Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect during the last quarter. It also examines some recent decisions of interest, including three from Delaware.

IN THE STATE LEGISLATURES

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

In Alabama, House Bill 2, effective Jan. 1, 2015, enacted a new LLC law that contains provisions on formation, members, management, dissolution, foreign registration and other issues. It also provides for Series LLCs. In Arizona, Senate Bill 1353, effective Dec. 31, 2014, enacted the Arizona Entity Restructuring Act, revising the provisions authorizing and governing mergers, exchanges, conversions, domestications and divisions by and among business and nonprofit entities.

In California, Senate Bill 1041, effective Jan. 1, 2015, amended the business entity laws relating to the resignation of registered agents, cancellation of registered names, and reinstatement of fraudulently terminated entities. Also in California, Senate Bill 1301, effective Jan. 1, 2015, amended the Corporate Flexibility Act, renaming it the Social Purpose Corporations Act, renaming the entity as a social purpose corporation, and revising the provisions governing social purpose corporations.

In Connecticut, House Bill 5489, effective Jan. 1, 2015, amended the business entity laws relating to administrative dissolution and revocation. Minnesota (House Bill 2582) and New Hampshire (Senate Bill 215) both enacted laws, effective Jan. 1, 2015, authorizing benefit corporations.

In Oklahoma, Senate Bill 1799, effective Nov. 1, 2014, amended the corporation law provision governing derivative suits to permit or require the court to award reasonable costs and attorney fees. And in Tennessee, Senate Bill 1505, effective Jan. 1, 2015, amended the Nonprofit Corporation Act provisions governing notices, corporate powers, filings, directors and officers, meetings, mergers, and other issues.

IN THE STATE COURTS

DE Supreme Court Affirms Denial of Injunction in Multi-Forum Litigation

In North River Insurance Co. v. Mine Safety Appliance Company, No. 8, 2014 (Delaware Supreme Court) decided Nov. 6, 2014, the plaintiff insurance company appealed the Chancery Court's denial of its request to permanently enjoin the defendant corporation from assigning to tort claimants in West Virginia its right to recover under policies issued to it by the plaintiff.

The issue of whether the defendant was covered by the policies was being litigated in three states, including West Virginia. In addition, tort claimants filed suits in West Virginia against the defendant. The defendant settled and assigned its rights under the policies to the tort claimants, who then sought declaratory judgments that the insurance company had to provide coverage.

The Delaware Supreme Court affirmed the Chancery Court's denial of the request for a permanent injunction. The Chancery Court noted that under West Virginia law, the tort claimants could have filed their suits for declaratory judgments even without the assignments. Thus, the injunction would not have remedied the harm sought to be avoided ' the risk of inconsistent judgments. The Delaware Supreme Court found no abuse of discretion, noting that no evidence was presented that granting the injunction would stop or reduce the tort claimants' lawsuits. The Chancery Court was also correct in being sensitive to principles of comity as the West Virginia courts repeatedly stated that West Virginia had a strong interest in having the tort claimants' cases heard in West Virginia.

DE Chancery Court Dismisses Bad Faith Claim

In In Re Novell, Inc. Shareholder Litigation, C.A. 6032, (Delaware Chancery Court) decided Nov. 25, 2014, former shareholders of an acquired corporation brought an action against the board of directors, claiming it acted in bad faith by favoring the acquirer over another bidder by, among other actions, being unresponsive to its proposals and requests, and imposing unfair restrictions. The defendants moved to dismiss.

The Delaware Chancery Court held that the enhanced scrutiny standard of review applied because the actions involved a change of control and the board was disinterested and independent. To establish bad faith, the plaintiffs had to cite evidence supporting an inference that the board's decision fell outside of the range of reasonableness. According to the court, the plaintiffs failed to do so. The evidence showed that while the board may have favored the acquirer, it was not required to treat all bidders equally and its actions were not unreasonable in light of its belief that a merger with the acquirer was more certain to close. More importantly, the plaintiffs did not supply any facts from which to conclude that the board acted with an improper motive. The motion to dismiss was granted.

DE Chancery Court Allows Class Action to Proceed Against Directors

Lee v. Pincus, C.A. 8485, (Delaware Chancery Court) decided Nov. 14, 2014, was a class action filed by a stockholder of a Delaware corporation that completed an IPO in 2011. Pre-IPO stockholders agreed to a lockup that prevented them from selling their shares for 165 days after the IPO. However, before that date, the corporation's board of directors approved a waiver of the lockup that allowed some of the stockholders, including half of the directors, to sell their stock earlier. They received a price double that which the other stockholders, including the plaintiff, received on the original date. The plaintiff brought a class action alleging that the board of directors breached the fiduciary duty of loyalty by approving the waiver. The defendants moved to dismiss, claiming that the suit was derivative and the plaintiff failed to comply with the demand requirement, and that the plaintiff failed to state a claim.

The Delaware Chancery Court first held that the plaintiff's action was direct, and not derivative. The court noted that essential to asserting a direct claim are allegations of some individual harm not suffered by all of the stockholders. Here, the complaint asserts a direct claim because the board's decision to restructure the lockup gave preferential treatment to certain stockholders over others.

The court next rejected the defendants' argument that the plaintiff's claim was governed by contract law and not fiduciary duty principles. According to the court, the fact that the class members' shares were governed by contracts containing lockup restrictions did not eliminate the fiduciary duties of the directors to act loyally to all stockholders.

Finally, the court found that the plaintiff pled facts sufficient to rebut the business judgment standard of review because the lockup waiver was not approved by a majority of disinterested and independent directors and because it was reasonably conceivable the benefit the directors received was not entirely fair. Thus, the motion to dismiss was denied.

FL's Supreme Court: Statute Unconstitutionally Impaired Not-for-Profit Corporation's Contracts

Citrus County Hospital Board v. Citrus Memorial Health Foundation, Inc., No. SC13-411 (Florida Supreme Court) decided Nov. 13, 2014, arose out of a dispute between a county hospital board and a not-for-profit corporation. The county hospital board contracted with the corporation to operate a hospital. In response to the dispute Florida's legislature enacted a special law that, among other things, required the county hospital board to approve the corporation's articles of incorporation, directors, and certain borrowing, policies, budgets and expenditures. The corporation filed suit against the county hospital board and the state claiming the special law was an unconstitutional impairment of its contractual rights. The trial court held that the corporation could not challenge the constitutionality of the special law because it was a public or quasi-public corporation and that the law did not impair the corporation's contracts. The appellate court reversed.

The Florida Supreme Court affirmed the appellate court's decision. The court noted that the corporation was not legislatively created and was not a state agency or local government. It was incorporated as a not-for-profit corporation under the Florida not-for-profit corporation act like any other Florida not-for-profit corporation would be. Accordingly, the contract clause applied to the corporation's contracts. Furthermore, the special law eliminated the corporation's ability to operate and manage the hospital as it had contracted to do, and obligated it to comply with accountability and financial responsibility measures that were not mentioned in the parties' contracts. Thus, the special law impaired the corporation's contracts.

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 during the last quarter. It also examines some recent decisions of interest, including three from Delaware.

IN THE STATE LEGISLATURES

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

In Alabama, House Bill 2, effective Jan. 1, 2015, enacted a new LLC law that contains provisions on formation, members, management, dissolution, foreign registration and other issues. It also provides for Series LLCs. In Arizona, Senate Bill 1353, effective Dec. 31, 2014, enacted the Arizona Entity Restructuring Act, revising the provisions authorizing and governing mergers, exchanges, conversions, domestications and divisions by and among business and nonprofit entities.

In California, Senate Bill 1041, effective Jan. 1, 2015, amended the business entity laws relating to the resignation of registered agents, cancellation of registered names, and reinstatement of fraudulently terminated entities. Also in California, Senate Bill 1301, effective Jan. 1, 2015, amended the Corporate Flexibility Act, renaming it the Social Purpose Corporations Act, renaming the entity as a social purpose corporation, and revising the provisions governing social purpose corporations.

In Connecticut, House Bill 5489, effective Jan. 1, 2015, amended the business entity laws relating to administrative dissolution and revocation. Minnesota (House Bill 2582) and New Hampshire (Senate Bill 215) both enacted laws, effective Jan. 1, 2015, authorizing benefit corporations.

In Oklahoma, Senate Bill 1799, effective Nov. 1, 2014, amended the corporation law provision governing derivative suits to permit or require the court to award reasonable costs and attorney fees. And in Tennessee, Senate Bill 1505, effective Jan. 1, 2015, amended the Nonprofit Corporation Act provisions governing notices, corporate powers, filings, directors and officers, meetings, mergers, and other issues.

IN THE STATE COURTS

DE Supreme Court Affirms Denial of Injunction in Multi-Forum Litigation

In North River Insurance Co. v. Mine Safety Appliance Company, No. 8, 2014 (Delaware Supreme Court) decided Nov. 6, 2014, the plaintiff insurance company appealed the Chancery Court's denial of its request to permanently enjoin the defendant corporation from assigning to tort claimants in West Virginia its right to recover under policies issued to it by the plaintiff.

The issue of whether the defendant was covered by the policies was being litigated in three states, including West Virginia. In addition, tort claimants filed suits in West Virginia against the defendant. The defendant settled and assigned its rights under the policies to the tort claimants, who then sought declaratory judgments that the insurance company had to provide coverage.

The Delaware Supreme Court affirmed the Chancery Court's denial of the request for a permanent injunction. The Chancery Court noted that under West Virginia law, the tort claimants could have filed their suits for declaratory judgments even without the assignments. Thus, the injunction would not have remedied the harm sought to be avoided ' the risk of inconsistent judgments. The Delaware Supreme Court found no abuse of discretion, noting that no evidence was presented that granting the injunction would stop or reduce the tort claimants' lawsuits. The Chancery Court was also correct in being sensitive to principles of comity as the West Virginia courts repeatedly stated that West Virginia had a strong interest in having the tort claimants' cases heard in West Virginia.

DE Chancery Court Dismisses Bad Faith Claim

In In Re Novell, Inc. Shareholder Litigation, C.A. 6032, (Delaware Chancery Court) decided Nov. 25, 2014, former shareholders of an acquired corporation brought an action against the board of directors, claiming it acted in bad faith by favoring the acquirer over another bidder by, among other actions, being unresponsive to its proposals and requests, and imposing unfair restrictions. The defendants moved to dismiss.

The Delaware Chancery Court held that the enhanced scrutiny standard of review applied because the actions involved a change of control and the board was disinterested and independent. To establish bad faith, the plaintiffs had to cite evidence supporting an inference that the board's decision fell outside of the range of reasonableness. According to the court, the plaintiffs failed to do so. The evidence showed that while the board may have favored the acquirer, it was not required to treat all bidders equally and its actions were not unreasonable in light of its belief that a merger with the acquirer was more certain to close. More importantly, the plaintiffs did not supply any facts from which to conclude that the board acted with an improper motive. The motion to dismiss was granted.

DE Chancery Court Allows Class Action to Proceed Against Directors

Lee v. Pincus, C.A. 8485, (Delaware Chancery Court) decided Nov. 14, 2014, was a class action filed by a stockholder of a Delaware corporation that completed an IPO in 2011. Pre-IPO stockholders agreed to a lockup that prevented them from selling their shares for 165 days after the IPO. However, before that date, the corporation's board of directors approved a waiver of the lockup that allowed some of the stockholders, including half of the directors, to sell their stock earlier. They received a price double that which the other stockholders, including the plaintiff, received on the original date. The plaintiff brought a class action alleging that the board of directors breached the fiduciary duty of loyalty by approving the waiver. The defendants moved to dismiss, claiming that the suit was derivative and the plaintiff failed to comply with the demand requirement, and that the plaintiff failed to state a claim.

The Delaware Chancery Court first held that the plaintiff's action was direct, and not derivative. The court noted that essential to asserting a direct claim are allegations of some individual harm not suffered by all of the stockholders. Here, the complaint asserts a direct claim because the board's decision to restructure the lockup gave preferential treatment to certain stockholders over others.

The court next rejected the defendants' argument that the plaintiff's claim was governed by contract law and not fiduciary duty principles. According to the court, the fact that the class members' shares were governed by contracts containing lockup restrictions did not eliminate the fiduciary duties of the directors to act loyally to all stockholders.

Finally, the court found that the plaintiff pled facts sufficient to rebut the business judgment standard of review because the lockup waiver was not approved by a majority of disinterested and independent directors and because it was reasonably conceivable the benefit the directors received was not entirely fair. Thus, the motion to dismiss was denied.

FL's Supreme Court: Statute Unconstitutionally Impaired Not-for-Profit Corporation's Contracts

Citrus County Hospital Board v. Citrus Memorial Health Foundation, Inc., No. SC13-411 (Florida Supreme Court) decided Nov. 13, 2014, arose out of a dispute between a county hospital board and a not-for-profit corporation. The county hospital board contracted with the corporation to operate a hospital. In response to the dispute Florida's legislature enacted a special law that, among other things, required the county hospital board to approve the corporation's articles of incorporation, directors, and certain borrowing, policies, budgets and expenditures. The corporation filed suit against the county hospital board and the state claiming the special law was an unconstitutional impairment of its contractual rights. The trial court held that the corporation could not challenge the constitutionality of the special law because it was a public or quasi-public corporation and that the law did not impair the corporation's contracts. The appellate court reversed.

The Florida Supreme Court affirmed the appellate court's decision. The court noted that the corporation was not legislatively created and was not a state agency or local government. It was incorporated as a not-for-profit corporation under the Florida not-for-profit corporation act like any other Florida not-for-profit corporation would be. Accordingly, the contract clause applied to the corporation's contracts. Furthermore, the special law eliminated the corporation's ability to operate and manage the hospital as it had contracted to do, and obligated it to comply with accountability and financial responsibility measures that were not mentioned in the parties' contracts. Thus, the special law impaired the corporation's contracts.

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).