New England Biz Law Update
The new business corporation Act (Title 7, Chapter 1.2 of the Rhode Island General Laws) replaces the old statute with modern laws that follow the principles found in the Model Business Corporation Act and the Delaware Code. The new Act provides greater flexibility and clarity for corporations and their shareholders, directors and officers.
This article evolved from the Adler Pollock & Sheehan P.C. Corporate Law Project, in which the authors, along with Sarah Dowling, Paul Campellone, Joshua Celeste, Giovanni Cicione and Thomas Westort, compared the new Act to the old and analyzed the changes.
A section-by-section comparison of the New Business Corporation Act to the Old Business Corporation Act is available at www.apslaw.com.
Filing Requirements
By no longer requiring duplicate filings or notarized signatures, as well as permitting facsimile and “electronically transmitted” signatures, the New Business Corporation Act simplifies the filing requirements for domestic and foreign corporations.
Corporate Name
The New Business Corporation Act says that a corporate name may be used if it is “distinguishable upon the records” of the secretary of state. The purpose for requiring a distinguishable name is to prevent confusion within the secretary of state’s office and the division of taxation, as well as to facilitate accuracy in bringing a suit or claim against a corporate defendant.
The role of the secretary of state is not to prevent unfair competition between corporations with respect to their names. Replacing the “deceptively similar” standard with the “distinguishable upon the records” standard emphasizes this point.
Articles of Incorporation
Although the New Business Corporation Act reduces the number of required statements in a corporation’s articles of incorporation, a corporation may include additional optional provisions in its articles, so long as such provisions are consistent with the law.
For example, a corporation may include in its articles provisions regarding:
• Preemptive rights;
• A future effective date of the articles;
• Authorization for the board of directors to designate classes of shares and series of shares within a class;
• Prohibitions against certain types of stock distributions;
• The removal of directors only for cause;
• Director and officer indemnification;
• Supermajority voting;
• The elimination of a close corporation’s annual meeting;
• Restrictions on the power of the board of directors to acquire, dispose of and cancel shares;
• The manner in which outside facts operate on voting powers, designations, preferences, rights and qualifications, limitations or restrictions of any class or series of shares;
• Par value of shares (unless otherwise stated, shares that are silent as to par value are presumed to have a $.01 par value solely for calculating a tax or fee on capital); and
• The elimination of the board of directors.
Consideration of Shares
A corporation may now issue shares for consideration consisting of promissory notes and contracts for future services by officers, employees and/or strategic partners. The corporation may escrow such issued shares until the note is paid or the services are performed. If the note is not paid or if the services are not performed, then the corporation may cancel the escrowed shares.
Preemptive Rights
Rhode Island adopts the “opt in” approach to shareholder preemptive rights. A shareholder of a corporation incorporated on or after July 1 will no longer have a right to purchase additional shares of a new issue to preserve his or her proportionate share of ownership in the corporation unless the corporation provides for preemptive rights in its articles.
Distributions
The New Business Corporation Act simplifies distribution of corporate assets by abandoning the antiquated and overly complex tests for measuring “stated capital,” “capital surplus” and “earned surplus.”
Now, corporations are prohibited from distributing assets other than shares only if (1) the corporation is insolvent or (2) the distribution will render the corporation insolvent. Although a corporation may limit stock distributions in its articles of incorporation, stock distributions are not subject to the insolvency test because a stock distribution will not affect the amount or type of the corporation’s assets or liabilities and, thus, will not render the corporation insolvent.
Indemnification
As clarified by the New Business Corporation Act, even if a director or officer is not entitled to indemnification as provided under the “permissible indemnification” provisions of the new Act, a court may nevertheless order indemnification upon application of the affected director or officer.
Furthermore, to the extent that broader indemnification provisions are included in a corporation’s articles of incorporation, directors and officers of such corporation are entitled to broader indemnification than is provided by the “permissible indemnification” provisions of the New Business Corporation Act.
Nevertheless, a corporation may not indemnify a director or officer in connection with (1) a derivative action (unless the director or officer meets the applicable standard of care and, if so, then only for his or her reasonable expenses) or (2) a proceeding in which a director or officer is found liable for receiving an improper personal benefit.
Merger/Right to Dissent
The New Business Corporation Act adopts a stricter standard for eliminating the shareholder voting and notice requirements in a merger.
Unless required by the articles of incorporation, no shareholder approval or notice of the merger is required if: (1) the plan of merger does not amend the articles of incorporation of the corporation; (2) each shareholder immediately prior to the merger will hold the same number of shares with identical preferences, limitations and relative rights immediately after the effective date of the merger; and (3) the securities issued in connection with the merger represent less than 20 percent of the total voting power of all outstanding shares entitled to vote for directors of the corporation after the merger. The holding requirement is new and the percentage requirement has been reduced from 33 percent.
The New Business Corporation Act narrows a shareholder’s right to challenge a merger. In particular, a shareholder may not challenge a merger where the right to dissent is available unless such corporate action: (1) was not done in accordance with statute, articles of incorporation, bylaws or board of directors’ resolution authorizing the action; or (2) was procured as a result of fraud or material misrepresentation.
If a majority of shareholders has voted to approve a corporate action based upon the board of directors’ recommendation, then the remaining minority will have the remedy of receiving fair value for their ownership interests, with judicial review limited to “exceptional” circumstances when such review is warranted.
Derivative Actions
Drawn from equitable principles, the derivative action allows shareholders to bring suit in the corporation’s name to compel the corporation to pursue claims against third parties or insiders because the corporation has failed, deliberately or otherwise, to do so.
For example, a shareholder may bring a derivative suit against: (1) the corporation to compel it to bring a specified suit; (2) officers or directors for breach of a fiduciary duty; or (3) third parties because of dissatisfactory dealings between the third party and the corporation.
Retaining this purpose yet modernizing the approach, the New Business Corporation Act has adopted the provisions of the Model Business Corporation Act law governing shareholder derivative suits.
The following discussion highlights two particular areas: demand and dismissal.
To eliminate the excessive time and expense involved in litigating the question of whether demand on the board of directors is required, a written demand on the corporation is now required in all cases.
In particular, a shareholder may not commence a derivative action until he or she has made a written demand on the corporation to take suitable action and 90 days has elapsed, unless irreparable injury to the corporation would result.
As for dismissal, a plaintiff-shareholder brings a derivative suit on behalf of the corporation and the corporation’s independent directors control its continuance. The court’s role is to consider any actual bias of the directors, as well as the reasonableness of their inquiry and the good faith of their ultimate determination.
Under the New Business Corporation Act, none of the following by itself disproves a director’s independence: (1) the director’s appointment by non-independent directors; (2) the director being named as a defendant in the proceeding; or (3) the director’s approval of the challenged act if the director did not receive a personal benefit.
Therefore, a plaintiff-shareholder may find it difficult to prove that a director lacked independent judgment given this director-friendly standard.
With these principles in mind, the New Business Corporation Act adopts the following procedure governing dismissal. On motion of the corporation, the court will dismiss a derivative proceeding upon: (1) a majority vote of independent directors if the independent directors constitute a quorum; (2) a majority vote of a committee of at least two or more independent directors appointed by a majority vote of independent directors, whether or not such independent directors constitute a quorum; or (3) a decision by a panel of independent persons appointed by the court upon motion of the corporation, after the group specified in (1), (2) or (3) above has determined in good faith, and after reasonable inquiry upon which its conclusions are based, that the derivative proceeding is not in the corporation’s best interests.
This standard limits the court’s review to whether the directors were independent and whether the inquiry supports the determination.
If a majority of the directors is independent, or if a court-appointed panel makes the determination, then the burden of proof is on the plaintiff-shareholder to show that the inquiry was not reasonable and the final determination was not made in good faith. If, however, the plaintiff-shareholder proves that the majority of directors was not independent, then the burden shifts to the defendant.
Duty of Care for Directors
Under the Old Business Corporation Act, directors were required to discharge their duties “with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” This language, which suggests a tort law negligence standard as the proper measure for determining deficient conduct, has confused the relationship between the statutory duty of care and the common law “business judgment” rule.
Adopted by Rhode Island courts when adjudicating claims of liability based on breach of fiduciary duty, the business judgment rule is essentially a rebuttable presumption that, in making a business decision, the directors of a corporation have acted on an informed basis, in good faith and in honest belief that the action taken was in the best interests of the corporation. Courts typically will not intervene unless the corporate acts indicate gross mismanagement or threaten the corporation’s continued existence.
Thus, to deal with the statutory confusion, when adjudicating claims of liability based on a director’s breach of his or her fiduciary duty to the corporation, Rhode Island courts have interpreted the standard of care for directors using the business judgment rule.
Following suit, the new Act replaces the former subjective standard of care with a new objective standard, requiring directors to discharge their duties “with the care that a person in a like position would reasonably believe appropriate under similar circumstances.” By adopting this new standard, the new Act codifies the test used by the Rhode Island judiciary, aligning the statutory duty of care with the concepts set forth in the business judgment rule.
