Quarterly State Compliance Review

In addition, there are a number of bills pending in the state legislatures that business entity lawyers may find of interest. These include the following:

California (Senate Bill 323), Kansas (House Bill 2261), Missouri (House Bill 718), and Utah (Senate Bill 131) have bills pending to repeal their current LLC acts and enact new laws based on the Revised Uniform LLC Act.

In Illinois, Senate Bill 2084 would reduce the fees for forming and registering LLCs. In Maryland, Senate Bill 790 would amend provisions of the LLC act governing bearer certificates, operating agreements, fiduciary duties, assignments, and charging orders. In Nevada, Assembly Bill 78 would amend provisions governing the penalties imposed on foreign business entities for failing to qualify or obtain or renew a business license.

In New York, Assembly Bill 696 would require shareholder approval of corporate contributions to political candidates and Assembly Bill 1710 would require public corporations to permit shareholders to attend meetings via remote communications. In Ohio, House Bill 48 would amend provisions of the corporation act governing dissenters' rights, dissolution, indemnification, and fiduciary duties. In Utah, House Bill 29 would clarify that a corporation may merge with other domestic and foreign business entity types.

Attorneys interested in the new “hybrid” entities (for-profits formed for charitable or socially beneficial purposes) may wish to note that Arkansas (Senate Bill 5), Iowa (Senate Bill 158), New York (Senate Bill 3011), and Oklahoma (House Bill 1088) have bills pending that would authorize the formation of low-profit LLCs, while New York (Senate Bill 79) and Virginia (House Bill 2358) are considering bills that would authorize the formation of benefit corporations.

IN THE STATE COURTS

DE Supreme Court Upholds Rulings That LLC Manager Breached Fiduciary Duties and That Member Was
Entitled to Attorneys' Fees

William Penn Partnership v. Saliba, No. 362, 2010, decided Feb. 9, 2011, involved a Delaware LLC whose sole asset was a hotel. The LLC's managers, who also owned the partnership that owned 50% of the LLC, sold the hotel. The buyer was a corporation. The managers owned 40% of the buyer and controlled its board of directors. By buying the hotel, the corporation received a $1.6 million tax credit. The managers' share was $434,000.

Minority members ' who had also expressed an interest in buying the hotel ' brought a suit claiming the managers breached their fiduciary duties. An independent court-appointed appraiser valued the hotel at $5.5 million. The purchase price paid by the corporation was over $6.6 million. Nevertheless, the Chancery Court found that the managers failed to meet their burden of establishing the entire fairness of the transaction. The court also awarded the plaintiffs attorneys' fees and expenses. The defendant managers appealed.

The Delaware Supreme Court affirmed. The court noted that because the managers stood on both sides of the hotel sale, they had the burden of demonstrating the entire fairness of the transaction. The managers argued the deal was entirely fair because the purchase price was higher than the appraised value. However, the court noted that entire fairness consists of both fair price and fair dealing. And, in this case, the record showed that the managers manipulated the sales process through misrepresentations and repeated material omissions. This precluded the possibility that the hotel would be sold pursuant to an open and fair process.

The court also held that the awarding of attorneys' fees and expenses was supported by law and equity. The court pointed out that the Chancery Court has broad discretionary power to fashion appropriate equitable relief. Here, the plaintiffs were left without a typical damage award because the court's appraisal price was lower than the sale price. Absent this award the plaintiffs would have been penalized for bringing a successful claim against the managers for breach of fiduciary duties.

Stockholder Who Brought a Derivative Action Without First Inspecting Books and Records May Bring a
Later-Filed Action

In King v. Verifone Holdings, Inc., No. 362, 2010, decided Jan. 28, 2011, the plaintiff (King) filed a derivative action in a California federal court on behalf of a Delaware corporation. Three other derivative actions followed. All four were consolidated and the California court appointed King lead plaintiff. The court then dismissed the action, without prejudice and with leave to amend, for failure to make a demand or plead that demand would be excused.

King then filed an action in the Delaware Chancery Court to inspect books and records pursuant to Sec. 220 of the Delaware corporation law. The Chancery Court dismissed the action, holding that King lacked a proper purpose because he elected to file his California derivative action before conducting a pre-suit investigation in order to be the first to file and be named lead plaintiff. King appealed.

The Delaware Supreme Court reversed. The court concluded that the Chancery Court's bright line rule, which bars stockholders from pursuing inspections under Sec. 220 solely because they filed a derivative action first, did not comport with existing Delaware law or sound policy. The court discussed three previous cases in which the Chancery Court had permitted inspections where the plaintiff's purpose was to investigate facts needed to plead demand futility in earlier filed derivative actions. In those cases, like this one, the derivative actions were dismissed without prejudice and with leave to amend. In those cases in which inspections were denied, the derivative complaints were dismissed with prejudice, meaning that an inspection would have been an empty exercise.

The court did state that it was sensitive to the Chancery Court's concerns about investors wasting the court's and litigants' resources by repeatedly litigating the issue of demand futility. However, the court found that a bright line rule precluding stockholders from bringing Sec. 220 actions was overly broad and that there were a number of narrower remedies available to address those concerns.

NY Appellate Court Rules on Insurer's Obligation to Reimburse Corporation for Attorneys' Fees in Derivative and Class Actions

In XL Specialty Insurance Co. v. Loral Space & Communication, Inc., 2011 N.Y. Slip Op. 1145 (A.D. 1 Dept), decided Feb. 17, 2011, the plaintiff insurance companies issued a policy to a Delaware corporation under which they agreed to reimburse the corporation for losses resulting from securities claims made against it during the policy period.

During the policy period a shareholder derivative action and a class action were filed in Delaware arising out of an agreement whereby the corporation was to receive $300 million in financing from its controlling shareholder in exchange for convertible preferred stock. The derivative suit sought recession of the agreement. The class action sought money damages for breach of fiduciary duty by the board of directors. The Delaware Chancery Court held that the transaction was unfair to the corporation. To remedy the unfairness the court restructured the financing. No money damages were awarded, nor did the court make any findings concerning the fault of the directors.

Counsel for the plaintiffs in the derivative and class actions applied for, and were granted, awards of attorneys' fees of $8.8 million and $10.7 million, respectively. The corporation then sought reimbursement of the fees from the insurers. The insurers brought an action in New York seeking a declaration that they were not obligated to reimburse the corporation. The trial court declared that the insurers were obligated and they appealed.

The New York Supreme Court, Appellate Division, First Department, affirmed the insurers' obligation to pay the attorney's fees in the shareholder derivative action. The insurers argued that the corporation had not suffered a covered loss because the Delaware Chancery Court found no liability against the corporation and the corporation actually received a benefit from the court remedy. The court noted that the policy defined “loss” to include “other amounts” the corporation becomes “legally obligated” to pay. The corporation here was legally obligated to pay the fee award. Thus, it was within the definition of loss. The court further noted that the corporation did not receive a benefit. At best, the reformation of the transaction repaired a wrong the corporation otherwise would have suffered.

However, the court reversed the holding that the insurers were obligated to pay the attorneys' fees in the class action. According to the court, the claims in the class action did not fall within the policy's coverage because they did not involve a securities claim. The class action alleged only a breach of fiduciary duty by the corporation's directors. The clear language of the policy did not encompass losses arising from such a claim.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for CT Corporation, part of Wolters Kluwer Corporate Legal Services (www.ctlegalsolutions.com).

This edition of the Quarterly State Compliance Review looks at some enacted and pending legislation of interest to corporate lawyers. It also discusses some recent cases of interest, including decisions from Delaware and New York concerning the awarding of attorneys' fees.

IN THE STATE LEGISLATURES

The period between Jan. 1 and April 1 tends to be a slow one when it comes to amendments to state business organization statutes. This was particularly true this year as few amendments went into effect during the last quarter. There were, however, four bills that went into effect in New Jersey on March 1. Assembly Bill 3253 allows a corporation to renounce the corporate opportunity doctrine in its certificate of incorporation or by action of its board of directors. Senate Bill 914 allows a professional corporation to use or register an alternate name. Senate Bill 2493 prevents the elimination or impairment of a right to indemnification under a corporation's certificate of incorporation or bylaws under certain circumstances, and Senate Bill 2170 authorizes the formation of a benefit corporation.

In addition, there are a number of bills pending in the state legislatures that business entity lawyers may find of interest. These include the following:

California (Senate Bill 323), Kansas (House Bill 2261), Missouri (House Bill 718), and Utah (Senate Bill 131) have bills pending to repeal their current LLC acts and enact new laws based on the Revised Uniform LLC Act.

In Illinois, Senate Bill 2084 would reduce the fees for forming and registering LLCs. In Maryland, Senate Bill 790 would amend provisions of the LLC act governing bearer certificates, operating agreements, fiduciary duties, assignments, and charging orders. In Nevada, Assembly Bill 78 would amend provisions governing the penalties imposed on foreign business entities for failing to qualify or obtain or renew a business license.

In New York, Assembly Bill 696 would require shareholder approval of corporate contributions to political candidates and Assembly Bill 1710 would require public corporations to permit shareholders to attend meetings via remote communications. In Ohio, House Bill 48 would amend provisions of the corporation act governing dissenters' rights, dissolution, indemnification, and fiduciary duties. In Utah, House Bill 29 would clarify that a corporation may merge with other domestic and foreign business entity types.

Attorneys interested in the new “hybrid” entities (for-profits formed for charitable or socially beneficial purposes) may wish to note that Arkansas (Senate Bill 5), Iowa (Senate Bill 158), New York (Senate Bill 3011), and Oklahoma (House Bill 1088) have bills pending that would authorize the formation of low-profit LLCs, while New York (Senate Bill 79) and Virginia (House Bill 2358) are considering bills that would authorize the formation of benefit corporations.

IN THE STATE COURTS

DE Supreme Court Upholds Rulings That LLC Manager Breached Fiduciary Duties and That Member Was
Entitled to Attorneys' Fees

William Penn Partnership v. Saliba, No. 362, 2010, decided Feb. 9, 2011, involved a Delaware LLC whose sole asset was a hotel. The LLC's managers, who also owned the partnership that owned 50% of the LLC, sold the hotel. The buyer was a corporation. The managers owned 40% of the buyer and controlled its board of directors. By buying the hotel, the corporation received a $1.6 million tax credit. The managers' share was $434,000.

Minority members ' who had also expressed an interest in buying the hotel ' brought a suit claiming the managers breached their fiduciary duties. An independent court-appointed appraiser valued the hotel at $5.5 million. The purchase price paid by the corporation was over $6.6 million. Nevertheless, the Chancery Court found that the managers failed to meet their burden of establishing the entire fairness of the transaction. The court also awarded the plaintiffs attorneys' fees and expenses. The defendant managers appealed.

The Delaware Supreme Court affirmed. The court noted that because the managers stood on both sides of the hotel sale, they had the burden of demonstrating the entire fairness of the transaction. The managers argued the deal was entirely fair because the purchase price was higher than the appraised value. However, the court noted that entire fairness consists of both fair price and fair dealing. And, in this case, the record showed that the managers manipulated the sales process through misrepresentations and repeated material omissions. This precluded the possibility that the hotel would be sold pursuant to an open and fair process.

The court also held that the awarding of attorneys' fees and expenses was supported by law and equity. The court pointed out that the Chancery Court has broad discretionary power to fashion appropriate equitable relief. Here, the plaintiffs were left without a typical damage award because the court's appraisal price was lower than the sale price. Absent this award the plaintiffs would have been penalized for bringing a successful claim against the managers for breach of fiduciary duties.

Stockholder Who Brought a Derivative Action Without First Inspecting Books and Records May Bring a
Later-Filed Action

In King v. Verifone Holdings, Inc., No. 362, 2010, decided Jan. 28, 2011, the plaintiff (King) filed a derivative action in a California federal court on behalf of a Delaware corporation. Three other derivative actions followed. All four were consolidated and the California court appointed King lead plaintiff. The court then dismissed the action, without prejudice and with leave to amend, for failure to make a demand or plead that demand would be excused.

King then filed an action in the Delaware Chancery Court to inspect books and records pursuant to Sec. 220 of the Delaware corporation law. The Chancery Court dismissed the action, holding that King lacked a proper purpose because he elected to file his California derivative action before conducting a pre-suit investigation in order to be the first to file and be named lead plaintiff. King appealed.

The Delaware Supreme Court reversed. The court concluded that the Chancery Court's bright line rule, which bars stockholders from pursuing inspections under Sec. 220 solely because they filed a derivative action first, did not comport with existing Delaware law or sound policy. The court discussed three previous cases in which the Chancery Court had permitted inspections where the plaintiff's purpose was to investigate facts needed to plead demand futility in earlier filed derivative actions. In those cases, like this one, the derivative actions were dismissed without prejudice and with leave to amend. In those cases in which inspections were denied, the derivative complaints were dismissed with prejudice, meaning that an inspection would have been an empty exercise.

The court did state that it was sensitive to the Chancery Court's concerns about investors wasting the court's and litigants' resources by repeatedly litigating the issue of demand futility. However, the court found that a bright line rule precluding stockholders from bringing Sec. 220 actions was overly broad and that there were a number of narrower remedies available to address those concerns.

NY Appellate Court Rules on Insurer's Obligation to Reimburse Corporation for Attorneys' Fees in Derivative and Class Actions

In XL Specialty Insurance Co. v. Loral Space & Communication, Inc. , 2011 N.Y. Slip Op. 1145 (A.D. 1 Dept), decided Feb. 17, 2011, the plaintiff insurance companies issued a policy to a Delaware corporation under which they agreed to reimburse the corporation for losses resulting from securities claims made against it during the policy period.

During the policy period a shareholder derivative action and a class action were filed in Delaware arising out of an agreement whereby the corporation was to receive $300 million in financing from its controlling shareholder in exchange for convertible preferred stock. The derivative suit sought recession of the agreement. The class action sought money damages for breach of fiduciary duty by the board of directors. The Delaware Chancery Court held that the transaction was unfair to the corporation. To remedy the unfairness the court restructured the financing. No money damages were awarded, nor did the court make any findings concerning the fault of the directors.

Counsel for the plaintiffs in the derivative and class actions applied for, and were granted, awards of attorneys' fees of $8.8 million and $10.7 million, respectively. The corporation then sought reimbursement of the fees from the insurers. The insurers brought an action in New York seeking a declaration that they were not obligated to reimburse the corporation. The trial court declared that the insurers were obligated and they appealed.

The New York Supreme Court, Appellate Division, First Department, affirmed the insurers' obligation to pay the attorney's fees in the shareholder derivative action. The insurers argued that the corporation had not suffered a covered loss because the Delaware Chancery Court found no liability against the corporation and the corporation actually received a benefit from the court remedy. The court noted that the policy defined “loss” to include “other amounts” the corporation becomes “legally obligated” to pay. The corporation here was legally obligated to pay the fee award. Thus, it was within the definition of loss. The court further noted that the corporation did not receive a benefit. At best, the reformation of the transaction repaired a wrong the corporation otherwise would have suffered.

However, the court reversed the holding that the insurers were obligated to pay the attorneys' fees in the class action. According to the court, the claims in the class action did not fall within the policy's coverage because they did not involve a securities claim. The class action alleged only a breach of fiduciary duty by the corporation's directors. The clear language of the policy did not encompass losses arising from such a claim.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for CT Corporation, part of Wolters Kluwer Corporate Legal Services (www.ctlegalsolutions.com).