Effectively Forming Delaware Business Entities

Transcription

1 Effectively Forming Delaware Business Entities September 17, 2014 Elisa Erlenbach Maas Richards, Layton & Finger, P.A. Wilmington, Delaware

2 Overview Entity and Delaware Choice Delaware Entity Acts Incorporation/Formation Operations Dissolution & Winding-up 2

3 Entity Choice Tax considerations Liability limitation Type of transaction Business Jurisdiction of organization Where is business located? Additional filings, qualifications required? Favorable laws Tax 3

4 Delaware Choice Leading statutes Delaware General Corporation Law ( DGCL ) Delaware Limited Liability Company Act ( LLC Act ) Delaware Revised Uniform Limited Partnership Act ( LP Act ) Delaware Revised Uniform Partnership Act ( GP Act ) Delaware Statutory Trust Act ( DSTA ) Annual (or biannual) amendments Reflect Delaware's continuing commitment to maintaining statutes that effectively serve the business needs of the national and international business communities. Members of Bar active in amendment process Responsive Delaware Secretary of State Conformed, faxed or ed signatures Expedited filings Preclearance 4

5 Delaware Choice Experienced Courts Highly specialized courts with substantial experience handling business disputes, including corporate governance and fiduciary; M&A ; complex commercial; patent and intellectual property; bankruptcy Ranked # 1 court system by U.S. Chamber of Commerce for last 11 years ( ) Extensive case law Offers certainty in structuring transactions and predictability for management 5

6 Delaware Choice Total Number of Delaware Entities 1,073, ,

7 Delaware Choice As of July 2014: 700,000 Delaware LLCs 300,000 Delaware corporations DGCL Specialized and highly specific statute governing respective roles, duties and relationships of those who manage and direct Delaware corporations. Provides specific direction regarding organizational documents, stockholders rights and directors fiduciary duties for companies incorporated in Delaware. Concerned largely with formation, governance and structure. Does not address varied other aspects of business law, such as antitrust, labor or securities. 7

8 Delaware Choice LLC Act, LP Act, GP Act and DSTA Policy is to give maximum effect to the principle of freedom of contract and to the enforceability of the operating agreement. See Touch of Italy Salumeria& Pasticceria, LLC v. Bascio, 2014 WL (Del. Ch. January 13, 2014). Default-rule statutes. LLCsand other alternative entities have been described by the Court of Chancery as "creatures of contract, designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved." R&RCapital, LLC v. Buck & DoeRun Valley Farms, LLC, 2008 WL , at *4 (Del. Ch. Aug. 19, 2008) (internal quotation marks omitted). 8

9 Incorporation At a minimum, a certificate of incorporation must contain: Name - include a designate corporate signifier such as Inc. Bank or trust are generally not permitted Address of registered office & name/address of registered agent in Delaware Nature of business or purpose Permissible to state that it is organized for any lawful purpose under the DGCL Total number of authorized shares, including par value or statement that shares are to be without par value Name and address of the incorporator(s) If the incorporators power is to terminate before election of directors, the name(s) and address(es) of initial director(s) 9

10 Incorporation To be effective, certain additional provisions must be set forth in the certificate of incorporation Such provisions include: Section 102(b)(7) exculpation of directors from certain breaches of the duty of care Grants of preemptive rights to subscribe for additional issues of stock Limitation of duration of the corporation s existence to a particular time period/date Certificate of incorporation generally may also contain any provision that does not violate Delaware law, as well as any provision that the DGCL expressly permits to be included in the bylaws 10

11 Incorporation Bylaws of a Delaware corporation may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees 8 Del. C. 109 Stockholders have the power to adopt, amend or repeal the bylaws unilaterally Board may adopt, amend or repeal the bylaws if the certificate of incorporation confers such power on the board 11

12 Formation Certificate of formation/limited partnership Minimal requirements in Delaware Name (distinguishable on the Secretary of State s records) Address of registered office Name and address of registered agent Certificate of limited partnership also must contain general partners name(s) and address(es) Executed by an authorized person /all general partners(s) Only constitutes notice of formation and of those facts required to be set forth in the certificate Section and Section Other jurisdictions may require same or additional information 12

13 Formation Limited liability company/partnership agreement ( operating agreement ) Required to be entered into or otherwise existing before or after or at the time of the filing of certificate May be made effective as of filing or such other time or date, as set forth in the operating agreement LLC Need at least one member LP Need one general partner and one limited partner (who must be different persons) Member, Partner broadly-defined 13

14 Formation No statutory requirements for substance of limited liability company/partnership agreements Recommended provisions will depend on deal Flexibility provides an opportunity, but puts significant emphasis on the operating agreement Drafters should consider issues, how parties want to address them and understand the default rules Delaware courts will generally not re-write the operating agreement 14

15 Formation The LLC Act, LP Act, GP Act permit parties to: Structure management Limit voting rights Establish virtually any equity structure (including series) Provide requirements for admission and issuance of interests Provide standards for indemnification and advancement Define duties (including elimination of fiduciary duties) Provide exculpation Establish penalties and specified consequences for breach Establish non-statutory events of dissolution Provide transfer restrictions (and rights of first refusal, drag/tag, exits, deadlock, valuation) Provide for choice of venue, arbitration, waiver of jury trial 15

16 Formation As enabling statutes, the alternative entity statutes default rules are designed to fill gaps in the operating agreement In order to avoid a default rule, must otherwise provide Many matters that may be of concern to parties have no default rule (e.g., removal of manager or partner) 16

17 Operations DE Corporation The business and affairs of a Delaware corporation are governed by or under the direction of its board If initial directors are not named in the initial certificate of incorporation, the incorporator must adopt an incorporator s consent electing the initial directors Importantly, it is the board, and not the stockholders, who manage the corporate enterprise Stockholders govern by electing (and removing) the directors 17

18 Operations DE Corporation Directors, as such: Owe fiduciary duties of care and loyalty to the corporation and all of its stockholders (and not just the stockholders who elected them) May only act as a board and generally do not have the authority to bind the corporation when acting in an individual, non-officer capacity May not act by proxy Must be given (or waive) notice of every meeting of the board May only act by written consent if such consent is unanimous May be entitled to indemnification and advancement under the certificate of incorporation or the bylaws, by agreement or by law in certain instances 18

19 Operations DE Corporation Corporations are subject to certain statutory restrictions Certain actions (e.g., amendments to the certificate of incorporation, mergers, dissolutions), must be accomplished in the prescribed statutory sequence to be valid It is important to consult with counsel prior to, among other things: Engaging in debt or equity financings; Creating or issuing shares of any class or series of capital; Effecting significant corporate transactions, such as mergers, sales of all or substantially all of the corporation s assets, conversions or dissolutions 19

20 Operations DE Corporation Note that Section 204 of the DGCL, effective April 1, 2014, permits corporations means of ratifying defective corporate acts, including validating putative stock Section 205, effective April 1, 2014, permits a corporation and other constituents to apply to the Court of Chancery to determine the validity and effectiveness of, among other things, defective corporate acts 20

21 Operations DE Alternative Entities May be managed in any structure Delaware LLC may be board, manager, member managed While most LPs are managed by a general partner, a partnership agreement may establish a board instead or in addition to the general partner The participation of limited partners in the business of an LP is subject to restrictions tied to liability to third parties While GPs may be managed by the partners, they may have a board of managing partners with management authority 21

22 Operations DE Alternative Entities Since Delaware alternative entities are creatures of contract as well as created by statute, issues concerning contract interpretation (of the operating agreement) are very common Case law involving contract interpretation principles may be instructive even if not involving alternative entities Norton, et al. v. K-Sea Transp. Ptrs. L.P., et al., 67 A.3d354 (Del. 2013) Supreme Court provided a primer on contract interpretation of an operating agreement 22

23 Operations DE Alternative Entities Fiduciary Duties Absent express contractual modification, general partners/managers have traditional fiduciary duties to the limited partnership/llc and its equityholders Controlling stockholder/equityholderalso may have fiduciary duties in certain contexts Duty of Loyalty Motivated solely by the best interests of the entity and its owners Not permitted to use position of trust and confidence to further own interests Duty of Care Be attentive and informed of all material facts regarding a decision before acting Affirmative duty to protect the financial interests of the entity and its equity owners and to proceed with a critical eye in assessing information 23

24 Operations DE Alternative Entities Delaware courts have long imposed fiduciary duties upon those who act for the benefit of another. See In re USACafes, L.P. Litig., 600 A.2d43 (Del. Ch. 1991). The USACafesCourt stated that "the principle of fiduciary duty, stated most generally, [is] that one who controls property of another may not, without implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner." Id. at 48. In USACafes, the Court found that directors of a corporate general partner owed fiduciary duties to the partnership and its limited partners. The Court described such fiduciary duty as "the duty not to use control over the partnership's property to advantage the corporate director at the expense of the partnership." Id.at 49. Court of Chancery has applied default fiduciary duties in LP and LLC contexts 24

25 Operations DE Alternative Entities 2013 LLC Act Amendment Whether fiduciary duties applied by default in the LLC context had been the subject of debate: Delaware Court of Chancery -managers and controlling members owe default fiduciary duties (Auriga Capital Corp. v. GatzProperties, LLC, 40 A.3d839 (Del. Ch. Jan. 27, 2012)). Delaware Supreme Court -Court of Chancery statements are dictum without any precedential value ; but it did not take its own definitive position (GatzProperties, LLC v. Auriga Capital Corp., 59 A.3d1206 (Del. 2012). Delaware legislature took action to address the issue 25

26 Operations DE Alternative Entities Section of the LLC Act: - Inanycasenotprovidedforin thischapter,the rulesoflaw and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern. Synopsis - The amendment to Section confirms that in some circumstances fiduciary duties not explicitly provided for in a limited liability company agreement apply. For example, a manager of a manager-managed limited liability company would ordinarily have fiduciary duties even in the absence of a provision in the limited liability company agreement establishing such duties. Section (c) continues to provide that such duties may be expanded, restricted or eliminated by the limited liability company agreement. 26

27 Operations DE Alternative Entities Fiduciary duties may be expanded, restricted or eliminated in an LLC/LP Agreement Sections (c) of the LLC Act and (d) of the LP Act. The Delaware Court of Chancery has distinguished the LLC/LP ability to modify fiduciary duties from the corporate context, stating that unlike the corporate context, the relationship between limited partners and a general partner is "primarily contractual in nature." In re CencomCable Income Partners, L.P. Litigation, C.A. No , at 5 (Del. Ch. Feb. 15, 1996). 27

28 Operations DE Alternative Entities To modify default fiduciary duties, the language in the operating agreement must be clear and unambiguous. See, e.g., Miller v. Am. Real Estate Partners, L.P., 2001 WL , at *8 (Del. Ch. Sept. 6, 2001) (citing Sonetv. Timber Co., L.P., 772 A.2d319, 322 (Del. Ch. 1998)). The Court will attempt to reconcile the application of traditional default fiduciary duties with the terms of the partnership agreement. Default fiduciary duties will only be supplanted when the application of those duties irreconcilably conflicts with the rights and obligations of partners as set forth in the partnership agreement. See R.S.M. Inc. v. Alliance Capital Mgmt. Holdings L.P., 790 A.2d478 (Del. Ch. 2001); Miller v. American Real Estate Partners, L.P., 2001 WL (Del. Ch. Sept. 6, 2001). 28

29 Operations DE Alternative Entities Implied Contractual Covenant of Good Faith and Fair Dealing Unlike fiduciary duties, the implied contractual covenant may not be eliminated See, 6Del C (c) and 6Del C (d). The purpose of the implied contractual covenant is to enforce the reasonable expectations of parties to a contract where situations arise that are not expressly contemplated and provided for in the language of the contract itself. See Dunlap v. State Farm Fire & Cas. Co., 878 A.2d434, 442 (Del. 2005). 29

30 Operations DE Alternative Entities Application of Implied Covenant The use of the covenant to imply contract terms is a fact-intensive exercise governed by issues of compelling fairness. Id. at 442. The test for determining whether the covenant has been breached requires the court to extrapolate the "spirit" of the contract from its express terms, and to determine whether it is clear that the parties would have agreed to proscribe the act complained of as a breach of the covenant had they thought to negotiate with respect to that matter. See PAMI-LEMBI Inc. v. EMB-NHC, L.L.C., 2004 WL , at *14 (Del. Ch. 21, 2004) 30

31 Operations DE Alternative Entities Duty of Good Faith vs. Implied Covenant ASBAllegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, (Del. Ch. 2012). Temporal focus. Duty of Good Faith [L]iablitydepends on the parties relationship when the alleged breach occurred, not on the relationship as it existed in the past. Implied Covenant Looks to the past. The court asks, what the parties would have agreed had they considered the issue in their original bargaining positions at the time of contracting? The Courts have stated that "where the parties have contractually agreed to eliminate fiduciary duties, they may not invoke the implied covenant of good faith and fair dealing as a back door through which such duties may be reimposedafter the fact." In re Atlas Energy Res., LLC, 2010 WL , at *13 (Del. Ch. Oct. 28, 2010). 31

32 Operations DE Alternative Entities Allen v. El Paso Pipeline Partners, L.P., C.A VCL(Del.Ch. June 20, 2014). MLPcase involving an asset drop-down transaction. Operating agreement eliminated fiduciary duties. The court noted that the relevant inquiry under the operating agreement standard was whether the members of the Special Committee subjectively believed, in good faith, that the drop-down was in the best interests of the partnership. The court focused the term partnership and read it broadly to include various interest holders in the partnership, including the limited partners and the general partner. This case demonstrates that the implied covenant is used sparingly and is not used to re-write a contract. 32

33 Operations DE Alternative Entities Derivative Actions Unlike corporations, creditors do not have standing to bring derivative actions on behalf of an LLC under the LLC Act. CML v. Bax, C.A. No. 735, 2010 (Del. 2011). The Court stated that Section of the LLC Act expressly limits the right to sue derivatively on behalf of an LLC to members and assignees. The Court noted appellant had ample remedy at law because it could have negotiated its remedies by contract. Same likely applies to LPs in light of the similarity between the LLC Act and the LP Act. 33

34 Corporate Dissolution and Winding Up A corporation is dissolved By the filing of a certificate of dissolution following resolution of board of directors and approval by majority of stockholders When it has not issued shares or commenced its business, upon effectiveness of a certificate to that effect filed by a majority of its incorporators or directors, as applicable In a 50/50 JV deadlock, by order of the Court of Chancery following either stockholder's filing a petition to dissolve the JV Upon application by a stockholder, by order of the Court of Chancery if the corporation has abandoned its business and failed to dissolve within a reasonable time. In certain circumstances, the Court of Chancery may also revoke or forfeit a corporation's charter upon motion by the Attorney General. 34

35 Corporate Dissolution and Winding Up A corporation is continued, for the term of 3 years from the date of dissolution or for such longer period as the Court of Chancery directs, as a corporate body for the purpose of: Prosecuting and defending suits Enabling the corporation to gradually to settle and close its business, but not for the purpose of continuing the business for which the corporation was organized. The corporation shall, solely for the purpose of an action begun prior to or within the 3 year period, be continued as a body corporate beyond the 3- year period and until any judgments shall be fully executed. 35

36 Corporate Dissolution and Winding Up A dissolved corporation may satisfy its liabilities under 280 or involves notices to creditors, a claims and rejection process and involvement of the Court of Chancery If the corporation follows the procedures described in 280 it must first pay the claims made and not rejected; then post the security offered and not rejected pursuant to 280(b)(2); then post any security ordered by the Court of Chancery; and pay or make provision for all other claim that are mature, known and uncontested. If there are insufficient assets, those with priority will be paid first, then ratably to others of equal priority to the extent funds are legally available. Any remaining assets shall be distributed to the stockholders. 36

37 Corporate Dissolution and Winding Up For a corporation that has not followed the provisions of 280, prior to 3 years from the date of dissolution, the dissolved corporation may adopt a plan of distribution pursuant to which the dissolved corporation: shall pay or make reasonable provision to pay all claims and obligations known to the corporation including contingent, conditional and known unmatured contractual claims shall make such provision as will be reasonably likely to be sufficient to provide compensation for any claim against the corporation which is the subject of a pending action, and shall make such provision as will reasonably be likely to be sufficient to provide compensation for claims that have not been made known to the corporation or have not arisen but that are likely to arise or to become known within 10 years after the date of dissolution. 37

38 Alternative Entity Dissolution, Winding-up and Termination Dissolution occurs at a moment in time upon either a statutory event of dissolution or a contractual event Statutory events No member Change of general partner No limited partner Expiration of term Judicial dissolution Contractual events may include sale of all or substantially all of the assets (although disfavored), percentage vote of investors, etc. 38

39 Alternative Entity Dissolution, Winding-up and Termination Upon dissolution, an LP or LLC continues to exist as a separate legal entity and will continue to generally be governed by its operating agreement, but is required by Delaware law to immediately commence winding up its affairs and is only permitted to conduct those activities in furtherance of its winding up Winding up occurs over a period of time No specific statutory procedure No statutory timeframe What activities constitute "in furtherance of the winding up" is not clearly defined under Delaware law Very limited case law Paciaroniv. Crane, 408 A.2d946 (Del. Ch. 1979) 39

40 Alternative Entity Dissolution, Winding-up and Termination Must first satisfy all of its liabilities (whether by payment or the making of reasonable provision for payment) before making liquidating distributions to its equity owners Liabilities include contingent, conditional or umatured contractual claims Includes requirement that reasonable provision be made for unknown liabilities that, based on facts known to the LP or LLC, are likely to arise or become known within the next 10 years The manner in which to satisfy contingent, conditional or unmatured liabilities may be an especially complicated analysis. The LP/LLC Acts do not have any express statutory safe harbors that state how to satisfy liabilities, especially contingent liabilities. Limited case law Boesky v. CX Partners, L.P., 1988 WL (Del. Ch. Apr. 28, 1988) 40

41 Alternative Entity Dissolution, Winding-up and Termination After completion of winding up, the only public filing is made Certificate of Cancellation Upon the filing of the Certificate of Cancellation, the separate legal existence of the LP or LLC is terminated Cannot revoke other than with court action, unless the Certificate of Cancellation was filed before dissolution occurred or the winding up had been completed Section and Section

42 This presentation and the material contained herein are provided as general information and should not be construed as legal advice on any specific matter or as creating an attorney-client relationship. Before relying on general legal information or deciding on legal action, request a consultation or information from a Richards, Layton & Finger attorney on specific legal needs. 42