Quarterly State Compliance Review

Alabama (Senate Bill 87) and Washington (House Bill 1067) both enacted the Uniform Limited Partnership Act. The new LP laws govern LPs formed in those states on or after Jan. 1, and LPs formed before that date that elect to be governed by the new laws. In Alabama, all LPs will be governed by the new law on Jan. 1, 2012. In Washington, all LPs will be governed by the new law on July 1, 2010.

In California, Assembly Bill 285 amended the corporation law to provide that an electronic transmission by a corporation to an individual shareholder is not authorized unless the consent to the transmission has been preceded by or includes a written statement setting forth the shareholder's right to receive non-electronic records, stating which communications the consent applies to, and explaining the procedures for withdrawing consent. Assembly Bill 1546 amended the California limited partnership law to provide that the certificate of revival filed by a canceled limited partnership must be accompanied by the written confirmation of the Franchise Tax Board that all required tax returns have been filed by the LP. Assembly Bill 1233 amended the California nonprofit corporation law to, among other things, authorize the articles or bylaws to require the presence of one or more specified directors to constitute a quorum, prohibit a committee exercising the authority of the board from including, as members, persons who are not directors, and prohibit claims for monetary damages for negligence against a director or officer who serves without compensation, if the nonprofit corporation maintains a liability insurance policy that is applicable to the claim.

In Delaware, House Bill 267 increased the minimum franchise tax payable by Delaware corporations that calculate the tax under the assumed par value test and increased the penalty for the late filing of the annual franchise tax report.

In Illinois, Senate Bill 1390 amended the General Not For Profit Corporation Act to, among other things, provide that unless otherwise prohibited by the articles or bylaws actions required or permitted to be taken at a members' meeting may be taken without a meeting by electronic means, that the election of directors may be conducted by electronic means, that a voting member has the right to examine books and records of account and minutes for a proper purpose, upon the making of a written demand, and that a director shall not be liable for damages resulting from the exercise of judgment or discretion in connection with his or her duties unless the director earned in excess of $25,000 (formerly $5,000) per year from those duties.

In North Carolina, Senate Bill 412 amended the LLC Act to, among other things, provide that a document filed with the Secretary of State may be executed by a director or executive as well as a manager, to clarify in the section restricting distributions that a distribution does not include reasonable compensation for services or payments made under a retirement plan and to add a provision stating that it is the policy of the LLC law to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements.

In Oregon, House Bill 2353 provided that a publicly traded corporation is required to hold a special meeting of shareholders at the demand of the shareholders only if its articles or bylaws authorize shareholders to demand a special meeting and House Bill 2304 provided that within 10 days after the effective date of a parent-subsidiary merger, (formerly, before the articles of merger were filed) a surviving parent corporation must mail a copy or summary of the plan to the subsidiary's shareholders.

In Texas, House Bill 1787 amended provisions of the Business Organizations Code dealing with registered agents for service of process to make clear that a registered agent is a person that has consented to serve as such, to clarify the duties of a registered agent, and to provide a procedure by which a person appointed as registered agent without its consent can reject the appointment.

IN THE STATE COURTS

DE Chancery Court Clarifies What Must be Shown to Establish A Breach of the Implied Covenant of Good Faith and Fair Dealing

In Amirsaleh v. Board of Trade of the City of New York, Inc., C.A. No. 2822, decided Nov. 9, 2009, the plaintiff was a member of a corporation that was involved in a merger. The merger agreement permitted members to choose their form of merger consideration provided they returned an election form by a certain date. The plaintiff returned his form after the deadline and the defendants (the successor corporation and its parent) refused to accept it. However, the defendants had already accepted the elections of 25 members that were sent in after the due date.

The plaintiff filed suit alleging that the defendants breached the merger agreement's covenant of good faith and fair dealing by improperly declaring his election untimely. The Chancery Court denied the plaintiff's motion for summary judgment because a factual dispute existed as to the reason for the defendants' actions. However, the court went on to set forth what a plaintiff must establish when alleging a breach of the implied covenant of good faith and fair dealing.

According to the Chancery Court, a plaintiff must allege an implied contractual obligation not to engage in certain conduct, a breach of the obligation and resulting damages. Furthermore, the plaintiff must demonstrate that the defendant acted in bad faith, which requires a showing that the defendant's conduct was motivated by a culpable mental state or an improper purpose. Applying that standard to this case, the court noted that the defendants were subject to an implied contractual obligation not to make discretionary decisions to accept election forms for the reason alleged by the plaintiff ' which was to accommodate certain “connected” members who sent their forms in late. Such conduct would be in bad faith. Conversely, if the defendants were driven, as they claimed, by a desire to satisfy their post-merger members and leave enough time to calculate and distribute the consideration, then they would not have the wrongful intent necessary to breach the implied covenant.

DE Chancery Court Allows LLC Member's Claims for Dissolution and Breaches of Fiduciary Duty and the Implied Covenant to Proceed

The plaintiff in Lola Cars International Limited v. Krohn Racing, LLC, C.A. No. 4479, decided Nov. 12, 2009, was one member of a two-member Delaware LLC. The plaintiff sought to judicially dissolve the LLC. The plaintiff also alleged that the LLC's CEO breached his fiduciary duties and that the other member breached the implied covenant of good faith and fair dealing found in the LLC agreement. The defendants moved to dismiss all three claims and the Chancery Court denied the motion.

The Chancery Court first found that the plaintiff pleaded enough facts to suggest that it was entitled to judicial dissolution on the grounds that it was no longer reasonably practicable to carry on the LLC's business in conformity with the LLC agreement. The plaintiff pleaded that the two members were deadlocked on whether to replace the CEO, that the LLC was insolvent, and that the CEO had mismanaged the LLC and had been disloyal.

The court also found that the plaintiff had satisfied the demand excusal pleading standard and allowed the derivative claims of breach of fiduciary duty against the CEO to proceed. In so holding the court noted that the plaintiff detailed the CEO's alleged mismanagement and lack of oversight and disloyalty, including his failure to maintain adequate inventory and pay taxes and his use of LLC assets for the other member's benefit. Thus the plaintiff made a particularized showing that the CEO faced a substantial likelihood of personal liability and that he was therefore not disinterested in the litigation.

The plaintiff also alleged that the defendant member breached the implied covenant of good faith and fair dealing by unreasonably withholding its consent to remove the CEO. The court noted that in the context of a motion to dismiss it may draw a reasonable inference that the defendant member acted inappropriately and in bad faith by failing to consider the plaintiff's request to remove the CEO.

CA Appellate Court Holds That Derivative Suit Based on Proxy Misstatement Is Not Exempt from Demand Requirement

In Bader v. Anderson, HO32372, the CA Court of Appeal, Sixth District, decided Nov. 23, 2009, the plaintiff filed a shareholder derivative suit against Apple Inc. and its directors and officers, challenging a bonus plan approved by the shareholders after the dissemination of an allegedly false and misleading proxy statement. The trial court sustained the defendants' demurrer on the grounds that the plaintiff failed to make a presuit demand on the board of directors or adequately plead demand futility.

The plaintiff contended that the trial court erred because the demand futility doctrine is inapplicable to claims based upon materially false and misleading proxy statements. According to the plaintiff, the submission of such a statement is not an exercise of business judgment and when the business judgment rule does not come into play, demand futility is established.

The CA Court of Appeal rejected the plaintiff's contention. According to the court, such an exception to the demand requirement would unnecessarily divest directors of their power to control litigation. The court further noted that a demand should be excused only by “extraordinary conditions” and in the court's view the fact that the underlying dispute concerned an allegedly misleading proxy statement did not constitute such a condition.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT (http://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, 2010. It also looks at some recent decisions of interest, including two from the Delaware Chancery Court.

IN THE STATE LEGISLATURES

In several states, legislation affecting corporations, LLCs and other types of business organizations went into effect on Jan. 1, 2010. Highlights include the following:

Alabama (Senate Bill 87) and Washington (House Bill 1067) both enacted the Uniform Limited Partnership Act. The new LP laws govern LPs formed in those states on or after Jan. 1, and LPs formed before that date that elect to be governed by the new laws. In Alabama, all LPs will be governed by the new law on Jan. 1, 2012. In Washington, all LPs will be governed by the new law on July 1, 2010.

In California, Assembly Bill 285 amended the corporation law to provide that an electronic transmission by a corporation to an individual shareholder is not authorized unless the consent to the transmission has been preceded by or includes a written statement setting forth the shareholder's right to receive non-electronic records, stating which communications the consent applies to, and explaining the procedures for withdrawing consent. Assembly Bill 1546 amended the California limited partnership law to provide that the certificate of revival filed by a canceled limited partnership must be accompanied by the written confirmation of the Franchise Tax Board that all required tax returns have been filed by the LP. Assembly Bill 1233 amended the California nonprofit corporation law to, among other things, authorize the articles or bylaws to require the presence of one or more specified directors to constitute a quorum, prohibit a committee exercising the authority of the board from including, as members, persons who are not directors, and prohibit claims for monetary damages for negligence against a director or officer who serves without compensation, if the nonprofit corporation maintains a liability insurance policy that is applicable to the claim.

In Delaware, House Bill 267 increased the minimum franchise tax payable by Delaware corporations that calculate the tax under the assumed par value test and increased the penalty for the late filing of the annual franchise tax report.

In Illinois, Senate Bill 1390 amended the General Not For Profit Corporation Act to, among other things, provide that unless otherwise prohibited by the articles or bylaws actions required or permitted to be taken at a members' meeting may be taken without a meeting by electronic means, that the election of directors may be conducted by electronic means, that a voting member has the right to examine books and records of account and minutes for a proper purpose, upon the making of a written demand, and that a director shall not be liable for damages resulting from the exercise of judgment or discretion in connection with his or her duties unless the director earned in excess of $25,000 (formerly $5,000) per year from those duties.

In North Carolina, Senate Bill 412 amended the LLC Act to, among other things, provide that a document filed with the Secretary of State may be executed by a director or executive as well as a manager, to clarify in the section restricting distributions that a distribution does not include reasonable compensation for services or payments made under a retirement plan and to add a provision stating that it is the policy of the LLC law to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements.

In Oregon, House Bill 2353 provided that a publicly traded corporation is required to hold a special meeting of shareholders at the demand of the shareholders only if its articles or bylaws authorize shareholders to demand a special meeting and House Bill 2304 provided that within 10 days after the effective date of a parent-subsidiary merger, (formerly, before the articles of merger were filed) a surviving parent corporation must mail a copy or summary of the plan to the subsidiary's shareholders.

In Texas, House Bill 1787 amended provisions of the Business Organizations Code dealing with registered agents for service of process to make clear that a registered agent is a person that has consented to serve as such, to clarify the duties of a registered agent, and to provide a procedure by which a person appointed as registered agent without its consent can reject the appointment.

IN THE STATE COURTS

DE Chancery Court Clarifies What Must be Shown to Establish A Breach of the Implied Covenant of Good Faith and Fair Dealing

In Amirsaleh v. Board of Trade of the City of New York, Inc., C.A. No. 2822, decided Nov. 9, 2009, the plaintiff was a member of a corporation that was involved in a merger. The merger agreement permitted members to choose their form of merger consideration provided they returned an election form by a certain date. The plaintiff returned his form after the deadline and the defendants (the successor corporation and its parent) refused to accept it. However, the defendants had already accepted the elections of 25 members that were sent in after the due date.

The plaintiff filed suit alleging that the defendants breached the merger agreement's covenant of good faith and fair dealing by improperly declaring his election untimely. The Chancery Court denied the plaintiff's motion for summary judgment because a factual dispute existed as to the reason for the defendants' actions. However, the court went on to set forth what a plaintiff must establish when alleging a breach of the implied covenant of good faith and fair dealing.

According to the Chancery Court, a plaintiff must allege an implied contractual obligation not to engage in certain conduct, a breach of the obligation and resulting damages. Furthermore, the plaintiff must demonstrate that the defendant acted in bad faith, which requires a showing that the defendant's conduct was motivated by a culpable mental state or an improper purpose. Applying that standard to this case, the court noted that the defendants were subject to an implied contractual obligation not to make discretionary decisions to accept election forms for the reason alleged by the plaintiff ' which was to accommodate certain “connected” members who sent their forms in late. Such conduct would be in bad faith. Conversely, if the defendants were driven, as they claimed, by a desire to satisfy their post-merger members and leave enough time to calculate and distribute the consideration, then they would not have the wrongful intent necessary to breach the implied covenant.

DE Chancery Court Allows LLC Member's Claims for Dissolution and Breaches of Fiduciary Duty and the Implied Covenant to Proceed

The plaintiff in Lola Cars International Limited v. Krohn Racing, LLC, C.A. No. 4479, decided Nov. 12, 2009, was one member of a two-member Delaware LLC. The plaintiff sought to judicially dissolve the LLC. The plaintiff also alleged that the LLC's CEO breached his fiduciary duties and that the other member breached the implied covenant of good faith and fair dealing found in the LLC agreement. The defendants moved to dismiss all three claims and the Chancery Court denied the motion.

The Chancery Court first found that the plaintiff pleaded enough facts to suggest that it was entitled to judicial dissolution on the grounds that it was no longer reasonably practicable to carry on the LLC's business in conformity with the LLC agreement. The plaintiff pleaded that the two members were deadlocked on whether to replace the CEO, that the LLC was insolvent, and that the CEO had mismanaged the LLC and had been disloyal.

The court also found that the plaintiff had satisfied the demand excusal pleading standard and allowed the derivative claims of breach of fiduciary duty against the CEO to proceed. In so holding the court noted that the plaintiff detailed the CEO's alleged mismanagement and lack of oversight and disloyalty, including his failure to maintain adequate inventory and pay taxes and his use of LLC assets for the other member's benefit. Thus the plaintiff made a particularized showing that the CEO faced a substantial likelihood of personal liability and that he was therefore not disinterested in the litigation.

The plaintiff also alleged that the defendant member breached the implied covenant of good faith and fair dealing by unreasonably withholding its consent to remove the CEO. The court noted that in the context of a motion to dismiss it may draw a reasonable inference that the defendant member acted inappropriately and in bad faith by failing to consider the plaintiff's request to remove the CEO.

CA Appellate Court Holds That Derivative Suit Based on Proxy Misstatement Is Not Exempt from Demand Requirement

In Bader v. Anderson, HO32372, the CA Court of Appeal, Sixth District, decided Nov. 23, 2009, the plaintiff filed a shareholder derivative suit against Apple Inc. and its directors and officers, challenging a bonus plan approved by the shareholders after the dissemination of an allegedly false and misleading proxy statement. The trial court sustained the defendants' demurrer on the grounds that the plaintiff failed to make a presuit demand on the board of directors or adequately plead demand futility.

The plaintiff contended that the trial court erred because the demand futility doctrine is inapplicable to claims based upon materially false and misleading proxy statements. According to the plaintiff, the submission of such a statement is not an exercise of business judgment and when the business judgment rule does not come into play, demand futility is established.

The CA Court of Appeal rejected the plaintiff's contention. According to the court, such an exception to the demand requirement would unnecessarily divest directors of their power to control litigation. The court further noted that a demand should be excused only by “extraordinary conditions” and in the court's view the fact that the underlying dispute concerned an allegedly misleading proxy statement did not constitute such a condition.

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