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 recently. It also examines some recent decisions of interest, including two from the Delaware Chancery Court.

IN THE STATE LEGISLATURES

The period between Jan. 1 and April 1 is generally a slow one when it comes to amendments to state business organization statutes. Nevertheless there were some bills of interest that went into effect during that period. Highlights include the following:

In Delaware, House Bill 297, which was signed Jan. 26, 2010 and made effective retroactively to Jan. 1, 2006, amended the Franchise Tax Law to require corporations filing franchise tax reports on a consolidated basis to submit to the Secretary of State the consolidating ending balance sheets which accompanied their federal Form 1120 Schedule L.

In New Jersey, Assembly Bill 2882, effective Jan. 11, authorized the Department of State to offer one- and two-hour service options for expedited over-the-counter corporate service requests. Also in New Jersey, Assembly Bill 2879, effective Jan. 11, amended the Business Corporation Act to provide that any notice to shareholders given by a corporation pursuant to any provision of the Act, its certificate of incorporation, bylaws or a resolution of directors or shareholders, may be given by a form of electronic transmission consented to by the shareholder to whom the notice is given.

In Oregon, House Bill 3405, ratified by Ballot Measure 67, provided that effective Feb. 27, filing fees with the Secretary of State will increase from $50 to $100 for domestic entity formations, annual reports, amendments, and dissolutions and from $50 to $275 for foreign entity qualifications, annual reports, amendments and withdrawals.

In Virginia, House Bill 1957 (Laws of 2009) effective April 1, 2010, provided that a limited liability company may change its principal office address on the records of the State Corporation Commission by filing a statement of change on a form supplied by the Commission for that purpose.

IN THE STATE COURTS

DE Chancery Court Rules on Whether LLC Managers and Controlling Members Owe a Fiduciary Duty of Loyalty

In Kelly v. Marconi Broadcasting, Co., LLC, C.A. No. 4516, decided Feb. 24, 2010, the plaintiff, a former minority member of a Delaware LLC, brought an action against the LLC'fs managers and controlling members. Among other claims, the plaintiff alleged that the defendants breached the fiduciary duty of loyalty owed to him by entering into a self-interested merger on terms that were unfair to him. The defendants moved to dismiss the claim, arguing that any fiduciary duties of members or managers must be expressly set forth in the LLC agreement and that the LLC agreement in this case did not impose a duty of loyalty.

The Delaware Chancery Court pointed out that in the absence of a provision in the LLC agreement restricting or eliminating fiduciary duties, members and managers owe traditional fiduciary duties of loyalty and care to each other and the LLC. Here, the LLC agreement stated that the managers shall run the LLC'fs affairs in a prudent and business-like manner and devote such time to those affairs as they determine in good faith is reasonably necessary. According to the court, that provision not only did not explicitly limit the applicability of the default principles of fiduciary duties, they suggest the parties intended the default principles to apply.

The court then noted that the plaintiff alleged that the managers entered into the merger to profit from a premeditated scheme to squeeze the plaintiff out and seize control of an FCC license held by the LLC. According to the court, if those allegations were true they supported a claim for breach of the duty of loyalty.

The LLC agreement also contained an exculpatory clause eliminating monetary liability for all conduct except willful or fraudulent misconduct or willful breaches of fiduciary duties. According to the court, the alleged facts suggest that the managers'f actions were willfully intended to extinguish the plaintiff'fs membership interest. Thus, the court denied the motion to dismiss the claim that the managers breached their fiduciary duty of loyalty.

As to the controlling members, the LLC agreement was silent as to what duties were owed to minority members. And, according to the court, in the absence of a provision, controlling members owe the traditional fiduciary duties that controlling shareholders owe minority shareholders. Thus, the controlling members had a duty not to cause the LLC to enter into a merger that would benefit the controlling members at the expense of minority members. And because the plaintiff alleged facts that, if true, showed that the members did effect the merger to benefit themselves at the plaintiff'fs expense, the court denied the motion to dismiss the claim that the controlling members breached their fiduciary duty of loyalty.

DE Chancery Court Rules on Stockholders of Record, Bylaws That Reduce Board, and Vote Buying

Kurz v. Holbrook, C.A. No. 5019, decided Feb. 9, 2010, involved a contest for control of the board of directors of a publicly traded corporation (EMAK). Before the litigation, EMAK'fs board consisted of four members with three vacancies. The plaintiff group solicited consents to remove certain directors and fill the vacancies. The defendant group solicited consents to amend the bylaws to reduce the board size to three directors. The inspector of elections disallowed the plaintiff group'fs consents for shares in which the record owner was the Depository Trust Company (DTC), but in which the shares were voted by DTC participant banks and brokers, because the consents were not accompanied by an omnibus proxy from DTC granting the banks and brokers voting authority. The plaintiff group sued, claiming its consents were valid and the defendant group'fs were not.

The Delaware Chancery Court held that the plaintiff group'fs consents were valid. The court acknowledged that under Delaware law only the stockholder of record can vote or act by consent and that the stock ledger is the only evidence as to who is a stockholder entitled to vote or act by consent. However, according to the court it was not necessary for DTC to give a proxy to the banks and brokers because their names appeared in the “Cede breakdown.” And, according to the court, the “Cede breakdown” is part of the stock ledger for the purpose of determining who is entitled to vote or act by consent. Thus, the banks and brokers were stockholders of record.

The defendant group also claimed that the plaintiff group engaged in improper vote buying. A member of the plaintiff group bought shares from an EMAK shareholder shortly before the closing date of the solicitation in order to have consents from a majority of shares. According to the court, even though the buyer did not use corporate resources, the purchase had to be reviewed because it resulted in disenfranchising the stockholders who were against the consent solicitation. However, the court found that the purchase was not improper. The court noted that there was no fraud involved. The court pointed out that the seller knew about the competing consent solicitations. In addition, he transferred 100% of the economic risk to the buyer, meaning that the buyer had an interest in the corporation'fs performance.

The Chancery Court also held that the defendant group'fs consents were ineffective because they purported to amend the bylaws in a manner that conflicted with the General Corporation Law. According to the court, a bylaw that would reduce the board size below the number of currently sitting directors would result in ending the term of a director in a manner not contemplated by Sec. 141 ” which provides that a director'fs term ends when a successor is elected or the director resigns.

GA Supreme Court Holds That Common Law Fraud Claims May Be Based on Forbearance in the Sale of Publicly Traded Securities

In Holmes v. Grubman, S09Q1585, decided Feb. 8, 2010, the plaintiffs, Holmes and four entities he controlled, owned over two million shares of WorldCom stock. They alleged that in June 1999 Holmes ordered his broker to sell all their WorldCom stock ” which was being traded at $92 per share ” and that the broker convinced him not to sell, knowing that the stock was grossly overvalued, in order to keep WorldCom'fs lucrative investment banking business. Eventually they sold the shares and suffered alleged losses of $200 million. The plaintiffs brought an action for fraud and other claims in a federal court ” which dismissed for failure to state a claim upon which relief can be granted. On appeal, the U.S. Court of Appeals for the Second Circuit certified questions to the Georgia Supreme Court including whether Georgia common law recognizes fraud claims based on forbearance in the sale of publicly traded securities.

The Georgia Supreme Court noted that it is well settled in Georgia and elsewhere that induced forbearance can be the basis for tort liability. The court also noted that while the U.S. Supreme Court has held that only buyers or sellers can make a claim under Rule 10b-5, the Court has long recognized that in the ordinary case of deceit a misrepresentation that leads to refusal to sell is actionable. Thus, the court concluded that Georgia law permits fraud and negligent misrepresentation claims based on forbearance in the sale of publicly traded securities as long as the plaintiffs allege that the misrepresentations were directed at them to their injury and that there was specific reliance on the defendants'f misrepresentations.

Sandra Feldman, a member of this newsletter'fs 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 recently. It also examines some recent decisions of interest, including two from the Delaware Chancery Court.

IN THE STATE LEGISLATURES

The period between Jan. 1 and April 1 is generally a slow one when it comes to amendments to state business organization statutes. Nevertheless there were some bills of interest that went into effect during that period. Highlights include the following:

In Delaware, House Bill 297, which was signed Jan. 26, 2010 and made effective retroactively to Jan. 1, 2006, amended the Franchise Tax Law to require corporations filing franchise tax reports on a consolidated basis to submit to the Secretary of State the consolidating ending balance sheets which accompanied their federal Form 1120 Schedule L.

In New Jersey, Assembly Bill 2882, effective Jan. 11, authorized the Department of State to offer one- and two-hour service options for expedited over-the-counter corporate service requests. Also in New Jersey, Assembly Bill 2879, effective Jan. 11, amended the Business Corporation Act to provide that any notice to shareholders given by a corporation pursuant to any provision of the Act, its certificate of incorporation, bylaws or a resolution of directors or shareholders, may be given by a form of electronic transmission consented to by the shareholder to whom the notice is given.

In Oregon, House Bill 3405, ratified by Ballot Measure 67, provided that effective Feb. 27, filing fees with the Secretary of State will increase from $50 to $100 for domestic entity formations, annual reports, amendments, and dissolutions and from $50 to $275 for foreign entity qualifications, annual reports, amendments and withdrawals.

In Virginia, House Bill 1957 (Laws of 2009) effective April 1, 2010, provided that a limited liability company may change its principal office address on the records of the State Corporation Commission by filing a statement of change on a form supplied by the Commission for that purpose.

IN THE STATE COURTS

DE Chancery Court Rules on Whether LLC Managers and Controlling Members Owe a Fiduciary Duty of Loyalty

In Kelly v. Marconi Broadcasting, Co., LLC, C.A. No. 4516, decided Feb. 24, 2010, the plaintiff, a former minority member of a Delaware LLC, brought an action against the LLC'fs managers and controlling members. Among other claims, the plaintiff alleged that the defendants breached the fiduciary duty of loyalty owed to him by entering into a self-interested merger on terms that were unfair to him. The defendants moved to dismiss the claim, arguing that any fiduciary duties of members or managers must be expressly set forth in the LLC agreement and that the LLC agreement in this case did not impose a duty of loyalty.

The Delaware Chancery Court pointed out that in the absence of a provision in the LLC agreement restricting or eliminating fiduciary duties, members and managers owe traditional fiduciary duties of loyalty and care to each other and the LLC. Here, the LLC agreement stated that the managers shall run the LLC'fs affairs in a prudent and business-like manner and devote such time to those affairs as they determine in good faith is reasonably necessary. According to the court, that provision not only did not explicitly limit the applicability of the default principles of fiduciary duties, they suggest the parties intended the default principles to apply.

The court then noted that the plaintiff alleged that the managers entered into the merger to profit from a premeditated scheme to squeeze the plaintiff out and seize control of an FCC license held by the LLC. According to the court, if those allegations were true they supported a claim for breach of the duty of loyalty.

The LLC agreement also contained an exculpatory clause eliminating monetary liability for all conduct except willful or fraudulent misconduct or willful breaches of fiduciary duties. According to the court, the alleged facts suggest that the managers'f actions were willfully intended to extinguish the plaintiff'fs membership interest. Thus, the court denied the motion to dismiss the claim that the managers breached their fiduciary duty of loyalty.

As to the controlling members, the LLC agreement was silent as to what duties were owed to minority members. And, according to the court, in the absence of a provision, controlling members owe the traditional fiduciary duties that controlling shareholders owe minority shareholders. Thus, the controlling members had a duty not to cause the LLC to enter into a merger that would benefit the controlling members at the expense of minority members. And because the plaintiff alleged facts that, if true, showed that the members did effect the merger to benefit themselves at the plaintiff'fs expense, the court denied the motion to dismiss the claim that the controlling members breached their fiduciary duty of loyalty.

DE Chancery Court Rules on Stockholders of Record, Bylaws That Reduce Board, and Vote Buying

Kurz v. Holbrook, C.A. No. 5019, decided Feb. 9, 2010, involved a contest for control of the board of directors of a publicly traded corporation (EMAK). Before the litigation, EMAK'fs board consisted of four members with three vacancies. The plaintiff group solicited consents to remove certain directors and fill the vacancies. The defendant group solicited consents to amend the bylaws to reduce the board size to three directors. The inspector of elections disallowed the plaintiff group'fs consents for shares in which the record owner was the Depository Trust Company (DTC), but in which the shares were voted by DTC participant banks and brokers, because the consents were not accompanied by an omnibus proxy from DTC granting the banks and brokers voting authority. The plaintiff group sued, claiming its consents were valid and the defendant group'fs were not.

The Delaware Chancery Court held that the plaintiff group'fs consents were valid. The court acknowledged that under Delaware law only the stockholder of record can vote or act by consent and that the stock ledger is the only evidence as to who is a stockholder entitled to vote or act by consent. However, according to the court it was not necessary for DTC to give a proxy to the banks and brokers because their names appeared in the “Cede breakdown.” And, according to the court, the “Cede breakdown” is part of the stock ledger for the purpose of determining who is entitled to vote or act by consent. Thus, the banks and brokers were stockholders of record.

The defendant group also claimed that the plaintiff group engaged in improper vote buying. A member of the plaintiff group bought shares from an EMAK shareholder shortly before the closing date of the solicitation in order to have consents from a majority of shares. According to the court, even though the buyer did not use corporate resources, the purchase had to be reviewed because it resulted in disenfranchising the stockholders who were against the consent solicitation. However, the court found that the purchase was not improper. The court noted that there was no fraud involved. The court pointed out that the seller knew about the competing consent solicitations. In addition, he transferred 100% of the economic risk to the buyer, meaning that the buyer had an interest in the corporation'fs performance.

The Chancery Court also held that the defendant group'fs consents were ineffective because they purported to amend the bylaws in a manner that conflicted with the General Corporation Law. According to the court, a bylaw that would reduce the board size below the number of currently sitting directors would result in ending the term of a director in a manner not contemplated by Sec. 141 ” which provides that a director'fs term ends when a successor is elected or the director resigns.

GA Supreme Court Holds That Common Law Fraud Claims May Be Based on Forbearance in the Sale of Publicly Traded Securities

In Holmes v. Grubman, S09Q1585, decided Feb. 8, 2010, the plaintiffs, Holmes and four entities he controlled, owned over two million shares of WorldCom stock. They alleged that in June 1999 Holmes ordered his broker to sell all their WorldCom stock ” which was being traded at $92 per share ” and that the broker convinced him not to sell, knowing that the stock was grossly overvalued, in order to keep WorldCom'fs lucrative investment banking business. Eventually they sold the shares and suffered alleged losses of $200 million. The plaintiffs brought an action for fraud and other claims in a federal court ” which dismissed for failure to state a claim upon which relief can be granted. On appeal, the U.S. Court of Appeals for the Second Circuit certified questions to the Georgia Supreme Court including whether Georgia common law recognizes fraud claims based on forbearance in the sale of publicly traded securities.

The Georgia Supreme Court noted that it is well settled in Georgia and elsewhere that induced forbearance can be the basis for tort liability. The court also noted that while the U.S. Supreme Court has held that only buyers or sellers can make a claim under Rule 10b-5, the Court has long recognized that in the ordinary case of deceit a misrepresentation that leads to refusal to sell is actionable. Thus, the court concluded that Georgia law permits fraud and negligent misrepresentation claims based on forbearance in the sale of publicly traded securities as long as the plaintiffs allege that the misrepresentations were directed at them to their injury and that there was specific reliance on the defendants'f misrepresentations.

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