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General Counsel and In House Counsel Litigation Regulations

Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at legislation of interest to corporate lawyers that recently went into effect, and looks at some recent decisions of interest from courts in Delaware, New York, and California.

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This edition of the Quarterly State Compliance Review looks at legislation of interest to corporate lawyers that recently went into effect, and looks at some recent decisions of interest from courts in Delaware, New York, and California.

IN THE STATE LEGISLATURES

There was not much legislative activity amending the business entity statutes this quarter. One significant bill was Pennsylvania House Bill 1398, which repealed and replaced the laws governing general partnerships (including LLPs), LPs, and LLCs. The new laws are based on the most recent versions of the Uniform Partnership Act, Uniform Limited Partnership Act, and Uniform Limited Liability Company Act. The new laws went into effect on Feb. 21 for all GPs, LPs, and LLCs formed on or after that date, and April 1 for all GPs, LPs, and LLCs formed before that date unless they elected to be governed by the new law on an earlier date.

Among other key changes, H.B. 1398 did the following: 1) clarified that a general partnership is an entity and permitted the filing of a certificate to give third parties notice of a partner’s authority; 2) provided that partners in an LLP have the same liability protection as shareholders of a corporation and members of an LLC; 3) removed the default right of a limited partner to dissociate before termination; 4) changed the written consent requirement for LP dissolution; 5) clarified that an LLC’s operating agreement governs the rights and obligations of members; 6) eliminated the requirement to set forth whether an LLC would be member-managed or manager-managed in the certificate of organization; 7) restricted remedies of judgment creditors of members to a charging order; 8) eliminated the statutory apparent authority of a member; 9) clarified that an LLC and an LLP must file a certificate of termination when they terminate; and 10) allowed the creation of a Benefit LLC with the purpose of creating a general public benefit.

Elsewhere, in Louisiana, House Bill 806, effective Feb. 1, 2017, amended the LLC law relative to the dissolution by affidavit of an LLC to provide for such dissolution if the LLC does not own immovable property. And in New Jersey, Assembly Bill 1934, effective Feb. 28, 2017, amended the Nonprofit Corporation Act by exempting veterans organizations from paying the Annual Report filing fee.

IN THE STATE COURTS

DE Supreme Court Affirms Custodian’s Authority to Sell Solvent Corporation

Shawe v. Elting, No. 423, 2016 (Del. Supr.) decided Feb. 13, 2017, involved a profitable Delaware corporation with feuding co-owners. One of the owners sought the appointment of a custodian to sell the corporation. After a trial filled with what was termed “unprecedented evidence of a lengthy and seriously dysfunctional relationship between the owners,” the Chancery Court granted the relief sought. The other owner appealed.

The Delaware Supreme Court affirmed. The court found that the Chancery Court had the right to appoint a custodian under Sec. 226 of the General Corporation Law, as the parties stipulated that they were deadlocked and there was evidence that showed the business was suffering irreparable harm because of the dysfunction. This evidence included testimony of low employee morale, employees quitting, customers being concerned, and an inability to make acquisitions. The court also noted that the Chancery Court had considered less drastic measures than selling the corporation, but found them inadequate.

The court also acknowledged that selling a profitable corporation is unusual and should be implemented only as a last resort. However, based on the facts of this case, separating the co-owners and selling the company was the only way to protect the enterprise. The court affirmed that a custodian has the authority to sell a solvent corporation under Sec. 226, and rejected the dissent’s arguments to the contrary.

DE Supreme Court Applies Implied Covenant of Good Faith and Fair Dealing to LP Agreement

In Dieckman v. Regency GP LP, No. 208, 2016 (Del. Supr.) decided Jan. 20, 2017, a unitholder in a master LP challenged a merger that involved a conflict of interest. The LP agreement contained two safe harbors for conflict transactions. One required approval by an independent conflicts committee, and the other approval by unaffiliated unitholders. The plaintiff claimed the general partner was not entitled to the protections of the safe harbors because the committee was not independent and the proxy statement sent to unitholders contained misleading disclosures. The Chancery Court dismissed the suit, finding that because the LP agreement expressly waived fiduciary duties the approval by unitholders safe harbor was met.

The Delaware Supreme Court reversed. The court held that the implied covenant of good faith and fair dealing protects investors even when the LP agreement expressly waives fiduciary duties. Thus, even though the LP agreement here did not address how the general partner was to conduct itself when seeking safe harbor protection, the implied covenant of good faith and fair dealing implied the requirement that the general partner not engage in misleading or deceptive conduct. Furthermore, the plaintiff had pled sufficient facts to raise a doubt that the committee was independent and to show that the proxy misled unitholders.

DE Chancery Court Rules Plaintiff Must Be a Stockholder To File Action Under Sec. 220

In Weingarten v. Monster Worldwide, Inc., C.A. No. 12931 (Del. Ch.), decided Feb. 27, 2017, the Chancery Court was presented with an issue of first impression — namely, must a plaintiff seeking to inspect corporate records under Sec. 220 of the General Corporation Law be a stockholder at the time the plaintiff files the complaint? The plaintiff in this case was a stockholder when he made his demand on the corporation to inspect records. The corporation refused his demand. By the time the plaintiff filed his action under Sec. 220, the corporation had been acquired and the plaintiff was no longer a stockholder. The corporation moved to dismiss for lack of standing.

The Delaware Chancery Court noted that Sec. 220(c) requires a plaintiff seeking relief from the Chancery Court to demonstrate both that it “has” — past tense — complied with the requirement to demand an inspection, and that it “is” — present tense — a stockholder. Thus, the legislature has made clear that only those who are stockholders at the time of filing have standing to invoke the court’s assistance under Sec. 220. The language of Sec. 220(c) is plain and unambiguous. And where no ambiguity exists, the plain meaning of the statutory language dictates construction. Therefore, the court called the plaintiff’s policy arguments misplaced, in view of the plain language employed. The court dismissed the complaint.

NY Appellate Court Approves Disclosure Settlement

In Gordon v. Verizon Communications, Inc., 2017 Slip Op. 00742 (N.Y. App.) decided Feb. 2, 2017, the plaintiff appealed the trial court’s order denying her motion for final approval of a proposed settlement of a putative shareholder class action challenging a corporate acquisition. The proposed settlement included additional disclosures, corporate governance reforms and an award of attorney’s fees, but no monetary compensation.

The New York Supreme Court, Appellate Division, reversed and approved the settlement. The court applied New York law, although the corporation was a Delaware corporation, based on a choice of law clause in the settlement agreement. The court first applied the existing test, which focused on five factors: 1) the likelihood of success on the merits; 2) the extent of support for the agreement from the parties; 3) the judgment of counsel for the parties, 4) the presence of bargaining in good faith; and 5) the nature of the issues. All of those factors favored approval of the settlement. The court then added two new factors to the test — whether the proposed settlement is in the best interests of the corporation, and the shareholder class. These factors also favored approval of the settlement.

CA Appellate Court Holds That Promissory Note Was Not a Security

In People v. Black, No. H043360 (Cal. App.), decided Feb. 16, 2017, the defendant persuaded an acquaintance to invest in a real estate development opportunity in return for a promissory note. The defendant was later charged with violating the California securities law by using false statements in the offer or sale of a security. The trial court dismissed the charges on the grounds that the promissory note was not a security — and the state appealed.

The California Court of Appeal affirmed. The court noted that California courts have relied on two tests in evaluating an alleged security: the risk capital test, and the federal Howey test. And, according to the court, the promissory note here did not pass either test. It was an individually negotiated one-on-one transaction between associates rather than an indiscriminate offering to a randomly selected public at large as required by the risk capital test. Nor was it an instrument intended for wide distribution as required by the Howey test. Furthermore, the note provided for repayment to the investor if the deal failed, an element of redress unlikely to fall within the ordinary meaning of a security.

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

The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.

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