Quarterly State Compliance Review

In California, Assembly Bill 1394 amends the penal code section imposing punishment on a corporation that willfully manufactures, intentionally sells, or knowingly possesses for sale any counterfeit registered trademark to make the punishment also applicable to LLCs and partnerships. In addition, Assembly Bill 2749 provides that a California state depository corporation may merge with a corporation or other business entity that is not a depository corporation if the California state depository corporation is the survivor.
Formerly, such a merger was prohibited.

In Hawaii, Senate Bill 3171 requires every public benefit corporation domiciled in Hawaii and every charitable organization not otherwise exempt to register with the state attorney general before making any charitable solicitations and to file annual financial reports. In Iowa, House Bill 2633 adopts the Revised Uniform Limited Liability Company Act. The revised Act applies to LLCs formed or qualified on or after Jan. 1, 2009 and to pre-existing LLCs that elect to be governed under the Act. The revised Act applies to all LLCs on Jan. 1, 2011. In Minnesota, House Bill 3500 adds a subdivision to the LLC act to provide for the formation of nonprofit LLCs. The bill provides that the articles of organization must state that it is a nonprofit LLC. The bill also contains limitations on pecuniary gain and distributions to members and restricts the type of persons who may be members.

In Ohio, House Bill 332 adopts the Revised Uniform Partnership Act. The revised Act applies to general and limited liability partnerships formed on or after Jan. 1, 2009 and to pre-existing partnerships that elect to be governed under the Act. The revised Act applies to all partnerships on Jan. 1, 2010. In Washington, Senate Bill 5882 (approved during the 2007 session) provides that a new $5 fee will be added to the fees already collected for filing domestic formation and foreign registration documents for business corporations, LLCs, LPs, and LLPs. And in Wyoming, Senate Bill 18 provides that a person who knowingly or willfully files a false document with the Secretary of State commits a felony, removes the requirement that the Secretary of State publish a notice of forfeiture of an LLC's authority to do business, adds a penalty of $250 if an LLC fails to maintain a registered agent, and adds new grounds for administratively dissolving an LLC.

IN THE STATE COURTS

Delaware Supreme Court Rules That Chancery Court May Not Correct an Appraisal Opinion After the Parties Have Settled

Crescent/Mach I Partners LP v. Dr Pepper Bottling Co. of Texas, No. 330, 2008, decided Dec. 1, 2008, arose out of a merger. Certain minority shareholders of the merged corporation dissented and brought a statutory appraisal action. In the action, the Chancery Court awarded the shareholders $32.31 per share. The shareholders and acquirer then entered into a settlement agreement that was based in part on the court's award. The acquirer then learned that the Chancery Court's appraisal contained errors and that the shares should have been appraised at $30.04 per share. The acquirer moved to have the Chancery Court correct its opinion. The shareholders argued that the settlement had rendered the motion moot. The Chancery Court granted the motion and amended its opinion to reflect the $30.04 per share valuation. The shareholders appealed.

The Delaware Supreme Court reversed. The court noted that Delaware law favors settlements and treats them as binding contracts. Here, the parties' settlement agreement fully and finally resolved the dispute over the appraised value of the corporation's shares. Upon the execution of that agreement, the appraisal opinion ceased to govern the litigating parties' relationship. In voluntarily settling both parties assumed the risks that there might be errors in the Chancery Court's appraisal opinion. Thus, the parties' settlement foreclosed any action to modify the appraisal opinion because there was no longer a justiciable controversy.

Delaware Chancery Court Rules That Parent of a Statutory Trust's Fiduciary May Owe the Statutory Trust Fiduciary Duties

Cargill, Inc. v. JWH Special Circumstance, LLC, C.A. No. 3234, decided Nov. 7, 2008, is one of the few decisions dealing with the fiduciary duties owed to a Delaware statutory trust. In this case the representative of a statutory trust alleged a breach of fiduciary duties on the part of the statutory trust's managing entity and the managing entity's grandparent and parent corporations. The claim arose out of an agreement entered into by the grandparent corporation to sell certain of its assets and its promise to make sure that certain of the statutory trust's agreements were assigned to the asset buyer. The managing entity's grandparent and parent corporations sought a declaratory judgment that they did not owe the statutory trust fiduciary duties.

The Delaware Chancery Court held that the grandparent and parent corporations could be held directly liable for breaching fiduciary duties owed to the statutory trust based on the USACafe line of cases. That is a line of partnership cases holding that if a corporate parent of a partnership's fiduciary exercises dominion and control over the fiduciary in connection with a transaction that benefits the parent at the expense of the partnership, the parent may owe fiduciary duties directly to the partnership. The court rejected the grandparent and parent's argument that USACafe did not apply to statutory trusts because the theory was based on common law trust principles and these principles were preempted by the Delaware Statutory Trust Act. The court found that neither the Act nor the trust agreement at issue in this case preempted common law trust principles. In addition, the court found that the statutory trust's representative, in its counterclaim, adequately pleaded facts which, if true, would support a reasonable inference that the grandparent and parent were liable under USACafe. Thus, their motion to dismiss the breach of fiduciary duty claims was denied.

Delaware Chancery Court Rules That Statute of Frauds Applies to LLC Agreements

In Olson v. Halvorsen, C.A. No. 1884, decided Oct. 22, 2008, a member of a Delaware LLC sought to enforce an earnout provision set forth in an unsigned LLC agreement. The provision entitled retiring members to a percentage of the LLC's profits for 6 years after retirement. The primary issue before the Chancery Court, and a matter of first impression, was whether the Delaware statute of frauds applies to LLC agreements.

The Delaware Chancery Court noted that the Delaware LLC Act allows oral LLC agreements but does not address whether the statute of frauds applies to them. The court then held that as a matter of law the statute of frauds does apply to LLC agreements. As a result, if an LLC agreement contains a provision that cannot possibly be performed within one year, that provision is unenforceable under the Delaware statute of frauds. The court stated that this decision is in line with the policy behind the enactment of the statute of frauds ' which is to protect defendants against unfounded or fraudulent claims that would require performance over an extended period of time. However, the court also recognized that the legislature has expressed its intent, in the LLC Act, to give maximum effect to the enforceability of LLCs. Consequently, provisions of an oral LLC agreement that could possibly be performed within one year will remain enforceable.

The court went on to hold that the earnout provision in this case was unenforceable because it imposed certain obligations on the remaining members that lasted for more than one year and because the earnout could not be calculated until more than one year after an event triggering the payment obligation.

Texas Supreme Court Rejects Single Business Enterprise Liability Theory

SSP Partners and Metro Novelties, Inc. v. Gladstrong Investments (USA) Corporation, No. 05-0721, decided Nov. 14, 2008, arose out of a products liability claim. The plaintiffs settled with the company that sold them the allegedly defective product. The seller then sought indemnity against a subsidiary of the corporation that manufactured the product, pursuant to a Texas statute entitling sellers to indemnity from manufacturers. One of the seller's arguments for holding the subsidiary liable was that the parent and subsidiary were part of a single business enterprise.

The Texas Supreme Court held that corporations cannot be held liable for each other's obligations merely because they were part of a single business enterprise. The court stated that the limitation on liability afforded by the corporate structure can be ignored only when the corporate form has been used as part of an unfair device to achieve an inequitable result. The single business enterprise liability theory, however, does not entail the level of abuse required. The theory advocates liability when two corporations coordinate operations and combine resources in pursuit of the same business purpose. However, as the court noted, there is nothing abusive or unjust about this practice.

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 on Jan. 1. It also examines some recent decisions of interest, including one from the Delaware Supreme Court dealing with an appraisal, and two from the Delaware Chancery Court dealing with Delaware's alternative business organizations.

IN THE STATE LEGISLATURES

In several states, legislation affecting corporations, LLCs and other types of business organizations went into effect on Jan. 1. Highlights include the following:

In California, Assembly Bill 1394 amends the penal code section imposing punishment on a corporation that willfully manufactures, intentionally sells, or knowingly possesses for sale any counterfeit registered trademark to make the punishment also applicable to LLCs and partnerships. In addition, Assembly Bill 2749 provides that a California state depository corporation may merge with a corporation or other business entity that is not a depository corporation if the California state depository corporation is the survivor.
Formerly, such a merger was prohibited.

In Hawaii, Senate Bill 3171 requires every public benefit corporation domiciled in Hawaii and every charitable organization not otherwise exempt to register with the state attorney general before making any charitable solicitations and to file annual financial reports. In Iowa, House Bill 2633 adopts the Revised Uniform Limited Liability Company Act. The revised Act applies to LLCs formed or qualified on or after Jan. 1, 2009 and to pre-existing LLCs that elect to be governed under the Act. The revised Act applies to all LLCs on Jan. 1, 2011. In Minnesota, House Bill 3500 adds a subdivision to the LLC act to provide for the formation of nonprofit LLCs. The bill provides that the articles of organization must state that it is a nonprofit LLC. The bill also contains limitations on pecuniary gain and distributions to members and restricts the type of persons who may be members.

In Ohio, House Bill 332 adopts the Revised Uniform Partnership Act. The revised Act applies to general and limited liability partnerships formed on or after Jan. 1, 2009 and to pre-existing partnerships that elect to be governed under the Act. The revised Act applies to all partnerships on Jan. 1, 2010. In Washington, Senate Bill 5882 (approved during the 2007 session) provides that a new $5 fee will be added to the fees already collected for filing domestic formation and foreign registration documents for business corporations, LLCs, LPs, and LLPs. And in Wyoming, Senate Bill 18 provides that a person who knowingly or willfully files a false document with the Secretary of State commits a felony, removes the requirement that the Secretary of State publish a notice of forfeiture of an LLC's authority to do business, adds a penalty of $250 if an LLC fails to maintain a registered agent, and adds new grounds for administratively dissolving an LLC.

IN THE STATE COURTS

Delaware Supreme Court Rules That Chancery Court May Not Correct an Appraisal Opinion After the Parties Have Settled

Crescent/Mach I Partners LP v. Dr Pepper Bottling Co. of Texas, No. 330, 2008, decided Dec. 1, 2008, arose out of a merger. Certain minority shareholders of the merged corporation dissented and brought a statutory appraisal action. In the action, the Chancery Court awarded the shareholders $32.31 per share. The shareholders and acquirer then entered into a settlement agreement that was based in part on the court's award. The acquirer then learned that the Chancery Court's appraisal contained errors and that the shares should have been appraised at $30.04 per share. The acquirer moved to have the Chancery Court correct its opinion. The shareholders argued that the settlement had rendered the motion moot. The Chancery Court granted the motion and amended its opinion to reflect the $30.04 per share valuation. The shareholders appealed.

The Delaware Supreme Court reversed. The court noted that Delaware law favors settlements and treats them as binding contracts. Here, the parties' settlement agreement fully and finally resolved the dispute over the appraised value of the corporation's shares. Upon the execution of that agreement, the appraisal opinion ceased to govern the litigating parties' relationship. In voluntarily settling both parties assumed the risks that there might be errors in the Chancery Court's appraisal opinion. Thus, the parties' settlement foreclosed any action to modify the appraisal opinion because there was no longer a justiciable controversy.

Delaware Chancery Court Rules That Parent of a Statutory Trust's Fiduciary May Owe the Statutory Trust Fiduciary Duties

Cargill, Inc. v. JWH Special Circumstance, LLC, C.A. No. 3234, decided Nov. 7, 2008, is one of the few decisions dealing with the fiduciary duties owed to a Delaware statutory trust. In this case the representative of a statutory trust alleged a breach of fiduciary duties on the part of the statutory trust's managing entity and the managing entity's grandparent and parent corporations. The claim arose out of an agreement entered into by the grandparent corporation to sell certain of its assets and its promise to make sure that certain of the statutory trust's agreements were assigned to the asset buyer. The managing entity's grandparent and parent corporations sought a declaratory judgment that they did not owe the statutory trust fiduciary duties.

The Delaware Chancery Court held that the grandparent and parent corporations could be held directly liable for breaching fiduciary duties owed to the statutory trust based on the USACafe line of cases. That is a line of partnership cases holding that if a corporate parent of a partnership's fiduciary exercises dominion and control over the fiduciary in connection with a transaction that benefits the parent at the expense of the partnership, the parent may owe fiduciary duties directly to the partnership. The court rejected the grandparent and parent's argument that USACafe did not apply to statutory trusts because the theory was based on common law trust principles and these principles were preempted by the Delaware Statutory Trust Act. The court found that neither the Act nor the trust agreement at issue in this case preempted common law trust principles. In addition, the court found that the statutory trust's representative, in its counterclaim, adequately pleaded facts which, if true, would support a reasonable inference that the grandparent and parent were liable under USACafe. Thus, their motion to dismiss the breach of fiduciary duty claims was denied.

Delaware Chancery Court Rules That Statute of Frauds Applies to LLC Agreements

In Olson v. Halvorsen, C.A. No. 1884, decided Oct. 22, 2008, a member of a Delaware LLC sought to enforce an earnout provision set forth in an unsigned LLC agreement. The provision entitled retiring members to a percentage of the LLC's profits for 6 years after retirement. The primary issue before the Chancery Court, and a matter of first impression, was whether the Delaware statute of frauds applies to LLC agreements.

The Delaware Chancery Court noted that the Delaware LLC Act allows oral LLC agreements but does not address whether the statute of frauds applies to them. The court then held that as a matter of law the statute of frauds does apply to LLC agreements. As a result, if an LLC agreement contains a provision that cannot possibly be performed within one year, that provision is unenforceable under the Delaware statute of frauds. The court stated that this decision is in line with the policy behind the enactment of the statute of frauds ' which is to protect defendants against unfounded or fraudulent claims that would require performance over an extended period of time. However, the court also recognized that the legislature has expressed its intent, in the LLC Act, to give maximum effect to the enforceability of LLCs. Consequently, provisions of an oral LLC agreement that could possibly be performed within one year will remain enforceable.

The court went on to hold that the earnout provision in this case was unenforceable because it imposed certain obligations on the remaining members that lasted for more than one year and because the earnout could not be calculated until more than one year after an event triggering the payment obligation.

Texas Supreme Court Rejects Single Business Enterprise Liability Theory

SSP Partners and Metro Novelties, Inc. v. Gladstrong Investments (USA) Corporation, No. 05-0721, decided Nov. 14, 2008, arose out of a products liability claim. The plaintiffs settled with the company that sold them the allegedly defective product. The seller then sought indemnity against a subsidiary of the corporation that manufactured the product, pursuant to a Texas statute entitling sellers to indemnity from manufacturers. One of the seller's arguments for holding the subsidiary liable was that the parent and subsidiary were part of a single business enterprise.

The Texas Supreme Court held that corporations cannot be held liable for each other's obligations merely because they were part of a single business enterprise. The court stated that the limitation on liability afforded by the corporate structure can be ignored only when the corporate form has been used as part of an unfair device to achieve an inequitable result. The single business enterprise liability theory, however, does not entail the level of abuse required. The theory advocates liability when two corporations coordinate operations and combine resources in pursuit of the same business purpose. However, as the court noted, there is nothing abusive or unjust about this practice.

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.