Quarterly State Compliance Review

In Delaware, House Bill 235 enacted the Delaware Competes Act, which, among other things, changes how income is apportioned to Delaware for purposes of the corporate income tax beginning in tax year 2017, and reduces tax payment and filing burdens for smaller businesses. Illinois passed a law, House Bill 3887, requiring all state agencies to review their rules, regulations and procedures pertaining to small businesses and recommend changes.

In Michigan, Senate Bills 66 and 67 amended the Limited Liability Company Act and the Business Corporation Act to clarify the meaning of the term “services in a learned profession.” In Nebraska, Legislative Bill 157 delayed until Jan. 1, 2017 the operative date for the state's new Business Corporation Act to go into effect.

In New York, Assembly Bill 737 amended Sec. 630 of the Business Corporation Law ' which provides that the 10 largest shareholders of privately held corporations may, under certain circumstances, be held jointly and severally liable for the wages, salaries and other compensation and benefits payable by an employer for services performed for the corporation. The amendment provided that the section now applies to shareholders of foreign corporations when the unpaid services were performed in New York. Also in New York, Assembly Bill 7641 delayed until Jan. 1, 2017 the effective date of an amendment to the Not-for-Profit Corporation Law prohibiting employees of a not-for-profit corporation from serving as chairperson of the board.

IN THE STATE COURTS

DE Supreme Court: Investor in Feeder Fund Cannot Sue Master Fund's General Partners Directly

In Culverhouse v. Paulson & Co., No. 349, 2015, (Del. Supr. Ct.) decided Jan. 26, 2016, an investor in a feeder fund filed a putative class action against the general partners of the master fund after an investment they made led to losses for the funds. The federal court certified a question to the Delaware Supreme Court on whether the suit was direct or derivative.

The court held that it was derivative. The court applied the traditional test ' which asks whether it is the shareholder or the corporation who suffered the harm and whether it is the shareholder or the corporation who would benefit from a recovery. Here, the plaintiff invested in an LLC (the feeder fund) that in turn invested in an LP (the master fund). The LP's general partners owed a fiduciary duty to the feeder fund ' which was one its limited partners ' but not to the feeder fund's investors. Thus, any harm was suffered by the feeder fund and any recovery would benefit the feeder fund ' and not the plaintiff.

DE Chancery Court Orders Inspection of Documents to Investigate Hiring and Firing of COO

In Amalgamated Bank v. Yahoo! Inc., C.A. No. 10774 (Del. Ch. Ct.) decided Feb. 2, 2016, the plaintiff demanded to inspect documents to investigate possible wrongdoing on the part of the CEO and directors in the hiring and subsequent firing without cause of the corporation's COO. The corporation provided documents reflecting decisions or discussions about the hiring and firing by the board or the compensation committee, but declined to provide documents that the CEO had reviewed but the directors had not.

The Delaware Chancery Court held that the plaintiff was entitled to an inspection of the documents that the directors had not reviewed pursuant to Sec. 220 of the General Corporation Law. The plaintiff had established a credible basis to suspect wrongdoing in connection with the COO's hiring and firing. Among the facts cited were that the CEO failed to provide the committee with material information early in the hiring process, provided inaccurate information about terms that doubled the COO's payout, that the directors' involvement in the hiring was tangential and episodic and that they accepted the CEO's statements uncritically, and that the directors rubber stamped the CEO's decision to fire the COO without cause when grounds existed to fire him with cause.

Also of note was the court's determination that Sec. 220 requires production of e-mails and other electronically stored information and its conditioning the production on the plaintiff's incorporating by reference into any Delaware action complaint the full scope of the documents produced.

DE Chancery Court: LLC Act Allows a Manager to Inspect a Subsidiary's Financial Records

RED Capital Investment LP v. RED Parent LLC, C.A. No. 11575, (Del. Ch. Ct.) decided Feb. 11, 2016, involved an LLC with two wholly owned subsidiaries ' one of which was a holding company with its own subsidiaries. The LLC's manager sought to inspect financial records of the holding company's subsidiaries.

The Delaware Chancery Court held that the manager was entitled to the inspection. The court noted that an LLC can restrict a manager's inspection rights in its LLC agreement. However, the LLC in this case did not do so. Therefore he was entitled to inspect the documents set forth in Sec. 18-305 of the LLC Act as long as he had a proper purpose and the documents were reasonably related to that purpose. The manager here had a proper purpose. He wanted to understand the LLC's cash position so he could discharge his fiduciary duties as a manager. The court rejected the LLC's arguments that the manager was not entitled to the subsidiaries' documents because they were distinct entities with their own operations. According to the court the subsidiaries were not distinct from the LLC. Each was wholly owned and its value accrued to the LLC. In addition, the LLC's CEO and controller were the CEO and controller of each subsidiary. Under these circumstances it would be unfair to prevent the LLC's manager from inspecting the subsidiaries' financial records.

NY Court Cannot Dissolve Delaware LLC

In re Raharney Capital, LLC v. Capital Stack LLC, No. 160175/14, 15854, 2016 N.Y. Slip Op 01425 (N.Y. App.) decided Feb. 25, 2016, involved a Delaware LLC whose sole place of business was in New York. One 50% member brought a petition in a New York court seeking an order to judicially dissolve the LLC pursuant to Sec. 18-802 of the Delaware LLC Act, alleging that the members were hopelessly deadlocked and that it was not reasonably practicable for the LLC to continue operating. The other 50% member moved to dismiss for lack of subject matter jurisdiction and the motion was granted.

The New York Supreme Court, Appellate Division affirmed, agreeing with the “near-universal view” that the courts of one state do not have the power to dissolve a business entity formed under another state's laws. An order of dissolution from a New York court would infringe on the sovereign authority of another state by, in effect, forcing that state to extinguish an entity formed under its own laws. Instead, the decision as to whether dissolution is appropriate lies with the courts of the state in which the entity was created.

NY Appellate Court Rules On De Facto Mergers

In Ring v. The Elizabeth Foundation for the Arts, No. 240, 113849/11, 2016 N.Y. Slip Op 01127 (N.Y. App.) decided Feb. 16, 2016, two not-for-profit corporations were involved in an asset sale. A suit was filed against the asset buyer seeking to hold it liable as a successor to the asset seller under the de facto merger doctrine. The trial court denied the asset buyer's motion for summary judgment and the buyer appealed.

The New York Supreme Court, Appellate Division noted that one of the factors to be considered in determining whether an asset sale is a de facto merger is the continuity of ownership. New York courts have required, in the case of for profit corporations, that the shareholders of the asset seller become shareholders of the asset buyer. However, not-for-profit corporations do not have shareholders. Therefore, the court held that a continuity of ownership is not a necessary element where the asset sale involved not-for-profit corporations. Instead, the court examined the other elements of a de facto merger and found that because there were triable issues of fact as to one of those elements ' the continuity of management, personnel, location and general business operations ' the trial court did not err in denying the defendant's motion for summary judgment.

Sandra Feldman is an attorney with CT Corporation and a member of this newsletter's Board of Editors.