Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that recently went into effect. It also looks at some recent important cases, including a Delaware Supreme Court decision dealing with annual meeting dates, and a New York Court of Appeals decision dealing with the in pari delicto defense.

IN THE STATE LEGISLATURES

In several states, legislation affecting corporations and unincorporated entities went into effect on Jan. 1, 2011. Highlights include the following:

In Alabama, House Bill 222 enacted the Alabama Business and Nonprofit Entities Code. The bill rearranged and recodified the provisions governing corporations, LLCs, and other business entities and also increased filing fees, allowed for name reservation and registration, and authorized conversions and inter-entity mergers.

In California, Senate Bill 392 amended the LLC law to authorize LLCs to render services for which a license, certificate or registration is required by the Business & Professions Code if that Code authorizes LLCs to hold such a license, certificate or registration.

In Illinois, Senate Bill 3211 eliminated the requirement that corporations record incorporation, qualification, change of registered office or agent, assumed name, and various other documents with the county recorder.

In Kentucky, Senate Bill 151 enacted the Business Entity Filing Act, which establishes uniform standards and requirements governing filings, names, annual reports, registered agents, and foreign qualification for corporations, LLCs, and other business entities.

Mississippi (House Bill 683) and Nebraska (Legislative Bill 888) enacted new LLC Acts, based on the Revised Uniform Limited Liability Company Act. The new Acts provide default rules and certain mandatory requirements for LLCs. Oklahoma (Senate Bill 1132) enacted the Uniform Limited Partnership Act, which will provide the default rules and certain mandatory requirements for LPs.

IN THE STATE COURTS

DE Supreme Court Invalidates Bylaw Amendment

In Airgas, Inc. v. Air Products and Chemical, Inc., No. 649, 2010, decided Nov. 23, 2010, Air Products engaged in a proxy contest at Airgas' 2010 annual meeting, held in September. Airgas had a staggered board with nine directors, three of whom were up for election. Air Products nominated three directors and they were elected. Air Products also proposed a bylaw that would schedule Airgas' next annual meeting for January 2011. The bylaw was approved by a majority vote.

Airgas' charter provided that directors serve terms that expire at “the annual meeting of stockholders held in the third year following the year of their election.” The charter also required a supermajority vote for any bylaw inconsistent with the staggered board provision or that removed a director without cause.

Airgas brought an action in the Chancery Court claiming that the bylaw moving up the meeting date was invalid because it reduced the term of directors by eight months and therefore was inconsistent with the charter. The Chancery Court upheld the bylaw, finding that because a January 2011 annual meeting would occur in the third year following the year of the directors' election, there was no inconsistency with the charter. Airgas appealed.

The Delaware Supreme Court reversed. According to the court, there was overwhelming extrinsic evidence that under Airgas' staggered board charter provision, a term of three years was intended. The court noted that Delaware cases involving similar charter language to Airgas' have regarded the charters as creating staggered boards with classes of directors who serve three-year terms. In addition, the court stated that industry practice and understanding support its interpretation. For example, the court noted that nearly 80% of the Delaware corporations in the Fortune 500 that have similar charter language represent in their proxy statements that their directors serve three-year terms. The court also pointed out that commentators and secondary sources had interpreted the Airgas language as intending to provide for a three-year term.

Thus, the court held that under Airgas' charter provision creating a staggered board, a term of three years was intended. Therefore, Air Products' bylaw was inconsistent with the charter because it materially shortened the directors' three-year term and was not approved by a supermajority vote.

DE Chancery Court: Creditors of Insolvent LLCs May Not Sue Derivatively

In CML V, LLC v. Bax, C.A. No. 5373, decided Nov. 3, 2010, the Delaware Chancery Court dismissed derivative claims brought by a creditor of an insolvent LLC on the grounds that creditors of Delaware LLCs lack standing to bring a derivative suit.

The court based its holding on a literal reading of Sec. 18-1002 of the Delaware LLC Act. That section states that in a derivative action, the plaintiff “must be a member or an assignee of a limited liability company interest.” According to the court, Sec. 18-1002 is exclusive ' creditors and anyone else other than a member or an assignee are excluded from bringing a derivative suit.

The court stated that its literal reading of Sec. 18-1002 was supported by the fact that the almost identical provision in the Delaware LP Act has been interpreted as being exclusive. In addition, the legislative history of the LP Act shows that the General Assembly consciously chose that exclusive language.

The court also rejected the creditor's argument that a literal reading of Sec. 18-1002 generates an absurd distinction between insolvent corporations ' where creditors can sue derivatively ' and insolvent LLCs, and that it would be inconsistent with the purpose of the LLC Act. The court noted that the General Corporation Law does not contain the exclusive language of the LLC Act. In addition, the court noted that creditors of Delaware LLCs have numerous statutory and contractual remedies available to them. Therefore, refusing to grant them derivative standing fulfills the contractarian spirit of the LLC Act. [Editor's Note: At press time a Notice of Appeal had just been filed in this matter.]

Directors Did Not Violate Revlon Duties in Two
Separate Cases, Says DE Chancery Court

In re Dollar Thrifty Shareholder Litigation, C.A. No. 5458, decided Sept. 8, 2010, and In re Cogent, Inc. Shareholder Litigation, C.A. No. 5780, decided Oct. 5, 2010, were two cases in which the plaintiffs moved for preliminary injunctions to enjoin the sale of Delaware companies. In each case the plaintiffs claimed that the defendant directors breached their duties under Revlon to take a reasonable approach to immediate value maximization. And in each case the Delaware Chancery Court denied the plaintiffs' motions, finding they had not demonstrated a likelihood of success on the merits.

In In re Dollar Thrifty, the defendant board of directors agreed to sell Dollar Thrifty to Hertz. After the deal was announced, Avis made an offer for a higher price per share. The board declined the offer after finding that a sale could not reasonably be expected to be consummated on a timely basis. The plaintiffs' main claim was that the board breached its duty under Revlon by failing to take affirmative steps to draw Avis into a bidding contest before signing the merger agreement with Hertz and by not engaging in a wider sales effort earlier on.

The Chancery Court pointed out that Dollar Thrifty's board was independent and disinterested, well motivated and exercised due care. And, as the court pointed out, it is rare for a court to second guess such a board. The court also explained that Revlon is a test of reasonableness. It asks whether the board made a reasonable decision, not a perfect one. And in this case the court found that it was reasonable for the board to conclude that it was not in the stockholders' best interests to engage in a wider sales effort because of the risk of distracting employees and of Hertz walking away. The board also had reasonable grounds for not reaching out to Avis before finalizing its deal with Hertz. The board reasonably believed that Avis was not in a position to make a firm bid. In contrast, Hertz was getting close to offering a good price and was offering real closing certainty through antitrust divestiture provisions and a reverse termination fee.

The court also found that the merger agreement offered a fair premium and that the deal protection devices were neither preclusive nor onerous, as was evidenced by the fact that Avis made a bid after the agreement was signed.

In re Cogent involved the proposed acquisition of Cogent, Inc. by 3M for $10.50 per share. The plaintiffs claimed Cogent's board of directors breached its Revlon duties because the purchase price was too low and was the result of an inadequate and unfair sales process, and because the merger agreement contained preclusive protection devices.

In finding that the process used by the board was reasonable, the Chancery Court noted that the board sought and communicated with numerous potential suitors, was disinterested and independent, gave other suitors an opportunity to contact it, and was not biased in favor of 3M.

In challenging the $10.50 per share price, the plaintiffs relied mainly on the fact that another company expressed an interest in buying Cogent for $11 ' $12 per share. However, according to the court, the board acted reasonably in discounting that price because there was only a non-binding expression of interest, with any offer being contingent upon the completion of due diligence.

The court also reviewed the deal protection devices and found that individually and collectively they were reasonable and did not preclude a higher bid from being successful. The plaintiffs mainly challenged a top-up option which, they claimed, allowed 3M to take control against the wishes of minority stockholders even if a majority of shares were not tendered. But, as the court noted, that could only happen upon the occurrence of several highly unlikely events.

NY Court of Appeals Upholds In Pari Delicto Defense for Professional Advisers Sued By Corporate Wrongdoers

In Kirschner v. KPMG LLP and Teachers' Retirement System of Louisiana v. American International Group, Inc., 2010 N.Y. Slip Op. 7415, decided Oct. 21, 2010, the New York Court of Appeals accepted certified questions from the U.S. Court of Appeals for the Second Circuit and the Delaware Supreme Court asking whether the in pari delicto defense ' under which a court will refuse to resolve a dispute between two wrongdoers ' limits the liability of professional service providers in suits brought by a corporation, or its representatives, for assisting or failing to prevent wrongdoing by the corporation's executives. And the court answered by reaffirming the applicability of the in pari delicto defense.

The court noted that in pari delicto “has been wrought in the inmost texture of our common law for at least two centuries” and that it survives because it serves important public policy purposes of deterring illegality and avoiding entangling courts in disputes between wrongdoers.

The court then pointed out that in determining if a corporation is a wrongdoer, New York courts apply the agency doctrine of imputation. This means that the acts of the agents, and the knowledge they acquire while acting within the scope of their authority, will be presumptively imputed to the principal. There is one exception that New York will apply ' the adverse interest exception. According to the court, this exception is narrow and will apply only when the agent has totally abandoned the principal's interests and was acting entirely on his or her own or for another's purposes.

The plaintiffs ' a post-bankruptcy litigation trustee in Kirschner and stockholders filing a derivative suit in AIG, argued for a change in the pari delicto doctrine for reasons of public policy ' specifically to recompense the innocent and make outside professionals responsible for their misconduct. However, the New York Court of Appeals rejected that approach ' which had previously been adopted by New Jersey and Pennsylvania. The court asked why the interests of innocent stakeholders of corporate fraudsters should trump the interests of innocent stakeholders of the professional service firms. The court also stated that it was not convinced that expanding remedies to “innocent” plaintiffs would produce a meaningful additional deterrent to professional misconduct.

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

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that recently went into effect. It also looks at some recent important cases, including a Delaware Supreme Court decision dealing with annual meeting dates, and a New York Court of Appeals decision dealing with the in pari delicto defense.

IN THE STATE LEGISLATURES

In several states, legislation affecting corporations and unincorporated entities went into effect on Jan. 1, 2011. Highlights include the following:

In Alabama, House Bill 222 enacted the Alabama Business and Nonprofit Entities Code. The bill rearranged and recodified the provisions governing corporations, LLCs, and other business entities and also increased filing fees, allowed for name reservation and registration, and authorized conversions and inter-entity mergers.

In California, Senate Bill 392 amended the LLC law to authorize LLCs to render services for which a license, certificate or registration is required by the Business & Professions Code if that Code authorizes LLCs to hold such a license, certificate or registration.

In Illinois, Senate Bill 3211 eliminated the requirement that corporations record incorporation, qualification, change of registered office or agent, assumed name, and various other documents with the county recorder.

In Kentucky, Senate Bill 151 enacted the Business Entity Filing Act, which establishes uniform standards and requirements governing filings, names, annual reports, registered agents, and foreign qualification for corporations, LLCs, and other business entities.

Mississippi (House Bill 683) and Nebraska (Legislative Bill 888) enacted new LLC Acts, based on the Revised Uniform Limited Liability Company Act. The new Acts provide default rules and certain mandatory requirements for LLCs. Oklahoma (Senate Bill 1132) enacted the Uniform Limited Partnership Act, which will provide the default rules and certain mandatory requirements for LPs.

IN THE STATE COURTS

DE Supreme Court Invalidates Bylaw Amendment

In Airgas, Inc. v. Air Products and Chemical, Inc., No. 649, 2010, decided Nov. 23, 2010, Air Products engaged in a proxy contest at Airgas' 2010 annual meeting, held in September. Airgas had a staggered board with nine directors, three of whom were up for election. Air Products nominated three directors and they were elected. Air Products also proposed a bylaw that would schedule Airgas' next annual meeting for January 2011. The bylaw was approved by a majority vote.

Airgas' charter provided that directors serve terms that expire at “the annual meeting of stockholders held in the third year following the year of their election.” The charter also required a supermajority vote for any bylaw inconsistent with the staggered board provision or that removed a director without cause.

Airgas brought an action in the Chancery Court claiming that the bylaw moving up the meeting date was invalid because it reduced the term of directors by eight months and therefore was inconsistent with the charter. The Chancery Court upheld the bylaw, finding that because a January 2011 annual meeting would occur in the third year following the year of the directors' election, there was no inconsistency with the charter. Airgas appealed.

The Delaware Supreme Court reversed. According to the court, there was overwhelming extrinsic evidence that under Airgas' staggered board charter provision, a term of three years was intended. The court noted that Delaware cases involving similar charter language to Airgas' have regarded the charters as creating staggered boards with classes of directors who serve three-year terms. In addition, the court stated that industry practice and understanding support its interpretation. For example, the court noted that nearly 80% of the Delaware corporations in the Fortune 500 that have similar charter language represent in their proxy statements that their directors serve three-year terms. The court also pointed out that commentators and secondary sources had interpreted the Airgas language as intending to provide for a three-year term.

Thus, the court held that under Airgas' charter provision creating a staggered board, a term of three years was intended. Therefore, Air Products' bylaw was inconsistent with the charter because it materially shortened the directors' three-year term and was not approved by a supermajority vote.

DE Chancery Court: Creditors of Insolvent LLCs May Not Sue Derivatively

In CML V, LLC v. Bax, C.A. No. 5373, decided Nov. 3, 2010, the Delaware Chancery Court dismissed derivative claims brought by a creditor of an insolvent LLC on the grounds that creditors of Delaware LLCs lack standing to bring a derivative suit.

The court based its holding on a literal reading of Sec. 18-1002 of the Delaware LLC Act. That section states that in a derivative action, the plaintiff “must be a member or an assignee of a limited liability company interest.” According to the court, Sec. 18-1002 is exclusive ' creditors and anyone else other than a member or an assignee are excluded from bringing a derivative suit.

The court stated that its literal reading of Sec. 18-1002 was supported by the fact that the almost identical provision in the Delaware LP Act has been interpreted as being exclusive. In addition, the legislative history of the LP Act shows that the General Assembly consciously chose that exclusive language.

The court also rejected the creditor's argument that a literal reading of Sec. 18-1002 generates an absurd distinction between insolvent corporations ' where creditors can sue derivatively ' and insolvent LLCs, and that it would be inconsistent with the purpose of the LLC Act. The court noted that the General Corporation Law does not contain the exclusive language of the LLC Act. In addition, the court noted that creditors of Delaware LLCs have numerous statutory and contractual remedies available to them. Therefore, refusing to grant them derivative standing fulfills the contractarian spirit of the LLC Act. [Editor's Note: At press time a Notice of Appeal had just been filed in this matter.]

Directors Did Not Violate Revlon Duties in Two
Separate Cases, Says DE Chancery Court

In re Dollar Thrifty Shareholder Litigation, C.A. No. 5458, decided Sept. 8, 2010, and In re Cogent, Inc. Shareholder Litigation, C.A. No. 5780, decided Oct. 5, 2010, were two cases in which the plaintiffs moved for preliminary injunctions to enjoin the sale of Delaware companies. In each case the plaintiffs claimed that the defendant directors breached their duties under Revlon to take a reasonable approach to immediate value maximization. And in each case the Delaware Chancery Court denied the plaintiffs' motions, finding they had not demonstrated a likelihood of success on the merits.

In In re Dollar Thrifty, the defendant board of directors agreed to sell Dollar Thrifty to Hertz. After the deal was announced, Avis made an offer for a higher price per share. The board declined the offer after finding that a sale could not reasonably be expected to be consummated on a timely basis. The plaintiffs' main claim was that the board breached its duty under Revlon by failing to take affirmative steps to draw Avis into a bidding contest before signing the merger agreement with Hertz and by not engaging in a wider sales effort earlier on.

The Chancery Court pointed out that Dollar Thrifty's board was independent and disinterested, well motivated and exercised due care. And, as the court pointed out, it is rare for a court to second guess such a board. The court also explained that Revlon is a test of reasonableness. It asks whether the board made a reasonable decision, not a perfect one. And in this case the court found that it was reasonable for the board to conclude that it was not in the stockholders' best interests to engage in a wider sales effort because of the risk of distracting employees and of Hertz walking away. The board also had reasonable grounds for not reaching out to Avis before finalizing its deal with Hertz. The board reasonably believed that Avis was not in a position to make a firm bid. In contrast, Hertz was getting close to offering a good price and was offering real closing certainty through antitrust divestiture provisions and a reverse termination fee.

The court also found that the merger agreement offered a fair premium and that the deal protection devices were neither preclusive nor onerous, as was evidenced by the fact that Avis made a bid after the agreement was signed.

In re Cogent involved the proposed acquisition of Cogent, Inc. by 3M for $10.50 per share. The plaintiffs claimed Cogent's board of directors breached its Revlon duties because the purchase price was too low and was the result of an inadequate and unfair sales process, and because the merger agreement contained preclusive protection devices.

In finding that the process used by the board was reasonable, the Chancery Court noted that the board sought and communicated with numerous potential suitors, was disinterested and independent, gave other suitors an opportunity to contact it, and was not biased in favor of 3M.

In challenging the $10.50 per share price, the plaintiffs relied mainly on the fact that another company expressed an interest in buying Cogent for $11 ' $12 per share. However, according to the court, the board acted reasonably in discounting that price because there was only a non-binding expression of interest, with any offer being contingent upon the completion of due diligence.

The court also reviewed the deal protection devices and found that individually and collectively they were reasonable and did not preclude a higher bid from being successful. The plaintiffs mainly challenged a top-up option which, they claimed, allowed 3M to take control against the wishes of minority stockholders even if a majority of shares were not tendered. But, as the court noted, that could only happen upon the occurrence of several highly unlikely events.

NY Court of Appeals Upholds In Pari Delicto Defense for Professional Advisers Sued By Corporate Wrongdoers

In Kirschner v. KPMG LLP and Teachers' Retirement System of Louisiana v. American International Group, Inc. , 2010 N.Y. Slip Op. 7415, decided Oct. 21, 2010, the New York Court of Appeals accepted certified questions from the U.S. Court of Appeals for the Second Circuit and the Delaware Supreme Court asking whether the in pari delicto defense ' under which a court will refuse to resolve a dispute between two wrongdoers ' limits the liability of professional service providers in suits brought by a corporation, or its representatives, for assisting or failing to prevent wrongdoing by the corporation's executives. And the court answered by reaffirming the applicability of the in pari delicto defense.

The court noted that in pari delicto “has been wrought in the inmost texture of our common law for at least two centuries” and that it survives because it serves important public policy purposes of deterring illegality and avoiding entangling courts in disputes between wrongdoers.

The court then pointed out that in determining if a corporation is a wrongdoer, New York courts apply the agency doctrine of imputation. This means that the acts of the agents, and the knowledge they acquire while acting within the scope of their authority, will be presumptively imputed to the principal. There is one exception that New York will apply ' the adverse interest exception. According to the court, this exception is narrow and will apply only when the agent has totally abandoned the principal's interests and was acting entirely on his or her own or for another's purposes.

The plaintiffs ' a post-bankruptcy litigation trustee in Kirschner and stockholders filing a derivative suit in AIG, argued for a change in the pari delicto doctrine for reasons of public policy ' specifically to recompense the innocent and make outside professionals responsible for their misconduct. However, the New York Court of Appeals rejected that approach ' which had previously been adopted by New Jersey and Pennsylvania. The court asked why the interests of innocent stakeholders of corporate fraudsters should trump the interests of innocent stakeholders of the professional service firms. The court also stated that it was not convinced that expanding remedies to “innocent” plaintiffs would produce a meaningful additional deterrent to professional misconduct.

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