Quarterly State Compliance Review

The Court of Appeals began by noting that the LP agreement set forth the general partners' fiduciary duties and that its analysis had to be based on contractual principles. Therefore, the fact that Clancy's actions would constitute a breach of fiduciary duties under common law or statutory law was irrelevant. The court then noted that the LP agreement in this case clearly and unambiguously allowed partners to compete with the LP and usurp its opportunities and that pursuant to that clause Clancy had the right to reserve control of his name for himself. However, the court went on to state that both the LP agreement and contract law in general obligated Clancy to act in good faith. If Clancy's motive for exercising his right to control his name was to decrease the LP's profits to punish or spite his ex-wife, that could be considered as acting in bad faith. Thus, the court remanded to determine whether Clancy acted in good faith or bad faith.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT (www.ctlegalsolutions.com), a Wolters Kluwer business.

This edition of the Quarterly State Compliance Review looks at some legislation of interest to corporate lawyers that went into effect recently, including amendments to the corporation laws of Delaware, California, and New York. This edition also includes two recent decisions of interest from the Delaware Chancery Court.

IN THE STATE LEGISLATURES

Delaware Amends Its General Corporation Law, LLC Act And LP Act

Every year, Delaware's legislature amends its corporation, LLC and LP laws ' and 2008 was no exception. Highlights of this year's amendments include the following: Senate Bill 244, effective June 26, amended Sec. 219 of the General Corporation Law to provide that if a corporation, or an officer or agent thereof, refuses to permit a stockholder to examine the list of stockholders before a meeting, the stockholder may apply to the Chancery Court for an order to compel the examination, that the corporation has the burden of proving that the examination is for a purpose not germane to the meeting, and that the Court may summarily order the corporation to permit the examination or make additional orders as may be appropriate. S.B. 244 also amended Sec. 225 of the GCL to authorize a corporation to apply to the Chancery Court for a hearing to determine the result of a stockholder vote upon matters other than the election of directors.

Delaware's LLC Act and LP Act were amended by House Bill 429 and House Bill 427 respectively, effective Aug. 1, to clarify that the term “person” as used in the Acts includes any form of trust and to clarify who may execute certificates of LLC or LP domestication and certificates of conversion. In addition, H.B. 429 clarified that the term “manager” as used in the sections of the LLC Act dealing with contested matters relating to managers and actions to interpret and enforce an LLC agreement, refers to a person who participates materially in the management of the LLC even if not named as a manager in the LLC agreement. Furthermore, H.B. 427 provided that a limited partner will not be considered to be participating in the control of the LP's business by selecting or removing certain agents, owners, governing officials or fiduciaries of the LP or a general partner that is an entity. Finally, House Bill 519, effective retroactively to Jan. 1, increased the rates at which franchise taxes on domestic corporations are assessed and House Bill 520, effective July 1, increased the annual tax paid by LLCs and LPs from $200 to $250.

Amendments to Business Entity Laws of Other States

In Arizona, Senate Bill 1410, effective Sept. 26, amended the corporation and LLC laws to make the requirement to file an affidavit of publication optional rather than mandatory for domestic and foreign corporations and domestic LLCs and to require corporations and LLCs to be in good standing in order to file documents with the Corporation Commission.

In California, Senate Bill 1409, effective July 22, provided that the requirement of the General Corporation Law to send an annual report to shareholders before the annual meeting will be considered satisfied if a corporation with an outstanding class of securities registered under Sec. 12 of the Exchange Act complies with federal regulations relating to the Internet availability of an annual report.

In New York, Assembly Bill 10825/Senate Bill 7349, effective July 21, amended the Business Corporation Law to provide that dividends and distributions may be paid either out of surplus, or if there is no surplus, out of net profits for the fiscal year in which the dividend is paid and/or the preceding fiscal year. Assembly Bill 10824/Senate Bill 7350, effective July 21, amended the Business Corporation Law to provide that the bylaws may provide that directors shall be elected by other than a plurality of the votes cast at a shareholders' meeting.

In Ohio, House Bill 374, effective Sept. 25, amended the corporation law to provide that an original articles of incorporation may set forth a provision eliminating the right to vote cumulatively, to eliminate the 90 day waiting period for a corporation to eliminate cumulative voting by amendment to its articles, to provide that the articles or regulations may provide for uncertificated shares, and to provide that a sale or other disposition of all or substantially all of a corporation's assets to a wholly owned subsidiary does not require shareholder approval.

IN THE STATE COURTS

Delaware Chancery Court Clarifies Difference Between Gross Negligence and Bad Faith

In McPadden v. Sidhu, C.A. No. 3310, decided Aug. 29, 2008, a derivative suit was filed against the directors of a corporation and a vice president of a wholly owned subsidiary, after the corporation sold the subsidiary to a management group led by the VP for $3 million. Shortly after buying the subsidiary, the VP sold it for over $25 million. The defendants moved to dismiss pursuant to Rule 23.1 for failure to make a demand or sufficiently plead demand futility and Rule 12(b)(6) for failure to state a claim.

The facts, as alleged, included that the directors: 1) tasked the VP with finding a buyer for the subsidiary even though they knew he was interested in buying it himself; 2) engaged in no oversight despite the VP's obvious conflict of interest; 3) knew before approving the sale that the VP made only half-hearted attempts to solicit bids and failed to contact the most obvious potential buyers ' including a competitor that had already indicated an interest in buying the subsidiary for $25 million; and 4) relied on a fairness opinion that they knew was based on projections provided by the VP.

The Chancery Court held that the directors' conduct constituted gross negligence, which the court defined as conduct or actions exhibiting reckless indifference or that are without the bounds of reason. As a result, the court held that the directors breached their duty of care and that the demand was excused as futile. However, the corporation's certificate of incorporation included an exculpation clause under which directors could not be held liable for breaches of the duty of care. They were not, however, protected against liability for actions taken in bad faith. The court then found that the directors did not act in bad faith ' which the court defined as conduct showing a conscious disregard for their duties. Thus, the court granted the director defendants' motion to dismiss for failure to state a claim based on the exculpation clause. The court did not, however, dismiss the claim against the VP because the exculpation clause did not apply to officers.

Delaware Chancery Court Upholds LLC Members'
Waiver of Statutory Right to Seek Judicial Dissolution

In R&R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, C.A. No. 3803, decided Aug. 19, 2008, members of Delaware LLCs petitioned for the judicial dissolution of the LLCs pursuant to Sec. 18-802 of the Delaware LLC Act. The LLC agreements provided that each member waives and renounces the right to seek judicial dissolution. The members conceded that the LLC agreements purported to effect a waiver of the right to seek judicial dissolution. However, they argued that such a waiver was invalid because it was prohibited by the LLC Act, public policy, and the principles of equity.

The Chancery Court enforced the waiver provision. The court rejected the argument that sections of the LLC Act are mandatory unless they contain the qualification “unless otherwise provided in an LLC agreement.” The court stated that a provision is mandatory only if the LLC Act explicitly says so. The court also pointed out that Sec. 18-802 uses the word “may” instead of “shall” and that none of the rights conferred by the section are designed to protect third parties. According to the court, these factors also indicate that the section is not mandatory.

The Chancery Court also rejected the members' argument that the waiver violates public policy, noting that the public policy of Delaware with respect to LLCs is freedom of contract. In addition, the court noted that the LLC Act provided other protections that the members could have availed themselves of and that therefore there was no reason for the court to exercise its equitable discretion to disregard a negotiated agreement among sophisticated parties.

Maryland Court of Appeals Holds that Limited
Partnership Agreement May Allow Good Faith Breaches of Fiduciary Duty

Clancy v. King, No. 112, decided Aug. 26, 2008, involved a Maryland LP formed and co-owned by author Tom Clancy and his then-wife. The LP entered into a very profitable venture in which Clancy lent his name to a series of paperback books. Clancy also entered into an agreement with the joint venturer in which he reserved to himself the right to control the venture. Clancy and his wife divorced. The wife retained her half interest in the LP. After the divorce Clancy denied permission to use his name in connection with the paperback book series. The ex-wife sued Clancy for breaching his fiduciary duties to the LP and her. The trial court found for the ex-wife, the appellate court affirmed and the Maryland Court of Appeals granted certiorari.

The Court of Appeals began by noting that the LP agreement set forth the general partners' fiduciary duties and that its analysis had to be based on contractual principles. Therefore, the fact that Clancy's actions would constitute a breach of fiduciary duties under common law or statutory law was irrelevant. The court then noted that the LP agreement in this case clearly and unambiguously allowed partners to compete with the LP and usurp its opportunities and that pursuant to that clause Clancy had the right to reserve control of his name for himself. However, the court went on to state that both the LP agreement and contract law in general obligated Clancy to act in good faith. If Clancy's motive for exercising his right to control his name was to decrease the LP's profits to punish or spite his ex-wife, that could be considered as acting in bad faith. Thus, the court remanded to determine whether Clancy acted in good faith or bad faith.

Sandra Feldman, a member of this newsletter's Board of Editors, is a publications and research attorney for New York-based CT (www.ctlegalsolutions.com), a Wolters Kluwer business.