Quarterly State Compliance Review

This edition of the Quarterly State Compliance Review looks at legislation of interest to corporate lawyers that went into effect from May 1 through July 1. It also examines recent decisions of interest from the courts of Delaware, Texas, and Washington.

IN THE STATE LEGISLATURES

This has been a busy quarter for those who track changes to state business entity statutes ' a significant number of amendments went into effect. Below are some of the legislative highlights from around the country.

In Alabama, Senate Bill 404, effective May 21, stated that a corporation has to provide its financial statements only to those shareholders who request them, rather than to all shareholders, and that the financial statements may be delivered by electronic transmission. In Colorado, House Bill 1248, effective May 14, provided that a person may be admitted to a limited partnership as a partner without making or being obligated to make a contribution or acquire a partnership interest if such admission is pursuant to a written partnership agreement or other writing.

In Georgia, House Bill 308, effective July 1, provided that a one-member LLC may have an enforceable operating agreement, that an LLC is bound by an operating agreement whether or not it executes it, that an operating agreement may provide enforceable rights to any person, and that judgment creditors of members have no right to interfere with management, force dissolution or seek foreclosure of a membership interest. In Hawaii, Senate Bill 886, effective July 1, provided that a nonprofit corporation may give notice to members by electronic transmission consented to by the members.

In Indiana, Senate Bill 450, effective July 1, stated that if shareholders may cumulate votes, directors may not be elected by less than unanimous consent, that a resignation of a director that is conditioned upon failing to receive a specified vote for election may be irrevocable, and that a director's taking advantage of a corporate business opportunity may not be the subject of sanctions if all material facts were known by the board or shareholders, who disclaimed the corporation's interest in the opportunity.

In Minnesota, Senate Bill 1288, effective May 16, eliminated the requirements that a foreign LLC provide a certificate of good standing along with its application for authority and file a certificate evidencing that it changed its name, dissolved or merged. In Mississippi, House Bill 515, effective July 1, provided that an administratively dissolved or revoked corporation may apply for reinstatement at any time after the effective date of dissolution or revocation. (Formerly, within five years). In South Dakota, House Bill 1069, and in Utah, Senate Bill 2, both effective July 1, increased the filing fees for many business entity documents, including those filed to organize and register corporations and LLCs.

In Virginia, House Bill 2445, effective July 1, provided that any foreign corporation that has converted to a different entity type, effective on or before its annual report due date, will not be required to pay the registration fee for that year. And in Utah, Senate Bill 148, effective May 12, and in Wyoming, House Bill 182, effective July 1, authorized the formation of a low profit limited liability company ' which is an LLC formed and operated to further charitable or educational purposes and where the production of income or the appreciation of property is not a significant purpose.

IN THE STATE COURTS

DE Chancery Court Upholds LLC Member's Right to Approve Amendments to LLC Agreement

In re Nextmedia Investors, LLC, C.A. No. 4067 (Delaware Chancery Court), decided May 6, 2009, involved a Delaware LLC, formed in 2008. The LLC agreement stated that it would dissolve in eight years. In March 2008, with the dissolution date looming, the LLC's board of managers proposed an amendment to the LLC agreement to extend the LLC's duration. Sec. 17.5 of the LLC agreement required the consent of “each member to be adversely affected” in order to amend the LLC agreement. Approximately 97% of the members approved the amendment. Two of the members who did not consent asked the board to begin dissolution procedures. When the board indicated that it considered the amendment extending the duration to be validly adopted, the members filed a petition with the Chancery Court seeking an order of dissolution.

The Chancery Court granted the members' motion for summary judgment, finding that they had demonstrated that their interpretation of Sec. 17.5 of the LLC agreement was the only reasonable one. The members contended that Sec. 17.5 required the consent of all members to approve the amendment because all members were adversely affected by the extension of the LLC's duration. The court agreed, noting the importance of the ability to withdraw from an investment and take one's capital elsewhere.

The LLC argued that Sec. 17.5 could reasonably be interpreted to require consent only from those members that the board intended to adversely affect. The court rejected that argument because it was at odds with the section's plain meaning ' which was to allow each investor to veto changes to certain economically meaningful terms of the LLC agreement regardless of the board's intent. The court also rejected the LLC's argument that the members had to prove that they were adversely affected. According to the court, the members only had to show that their approval was needed. And because the amendment would alter an economically meaningful term, their right to approve was triggered.

TX Supreme Court Holds That Derivative Suit Demand Must Name Shareholder

In re Schmitz, No. 07-0851 (Texas Supreme Court), decided May 22, 2009, involved a shareholder derivative suit filed on behalf of a Texas corporation. The defendant officers and directors moved to dismiss for failure to make a proper demand. The defendants asserted the demand was insufficient because it failed to name a shareholder or describe the subject matter of the claim with particularity. The trial and appellate courts denied relief. However, the Texas Supreme Court agreed with the defendants and ordered dismissal of the suit.

The court acknowledged that the section of the Texas corporation law requiring a demand did not expressly state that a shareholder must be named. However, the court found, in construing the article of the corporation law on derivative suits as a whole, that demand was required.

The court first noted that the article presumes that a corporation knows the identity of the shareholder making the demand. For example, it permits filing a suit before 90 days after the demand is made if the corporation notifies the shareholder it is rejecting the demand. The court also pointed out that the identity of the shareholder may play an important role in how the corporation responds to the demand and that a corporation cannot be expected to incur the time and expense involved in fully investigating a demand without verifying that it came from a valid source. In addition, the court expressed a concern over the potential for abuse if a demand could be sent without identifying any shareholder. The court also found that the demand in this case was not stated with particularity because it demanded the board of directors stop a merger after receiving a superior offer, but gave no reason why the later offer was superior.

WA Supreme Court Adopts Delaware Law in Derivative Suits Alleging Improper Backdating of Stock Options

Certified from the U.S. District Court in In re F5 Networks, Inc. Derivative Litigation v. McAdam, No. 81817-7 (Washington Supreme Court), decided May 21, 2009, began as a shareholder derivative suit filed in federal district court in Washington. The plaintiffs alleged that the defendants backdated stock options in violation of federal and state laws and their fiduciary duties. The defendants moved to dismiss because the plaintiffs failed to make a demand on the board of directors. The judge certified questions to the Washington Supreme Court, asking whether Washington follows the Delaware demand futility standard, and, if so, if it follows Delaware's reasoning in cases alleging improper backdating of stock options.

The Washington Supreme Court first concluded that Washington follows Delaware's demand futility standard. Under the Delaware standard, a shareholder can go directly to court without first asking the board to take action, under certain circumstances. The defendants claimed that Washington follows the “universal demand” standard. Under that standard, a demand is always required. In rejecting the universal demand standard the court noted that Washington's statute provides that a derivative suit complaint must allege the demand made, if any, and that if a demand was not made, the reason why not. Thus, the legislature clearly contemplated that there would be times a demand would not be made. The court then stated that in derivative suits alleging improper backdating of stock options Washington would adopt Delaware's reasoning, as set forth in Ryan v. Gifford, 918 A.2d 341 (Del. Ch. 2007). This would allow plaintiffs to rely on circumstantial evidence that tends to show a pattern indicative of wrongdoing as part of their initial case.

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 legislation of interest to corporate lawyers that went into effect from May 1 through July 1. It also examines recent decisions of interest from the courts of Delaware, Texas, and Washington.

IN THE STATE LEGISLATURES

This has been a busy quarter for those who track changes to state business entity statutes ' a significant number of amendments went into effect. Below are some of the legislative highlights from around the country.

In Alabama, Senate Bill 404, effective May 21, stated that a corporation has to provide its financial statements only to those shareholders who request them, rather than to all shareholders, and that the financial statements may be delivered by electronic transmission. In Colorado, House Bill 1248, effective May 14, provided that a person may be admitted to a limited partnership as a partner without making or being obligated to make a contribution or acquire a partnership interest if such admission is pursuant to a written partnership agreement or other writing.

In Georgia, House Bill 308, effective July 1, provided that a one-member LLC may have an enforceable operating agreement, that an LLC is bound by an operating agreement whether or not it executes it, that an operating agreement may provide enforceable rights to any person, and that judgment creditors of members have no right to interfere with management, force dissolution or seek foreclosure of a membership interest. In Hawaii, Senate Bill 886, effective July 1, provided that a nonprofit corporation may give notice to members by electronic transmission consented to by the members.

In Indiana, Senate Bill 450, effective July 1, stated that if shareholders may cumulate votes, directors may not be elected by less than unanimous consent, that a resignation of a director that is conditioned upon failing to receive a specified vote for election may be irrevocable, and that a director's taking advantage of a corporate business opportunity may not be the subject of sanctions if all material facts were known by the board or shareholders, who disclaimed the corporation's interest in the opportunity.

In Minnesota, Senate Bill 1288, effective May 16, eliminated the requirements that a foreign LLC provide a certificate of good standing along with its application for authority and file a certificate evidencing that it changed its name, dissolved or merged. In Mississippi, House Bill 515, effective July 1, provided that an administratively dissolved or revoked corporation may apply for reinstatement at any time after the effective date of dissolution or revocation. (Formerly, within five years). In South Dakota, House Bill 1069, and in Utah, Senate Bill 2, both effective July 1, increased the filing fees for many business entity documents, including those filed to organize and register corporations and LLCs.

In Virginia, House Bill 2445, effective July 1, provided that any foreign corporation that has converted to a different entity type, effective on or before its annual report due date, will not be required to pay the registration fee for that year. And in Utah, Senate Bill 148, effective May 12, and in Wyoming, House Bill 182, effective July 1, authorized the formation of a low profit limited liability company ' which is an LLC formed and operated to further charitable or educational purposes and where the production of income or the appreciation of property is not a significant purpose.

IN THE STATE COURTS

DE Chancery Court Upholds LLC Member's Right to Approve Amendments to LLC Agreement

In re Nextmedia Investors, LLC, C.A. No. 4067 (Delaware Chancery Court), decided May 6, 2009, involved a Delaware LLC, formed in 2008. The LLC agreement stated that it would dissolve in eight years. In March 2008, with the dissolution date looming, the LLC's board of managers proposed an amendment to the LLC agreement to extend the LLC's duration. Sec. 17.5 of the LLC agreement required the consent of “each member to be adversely affected” in order to amend the LLC agreement. Approximately 97% of the members approved the amendment. Two of the members who did not consent asked the board to begin dissolution procedures. When the board indicated that it considered the amendment extending the duration to be validly adopted, the members filed a petition with the Chancery Court seeking an order of dissolution.

The Chancery Court granted the members' motion for summary judgment, finding that they had demonstrated that their interpretation of Sec. 17.5 of the LLC agreement was the only reasonable one. The members contended that Sec. 17.5 required the consent of all members to approve the amendment because all members were adversely affected by the extension of the LLC's duration. The court agreed, noting the importance of the ability to withdraw from an investment and take one's capital elsewhere.

The LLC argued that Sec. 17.5 could reasonably be interpreted to require consent only from those members that the board intended to adversely affect. The court rejected that argument because it was at odds with the section's plain meaning ' which was to allow each investor to veto changes to certain economically meaningful terms of the LLC agreement regardless of the board's intent. The court also rejected the LLC's argument that the members had to prove that they were adversely affected. According to the court, the members only had to show that their approval was needed. And because the amendment would alter an economically meaningful term, their right to approve was triggered.

TX Supreme Court Holds That Derivative Suit Demand Must Name Shareholder

In re Schmitz, No. 07-0851 (Texas Supreme Court), decided May 22, 2009, involved a shareholder derivative suit filed on behalf of a Texas corporation. The defendant officers and directors moved to dismiss for failure to make a proper demand. The defendants asserted the demand was insufficient because it failed to name a shareholder or describe the subject matter of the claim with particularity. The trial and appellate courts denied relief. However, the Texas Supreme Court agreed with the defendants and ordered dismissal of the suit.

The court acknowledged that the section of the Texas corporation law requiring a demand did not expressly state that a shareholder must be named. However, the court found, in construing the article of the corporation law on derivative suits as a whole, that demand was required.

The court first noted that the article presumes that a corporation knows the identity of the shareholder making the demand. For example, it permits filing a suit before 90 days after the demand is made if the corporation notifies the shareholder it is rejecting the demand. The court also pointed out that the identity of the shareholder may play an important role in how the corporation responds to the demand and that a corporation cannot be expected to incur the time and expense involved in fully investigating a demand without verifying that it came from a valid source. In addition, the court expressed a concern over the potential for abuse if a demand could be sent without identifying any shareholder. The court also found that the demand in this case was not stated with particularity because it demanded the board of directors stop a merger after receiving a superior offer, but gave no reason why the later offer was superior.

WA Supreme Court Adopts Delaware Law in Derivative Suits Alleging Improper Backdating of Stock Options

Certified from the U.S. District Court in In re F5 Networks, Inc. Derivative Litigation v. McAdam, No. 81817-7 (Washington Supreme Court), decided May 21, 2009, began as a shareholder derivative suit filed in federal district court in Washington. The plaintiffs alleged that the defendants backdated stock options in violation of federal and state laws and their fiduciary duties. The defendants moved to dismiss because the plaintiffs failed to make a demand on the board of directors. The judge certified questions to the Washington Supreme Court, asking whether Washington follows the Delaware demand futility standard, and, if so, if it follows Delaware's reasoning in cases alleging improper backdating of stock options.

The Washington Supreme Court first concluded that Washington follows Delaware's demand futility standard. Under the Delaware standard, a shareholder can go directly to court without first asking the board to take action, under certain circumstances. The defendants claimed that Washington follows the “universal demand” standard. Under that standard, a demand is always required. In rejecting the universal demand standard the court noted that Washington's statute provides that a derivative suit complaint must allege the demand made, if any, and that if a demand was not made, the reason why not. Thus, the legislature clearly contemplated that there would be times a demand would not be made. The court then stated that in derivative suits alleging improper backdating of stock options Washington would adopt Delaware's reasoning, as set forth in Ryan v. Gifford , 918 A.2d 341 (Del. Ch. 2007). This would allow plaintiffs to rely on circumstantial evidence that tends to show a pattern indicative of wrongdoing as part of their initial case.

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.