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 between Jan. 1, 2015 and April 1, 2015. It also looks at some recent decisions of interest from the courts of Delaware, Georgia and Maryland.

IN THE STATE LEGISLATURES

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

In Massachusetts, House Bill 4380, effective Feb. 8, amended the LLC law to provide that upon dissolution, and notwithstanding the filing of a certificate of cancellation, the LLC cannot carry on any business except as necessary to wind up and distribute its assets. In Michigan, Senate Bill 623, effective Jan. 10, amended the nonprofit corporation law to, among other things, provide for voting by ballot, amend the voting procedures for mergers and dissolutions, permit the creation of non-executive committees, allow formation of corporations for the purpose of providing the services of learned professions, permit restrictions to members' inspection rights, and limit the liability of directors. Michigan Senate Bill 624, effective Jan. 10, provides that a nonprofit corporation or other entity whose purpose is to hold property for a charitable purpose cannot enter into a merger, conversion, or dissolution without the consent of the Attorney General. Michigan Senate Bill 929, effective Jan. 10, amended the LLC law to authorize a domestic LLC to merge with a nonprofit corporation.

In Montana, Senate Bill 35, effective Feb. 18, amended the business entity laws to eliminate the requirement that foreign corporations, foreign non-profit corporations, foreign LLCs and foreign LPs have to file a certificate of existence upon qualification. Also in Montana, Senate Bill 36, effective Feb. 18, amended the LP law to require foreign LPs to file an amendment to their certificate of authority upon a change in general partners or if any information in the certificate of authority has become false.

In New York, Assembly Bill 8106, effective Feb. 27, amended the LLC law to provide that the 10 members of a New York LLC with the largest percentage ownership interest may be held personally liable for unpaid wages, salaries and other compensation payable by the LLC for services performed for the LLC. Liability is joint and several and employees must provide notice first.

IN THE STATE COURTS

Corporation Cannot Serve As an Expert Witness

In In Re Dole Food Co., Inc. Stockholder Litigation, Consolidated C.A. No. 8703 and C.A. No. 9079, decided Feb. 27, 2015, the parties were seeking an appraisal of the value of Dole Food at the time of a take-private transaction. The defendants designated a corporation to serve as their expert witness on the subject of Dole's value. The plaintiffs objected, arguing that an expert witness must be a biological person.

The Delaware Chancery Court agreed with the plaintiffs. The court noted that the Rules of Evidence require, among other things, that a witness be able to testify from personal knowledge, be able to take an oath, have a memory that can be refreshed, and be able to hear the testimony of other witnesses. The court then stated “Lacking a voice, a corporation cannot testify. Lacking ears, it cannot hear. Lacking a mind, it cannot have personal knowledge or a memory to be refreshed. Lacking a conscience, it cannot take an oath ' .” In addition, the court noted that a corporation cannot meet the Rule's requirements that an expert be able to perceive facts and have requisite knowledge, skill, experience, training or education.

DE Chancery Court Dissolves Corporations

In the Matter of Bermor, Inc., C.A. No. 8401, decided Feb. 9, 2015, involved two Delaware corporations with two 50% shareholders. The corporations were the general partners in two LPs formed to hold property for the benefit of the shareholders' families. The corporations' boards of directors disagreed about the direction of the LPs. One of the shareholders filed a petition under GCL Sec. 273 to dissolve the corporations. Sec. 273 establishes a mechanism for the dissolution of a joint venture corporation with two 50% shareholders when the shareholders are unable to agree whether to discontinue the venture.

The Delaware Chancery Court granted the petition. The court noted that once the requirements of Sec. 273 ' which involve filing certain certifications with the court ' are met, the court's exercise of its discretion in determining whether to grant the petition is limited to determining whether or not a bona fide inability to agree exists between the two shareholders.

Here, the evidence showed that the joint venturers were unable to agree about how to dispose of the business' assets. In fact, both sides referred to their disagreement as a deadlock. The court rejected the respondent's arguments that the dispute had not lasted long enough and that the petitioner did not really want to dissolve, noting that Sec. 273 does not require extended suffering or that no shareholder have any misgivings.

Court Validates Stock

In In re Numoda Corporation Shareholders Litigation, C.A. No. 9163, decided Jan. 30, 2015, a Delaware corporation purported to issue stock in several transactions without following the GCL's requirements. An action was filed under Sec. 225 to determine the directors' identity. In that action the Chancery Court ruled that the stock issuances were invalid. The parties then brought an action under GCL Sec. 205 to validate five stock issuances.

The Delaware Chancery Court explained that Sec. 205 provides a mechanism under which the Chancery Court can validate corporate acts that otherwise would be invalid because of the failure to comply with a provision of the GCL or governing corporate documents. The court then stated that the first step was for it to determine if there was a corporate act. In this case, the court declined to ratify one stock issuance where there was no evidence to establish any board approval of the issuance and therefore there was no act to validate. However, the court validated the remaining stock issuances where the evidence showed the parties operated for years assuming the capital structure based on those issuances was the actual capital structure, where a shareholder could lose a significant voting interest absent validation, and where validation would put the shareholders where they expected to be.

GA Appellate Court Rules on Charging Order

In Mahalo Investments III v. First Citizens Bank and Trust Co., Inc., No. A14A1940, Georgia Court of Appeals, decided Feb. 19, 2015, a bank obtained a judgment in excess of $3 million and then discovered that two of the debtors owned interests in Georgia LLCs. The bank filed an application with the trial court that issued the judgment seeking an order charging the LLC interests. The trial court granted the charging order and the debtors appealed, arguing that the trial court could not enter the charging order as part of the original action and without first establishing jurisdiction over the LLCs.

The Georgia Court of Appeals noted that this case presented an issue of first impression ' whether, under the Georgia LLC law, an order charging a member's interest in an LLC with payment of an unsatisfied judgment must be initiated as a separate action against the LLC. The court noted that a charging order does not permit the judgment creditor to replace the member or interfere with governance. Thus, from the LLC's standpoint it is business as usual except that any distributions to the member subject to the order are diverted to the judgment creditor. Because the LLC has no right or direct interest that is affected by the charging order the court stated that it saw no reason why an LLC had to be added as a party to obtain the charging order. Judgment was affirmed.

Veil Piercing

In Schlossberg v. Bell Builders Remodeling, Inc., Misc. No. 5, Maryland Court of Appeals, decided Feb. 20, 2015, the U.S. Bankruptcy Court for the District of Maryland submitted a question of law to Maryland's Court of Appeals which the court reformulated as follows: “Under Maryland law, where there is no allegation of common law fraud, may a court disregard the corporate entity and establish personal liability to enforce a paramount equity?”

The court answered the question in the affirmative, holding that under Maryland law the corporate veil may be disregarded where there is no allegation of fraud upon proof of a paramount equity. However the court cautioned that in the case of a close corporation, when the court is deciding whether to disregard the corporate veil, it must take into account that the law allows close corporations to dispense with a board of directors and be run by the stockholders.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for CT Corporation.

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect between Jan. 1, 2015 and April 1, 2015. It also looks at some recent decisions of interest from the courts of Delaware, Georgia and Maryland.

IN THE STATE LEGISLATURES

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

In Massachusetts, House Bill 4380, effective Feb. 8, amended the LLC law to provide that upon dissolution, and notwithstanding the filing of a certificate of cancellation, the LLC cannot carry on any business except as necessary to wind up and distribute its assets. In Michigan, Senate Bill 623, effective Jan. 10, amended the nonprofit corporation law to, among other things, provide for voting by ballot, amend the voting procedures for mergers and dissolutions, permit the creation of non-executive committees, allow formation of corporations for the purpose of providing the services of learned professions, permit restrictions to members' inspection rights, and limit the liability of directors. Michigan Senate Bill 624, effective Jan. 10, provides that a nonprofit corporation or other entity whose purpose is to hold property for a charitable purpose cannot enter into a merger, conversion, or dissolution without the consent of the Attorney General. Michigan Senate Bill 929, effective Jan. 10, amended the LLC law to authorize a domestic LLC to merge with a nonprofit corporation.

In Montana, Senate Bill 35, effective Feb. 18, amended the business entity laws to eliminate the requirement that foreign corporations, foreign non-profit corporations, foreign LLCs and foreign LPs have to file a certificate of existence upon qualification. Also in Montana, Senate Bill 36, effective Feb. 18, amended the LP law to require foreign LPs to file an amendment to their certificate of authority upon a change in general partners or if any information in the certificate of authority has become false.

In New York, Assembly Bill 8106, effective Feb. 27, amended the LLC law to provide that the 10 members of a New York LLC with the largest percentage ownership interest may be held personally liable for unpaid wages, salaries and other compensation payable by the LLC for services performed for the LLC. Liability is joint and several and employees must provide notice first.

IN THE STATE COURTS

Corporation Cannot Serve As an Expert Witness

In In Re Dole Food Co., Inc. Stockholder Litigation, Consolidated C.A. No. 8703 and C.A. No. 9079, decided Feb. 27, 2015, the parties were seeking an appraisal of the value of Dole Food at the time of a take-private transaction. The defendants designated a corporation to serve as their expert witness on the subject of Dole's value. The plaintiffs objected, arguing that an expert witness must be a biological person.

The Delaware Chancery Court agreed with the plaintiffs. The court noted that the Rules of Evidence require, among other things, that a witness be able to testify from personal knowledge, be able to take an oath, have a memory that can be refreshed, and be able to hear the testimony of other witnesses. The court then stated “Lacking a voice, a corporation cannot testify. Lacking ears, it cannot hear. Lacking a mind, it cannot have personal knowledge or a memory to be refreshed. Lacking a conscience, it cannot take an oath ' .” In addition, the court noted that a corporation cannot meet the Rule's requirements that an expert be able to perceive facts and have requisite knowledge, skill, experience, training or education.

DE Chancery Court Dissolves Corporations

In the Matter of Bermor, Inc., C.A. No. 8401, decided Feb. 9, 2015, involved two Delaware corporations with two 50% shareholders. The corporations were the general partners in two LPs formed to hold property for the benefit of the shareholders' families. The corporations' boards of directors disagreed about the direction of the LPs. One of the shareholders filed a petition under GCL Sec. 273 to dissolve the corporations. Sec. 273 establishes a mechanism for the dissolution of a joint venture corporation with two 50% shareholders when the shareholders are unable to agree whether to discontinue the venture.

The Delaware Chancery Court granted the petition. The court noted that once the requirements of Sec. 273 ' which involve filing certain certifications with the court ' are met, the court's exercise of its discretion in determining whether to grant the petition is limited to determining whether or not a bona fide inability to agree exists between the two shareholders.

Here, the evidence showed that the joint venturers were unable to agree about how to dispose of the business' assets. In fact, both sides referred to their disagreement as a deadlock. The court rejected the respondent's arguments that the dispute had not lasted long enough and that the petitioner did not really want to dissolve, noting that Sec. 273 does not require extended suffering or that no shareholder have any misgivings.

Court Validates Stock

In In re Numoda Corporation Shareholders Litigation, C.A. No. 9163, decided Jan. 30, 2015, a Delaware corporation purported to issue stock in several transactions without following the GCL's requirements. An action was filed under Sec. 225 to determine the directors' identity. In that action the Chancery Court ruled that the stock issuances were invalid. The parties then brought an action under GCL Sec. 205 to validate five stock issuances.

The Delaware Chancery Court explained that Sec. 205 provides a mechanism under which the Chancery Court can validate corporate acts that otherwise would be invalid because of the failure to comply with a provision of the GCL or governing corporate documents. The court then stated that the first step was for it to determine if there was a corporate act. In this case, the court declined to ratify one stock issuance where there was no evidence to establish any board approval of the issuance and therefore there was no act to validate. However, the court validated the remaining stock issuances where the evidence showed the parties operated for years assuming the capital structure based on those issuances was the actual capital structure, where a shareholder could lose a significant voting interest absent validation, and where validation would put the shareholders where they expected to be.

GA Appellate Court Rules on Charging Order

In Mahalo Investments III v. First Citizens Bank and Trust Co., Inc., No. A14A1940, Georgia Court of Appeals, decided Feb. 19, 2015, a bank obtained a judgment in excess of $3 million and then discovered that two of the debtors owned interests in Georgia LLCs. The bank filed an application with the trial court that issued the judgment seeking an order charging the LLC interests. The trial court granted the charging order and the debtors appealed, arguing that the trial court could not enter the charging order as part of the original action and without first establishing jurisdiction over the LLCs.

The Georgia Court of Appeals noted that this case presented an issue of first impression ' whether, under the Georgia LLC law, an order charging a member's interest in an LLC with payment of an unsatisfied judgment must be initiated as a separate action against the LLC. The court noted that a charging order does not permit the judgment creditor to replace the member or interfere with governance. Thus, from the LLC's standpoint it is business as usual except that any distributions to the member subject to the order are diverted to the judgment creditor. Because the LLC has no right or direct interest that is affected by the charging order the court stated that it saw no reason why an LLC had to be added as a party to obtain the charging order. Judgment was affirmed.

Veil Piercing

In Schlossberg v. Bell Builders Remodeling, Inc., Misc. No. 5, Maryland Court of Appeals, decided Feb. 20, 2015, the U.S. Bankruptcy Court for the District of Maryland submitted a question of law to Maryland's Court of Appeals which the court reformulated as follows: “Under Maryland law, where there is no allegation of common law fraud, may a court disregard the corporate entity and establish personal liability to enforce a paramount equity?”

The court answered the question in the affirmative, holding that under Maryland law the corporate veil may be disregarded where there is no allegation of fraud upon proof of a paramount equity. However the court cautioned that in the case of a close corporation, when the court is deciding whether to disregard the corporate veil, it must take into account that the law allows close corporations to dispense with a board of directors and be run by the stockholders.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for CT Corporation.