Quarterly State Compliance Review

California (Senate Bill 323), North Carolina (Senate Bill 239), and Florida (Senate Bill 1300) all have new LLC laws that went into effect on Jan. 1, 2014. The new laws contain provisions on formation, governing documents, members, management, fiduciary duties, dissolution, foreign registration and other issues.

Also in California, Assembly Bill 457 amended the General Corporation Law to remove a provision requiring notice to be provided following the unanimous written consent of a reorganization; Assembly Bill 434 amended provisions regarding the rights, preferences and restrictions of preferred shares; Assembly Bill 491 amended provisions regarding the powers and authority of corporations in anticipation of and during emergencies; and Assembly Bill 1325 amended the requirements for filing fictitious business name statements.

In Iowa, House File 469 amended the Business Corporation Act provisions dealing with notices, qualified directors, elections, conflict of interests, meetings, voting, appraisal rights and conversions. In Nevada, House Bill 2296 authorized the creation of benefit corporations. In New Hampshire, Senate Bill 41 repealed and reenacted the New Hampshire Business Corporation Act.

In North Carolina, Senate Bill 239 amended provisions of the Business Corporation Act dealing with the delegation of powers, corporate shares, rights, options and warrants, shareholder meetings, shareholder voting, mergers, conversions, asset sales, and dissolution. In Oregon, House Bill 2567 amended the corporation law to permit the electronic delivery of documents and notices, and participation in meetings by remote communication and House Bill 2566 amended the corporation law to permit the board of directors to delegate to officers authority to designate receipients of rights, warrants and equity compensation awards. In Utah, Senate Bill 21 enacted the Unincorporated Business Entity Act, providing new laws to govern partnerships, limited partnerships, and LLCs.

IN THE STATE COURTS

DE Supreme Court: GCL Does Not Time-Bar Suits Against Dissolved Corporation

Anderson v. Krafft-Murphy Company, Inc., No. 85-2013, decided Nov. 26, 2013, was an appeal of a chancery court judgment denying a request for the appointment of a receiver made by asbestos claimants with pending claims against a corporation that had been dissolved for more than 10 years. The corporation's only assets were liability insurance policies it had purchased while it was in operation. The chancery court held that the General Corporation Law (GCL) did not extend a dissolved corporation's liability beyond 10 years. Therefore, the corporation could not be liable for suits of the kind at issue, and the insurers had no obligation to pay under the insurance policies. As a result, the insurance policies had no value and the corporation had no undistributed assets that justified the appointment of a receiver.

The Delaware Supreme Court reversed. The court held that contingent contractual rights, such as the insurance policies in this case, constitute property of a dissolved corporation as long as they are capable of vesting. The court then held that the insurance policies here were capable of vesting because no provision of the GCL operates to extinguish a dissolved corporation's potential liability to third parties by time-barring their claims. The chancery court's conclusion that the statutory provisions shield dissolved corporations from liability was not supported by either the statutes' plain language or legislative history.

DE Chancery Court: In a Merger, the Non-Survivor's Attorney-Client Privilege Passes to the Survivor

Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLP, C.A. 7906, decided Nov. 15, 2013, involved an acquisition via a statutory merger in which the target company was the survivor. The buyer filed suit against the seller, alleging fraudulent inducement. The buyer notified the seller that it had discovered in the target's computer certain communications between the seller and its then legal counsel regarding the merger. The seller asserted attorney-client privilege over the communications. The buyer claimed that the privilege belonged to the survivor and moved to resolve the dispute.

The Delaware Chancery Court held that the privilege over all pre-merger communications, including those relating to the merger negotiations, passed to the surviving corporation by plain operation of clear Delaware statutory law under Sec. 259 of the General Corporation Law.

The court noted that Sec. 259 states that “all property, rights, privileges, powers and franchises” shall be the property of the surviving corporation. The court rejected the seller's contention that the legislature did not intend to include attorney-client privilege. According to the court, accepting that argument would conflict with the only reasonable interpretation of the statute which is that “all” means “all” as to the enumerated category, and that includes all privileges. The court also pointed out that if the parties had wanted to they could have included a provision in the merger agreement excluding the attorney-client privilege from the assets to be transferred to the survivor. But they chose not to do so in this case.

DE Chancery Court Awards Limited Attorneys' Fees for Mooted Suit to Enjoin a Merger

In re Quest Software Inc. Shareholders Litigation, C.A. 7357, decided Nov. 12, 2013, involved the acquisition of Quest Software by Dell Inc. After Quest's board of directors agreed to a merger with another company, the plaintiffs filed actions to enjoin the transaction. Their actions were filed during a go-shop period. During this period Dell emerged as a potential buyer. The board ultimately agreed to a merger with Dell which resulted in $283 million more in consideration flowing to Quest's stockholders. The plaintiffs' suits were mooted and they sought attorney fees of $2.8 million, arguing that their suits were responsible for the corporate benefit.

The Delaware Chancery Court found that the plaintiffs were entitled to a fee award for their mooted case under the corporate benefit doctrine because they demonstrated that their suits were meritorious when filed, that the resolution sought occurred before judicial action was taken and the defendants could not rebut the presumption of a causal connection between the filing of the plaintiffs' suits and the resulting benefit.

However, the court rejected the plaintiffs' argument that they were responsible for the entire $283 million benefit. The court noted that the suits did not change the terms of the no-shop period or cause Dell to emerge and that the board was likely to be aware of its fiduciary duties to pursue other opportunities independent of the plaintiffs' efforts. According to the court, the plaintiffs were only 5% responsible for the benefit achieved and were awarded $1 million.

DE Chancery Court: Demand Was Excused Where Suit Alleged a Knowing Violation of a Stock Incentive Plan

In Pfeiffer v. Leedle, C.A. No. 7831, decided Nov. 8, 2013, a derivative suit was brought alleging that directors breached their fiduciary duties by approving stock options that exceeded the number that could be granted under the stock incentive plan.

The Delaware Chancery Court, in denying the defendants' motion to dismiss for failure to make a demand, noted that demand may be excused if the plaintiff's allegations create a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. The court further explained that demand will not be excused where the plaintiff merely alleges that the board failed to follow the terms of a stock option plan. However, demand will be excused if the plaintiff can show that the violation was committed knowingly or intentionally, such as by demonstrating that the alleged action was a clear and unambiguous violation of the stock incentive plan.

In this case, the plan unambiguously prohibited the granting of more than 150,000 stock options to an individual in any year. Because an executive was awarded nearly 450,000 options in one year and 285,000 in another year the plaintiff pled facts sufficient to support an inference that the board violated the unambiguous stock option plan and thus demand was excused.

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 on Jan. 1, 2014. It also looks at four recent decisions of interest from the Delaware courts.

IN THE STATE LEGISLATURES

Legislation affecting corporations, LLCs and other types of business organizations went into effect in a number of states on Jan. 1, 2014. Highlights from around the country include the following:

California (Senate Bill 323), North Carolina (Senate Bill 239), and Florida (Senate Bill 1300) all have new LLC laws that went into effect on Jan. 1, 2014. The new laws contain provisions on formation, governing documents, members, management, fiduciary duties, dissolution, foreign registration and other issues.

Also in California, Assembly Bill 457 amended the General Corporation Law to remove a provision requiring notice to be provided following the unanimous written consent of a reorganization; Assembly Bill 434 amended provisions regarding the rights, preferences and restrictions of preferred shares; Assembly Bill 491 amended provisions regarding the powers and authority of corporations in anticipation of and during emergencies; and Assembly Bill 1325 amended the requirements for filing fictitious business name statements.

In Iowa, House File 469 amended the Business Corporation Act provisions dealing with notices, qualified directors, elections, conflict of interests, meetings, voting, appraisal rights and conversions. In Nevada, House Bill 2296 authorized the creation of benefit corporations. In New Hampshire, Senate Bill 41 repealed and reenacted the New Hampshire Business Corporation Act.

In North Carolina, Senate Bill 239 amended provisions of the Business Corporation Act dealing with the delegation of powers, corporate shares, rights, options and warrants, shareholder meetings, shareholder voting, mergers, conversions, asset sales, and dissolution. In Oregon, House Bill 2567 amended the corporation law to permit the electronic delivery of documents and notices, and participation in meetings by remote communication and House Bill 2566 amended the corporation law to permit the board of directors to delegate to officers authority to designate receipients of rights, warrants and equity compensation awards. In Utah, Senate Bill 21 enacted the Unincorporated Business Entity Act, providing new laws to govern partnerships, limited partnerships, and LLCs.

IN THE STATE COURTS

DE Supreme Court: GCL Does Not Time-Bar Suits Against Dissolved Corporation

Anderson v. Krafft-Murphy Company, Inc., No. 85-2013, decided Nov. 26, 2013, was an appeal of a chancery court judgment denying a request for the appointment of a receiver made by asbestos claimants with pending claims against a corporation that had been dissolved for more than 10 years. The corporation's only assets were liability insurance policies it had purchased while it was in operation. The chancery court held that the General Corporation Law (GCL) did not extend a dissolved corporation's liability beyond 10 years. Therefore, the corporation could not be liable for suits of the kind at issue, and the insurers had no obligation to pay under the insurance policies. As a result, the insurance policies had no value and the corporation had no undistributed assets that justified the appointment of a receiver.

The Delaware Supreme Court reversed. The court held that contingent contractual rights, such as the insurance policies in this case, constitute property of a dissolved corporation as long as they are capable of vesting. The court then held that the insurance policies here were capable of vesting because no provision of the GCL operates to extinguish a dissolved corporation's potential liability to third parties by time-barring their claims. The chancery court's conclusion that the statutory provisions shield dissolved corporations from liability was not supported by either the statutes' plain language or legislative history.

DE Chancery Court: In a Merger, the Non-Survivor's Attorney-Client Privilege Passes to the Survivor

Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLP, C.A. 7906, decided Nov. 15, 2013, involved an acquisition via a statutory merger in which the target company was the survivor. The buyer filed suit against the seller, alleging fraudulent inducement. The buyer notified the seller that it had discovered in the target's computer certain communications between the seller and its then legal counsel regarding the merger. The seller asserted attorney-client privilege over the communications. The buyer claimed that the privilege belonged to the survivor and moved to resolve the dispute.

The Delaware Chancery Court held that the privilege over all pre-merger communications, including those relating to the merger negotiations, passed to the surviving corporation by plain operation of clear Delaware statutory law under Sec. 259 of the General Corporation Law.

The court noted that Sec. 259 states that “all property, rights, privileges, powers and franchises” shall be the property of the surviving corporation. The court rejected the seller's contention that the legislature did not intend to include attorney-client privilege. According to the court, accepting that argument would conflict with the only reasonable interpretation of the statute which is that “all” means “all” as to the enumerated category, and that includes all privileges. The court also pointed out that if the parties had wanted to they could have included a provision in the merger agreement excluding the attorney-client privilege from the assets to be transferred to the survivor. But they chose not to do so in this case.

DE Chancery Court Awards Limited Attorneys' Fees for Mooted Suit to Enjoin a Merger

In re Quest Software Inc. Shareholders Litigation, C.A. 7357, decided Nov. 12, 2013, involved the acquisition of Quest Software by Dell Inc. After Quest's board of directors agreed to a merger with another company, the plaintiffs filed actions to enjoin the transaction. Their actions were filed during a go-shop period. During this period Dell emerged as a potential buyer. The board ultimately agreed to a merger with Dell which resulted in $283 million more in consideration flowing to Quest's stockholders. The plaintiffs' suits were mooted and they sought attorney fees of $2.8 million, arguing that their suits were responsible for the corporate benefit.

The Delaware Chancery Court found that the plaintiffs were entitled to a fee award for their mooted case under the corporate benefit doctrine because they demonstrated that their suits were meritorious when filed, that the resolution sought occurred before judicial action was taken and the defendants could not rebut the presumption of a causal connection between the filing of the plaintiffs' suits and the resulting benefit.

However, the court rejected the plaintiffs' argument that they were responsible for the entire $283 million benefit. The court noted that the suits did not change the terms of the no-shop period or cause Dell to emerge and that the board was likely to be aware of its fiduciary duties to pursue other opportunities independent of the plaintiffs' efforts. According to the court, the plaintiffs were only 5% responsible for the benefit achieved and were awarded $1 million.

DE Chancery Court: Demand Was Excused Where Suit Alleged a Knowing Violation of a Stock Incentive Plan

In Pfeiffer v. Leedle, C.A. No. 7831, decided Nov. 8, 2013, a derivative suit was brought alleging that directors breached their fiduciary duties by approving stock options that exceeded the number that could be granted under the stock incentive plan.

The Delaware Chancery Court, in denying the defendants' motion to dismiss for failure to make a demand, noted that demand may be excused if the plaintiff's allegations create a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. The court further explained that demand will not be excused where the plaintiff merely alleges that the board failed to follow the terms of a stock option plan. However, demand will be excused if the plaintiff can show that the violation was committed knowingly or intentionally, such as by demonstrating that the alleged action was a clear and unambiguous violation of the stock incentive plan.

In this case, the plan unambiguously prohibited the granting of more than 150,000 stock options to an individual in any year. Because an executive was awarded nearly 450,000 options in one year and 285,000 in another year the plaintiff pled facts sufficient to support an inference that the board violated the unambiguous stock option plan and thus demand was excused.

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).