Quarterly State Compliance Review

In California, Assembly Bill 1680, effective Jan. 1, 2013, amended provisions of the corporation law governing dissenters' rights to modify the definition of dissenting shares, clarify when fair market value is to be determined, and eliminate a restriction on the eligibility of publicly held shares. In Louisiana, Senate Bill 746, effective Jan. 1, 2013, amended the LLC law to authorize and provide for the manner of converting the state of organization of domestic and foreign LLCs.

In Massachusetts, House Bill 4352, effective Dec. 1, 2012, and in Illinois, Senate Bill 2897, effective Jan. 1, 2013, enacted Benefit Corporation Acts, authorizing the incorporation and operation of a “benefit corporation,” which is a corporation formed to pursue a general public benefit. In Mississippi, House Bill 789, effective Jan. 1, 2013, amended provisions of the corporation law dealing with electronic communications, corporate names, shareholder meetings, director liability, mergers, administrative dissolution, and foreign corporations.

In Nebraska, Legislative Bill 854, effective Jan. 1, 2013, amended the LLC and corporation laws to provide that administratively dissolved or revoked LLCs and corporations must apply for reinstatement within five years after the effective date of dissolution or revocation. In New Hampshire, Senate Bill 1532 enacted the Revised LLC Act, which governs domestic LLCs formed on or after Jan. 1, 2013 and all foreign LLCs on Jan. 1, 2013. Domestic LLCs formed before that date will continue to be governed by the previous LLC law until Jan. 1, 2014, unless they elect to be governed by the Revised Act before then. In Oklahoma, Senate Bill 1279, effective Nov. 1, 2012, amended the Professional Entity Act to include, in the definition of “professional service,” the services rendered by a licensed alcohol and drug counselor and a licensed behavioral practitioner. And in Tennessee, House Bill 3459, effective Jan. 1, 2013, revised provisions of the corporation law dealing with actions taken without a meeting, dissenters' rights, mergers, share exchanges, conversions, conflict of interest transactions, and inspections of books and records.

IN THE STATE COURTS

DE Supreme Court Holds That LLC Manager Breached Contractual Fiduciary
Duties

In Gatz Properties, LLC v. Auriga Capital Corporation, No. 148, 2012 (Del. Supr., Nov. 7, 2012), the minority members of a Delaware LLC sued the manager, who was also the majority member, after he bought out the plaintiffs for a price well below market value. The Delaware Chancery Court held that the managers of Delaware LLCs owe default fiduciary duties of loyalty and care as well as the contractual fiduciary duties imposed by the LLC agreement. The Chancery Court also held that the manager in this case breached both his default and contractual fiduciary duties.

The Delaware Supreme Court affirmed the ruling that the manager breached his contractual fiduciary duties. The court noted that the LLC agreement required a manager entering into a conflict of interest transaction to obtain a fair price. According to the court, this language imposed fiduciary duties even though it did not use the term. The court also agreed with the Chancery Court that the manager breached his duties by, among other things, ignoring a legitimate bid made by a third party, providing the plaintiffs with false information about their own and the third party's bids, and conducting a sham auction.

However, the court also held that the Chancery Court's holding that managers owe default fiduciary duties had no precedential value. The court stated that because the issue of fiduciary duties could be resolved by reference to the LLC agreement, and because no litigant asked the court to resolve the issue, it was unnecessary to decide whether default fiduciary duties exist.

DE Supreme Court Upholds Personal Jurisdiction Under Conspiracy Theory

In Matthew v. Flakt Woods Group SA, No. 150, 2012, (Del. Supr., November 20, 2012), a former member and manager of a Delaware LLC filed suit against a Swiss company, claiming that the company conspired with other members and managers to divest him of his interest in a lucrative joint venture between the company and the LLC. The Chancery Court dismissed for lack of personal jurisdiction after finding that the Swiss company did not know that the conspiracy had a nexus to Delaware as required under the conspiracy theory of jurisdiction. The plaintiff appealed.

The Delaware Supreme Court reversed. The court noted that the court must first determine whether Delaware's long-arm statute applied ' an issue the Chancery Court did not address. The court then pointed out that as part of the alleged conspiracy the other members and managers filed a certificate of cancellation of the LLC, which, according to the court, constitutes the transaction of business in Delaware. Thus, because the alleged co-conspirators transacted business, the Swiss company transacted business and was subject to personal jurisdiction under the long arm-statute.

The court also held that the record showed that the Swiss company knew or should have known that the LLC was a Delaware entity and that therefore there was a Delaware nexus. The court stated that a sophisticated, global business like the Swiss company was likely to have conducted due diligence before entering into a long term venture with a startup, and likely to have investigated when its representative learned of the dispute over the LLC's dissolution. In either case the company would have discovered that the LLC was a Delaware entity.

NY Court of Appeals Upholds Contractual Waiver of Member's Fiduciary Duties

Pappas v. Tzolis, 2012 N.Y. Slip Op. 08053 (Court of Appeals, Nov. 27, 2012), involved a dispute among three members of a New York LLC that owned a lease to a building. The defendant member bought the plaintiffs' membership interests for $1 million and $500,000 respectively. The parties executed a Certificate in which the plaintiffs stated that the defendant, as the buyer, owed no fiduciary duties to them as the sellers. Shortly after the defendant became the sole member he assigned the LLC's lease for $17.5 million. The plaintiffs brought an action alleging, among other claims, that the defendant breached his fiduciary duties by failing to disclose his negotiations for the sublease before buying their interests. The trial court dismissed the complaint, relying on the Certificate. The Appellate Division allowed the breach of fiduciary duty claim to proceed and the defendant appealed.

The New York Court of Appeals reversed. The court noted that a sophisticated principal may release a fiduciary from claims of breach where the relationship is no longer one of unquestioning trust and it is no longer reasonable to rely on the fiduciary's representations without making additional inquiry. In this case the plaintiffs were sophisticated businessmen, represented by counsel. Their allegations made it clear that at the time of the buyout they had an antagonistic relationship with the defendant. Thus they could no longer rely on the defendant as trustworthy and the release contained in the Certificate was valid.

CA Appellate Court: Alter Ego Doctrine May Not Be Used to Circumvent
Licensing Statute

In Twenty-Nine Palms Enterprises Corp. v. Bardos, E051769 (Cal. App. 4 Dist., Nov. 10, 2012), the plaintiff entered into a contract with the defendant, a sole proprietorship, whereby the defendant was to construct a road and parking lot. The defendant was not a licensed contractor at the time. The plaintiff filed a suit to recover the more than $750,000 it paid the defendant pursuant to a section of California law providing that an unlicensed contractor must disgorge all compensation paid under a contract. The trial court found for the plaintiff. On appeal the defendant's sole proprietor argued that because he was also the sole shareholder and managing officer of a corporation that was a licensed contractor, the court should pierce the corporate veil and find that the defendant was operating under the corporation's license.

The California Court of Appeal rejected the defendant's argument, stating that the alter ego and piercing the corporate veil doctrines were not created to circumvent regulatory requirements. They were founded on equitable principles and are designed to prevent injustice. Here, the sole proprietor admitted he created the defendant to hide the fact that he hired himself to do the work on the contract. The court stated that it failed to see how equity required piercing of the corporate veil to remedy an injustice when the defendant was formed to hide self-dealing. Judgment for the plaintiff was affirmed.

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect between Nov. 1, 2012 and Jan. 1, 2013. It also reviews some recent decisions of interest, including two from the Delaware Supreme Court.

In The State Legislatures

Legislation affecting corporations, LLCs and other types of business organizations went into effect in a number of states during the last quarter. Highlights from around the country include the following:

In California, Assembly Bill 1680, effective Jan. 1, 2013, amended provisions of the corporation law governing dissenters' rights to modify the definition of dissenting shares, clarify when fair market value is to be determined, and eliminate a restriction on the eligibility of publicly held shares. In Louisiana, Senate Bill 746, effective Jan. 1, 2013, amended the LLC law to authorize and provide for the manner of converting the state of organization of domestic and foreign LLCs.

In Massachusetts, House Bill 4352, effective Dec. 1, 2012, and in Illinois, Senate Bill 2897, effective Jan. 1, 2013, enacted Benefit Corporation Acts, authorizing the incorporation and operation of a “benefit corporation,” which is a corporation formed to pursue a general public benefit. In Mississippi, House Bill 789, effective Jan. 1, 2013, amended provisions of the corporation law dealing with electronic communications, corporate names, shareholder meetings, director liability, mergers, administrative dissolution, and foreign corporations.

In Nebraska, Legislative Bill 854, effective Jan. 1, 2013, amended the LLC and corporation laws to provide that administratively dissolved or revoked LLCs and corporations must apply for reinstatement within five years after the effective date of dissolution or revocation. In New Hampshire, Senate Bill 1532 enacted the Revised LLC Act, which governs domestic LLCs formed on or after Jan. 1, 2013 and all foreign LLCs on Jan. 1, 2013. Domestic LLCs formed before that date will continue to be governed by the previous LLC law until Jan. 1, 2014, unless they elect to be governed by the Revised Act before then. In Oklahoma, Senate Bill 1279, effective Nov. 1, 2012, amended the Professional Entity Act to include, in the definition of “professional service,” the services rendered by a licensed alcohol and drug counselor and a licensed behavioral practitioner. And in Tennessee, House Bill 3459, effective Jan. 1, 2013, revised provisions of the corporation law dealing with actions taken without a meeting, dissenters' rights, mergers, share exchanges, conversions, conflict of interest transactions, and inspections of books and records.

IN THE STATE COURTS

DE Supreme Court Holds That LLC Manager Breached Contractual Fiduciary
Duties

In Gatz Properties, LLC v. Auriga Capital Corporation, No. 148, 2012 (Del. Supr., Nov. 7, 2012), the minority members of a Delaware LLC sued the manager, who was also the majority member, after he bought out the plaintiffs for a price well below market value. The Delaware Chancery Court held that the managers of Delaware LLCs owe default fiduciary duties of loyalty and care as well as the contractual fiduciary duties imposed by the LLC agreement. The Chancery Court also held that the manager in this case breached both his default and contractual fiduciary duties.

The Delaware Supreme Court affirmed the ruling that the manager breached his contractual fiduciary duties. The court noted that the LLC agreement required a manager entering into a conflict of interest transaction to obtain a fair price. According to the court, this language imposed fiduciary duties even though it did not use the term. The court also agreed with the Chancery Court that the manager breached his duties by, among other things, ignoring a legitimate bid made by a third party, providing the plaintiffs with false information about their own and the third party's bids, and conducting a sham auction.

However, the court also held that the Chancery Court's holding that managers owe default fiduciary duties had no precedential value. The court stated that because the issue of fiduciary duties could be resolved by reference to the LLC agreement, and because no litigant asked the court to resolve the issue, it was unnecessary to decide whether default fiduciary duties exist.

DE Supreme Court Upholds Personal Jurisdiction Under Conspiracy Theory

In Matthew v. Flakt Woods Group SA, No. 150, 2012, (Del. Supr., November 20, 2012), a former member and manager of a Delaware LLC filed suit against a Swiss company, claiming that the company conspired with other members and managers to divest him of his interest in a lucrative joint venture between the company and the LLC. The Chancery Court dismissed for lack of personal jurisdiction after finding that the Swiss company did not know that the conspiracy had a nexus to Delaware as required under the conspiracy theory of jurisdiction. The plaintiff appealed.

The Delaware Supreme Court reversed. The court noted that the court must first determine whether Delaware's long-arm statute applied ' an issue the Chancery Court did not address. The court then pointed out that as part of the alleged conspiracy the other members and managers filed a certificate of cancellation of the LLC, which, according to the court, constitutes the transaction of business in Delaware. Thus, because the alleged co-conspirators transacted business, the Swiss company transacted business and was subject to personal jurisdiction under the long arm-statute.

The court also held that the record showed that the Swiss company knew or should have known that the LLC was a Delaware entity and that therefore there was a Delaware nexus. The court stated that a sophisticated, global business like the Swiss company was likely to have conducted due diligence before entering into a long term venture with a startup, and likely to have investigated when its representative learned of the dispute over the LLC's dissolution. In either case the company would have discovered that the LLC was a Delaware entity.

NY Court of Appeals Upholds Contractual Waiver of Member's Fiduciary Duties

Pappas v. Tzolis , 2012 N.Y. Slip Op. 08053 (Court of Appeals, Nov. 27, 2012), involved a dispute among three members of a New York LLC that owned a lease to a building. The defendant member bought the plaintiffs' membership interests for $1 million and $500,000 respectively. The parties executed a Certificate in which the plaintiffs stated that the defendant, as the buyer, owed no fiduciary duties to them as the sellers. Shortly after the defendant became the sole member he assigned the LLC's lease for $17.5 million. The plaintiffs brought an action alleging, among other claims, that the defendant breached his fiduciary duties by failing to disclose his negotiations for the sublease before buying their interests. The trial court dismissed the complaint, relying on the Certificate. The Appellate Division allowed the breach of fiduciary duty claim to proceed and the defendant appealed.

The New York Court of Appeals reversed. The court noted that a sophisticated principal may release a fiduciary from claims of breach where the relationship is no longer one of unquestioning trust and it is no longer reasonable to rely on the fiduciary's representations without making additional inquiry. In this case the plaintiffs were sophisticated businessmen, represented by counsel. Their allegations made it clear that at the time of the buyout they had an antagonistic relationship with the defendant. Thus they could no longer rely on the defendant as trustworthy and the release contained in the Certificate was valid.

CA Appellate Court: Alter Ego Doctrine May Not Be Used to Circumvent
Licensing Statute

In Twenty-Nine Palms Enterprises Corp. v. Bardos, E051769 (Cal. App. 4 Dist., Nov. 10, 2012), the plaintiff entered into a contract with the defendant, a sole proprietorship, whereby the defendant was to construct a road and parking lot. The defendant was not a licensed contractor at the time. The plaintiff filed a suit to recover the more than $750,000 it paid the defendant pursuant to a section of California law providing that an unlicensed contractor must disgorge all compensation paid under a contract. The trial court found for the plaintiff. On appeal the defendant's sole proprietor argued that because he was also the sole shareholder and managing officer of a corporation that was a licensed contractor, the court should pierce the corporate veil and find that the defendant was operating under the corporation's license.

The California Court of Appeal rejected the defendant's argument, stating that the alter ego and piercing the corporate veil doctrines were not created to circumvent regulatory requirements. They were founded on equitable principles and are designed to prevent injustice. Here, the sole proprietor admitted he created the defendant to hide the fact that he hired himself to do the work on the contract. The court stated that it failed to see how equity required piercing of the corporate veil to remedy an injustice when the defendant was formed to hide self-dealing. Judgment for the plaintiff was affirmed.