Date:                January 6, 2003

To:                   Senator Andrew McDonald

Representative Michael P. Lawlor

CoChairs, Judiciary Committee

From:               Beth Cook, Law Fellow

Subject:            Law Revision Commission Report concerning an Act Concerning Professional

Service Corporations, Business Corporations, Nonstock Corporations, Limited

Partnerships, Limited Liability Companies And Partnerships

 

Pursuant to a request of Representative James Abrams and the Judiciary Committee of the General Assembly, the Connecticut Law Revision Commission voted to undertake a review of 2002 substitute House Bill 5676 which, among other things, would have permitted cross-entity mergers and consolidations of dissimilar business entities. The bill, which had been unanimously approved by the Judiciary Committee, died on the House Calendar during the 2002 legislative session. The Judiciary Committee asked the Commission to review the bill in the context of other models for corporate mergers, consolidations, conversions, and similar transactions between and among similar-type business entities, taking into consideration the views of the Business Law Section of the Connecticut Bar Association and others knowledgeable about such matters.

To complete the requested study, the Commission formed a study committee that held information and discussion sessions with representatives from the Business Law Section of the Connecticut Bar Association, the Connecticut Business and Industry Association, the Secretary of the State’s Office, legal practitioners and professors of business organization law. On November 15, 2002, the study committee voted to recommend the bill, with some relatively minor drafting changes, for enactment by the General Assembly. The Commission recommends enactment of the bill. A proposed bill reflecting the technical and substantive revisions suggested by the study committee is attached.

 

This memo provides a report of the key provisions of the bill. This report relies heavily on the OLR bill analysis memo and materials presented to the study committee by Attorneys Richard S. Smith, Jr. and Louis Schatz as representatives of the Business Law Section and the Tax Section of the Connecticut Bar Association (CBA), respectively.

 

This bill is part of the ongoing process of the Business Law Section of the CBA of updating corporate statutes and keeping them in harmony with the laws of other states. The bill would implement in Connecticut several changes to the Model Business Corporation Act (MBCA) that have been adopted since the enactment of the Connecticut Business Corporation Act (CBCA). It would also make several conforming changes to the statutes governing various other types of business organizations.  The MBCA has been widely adopted in other states – 32 in all. The act, together with its commentary and the decisional law interpreting the act, helps maintain a competitive business environment among the states. Keeping the MBCA current in Connecticut maintains Connecticut’s competitive position.

The changes reflected in the bill can be broadly characterized in five areas:

I. Fundamental Changes

 

The bill would implement in Connecticut the 1999 amendments to the MBCA relating to fundamental changes in a stock corporation. Because these amendments would enable corporations to merge or consolidate with other types of business entities, the bill also includes corresponding amendments to the statutes governing such other entities to enable them to merge or consolidate with corporations.

 

The key changes reflected in the bill are:

·        Permits corporations to merge with other types of business entities (cross-entity mergers or consolidations).

o       Under current law, stock corporations, limited liability companies, and limited partnerships organized under Connecticut law may merge only with their own type of entity. Connecticut and Alaska are the only states that currently do not permit cross-entity mergers. As a result, Connecticut companies, intending to merge or consolidate with another type of business entity such as an LLC, have needed to reincorporate or reorganize under the laws of another state such as Delaware.

o       This bill would amend Connecticut’s business laws to permit cross-entity mergers by allowing stock corporations to merge with partnerships, limited partnerships, limited liability partnerships, limited liability companies, joint ventures, joint stock companies, business trusts, statutory trusts, and real estate investment trusts. It grants similar authority to limited partnerships, limited liability companies, and partnerships. The bill also permits professional service corporations to consolidate or merge with a Connecticut limited liability company, partnership, or limited liability partnership, if it is organized to render the same specific professional service. Sections 18, 19, 55, 56, 61(a), 61(b), 68, 1. This change would eliminate the need for Connecticut companies to reincorporate or reorganize outside of the state to effect this organizational change.

o       The bill makes the laws that currently apply to these mergers also apply to mergers with the other entities. It makes a few adjustments to these laws to reflect mergers that involve other entities.

o       Nonstock corporations would be prohibited from merging with other entities. Section 42.

o       The bill also authorizes stock corporations to do share exchanges with these other business entities by allowing their shares to be exchanged for shares, cash, or other types of property.

 

·        Implements MBCA voting procedures, without adopting the voting standards themselves.

o       The MBCA revisions reflect a uniform voting standard calling for approval by a majority of the votes cast at a meeting at which a quorum, consisting of at least 50% of the votes entitled to be cast, is present. The bill does not implement these changes but retains the voting standards currently reflected in the CBCA. The CBCA generally requires approval by a majority of the votes entitled to be cast by each voting group. Corporations incorporated prior to January 1, 1997, however, are generally subject to the voting standards in effect prior to that date, such as two-thirds of the voting power of each voting group.

o       The bill, however, does not include the MBCA provision requiring shareholder approval of issuances of stock for noncash consideration when such issuance would increase the total outstanding voting power by more than 20%.  The drafters of the bill felt that shareholders had the right to approve the total authorized number of shares set forth in the certificate of incorporation, and within that authority, the shareholders had empowered the board to issue shares without further shareholder approval.

 

·        Eliminates separate class votes for certain types of amendments to the certificate of incorporation. Affected are amendments that (i) increase or decrease the aggregate number of shares of the class, and (ii) create or amend a new class of shares having rights or preferences that are substantially equal to the class.  The right to vote as a separate voting group provides statutory protection for classes with preferential rights against amendments that are especially burdensome to that class. The drafters  of the bill considered these types of transactions – increasing or decreasing the shares of a class or creating a new class that is without preference to an existing class -  not to be burdensome or detrimental to the class.  As a result of these revisions, approval by a class, voting as a separate voting group, is required in these cases only when the new or other class would have rights with respect to distributions or dissolution that would be prior or superior to the class, not when the rights would be substantially equal. Therefore, no potential dilution occurs and there is no harm to the class’s position. Section 11(a).

 

·        Provides that the terms in a plan of merger may be made dependent upon facts ascertainable outside the plan of merger.  Section 18(d).

 

·        Permits a plan of merger or share exchange to include a provision that the plan may be amended prior to the filing of a certificate of merger or share exchange with the Office of the Secretary of the State.  Sections 18(e) and 19(e).

 

·        Eliminates the need to set forth the plan of merger in the certificate of merger that is filed with the Office of the Secretary of the State.  Section 22(a).

 

·        Permits a merger to be abandoned after the filing of a certificate of merger but before the merger is effective.  Section 24.

 

·        Adopts a bright-line test for determining when a sale or transfer of assets requires shareholder approval.  Generally speaking, a sale, lease, exchange or other disposition of assets requires shareholder approval only if the disposition would leave the corporation without a significant continuing business activity.  A corporation will be conclusively deemed to have retained a significant continuing business activity if it retains a business activity that represented at least 25% of total assets at the end of the most recently completed fiscal year, and 25% of either income from continuing operations before taxes or revenues from continuing operations for that fiscal year.  Section 26.

 

II. Dissolution

 

The purpose of these changes is to update the provisions of the MBCA relating to voluntary dissolution of a corporation, including the provisions relating to liquidating distributions and director liability.

Current law allows corporations to dissolve by filing a certificate of dissolution with the Secretary of the State that contains certain information. If the shareholders approve the dissolution, the certificate of dissolution must include (1) the number of votes entitled to be cast on the proposal to dissolve and (2) either the total number of votes cast for and against dissolution or the total number of undisputed votes cast for dissolution and a statement that the number cast for dissolution was sufficient for approval. If voting by voting groups is required, the information must be provided separately for each voting group entitled to vote separately.

The bill replaces this detailed certificate with a certificate stating that the proposal to dissolve was duly approved by the shareholders, as required by law and by the certificate of incorporation.  This less detailed certificate is consistent with the current practice of filing shortened certificates with the Secretary of the State to avoid a complicated recitation of the approval process that is frequently incorrect. As a protection, all filings are subject to the provisions of section 33-616 which provides “A person who signs or otherwise executes a document he knows is false in any material respect with intent that the document be delivered to the Secretary of the State for filing shall be subject to the penalty for false statement under section 53a-157b.” This is classified as a Class A misdemeanor which carries the potential of imprisonment not to exceed one year and/or a fine not to exceed $2000.  

Under current law and the bill, a corporation is dissolved upon the effective date of its certificate of dissolution.

The bill defines a "dissolved corporation" as a corporation whose certificate of dissolution has become effective and includes a successor entity to which the remaining assets of the corporation are transferred subject to the corporation's liabilities for purposes of liquidation.

The key changes reflected in the bill are:

• Removes distributions in liquidation from the limitations on distributions in Section 33-687. Section 5.

 

• Adds a safe harbor court proceeding for dealing with contingent claims.  Sections 31 and 32.
• The bill allows a dissolved stock or nonstock corporation, that has published a dissolution notice and requested persons with claims to present them, to file an application with the Superior Court for a determination of the amount and form of security to be provided for payment of contingent claims. Contingent claims are ones that are (1) dependent on other events or have not been made known to the dissolved corporation or (2) based on an event occurring after the effective date of dissolution but that, based on the facts known to the dissolved corporation, are reasonably estimated to arise after the effective date of dissolution. The bill specifies that the provision does not have to be made for any claim that is or is reasonably anticipated to be barred. The application must be filed with the Superior Court for the stated judicial district where the dissolved corporation's principal office or, if there is none in this state, where its registered office, is located.
• Within 10 days after it files an application regarding contingent claims, the dissolved corporation must notify each claimant holding a contingent claim shown on the corporation's records.
• The court may appoint a guardian ad litem to represent all claimants whose identities are unknown in any such proceeding. The bill requires the corporation to pay the guardian's reasonable fees and expenses, including all reasonable expert witness fees.
• Under the bill, a dissolved corporation that provides security in the amount and the form the court orders satisfies its obligations for claims that (1) are contingent, (2) have not been made known to the corporation or (3) are based on an event occurring after the effective date of dissolution. These claims may not be enforced against a shareholder or member who received assets in liquidation.
• Clarification of director liability, defenses, contribution and recoupment in dissolution.  Section 7.

 

III. Judicial Removal of Directors

 

These changes revise section 33-743 of the CBCA to correct a number of perceived deficiencies dealing with the judicial removal of directors. The Connecticut version differs from the MBCA by retaining “dishonest conduct” as a stated ground for removal of a director.

 

The key changes reflected in the bill are:

• The bill changes the standards the court may use to remove a director from a corporation's board and expands the right of small shareholders to initiate the proceeding. Under current law, the corporation, or shareholders holding at least 10% of the outstanding shares of any class, may ask the court to do so. The bill eliminates the distinction between shareholders holding 10% or more of the outstanding stock and smaller shareholders and provides that a removal proceeding may be brought by the corporation directly or by any shareholder suing derivatively.

 

• The bill specifies that a shareholder who initiates such a lawsuit must comply with all the rules that apply to shareholders bringing a lawsuit in the name of the corporation except the requirement that the plaintiff (1) was a shareholder at the time of the act complained of or (2) became a shareholder through transfer by operation of law from one who was a shareholder at the time. It eliminates the requirement that a shareholder make the corporation a party defendant to such a lawsuit.

 

• MBCA revises the grounds for removal to require a finding that "the director engaged in fraudulent conduct with respect to the corporation or its shareholders, grossly abused the position of director or intentionally inflicted harm on the corporation."

 

• Before deciding that removal is in the best interest of the corporation, the court is directed to consider both "the director's course of conduct and the inadequacy of other available remedies."

 

• A new subsection is added to emphasize that section 33-743 is not exclusive and does not limit the court's ability to afford other equitable relief.

 

IV. Conforming Changes of the Nonstock Act

 

These changes adopt relevant conforming changes to the Nonstock Act consistent with those identified above. The bill does not change current law which does not permit Connecticut nonstock corporations to merge or consolidate with other business entities.

                                   

V. Other Miscellaneous Changes

 

These changes address other problem areas for Connecticut stock and nonstock corporations.

                                   

The key changes reflected in the bill are:

• Authorizes staggered board member terms and ex-officio director provisions to be set forth in the bylaws, as well as in the certificate of incorporation.  Sections 34 and 35.
• The bill allows a nonstock corporation's bylaws to provide that people occupying certain positions within or outside the corporation are ex-officio directors. Current law allows the certificate of incorporation to do so. But, unless otherwise provided in the certificate of incorporation or bylaws, ex-officio directors may not be counted in determining a quorum and are not entitled to vote. Under the bill, if the corporation has members entitled to vote on the adoption, amendment, or repeal of its bylaws, any bylaw providing for ex-officio directors must require approval, either before, on, or after October 1, 2003, by the same vote necessary to amend its bylaws.
• The bill allows a nonstock corporation's bylaws to provide for staggering the terms of directors, other than ex-officio directors, in the same manner that current law allows its certificate of incorporation to do so. Under the bill, if the corporation has members entitled to vote on the adoption, amendment, or repeal of its bylaws, any bylaw providing for staggering the terms of directors must require their approval, either before, on, or after October 1, 2003, by the same vote necessary to amend such bylaws.
• Authorizes interested parties to petition the Superior Court to appoint a new board of directors for a nonstock corporation when the board has ceased to exist and it is impossible to ascertain with certainty the members who are entitled to elect a new board.  Section 36.
• The bill authorizes any corporate officer of a nonstock corporation to petition the Superior Court for the judicial district where the corporation's principal office is located for an order appointing a new board of directors. This petition may be filed if a nonstock corporation's board ceases to exist and there are no members to elect a new board. If the nonstock corporation does not have a principal Connecticut office, the petition may be filed in the judicial district where its registered office is located. If there are no officers, the attorney general, any officer of any organization holding funds or other assets of the nonstock corporation, or any other person having dealings with the corporation may petition the court. The petition must specify the relevant circumstances, propose the names of three or more people willing to serve as directors under the circumstances, and contain their addresses and a brief statement of their backgrounds. The petitioner must provide a copy to the attorney general. The court may require additional information about the nonstock corporation and the people proposed as directors. It may order a hearing and notice to persons as it deems appropriate under the circumstances. It may give the notice in whatever manner it deems appropriate.
• The bill authorizes the court to appoint and set the terms of office of a new board of directors. The new board may include some or all of the persons proposed in the petition or may be composed entirely of others the court considers appropriate. The persons the court appoints are the directors of the corporation for the terms of office the court specifies in the order. They have the power, authority, duties, and responsibilities, and are subject to the same standards of conduct as if they had been otherwise validly elected and serving under the provisions of the certificate of incorporation, bylaws, and applicable statutes.

 

• Validates certificates of amendment and certificates of merger filed after January 1, 1997 and before the effective date of the bill to the extent that the certificates contain an incorrect or incomplete statement of the information required concerning shareholder approval of the transactions, which are the subject of such certificates.  Section 71.

 

• Authorizes the filing of a certificate of correction to address a document filed with the Office of the Secretary of the State that was defectively made.  Sections 3 and 33.