Quarterly State Compliance Review

House Bill 127 amended the General Corporation Law (GCL). The amendments went into effect on Aug. 1 unless otherwise specified, and include the following:

Sec. 152 was amended to state that the board of directors may determine the price for a stock issuance by approving a formula by which the price will be calculated. Sec. 251 was amended to provide that a Delaware public corporation does not have to obtain stockholder approval to effect a merger if the acquirer obtains, in a tender offer, the percentage of shares that would have been required to adopt the merger agreement and certain other requirements are met. Sec. 312 was amended to clarify that only a corporation's directors or stockholders may authorize a renewal or revival of its certificate of incorporation.

House Bill 127 also added new sections to the GCL, which will go into effect on April 1, 2014. They permit a corporation (or the Chancery Court) to ratify an overissue of stock or another corporate act or transaction that, due to a lack of compliance with the GCL, certificate of incorporation, bylaws or other agreement or plan, is void or voidable.

Senate Bill 47 added a new subchapter to the GCL governing Public Benefit Corporations ' which are for-profit corporations organized under the GCL that are intended to produce a public benefit and operate in a responsible and sustainable manner.

House Bill 126 enacted various amendments to the Delaware Limited Liability Company Act including the following:

Secs. 18-209, 18-212, 18-213, 18-214, and 18-216 were amended to confirm that the rights or securities of, or interests in, an entity that is surviving a merger, consolidating, domesticating, converting, transferring or continuing may remain outstanding. Sec. 18-703 was amended to clarify that attachment, garnishment, foreclosure or other legal or equitable remedies are not available to a member's judgment creditor, whether the LLC has one member or more than one member. Sec. 18-1101 was amended to state that the provisions of the LLC Act apply whether the LLC has one member or more than one member. And Sec. 18-1104 was amended to confirm that in the absence of a statutory or contractual provision the rules of law and equity relating to fiduciary duties govern.

Amendments to the Business Entity Laws of Other States

In Alabama, House Bill 403, effective Aug. 1, amended the business entity laws to extend the name reservation period from 120 days to one year. In Arizona, Senate Bill 1233, effective Sept. 13, amended the LLC law to add a provision governing the ownership of an interest in joint tenancy or as community property with a right of survivorship. In Arkansas, House Bill 1510, effective Aug. 16, amended the corporation law to permit the formation of benefit corporations.

In Louisiana, House Bill 430, effective Aug. 1, increased the fees for filing most corporate and LLC documents. In Missouri, House Bill 510, effective Aug. 28, authorized the formation of Series LLCs. In New Hampshire, Senate Bill 52, effective Aug. 5, permitted a limited partnership's name to end with the abbreviation “L.P.” In Pennsylvania, Senate Bill 304, effective Sept. 7, amended provisions of the corporation law dealing with expedited filing services, articles of incorporation, bearer shares and scrip, transfer restrictions, meetings, and the pricing, issuance and acquisition of shares.

In Texas, Senate Bill 849, effective Sept. 1, amended the Business Organizations Code to allow a for-profit corporation to include one or more social purposes in its certificate of formation and require directors and officers to consider the social purpose in discharging their duties. And in Washington, House Bill 1148 (this one effective July 28), amended the provision of the business corporation act dealing with dissenters' rights and parent-subsidiary mergers.

IN THE STATE COURTS

DE's Supreme Court Defines Good Faith Provision in Limited Partnership Agreement

In DV Realty Advisor LLC v. Policemen's Annuity and Benefit Fund of Chicago, No. 547, 2012 (Del. Supr.), decided Aug. 26, 2013, the limited partners of a Delaware limited partnership removed the general partner after the general partner failed to deliver audited financial statements as it was required to do by the limited partnership agreement (LPA). The limited partners filed a complaint in the Delaware Chancery Court seeking a declaratory judgment that the removal was valid under the LPA, which provided that a general partner could be removed by the limited partners if they determined, in good faith, that removal was necessary for the best interest of the limited partnership. The Chancery Court applied the definition of good faith found in the Uniform Commercial Code, found that the limited partners had acted in good faith, and declared the removal valid. The general partner appealed.

The Delaware Supreme Court held that the Chancery Court inappropriately applied the UCC definition of good faith. The court noted that the UCC does not apply to limited partnerships and had the parties wanted to use the UCC definition they could have so provided in the LPA. Instead, the Supreme Court held that the traditional business judgment rule definition should be applied. Under that definition the determination that the removal of the general partner was necessary in the best interests of the limited partnership will be considered in good faith unless the limited partners went so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.

The court then noted that the record established that the general partner repeatedly breached its obligation to deliver to the limited partners audited financial statements on time, and that based on this record, the Chancery Court correctly found that the limited partners acted in good faith. Thus, although the Chancery Court applied the wrong standard it came to the right conclusion and the declaratory judgment in favor of the limited partners was affirmed.

DE's Chancery Court Rules On Ownership of LLC Interests and Breach of Fiduciary Duties

In Grove v. Brown, C.A. No. 6793 (Del. Ch.), decided Aug. 8, 2013, the plaintiffs (the Groves) and the defendants (the Browns) formed a Delaware LLC (Heartfelt) that operated a healthcare agency. The operating agreement provided that each person owned 25% and it required an initial capital contribution of $10,000 each. The Browns, claiming that they were majority owners because one of the Groves had not made the required contribution, formed a new LLC, merged Heartfelt into it and squeezed out the Groves. The Groves brought a suit in the Delaware Chancery Court for breach of fiduciary duty arising from the merger. The Browns counterclaimed for breach of fiduciary duty based on the Groves forming their owned healthcare agencies that competed with Heartfelt.

The Delaware Chancery Court first addressed the claim arising out of the merger. The court noted that the operating agreement unambiguously stated that each member owned 25% of the LLC and did not provide that the failure to make the $10,000 contribution divested a member of his or her membership interest. Therefore, the Browns did not own a majority of the LLC and lacked the authority to enter into the merger. The court then found that the Groves breached their fiduciary duties by operating their healthcare agencies as they wrongfully took a business opportunity that belonged to Heartfelt. As for the remedies, the court ruled that each side had to account to Heartfelt for the profits they wrongfully took for themselves.

IL Appellate Court Interprets Door Closing Provision of Not for Profit Corporation Act

Young America's Foundation v. Doris A. Pistole Revocable Living Trust, 2013 IL App (2d) 121122, decided Aug. 20, 2013, involved a Tennessee not-for-profit corporation that worked with students to promote conservative ideas. The corporation filed a suit in Illinois. At the time it had not registered to do business in Illinois. The defendants claimed the plaintiff was barred from bringing suits in Illinois by the Not for Profit Corporation Act provision stating that no foreign corporation conducting affairs in the state without authority may maintain a civil action. The plaintiff then obtained a certificate of authority. The first action was voluntarily dismissed and a second action was filed. The defendant moved to dismiss on the grounds that the statute of limitations had expired, that the first action was a nullity and that therefore the second action could not relate back to the filing date of the first action. The trial court found for the defendants and the plaintiff appealed.

The Illinois Appellate Court reversed. The court stated that in the context of a not-for-profit corporation “conducting affairs” means engaging in the activities or functions for which the corporation was formed. Here, there was no doubt that in working actively with student groups on Illinois campuses, holding conferences in Illinois and meeting with donors the plaintiff was conducting affairs in the state. Thus, the trial court correctly held that the plaintiff was required to register. However, the trial court erred in holding that the first action was a nullity. According to the appellate court, the statutory bar on maintaining a civil action does not mean a corporation cannot file an action. It can file an action, but cannot continue it unless it complies with the registration requirement. Here, the plaintiff did comply, well before the motion to dismiss was decided.

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

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect between Aug. 1 and Oct. 1, including amendments to Delaware's corporation and LLC laws. It also reviews some recent decisions of interest, including two from Delaware's courts.

IN THE STATE LEGISLATURES

DE Amends Its Corporation and LLC Laws

House Bill 127 amended the General Corporation Law (GCL). The amendments went into effect on Aug. 1 unless otherwise specified, and include the following:

Sec. 152 was amended to state that the board of directors may determine the price for a stock issuance by approving a formula by which the price will be calculated. Sec. 251 was amended to provide that a Delaware public corporation does not have to obtain stockholder approval to effect a merger if the acquirer obtains, in a tender offer, the percentage of shares that would have been required to adopt the merger agreement and certain other requirements are met. Sec. 312 was amended to clarify that only a corporation's directors or stockholders may authorize a renewal or revival of its certificate of incorporation.

House Bill 127 also added new sections to the GCL, which will go into effect on April 1, 2014. They permit a corporation (or the Chancery Court) to ratify an overissue of stock or another corporate act or transaction that, due to a lack of compliance with the GCL, certificate of incorporation, bylaws or other agreement or plan, is void or voidable.

Senate Bill 47 added a new subchapter to the GCL governing Public Benefit Corporations ' which are for-profit corporations organized under the GCL that are intended to produce a public benefit and operate in a responsible and sustainable manner.

House Bill 126 enacted various amendments to the Delaware Limited Liability Company Act including the following:

Secs. 18-209, 18-212, 18-213, 18-214, and 18-216 were amended to confirm that the rights or securities of, or interests in, an entity that is surviving a merger, consolidating, domesticating, converting, transferring or continuing may remain outstanding. Sec. 18-703 was amended to clarify that attachment, garnishment, foreclosure or other legal or equitable remedies are not available to a member's judgment creditor, whether the LLC has one member or more than one member. Sec. 18-1101 was amended to state that the provisions of the LLC Act apply whether the LLC has one member or more than one member. And Sec. 18-1104 was amended to confirm that in the absence of a statutory or contractual provision the rules of law and equity relating to fiduciary duties govern.

Amendments to the Business Entity Laws of Other States

In Alabama, House Bill 403, effective Aug. 1, amended the business entity laws to extend the name reservation period from 120 days to one year. In Arizona, Senate Bill 1233, effective Sept. 13, amended the LLC law to add a provision governing the ownership of an interest in joint tenancy or as community property with a right of survivorship. In Arkansas, House Bill 1510, effective Aug. 16, amended the corporation law to permit the formation of benefit corporations.

In Louisiana, House Bill 430, effective Aug. 1, increased the fees for filing most corporate and LLC documents. In Missouri, House Bill 510, effective Aug. 28, authorized the formation of Series LLCs. In New Hampshire, Senate Bill 52, effective Aug. 5, permitted a limited partnership's name to end with the abbreviation “L.P.” In Pennsylvania, Senate Bill 304, effective Sept. 7, amended provisions of the corporation law dealing with expedited filing services, articles of incorporation, bearer shares and scrip, transfer restrictions, meetings, and the pricing, issuance and acquisition of shares.

In Texas, Senate Bill 849, effective Sept. 1, amended the Business Organizations Code to allow a for-profit corporation to include one or more social purposes in its certificate of formation and require directors and officers to consider the social purpose in discharging their duties. And in Washington, House Bill 1148 (this one effective July 28), amended the provision of the business corporation act dealing with dissenters' rights and parent-subsidiary mergers.

IN THE STATE COURTS

DE's Supreme Court Defines Good Faith Provision in Limited Partnership Agreement

In DV Realty Advisor LLC v. Policemen's Annuity and Benefit Fund of Chicago, No. 547, 2012 (Del. Supr.), decided Aug. 26, 2013, the limited partners of a Delaware limited partnership removed the general partner after the general partner failed to deliver audited financial statements as it was required to do by the limited partnership agreement (LPA). The limited partners filed a complaint in the Delaware Chancery Court seeking a declaratory judgment that the removal was valid under the LPA, which provided that a general partner could be removed by the limited partners if they determined, in good faith, that removal was necessary for the best interest of the limited partnership. The Chancery Court applied the definition of good faith found in the Uniform Commercial Code, found that the limited partners had acted in good faith, and declared the removal valid. The general partner appealed.

The Delaware Supreme Court held that the Chancery Court inappropriately applied the UCC definition of good faith. The court noted that the UCC does not apply to limited partnerships and had the parties wanted to use the UCC definition they could have so provided in the LPA. Instead, the Supreme Court held that the traditional business judgment rule definition should be applied. Under that definition the determination that the removal of the general partner was necessary in the best interests of the limited partnership will be considered in good faith unless the limited partners went so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.

The court then noted that the record established that the general partner repeatedly breached its obligation to deliver to the limited partners audited financial statements on time, and that based on this record, the Chancery Court correctly found that the limited partners acted in good faith. Thus, although the Chancery Court applied the wrong standard it came to the right conclusion and the declaratory judgment in favor of the limited partners was affirmed.

DE's Chancery Court Rules On Ownership of LLC Interests and Breach of Fiduciary Duties

In Grove v. Brown, C.A. No. 6793 (Del. Ch.), decided Aug. 8, 2013, the plaintiffs (the Groves) and the defendants (the Browns) formed a Delaware LLC (Heartfelt) that operated a healthcare agency. The operating agreement provided that each person owned 25% and it required an initial capital contribution of $10,000 each. The Browns, claiming that they were majority owners because one of the Groves had not made the required contribution, formed a new LLC, merged Heartfelt into it and squeezed out the Groves. The Groves brought a suit in the Delaware Chancery Court for breach of fiduciary duty arising from the merger. The Browns counterclaimed for breach of fiduciary duty based on the Groves forming their owned healthcare agencies that competed with Heartfelt.

The Delaware Chancery Court first addressed the claim arising out of the merger. The court noted that the operating agreement unambiguously stated that each member owned 25% of the LLC and did not provide that the failure to make the $10,000 contribution divested a member of his or her membership interest. Therefore, the Browns did not own a majority of the LLC and lacked the authority to enter into the merger. The court then found that the Groves breached their fiduciary duties by operating their healthcare agencies as they wrongfully took a business opportunity that belonged to Heartfelt. As for the remedies, the court ruled that each side had to account to Heartfelt for the profits they wrongfully took for themselves.

IL Appellate Court Interprets Door Closing Provision of Not for Profit Corporation Act

Young America's Foundation v. Doris A. Pistole Revocable Living Trust, 2013 IL App (2d) 121122, decided Aug. 20, 2013, involved a Tennessee not-for-profit corporation that worked with students to promote conservative ideas. The corporation filed a suit in Illinois. At the time it had not registered to do business in Illinois. The defendants claimed the plaintiff was barred from bringing suits in Illinois by the Not for Profit Corporation Act provision stating that no foreign corporation conducting affairs in the state without authority may maintain a civil action. The plaintiff then obtained a certificate of authority. The first action was voluntarily dismissed and a second action was filed. The defendant moved to dismiss on the grounds that the statute of limitations had expired, that the first action was a nullity and that therefore the second action could not relate back to the filing date of the first action. The trial court found for the defendants and the plaintiff appealed.

The Illinois Appellate Court reversed. The court stated that in the context of a not-for-profit corporation “conducting affairs” means engaging in the activities or functions for which the corporation was formed. Here, there was no doubt that in working actively with student groups on Illinois campuses, holding conferences in Illinois and meeting with donors the plaintiff was conducting affairs in the state. Thus, the trial court correctly held that the plaintiff was required to register. However, the trial court erred in holding that the first action was a nullity. According to the appellate court, the statutory bar on maintaining a civil action does not mean a corporation cannot file an action. It can file an action, but cannot continue it unless it complies with the registration requirement. Here, the plaintiff did comply, well before the motion to dismiss was decided.

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