) decided October 31, 2006, the defendant was a corporation whose powers had been suspended by the Secretary of State for failing to file the statutorily mandated information statement. The plaintiff, upon learning of the suspension, moved to preclude the corporation from defending the action. The trial court granted the motion and after the trial entered judgment against the corporation. Two days after the trial, the corporation filed the information statement and obtained a Notice of Revivor. The corporation then appealed the judgment.

On appeal, the California Court of Appeal held that the trial court abused its discretion in entering judgment against the corporation.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT (www.ctlegalsolutions.com), a Wolters Kluwer business.