Quarterly State Compliance Review

This has been a busy quarter in the legislatures as a significant number of amendments to state business entity statutes went into effect during May, June and July. Below are some of the legislative highlights from around the country.

In Hawaii, Senate Bill 3006, effective July 1, repealed a provision of the corporation law allowing parties of interest to petition the court to appoint a trustee to settle the affairs of an administratively dissolved corporation. In Idaho, Senate Bill 1350, effective July 1, enacted the Revised Uniform Limited Liability Company Act, which will govern the formation and operation of LLCs formed on or after July 1, 2008. LLCs formed before July 1, 2008 may elect to be governed by the new law. On July 1, 2010 the previous LLC law is repealed and all LLCs will be subject to the new law.

In Illinois, House Bill 3627, effective June 1, increased the fee for filing the annual report of a nonprofit corporation from $5 to $10. In Indiana, House Bill 1187, effective July 1, amended the nonprofit corporation law to provide that unless the articles of incorporation or bylaws provide otherwise, a contract or transaction between the corporation and one or more of its members, directors or officers is not void or voidable solely because of that relationship if the material facts as to the relationship were disclosed to or known by the board or members, who properly approved the contract or transaction.

In Nebraska, Legislative Bill 907, effective July 18, amended the LLC law to permit an LLC to use a name that is deceptively similar to the name of another business entity if that entity consents in writing or a court has issued a final judgment establishing the LLC's right to the name. In Utah, Senate Bill 69, effective May 5, enacted the Uniform Limited Cooperative Association Act, providing for the formation and governance of limited cooperative associations. In Vermont, House Bill 691, effective July 1, increased annual report fees to $35 for domestic corporations, $175 for foreign corporations, $25 for domestic LLCs, and $125 for foreign LLCs.

In Virginia, House Bill 1490, effective July 1, provided that the successor to a foreign LLC, LP or business trust transacting business in the Commonwealth without being registered, and the assignee of a cause of action arising out of that business, may not maintain a proceeding based on that cause of action in a court in Virginia until the foreign LLC, LP or business trust or its successor has registered. Also in Virginia, House Bill 918, effective July 1, authorized mergers between professional corporations and LLCs.

In West Virginia, House Bill 4421, effective July 1, repealed the corporate license tax and replaced the attorney-in-fact fee that was paid by all entity types with a $25 annual report fee.

In addition, South Dakota (House Bill 1137), Maine (Legislative Document 1853), and Nevada (Senate Bill 242, Laws of 2007) all enacted the Model Registered Agents Act, effective July 1. This Act governs the registered agent requirement for all business entity types in these states that are required to appoint and maintain a registered agent.

IN THE STATE COURTS

DE Supreme Court Holds That Claim Based on Stock Option's Effect on Merger Consideration Is Derivative

In Feldman v. Cutaia, No. 466, 2007, decided May 30, 2008, the plaintiff filed a derivative suit challenging stock options issued to certain members of a corporation's management. While that litigation was pending, the corporation was involved in a merger that resulted in the plaintiff no longer owning any shares. The defendants moved to dismiss on the grounds that the plaintiff lost standing to pursue derivative claims. The plaintiff filed an amended complaint and added Count XIII, a direct claim alleging that he received inadequate consideration from the merger because of the stock options and that the defendants breached their fiduciary duties by not reconsidering the validity of the stock options before approving the merger. The Chancery Court dismissed the entire complaint on the grounds that the plaintiff lacked standing. The plaintiff appealed the dismissal of Count XIII.

The Delaware Supreme Court affirmed, holding that Count XIII was derivative under the court's decisions in Tooley v. Donaldson, Lufkin & Jenrett, Inc., 845 A.2d 1031 (Del. 2004) and Kramer v. Western Pacific Industries, Inc., 546 A.2d 348 (Del. 1988). The court noted that to state a direct claim under Tooley, the plaintiff must have suffered some individual harm not suffered by all of the stockholders. However, the plaintiff did not plead any facts from which the court could conclude that the failure to reconsider the stock options caused him harm separate and distinct from the alleged harm to the corporation.

In addition, here, as in Kramer, the plaintiff attacked a portion of the merger consideration that he felt was wrongfully diverted to the defendants. His attack did not relate to the fairness of the merger or allege a harm distinct from that suffered by the corporation as a whole. Thus, it was derivative.

DE Supreme Court Rejects Vice Chancellor's Interpretation of Stock Option Plan

In AT&T Corp. v. Lillis, No. 490, 2007, decided May 22, 2008, the plaintiffs were granted options in MediaOne Corp. stock under a 1994 stock option plan. The plan contained a clause preserving the option holders' 'economic position' upon a merger and certain other events. The defendant, AT&T, acquired MediaOne in a stock for stock merger. The plaintiffs elected to receive options in AT&T. They also could have chosen to be cashed out for $85. Following a spin off and another merger the plaintiffs' options were cashed out for $15. They sued AT&T for breaching the 1994 stock option agreement by not preserving their economic position. The plaintiffs argued that the term 'economic position' included the time value of the options ' that is, the value attributable to their potential to appreciate. AT&T argued the term included only the intrinsic value.

The Chancery Court found that the term 'economic position' was ambiguous and held a trial to consider extrinsic evidence. The Vice Chancellor agreed with the plaintiffs that the term economic position included the time value. AT&T appealed.

The Delaware Supreme Court agreed with the Vice Chancellor that the term was ambiguous. However the court disagreed with the Vice Chancellor's analysis of the extrinsic evidence.

The Vice Chancellor analyzed several transactions that led up to the cash out, including the AT&T-MediaOne merger. The Vice Chancellor noted that in those transactions existing options were replaced with options in the new entities. He found that supported the plaintiffs' interpretation that 'economic position' meant both intrinsic value and time value.

However, the Delaware Supreme Court pointed out that the transactions the Vice Chancellor relied on were stock for stock transactions. Option holders in a stock for stock merger can have different expectations than option holders in a cash out merger. In addition, the Vice Chancellor did not consider the cash election MedioOne option holders had even though that cash election most resembled the cash out merger at issue in this case. Therefore, the Delaware Supreme Court remanded the case back to the Vice Chancellor to fully address the significance of the differences between stock for stock and cash mergers and the significance of the $85 cash election in determining the meaning of 'economic position'.

In addition, the Vice Chancellor found that AT&T had admitted it had a duty to preserve the time value in a letter from its counsel to the plaintiffs' counsel and in its answer. However, both the letter and answer referred to AT&T's duties to 'all' AT&T option holders, not just the plaintiffs. Thus, the admissions were referring to the option agreements entered into after the spin off ' which applied to all option holders ' and not to the 1994 agreement. Thus, on remand, the Vice Chancellor was instructed to afford no weight to these supposed admissions.

CA Court of Appeal Rejects Reverse Piercing the Corporate Veil

In Postal Instant Press, Inc. v. Kaswa Corporation, No. G038270 (Cal. App. 4 Dist.) decided May 20, 2008, the plaintiff, a franchisor, obtained a judgment against an individual who purchased a franchise. After the purchase, the individual formed a corporation to operate the franchise. The plaintiff moved to add the corporation as a defendant in order to hold it liable for the shareholder's debt. The trial court granted the motion, finding that the shareholder and corporation were alter egos.

The California Court of Appeal reversed. The court noted that the plaintiff was seeking to apply the doctrine of outsider reverse piercing the corporate veil. Under this doctrine, a third party creditor may pierce the corporate veil to reach corporate assets to satisfy a claim against a shareholder. The court noted that whether to accept or reject this doctrine was an issue of first impression in California. The court then analyzed nationwide authorities and stated that it agreed with those courts that rejected the doctrine.

The court stated that reverse piercing can harm innocent shareholders and corporate creditors. It also allows judgment creditors to bypass normal judgment collection procedures. The court also disagreed with the courts that had adopted the doctrine on the grounds that it was a logical extension of standard veil piercing. According to the court, traditional veil piercing addresses a shareholder's misuse of the corporate form to shield the shareholder from liability. However, outsider reverse piercing addresses a shareholder's fraudulent transfer of personal assets 'which is already addressed by the laws of conversion and fraudulent conveyance.

Sandra Feldman. a member of this newsletter's Board of Editors, is a publications and research attorney for CT- and 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. It also looks at some recent decisions of interest, including two decisions from the Delaware Supreme Court involving challenged stock options.

IN THE STATE LEGISLATURES

This has been a busy quarter in the legislatures as a significant number of amendments to state business entity statutes went into effect during May, June and July. Below are some of the legislative highlights from around the country.

In Hawaii, Senate Bill 3006, effective July 1, repealed a provision of the corporation law allowing parties of interest to petition the court to appoint a trustee to settle the affairs of an administratively dissolved corporation. In Idaho, Senate Bill 1350, effective July 1, enacted the Revised Uniform Limited Liability Company Act, which will govern the formation and operation of LLCs formed on or after July 1, 2008. LLCs formed before July 1, 2008 may elect to be governed by the new law. On July 1, 2010 the previous LLC law is repealed and all LLCs will be subject to the new law.

In Illinois, House Bill 3627, effective June 1, increased the fee for filing the annual report of a nonprofit corporation from $5 to $10. In Indiana, House Bill 1187, effective July 1, amended the nonprofit corporation law to provide that unless the articles of incorporation or bylaws provide otherwise, a contract or transaction between the corporation and one or more of its members, directors or officers is not void or voidable solely because of that relationship if the material facts as to the relationship were disclosed to or known by the board or members, who properly approved the contract or transaction.

In Nebraska, Legislative Bill 907, effective July 18, amended the LLC law to permit an LLC to use a name that is deceptively similar to the name of another business entity if that entity consents in writing or a court has issued a final judgment establishing the LLC's right to the name. In Utah, Senate Bill 69, effective May 5, enacted the Uniform Limited Cooperative Association Act, providing for the formation and governance of limited cooperative associations. In Vermont, House Bill 691, effective July 1, increased annual report fees to $35 for domestic corporations, $175 for foreign corporations, $25 for domestic LLCs, and $125 for foreign LLCs.

In Virginia, House Bill 1490, effective July 1, provided that the successor to a foreign LLC, LP or business trust transacting business in the Commonwealth without being registered, and the assignee of a cause of action arising out of that business, may not maintain a proceeding based on that cause of action in a court in Virginia until the foreign LLC, LP or business trust or its successor has registered. Also in Virginia, House Bill 918, effective July 1, authorized mergers between professional corporations and LLCs.

In West Virginia, House Bill 4421, effective July 1, repealed the corporate license tax and replaced the attorney-in-fact fee that was paid by all entity types with a $25 annual report fee.

In addition, South Dakota (House Bill 1137), Maine (Legislative Document 1853), and Nevada (Senate Bill 242, Laws of 2007) all enacted the Model Registered Agents Act, effective July 1. This Act governs the registered agent requirement for all business entity types in these states that are required to appoint and maintain a registered agent.

IN THE STATE COURTS

DE Supreme Court Holds That Claim Based on Stock Option's Effect on Merger Consideration Is Derivative

In Feldman v. Cutaia, No. 466, 2007, decided May 30, 2008, the plaintiff filed a derivative suit challenging stock options issued to certain members of a corporation's management. While that litigation was pending, the corporation was involved in a merger that resulted in the plaintiff no longer owning any shares. The defendants moved to dismiss on the grounds that the plaintiff lost standing to pursue derivative claims. The plaintiff filed an amended complaint and added Count XIII, a direct claim alleging that he received inadequate consideration from the merger because of the stock options and that the defendants breached their fiduciary duties by not reconsidering the validity of the stock options before approving the merger. The Chancery Court dismissed the entire complaint on the grounds that the plaintiff lacked standing. The plaintiff appealed the dismissal of Count XIII.

The Delaware Supreme Court affirmed, holding that Count XIII was derivative under the court's decisions in Tooley v. Donaldson, Lufkin & Jenrett, Inc. , 845 A.2d 1031 (Del. 2004) and Kramer v. Western Pacific Industries, Inc. , 546 A.2d 348 (Del. 1988). The court noted that to state a direct claim under Tooley, the plaintiff must have suffered some individual harm not suffered by all of the stockholders. However, the plaintiff did not plead any facts from which the court could conclude that the failure to reconsider the stock options caused him harm separate and distinct from the alleged harm to the corporation.

In addition, here, as in Kramer, the plaintiff attacked a portion of the merger consideration that he felt was wrongfully diverted to the defendants. His attack did not relate to the fairness of the merger or allege a harm distinct from that suffered by the corporation as a whole. Thus, it was derivative.

DE Supreme Court Rejects Vice Chancellor's Interpretation of Stock Option Plan

In AT&T Corp. v. Lillis, No. 490, 2007, decided May 22, 2008, the plaintiffs were granted options in MediaOne Corp. stock under a 1994 stock option plan. The plan contained a clause preserving the option holders' 'economic position' upon a merger and certain other events. The defendant, AT&T, acquired MediaOne in a stock for stock merger. The plaintiffs elected to receive options in AT&T. They also could have chosen to be cashed out for $85. Following a spin off and another merger the plaintiffs' options were cashed out for $15. They sued AT&T for breaching the 1994 stock option agreement by not preserving their economic position. The plaintiffs argued that the term 'economic position' included the time value of the options ' that is, the value attributable to their potential to appreciate. AT&T argued the term included only the intrinsic value.

The Chancery Court found that the term 'economic position' was ambiguous and held a trial to consider extrinsic evidence. The Vice Chancellor agreed with the plaintiffs that the term economic position included the time value. AT&T appealed.

The Delaware Supreme Court agreed with the Vice Chancellor that the term was ambiguous. However the court disagreed with the Vice Chancellor's analysis of the extrinsic evidence.

The Vice Chancellor analyzed several transactions that led up to the cash out, including the AT&T-MediaOne merger. The Vice Chancellor noted that in those transactions existing options were replaced with options in the new entities. He found that supported the plaintiffs' interpretation that 'economic position' meant both intrinsic value and time value.

However, the Delaware Supreme Court pointed out that the transactions the Vice Chancellor relied on were stock for stock transactions. Option holders in a stock for stock merger can have different expectations than option holders in a cash out merger. In addition, the Vice Chancellor did not consider the cash election MedioOne option holders had even though that cash election most resembled the cash out merger at issue in this case. Therefore, the Delaware Supreme Court remanded the case back to the Vice Chancellor to fully address the significance of the differences between stock for stock and cash mergers and the significance of the $85 cash election in determining the meaning of 'economic position'.

In addition, the Vice Chancellor found that AT&T had admitted it had a duty to preserve the time value in a letter from its counsel to the plaintiffs' counsel and in its answer. However, both the letter and answer referred to AT&T's duties to 'all' AT&T option holders, not just the plaintiffs. Thus, the admissions were referring to the option agreements entered into after the spin off ' which applied to all option holders ' and not to the 1994 agreement. Thus, on remand, the Vice Chancellor was instructed to afford no weight to these supposed admissions.

CA Court of Appeal Rejects Reverse Piercing the Corporate Veil

In Postal Instant Press, Inc. v. Kaswa Corporation, No. G038270 (Cal. App. 4 Dist.) decided May 20, 2008, the plaintiff, a franchisor, obtained a judgment against an individual who purchased a franchise. After the purchase, the individual formed a corporation to operate the franchise. The plaintiff moved to add the corporation as a defendant in order to hold it liable for the shareholder's debt. The trial court granted the motion, finding that the shareholder and corporation were alter egos.

The California Court of Appeal reversed. The court noted that the plaintiff was seeking to apply the doctrine of outsider reverse piercing the corporate veil. Under this doctrine, a third party creditor may pierce the corporate veil to reach corporate assets to satisfy a claim against a shareholder. The court noted that whether to accept or reject this doctrine was an issue of first impression in California. The court then analyzed nationwide authorities and stated that it agreed with those courts that rejected the doctrine.

The court stated that reverse piercing can harm innocent shareholders and corporate creditors. It also allows judgment creditors to bypass normal judgment collection procedures. The court also disagreed with the courts that had adopted the doctrine on the grounds that it was a logical extension of standard veil piercing. According to the court, traditional veil piercing addresses a shareholder's misuse of the corporate form to shield the shareholder from liability. However, outsider reverse piercing addresses a shareholder's fraudulent transfer of personal assets 'which is already addressed by the laws of conversion and fraudulent conveyance.

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