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 the last three months, including amendments to Nevada's corporation and unincorporated entity laws. This edition also discusses recent decisions of interest from the courts of Delaware, New York and California.

IN THE STATE LEGISLATURES

Nevada Amends Its Business Entity Laws

Nevada ' which has been referred to as the 'Delaware of the West' ' is one of the more important formation states in the country. Nevada's legislature enacted several amendments to the state's corporation and unincorporated entity laws that went into effective on Oct. 1. One of the bills enacting these amendments was Senate Bill 483. S.B. 483, which amended Nevada's corporation law to, among other things, allow a corporation to renounce in its articles of incorporation or by board action, certain business opportunities that are presented to it or its officers, directors, or stockholders, to provide that a corporation has no power to issue a stock certificate in bearer form, and to allow the articles of incorporation or bylaws to require that directors be elected by more than a plurality of votes cast by stockholders. S.B. 483 also amended the LLC law to, among other things, provide for the dissolution of an LLC before it has commenced business or issued member interests, provide that an LLC may be bound by an operating agreement adopted after formation whether or not it assented to the agreement, and provide that noneconomic members may bring an action on behalf of an LLC. The bill also provided that the renewal or revival of a forfeited domestic or foreign corporation, LLC, LP, LLP, BT, or professional entity relates back to the date of forfeiture and renews or revives the right to transact business as if it had remained in effect at all times.

Another bill amending Nevada's corporation and unincorporated entity laws was Assembly Bill 25. This bill provided that domestic and foreign business corporations that are not publicly traded, nonprofit corporations, LLCs, LPs, RLLPs, RLLLPs, BTs, and professional entities must maintain a current list of their owners, members and managers, general partners, or managing partners, as is appropriate, that upon request of any law enforcement agency in the course of a criminal investigation the Secretary of State may require the entity to submit a copy of the list or answer an interrogatory, and that upon a failure to comply, the Secretary of State may suspend or revoke the entity's charter or authority to transact business.

In addition, Senate Bill 72 enacted the Uniform Limited Partnership Act (2001). The new LP law is applicable on a voluntary basis. Nevada LPs formed before Oct. 1, 2007 may elect to be governed by the new law while Nevada LPs formed on or after that date will be subject to the new LP law unless they elect to be governed by the old law.

Amendments to Business Entity Laws of Other States

In Alaska, Senate Bill 141, effective Oct. 10, provided that LLCs may be organized for the purpose of rendering a professional service. The bill also provided that unless otherwise provided in the LLC's articles of organization or operating agreement (formerly, the operating agreement only), the written consent of all members is required to amend the articles of organization or operating agreement or authorize a manager or member to perform an act on the LLC's behalf that contravenes an operating agreement.

In Maryland, House Bill 386, effective Oct. 1, added physical therapy to the list of services that may be rendered through a professional service corporation. In Michigan, House Bills 5257 and 4866 provided that the annual report fees paid on or after Oct. 1, 2007 and before Oct. 1, 2012 will be $20 for nonprofit corporations and $25 for business corporations. (The fees had been scheduled to be reduced for payments made on or after Oct. 1, 2007). And in Montana, House Bill 158, effective Oct. 1, provided that a corporation or an LLC annual report may be executed by the corporation or LLC's authorized agent. Authorized agent is defined as any individual granted permission by an entity to execute a document on its behalf.

IN THE STATE COURTS

Delaware Chancery Court Rules That a General Partner's Oversight Duty Is Governed by the LP's Partnership Agreement

Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091, decided Oct. 9, 2007, was a derivative suit brought by the limited partners of a Delaware limited partnership, alleging that the general partner breached its duty of oversight. The LP was organized by a bank to allow certain employees to co-invest along with the bank. The partnership agreement required the general partner to delegate its investment and management related responsibilities but provided that the delegatees exercised their duties subject to the general partner's oversight. The defendants moved to dismiss for failure to make a demand or adequately plead demand futility as required by Delaware's LP Act.

The Delaware Chancery Court stated that the demand would be excused if particularized facts alleged in the complaint establish a substantial likelihood of liability for the general partner. Thus, the main issue was what the standard of liability should be. The defendants argued for imposition of the corporate standard, set forth in Caremark, which requires that the directors knew that they were not discharging their fiduciary duties. The plaintiffs argued for what they claimed was the lower standard imposed by the common law for partners. The Chancery Court, however, held that where parties have elaborated a statement of their rights and duties those apply. And in this case the partnership agreement stated that the general partner had the duty to oversee the activities of those actually managing the LP's affairs. It also outlined the standard governing the discharge of those duties by stating that the general partner was liable only for actions and omissions resulting from bad faith, willful misconduct, gross negligence or a material breach of the agreement. The plaintiffs in this case alleged facts supporting an inference that the general partner exercised no oversight, thus creating a substantial likelihood of liability. Therefore, demand was excused.

New York Appellate Court Holds That Private Party May Bring Common Law Securities Fraud Action

New York's Martin Act grants the Attorney General the power to bring actions against entities that engage in fraud or deceptive practices in connection with the sale of securities. In Kramer v. W105/515 Real Estate Limited Partnership, 2007 Slip Op. 07763, decided Oct. 16, 2007, the issue was whether the Martin Act precludes a private party from prosecuting a common law fraud claim in connection with the sale of securities whenever the fraudulent conduct is such that the AG would be authorized to bring an action against the defendant.

The New York Supreme Court, Appellate Division, First Department, held that such an action could be prosecuted by a private party. The court acknowledged that a previous First Department decision had held that private parties could not use artful pleading to press claims based on the sort of wrong given over to the AG. However, that decision should not be extended to cases in which there is no reason to question at the pleading stage the plaintiff's ability to prove all the essential elements of common law fraud. The court noted that the Martin Act was enacted to protect the public and that to construe it to abolish the right of purchasers of securities to sue sellers for common law fraud is to give the Martin Act a construction that is antithetical to its remedial purpose.

California Appellate Court Interprets LLC Operating Agreement As Compelling Arbitration of Claims

In Segal v. Silberstein, B191303, Court of Appeal of California, 2nd District, decided Oct. 29, 2007, the plaintiffs filed a lawsuit in a California court for breach of contract and fiduciary duty arising from a real estate development venture. Several business entities were formed as part of the venture including two Texas LLCs. The operating agreements of the Texas LLCs contained clauses stating that any action to enforce or interpret the operating agreement or resolve disputes among members shall be settled by arbitration. The clauses further stated that 'arbitration shall be the exclusive dispute resolution process in Texas, but arbitration shall be a nonexclusive process elsewhere'. The defendants petitioned to compel arbitration, based, in part, on those clauses. The trial court denied the petition, finding that those clauses made arbitration exclusive in Texas, but not in California.

The California Court of Appeal disagreed and reversed. According to the court, permitting this civil action to proceed would render meaningless the language of the arbitration provisions, which effectively require such lawsuits to be arbitrated. The court also pointed out that apart from the nonexclusive process language, the provisions were geared toward the arbitration process and did not appear to provide for civil litigation as an option. The court further noted that it could think of no good reason why a business entity or its investors would agree to being sued out of state, perhaps thousands of miles from where they do business, while requiring arbitration in their home state only. The court also stated that it believed what the parties meant by their nonexclusivity language was that outside of Texas they could use even less costly and time-consuming alternative dispute resolution processes such as mediation and conciliation.

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.

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect during the last three months, including amendments to Nevada's corporation and unincorporated entity laws. This edition also discusses recent decisions of interest from the courts of Delaware, New York and California.

IN THE STATE LEGISLATURES

Nevada Amends Its Business Entity Laws

Nevada ' which has been referred to as the 'Delaware of the West' ' is one of the more important formation states in the country. Nevada's legislature enacted several amendments to the state's corporation and unincorporated entity laws that went into effective on Oct. 1. One of the bills enacting these amendments was Senate Bill 483. S.B. 483, which amended Nevada's corporation law to, among other things, allow a corporation to renounce in its articles of incorporation or by board action, certain business opportunities that are presented to it or its officers, directors, or stockholders, to provide that a corporation has no power to issue a stock certificate in bearer form, and to allow the articles of incorporation or bylaws to require that directors be elected by more than a plurality of votes cast by stockholders. S.B. 483 also amended the LLC law to, among other things, provide for the dissolution of an LLC before it has commenced business or issued member interests, provide that an LLC may be bound by an operating agreement adopted after formation whether or not it assented to the agreement, and provide that noneconomic members may bring an action on behalf of an LLC. The bill also provided that the renewal or revival of a forfeited domestic or foreign corporation, LLC, LP, LLP, BT, or professional entity relates back to the date of forfeiture and renews or revives the right to transact business as if it had remained in effect at all times.

Another bill amending Nevada's corporation and unincorporated entity laws was Assembly Bill 25. This bill provided that domestic and foreign business corporations that are not publicly traded, nonprofit corporations, LLCs, LPs, RLLPs, RLLLPs, BTs, and professional entities must maintain a current list of their owners, members and managers, general partners, or managing partners, as is appropriate, that upon request of any law enforcement agency in the course of a criminal investigation the Secretary of State may require the entity to submit a copy of the list or answer an interrogatory, and that upon a failure to comply, the Secretary of State may suspend or revoke the entity's charter or authority to transact business.

In addition, Senate Bill 72 enacted the Uniform Limited Partnership Act (2001). The new LP law is applicable on a voluntary basis. Nevada LPs formed before Oct. 1, 2007 may elect to be governed by the new law while Nevada LPs formed on or after that date will be subject to the new LP law unless they elect to be governed by the old law.

Amendments to Business Entity Laws of Other States

In Alaska, Senate Bill 141, effective Oct. 10, provided that LLCs may be organized for the purpose of rendering a professional service. The bill also provided that unless otherwise provided in the LLC's articles of organization or operating agreement (formerly, the operating agreement only), the written consent of all members is required to amend the articles of organization or operating agreement or authorize a manager or member to perform an act on the LLC's behalf that contravenes an operating agreement.

In Maryland, House Bill 386, effective Oct. 1, added physical therapy to the list of services that may be rendered through a professional service corporation. In Michigan, House Bills 5257 and 4866 provided that the annual report fees paid on or after Oct. 1, 2007 and before Oct. 1, 2012 will be $20 for nonprofit corporations and $25 for business corporations. (The fees had been scheduled to be reduced for payments made on or after Oct. 1, 2007). And in Montana, House Bill 158, effective Oct. 1, provided that a corporation or an LLC annual report may be executed by the corporation or LLC's authorized agent. Authorized agent is defined as any individual granted permission by an entity to execute a document on its behalf.

IN THE STATE COURTS

Delaware Chancery Court Rules That a General Partner's Oversight Duty Is Governed by the LP's Partnership Agreement

Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091, decided Oct. 9, 2007, was a derivative suit brought by the limited partners of a Delaware limited partnership, alleging that the general partner breached its duty of oversight. The LP was organized by a bank to allow certain employees to co-invest along with the bank. The partnership agreement required the general partner to delegate its investment and management related responsibilities but provided that the delegatees exercised their duties subject to the general partner's oversight. The defendants moved to dismiss for failure to make a demand or adequately plead demand futility as required by Delaware's LP Act.

The Delaware Chancery Court stated that the demand would be excused if particularized facts alleged in the complaint establish a substantial likelihood of liability for the general partner. Thus, the main issue was what the standard of liability should be. The defendants argued for imposition of the corporate standard, set forth in Caremark, which requires that the directors knew that they were not discharging their fiduciary duties. The plaintiffs argued for what they claimed was the lower standard imposed by the common law for partners. The Chancery Court, however, held that where parties have elaborated a statement of their rights and duties those apply. And in this case the partnership agreement stated that the general partner had the duty to oversee the activities of those actually managing the LP's affairs. It also outlined the standard governing the discharge of those duties by stating that the general partner was liable only for actions and omissions resulting from bad faith, willful misconduct, gross negligence or a material breach of the agreement. The plaintiffs in this case alleged facts supporting an inference that the general partner exercised no oversight, thus creating a substantial likelihood of liability. Therefore, demand was excused.

New York Appellate Court Holds That Private Party May Bring Common Law Securities Fraud Action

New York's Martin Act grants the Attorney General the power to bring actions against entities that engage in fraud or deceptive practices in connection with the sale of securities. In Kramer v. W105/515 Real Estate Limited Partnership, 2007 Slip Op. 07763, decided Oct. 16, 2007, the issue was whether the Martin Act precludes a private party from prosecuting a common law fraud claim in connection with the sale of securities whenever the fraudulent conduct is such that the AG would be authorized to bring an action against the defendant.

The New York Supreme Court, Appellate Division, First Department, held that such an action could be prosecuted by a private party. The court acknowledged that a previous First Department decision had held that private parties could not use artful pleading to press claims based on the sort of wrong given over to the AG. However, that decision should not be extended to cases in which there is no reason to question at the pleading stage the plaintiff's ability to prove all the essential elements of common law fraud. The court noted that the Martin Act was enacted to protect the public and that to construe it to abolish the right of purchasers of securities to sue sellers for common law fraud is to give the Martin Act a construction that is antithetical to its remedial purpose.

California Appellate Court Interprets LLC Operating Agreement As Compelling Arbitration of Claims

In Segal v. Silberstein, B191303, Court of Appeal of California, 2nd District, decided Oct. 29, 2007, the plaintiffs filed a lawsuit in a California court for breach of contract and fiduciary duty arising from a real estate development venture. Several business entities were formed as part of the venture including two Texas LLCs. The operating agreements of the Texas LLCs contained clauses stating that any action to enforce or interpret the operating agreement or resolve disputes among members shall be settled by arbitration. The clauses further stated that 'arbitration shall be the exclusive dispute resolution process in Texas, but arbitration shall be a nonexclusive process elsewhere'. The defendants petitioned to compel arbitration, based, in part, on those clauses. The trial court denied the petition, finding that those clauses made arbitration exclusive in Texas, but not in California.

The California Court of Appeal disagreed and reversed. According to the court, permitting this civil action to proceed would render meaningless the language of the arbitration provisions, which effectively require such lawsuits to be arbitrated. The court also pointed out that apart from the nonexclusive process language, the provisions were geared toward the arbitration process and did not appear to provide for civil litigation as an option. The court further noted that it could think of no good reason why a business entity or its investors would agree to being sued out of state, perhaps thousands of miles from where they do business, while requiring arbitration in their home state only. The court also stated that it believed what the parties meant by their nonexclusivity language was that outside of Texas they could use even less costly and time-consuming alternative dispute resolution processes such as mediation and conciliation.

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.