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By: Richard Leisner
In my sixth decade of private practice, I describe myself as a corporate and securities lawyer focused on business transactions.
Because of Covid-19, I’ve been working remotely since mid-March. Thanks to modern technology, client services have not suffered substantively. I have missed personal interchanges with clients, colleagues and friends. There is no app that provides a digital equivalent of an open office door and the impromptu visits it invites.
Before Covid-19, younger lawyers in the firm, often unannounced stopped by my office, asking if I had a few minutes to discuss “what I thought” about a planned transaction structure or a challenging issue. Sometimes what I told them significantly changed the deal, led to consideration of additional issues or avoided potential disaster.
While waiting to return to a more normal world, I’m reprising several “hypothetical” corporate governance fact situations. The hypos are inspired by “open door” encounters and my expert witness work. Names and facts have been changed to protect client confidentiality and clarify practice pointers. Unless indicated to the contrary, all statutory references are to provisions of the Florida Statutes as currently in effect. For reader convenience, most specific statutory references and language and case law citations have been omitted. I anticipate sharing additional corporate governance hypotheticals and have therefore titled this article as “Corporate Governance Tales, From (Virtual) Open Door Encounters – Part 1.”
Some of my most fulfilling open-door encounters involved “corporate governance.”[1] By “corporate governance,” I mean the hierarchy of interrelated legal and practical rules, processes and practices dealing with the control and activities of corporations – the “how, why and who” of corporate life.[2] The corporate governance hierarchy is topped by court decisions and are followed in descending order by corporate statutes and regulations, entity governing documents (articles of incorporation, bylaws and shareholder agreements), actions approved or directed by the Board of Directors or shareholders and, finally, actions by officers based on inherent authority without prior Board approval. Court decisions are particularly important; not only do courts interpret the lower ranking elements in the hierarchy but they also are responsible for developing and interpreting essential non-statutory common law principles, such as directors’ fiduciary duties. The higher the court, the more important the decision.
Careful consideration of corporate governance issues often leads to multiple simultaneous analyses: court decisions, statutes, agency regulations, entity governing documents, contracts and directors’ and officers’ actions. My mentor, Sherwin P. Simmons, was fond of admonishing his charges to “think it through” before hastily proceeding to any solution.[3] In corporate governance problems, “thinking it through” is often the sine qua non for superior resolutions.
“Thinking it through” is the antithesis of what I see with some inexperienced business lawyers; their issue analysis too often begins and ends with a smartphone Google search or a single though well-conceived Westlaw search. One answer from one search, even if it seems to be “on point, on all fours,” may foreclose consideration of other crucial corporate governance disciplines. Artificial intelligence may soon power a single search inquiry to consider all the relevant corporate governance disciplines. For now, I rate EI (experiential intelligence) as superior to AI (artificial intelligence) in analyzing and solving corporate governance problems.
Heavy Voting Recap
Facts: Bob Brain owns 75% of the outstanding common stock of Unicorn Enterprises, Inc. (75,000 of 100,000 outstanding shares). There are 15 other shareholders, including Mary Minority who holds 12% (12,000 shares). Today, Mary and Bob are not on good terms. Bob wants Unicorn to make significant acquisitions using common stock but is concerned about losing voting control.
Bob proposes a recapitalization by amending the Articles of Incorporation in which every share of Bob’s stock will be converted into a new class of super common stock with 10 votes per share (Class B Common). The other outstanding shares of common stock (including those held by Mary) will be converted into Class A Common with one vote per share. Other than voting, the rights of Class A and Class B Common are identical. Bob will be the sole holder of Class B Common. After the recap, there will still be 100,000 outstanding shares, but Bob’s 75,000 Class B Common shares will have 750,000 votes; holders of the remaining 25,000 Class A Common shares will have 25,000 votes. Any shares issued after the recap will be Class A Common and have only one vote per share. It appears that the sole purpose of the recap is to lock in Bob’s voting control in case more shares are issued in future acquisitions.
Bob is the sole member of the Board of Directors and has sufficient voting power (75%) to assure required shareholder approval of the charter amendment effecting the recap. Mary announces she will oppose the amendment and is consulting with her lawyer about legal action.
Issue: The young transactions lawyer in my doorway (Sally Smart) explains the fact that Bob’s position as sole director and voting power assures satisfaction of the statutory, articles of incorporation and bylaw requirements to approve the charter amendment needed for Bob’s heavy voting recap. The Board and shareholder written consents are prepared and ready for Bob’s signature. But Sally was told stop by my office to see if I had any concerns.
Yes, I have concerns.
As structured, Bob’s recap is a conflict-of-interest transaction that will not be able to avail itself of the protection of the statutory or common law business judgment rule.[4] Instead, the heavy voting recap will garner special scrutiny under both statutory and common law about its fairness to Unicorn and Unicorn’s shareholders. This means that Mary’s litigation could hold up or invalidate Bob’s recap.
At common law, transactions between an agent (e.g., a corporate director or officer) and the agent’s principal (the corporation) were void. Modern corporate statues and case law generally operate to permit such transactions if, after disclosure of all material information, they are approved by “disinterested” directors or shareholders and if the transaction is “fair” to the corporation.[5]
Thinking we would need to work our way through the details of complying with the current statutory conflict-of-interest safe harbors of Chapter 607, we consulted with Gary Teblum, my partner who was active in the recent revision of Chapter 607.[6] Gary had a better idea: a revised recap structure to avoid status as a conflict-of-interest transaction.
Solution: The revised recap would apply the same treatment to all shareholders: Every holder of pre-recap common stock would receive one share of Class B Common with 10 votes per share and one share of Class A Common with one vote per share. Any future acquisitions would be made with one vote per share Class A Common.
The revised recap would assure Bob the voting control he desired even if significant future acquisitions were funded with new shares of Class A Common. The revised recap would not reduce Mary’s post-recap voting power (as Bob’s initial recap would have). Mary should have less to complain about and, in any event would have a far weaker legal basis for litigation. Because it would not be a conflict-of-interest transaction, the revised recap would qualify for the protections afforded by the business judgment rule.
Lessons: Transactions between the corporation and an officer, director or principal shareholder are subject to special scrutiny under statutes, corporate governing documents and common law fiduciary duties. Indirect interests trigger conflicts-of-interest subject to the same scrutiny as direct interests. These transactions need to be objectively “fair” to the corporation and its shareholders; such transactions must not benefit (or appear to benefit) the counter party to the detriment of the corporation or its shareholders. Litigating conflict-of-interest transactions can be costly, and adverse results are possible. Consider possible deal restructuring to avoid conflict relationships.
Taking Stock (in Florida) #1: Although Chapter 607, Florida Statutes, includes all the statutory provisions governing the issuance of corporate stock, there are more than sufficient opportunities for seemingly straight-forward stock issuances to go awry.
Facts: Old Guard Corp. was incorporated as a Florida corporation in 2000 with an authorized capitalization of 1 million shares of common stock. Until 2015, all issuances of stock had been approved by actions of the Board of Directors in strict compliance with the requirements of Chapter 607. On January 1, 2015 there were 100,000 shares of common stock issued and outstanding.
In May 2015, the Board approved an amendment to the bylaws granting the then existing Executive Committee authority to issue common stock. Old Guard’s bylaws then in effect authorized the Board to delegate to Executive Committee “such powers of the Board of Directors as can be lawfully delegated by the Board.” The resolutions creating and empowering the Executive Committee specifically delegated all of the Board’s powers to issue stock. In 2016, the Executive Committee approved the issuance of 50,000 shares to a small group of private investors. No additional shares were issued until May 2020 at which time the Executive Committee approved the issuance of an additional 51,000 shares to a private equity fund; in addition, the fund has agreed to buy the 50,000 shares the private investors acquired in 2016. One of the conditions to closing is a formal legal opinion from our firm to the effect that, among other things, all the outstanding common stock is validly issued, fully paid and nonassessable.
Issue: Sally Smart, an associate in the transactions practice group, is working on the valid stock issuance part of the opinion. Smart reviewed all stock issuance transactions since inception and obtained a certificate from Old Guard’s longtime CFO confirming receipt of the approved stock purchase price for each issuance. Smart spotted the issuance transactions approved by the Executive Committee. After reviewing Section 607.0825, Smart concluded issuance approvals by the Executive Committee were properly done and that the firm could give a standard favorable stock issuance opinion. Smart stops by for a visit with me to see if there are any concerns before completing her assignment.
Yes. Unfortunately, there are some problems.
The very language used by the Old Guard Board in attempting to delegate stock issuance power to the Executive Committee provided that the delegation was limited to powers that could be “lawfully delegated.” When Old Guard created its Executive Committee in 2015, Section 607.0825 then in effect did permit the Board of Directors to delegate some (but not all) of its stock issuance powers to any committee by providing in pertinent part: “no committee shall have the authority to: . . . . [a]uthorize or approve the issuance or sale or contract for the sale of shares . . . except that the board of directors may authorize a committee (or a senior executive officer of the corporation) to do so within limits specifically prescribed by the board of directors.”[7] The revisions to Chapter 607 that became effective in 2020 includes no limitation on delegating stock issuance powers to a committee.
Solutions: After discussion, Smart suggests that the first thing to do is to have the Old Guard Board adopt resolutions establishing the powers of its Executive Committee to approve stock issuances and then to re-approve the upcoming private equity sale transaction (retroactive to the date of execution of the stock purchase agreement).
Fixing the 2016 issuance is not so easy. Smart and I consider whether revised Section 607.0825 could be accorded retroactive effect to “cure” the statute in effect in 2015. We conclude the new statute cannot be read to provide a retroactive cure of the defect in the 2016 issuance. We will need to work with counsel for the private equity investor on our closing opinion for the 2016 issuance. Additional research and interaction with the owners of the stock issued in 2016 will be needed to find the best way to provide the 2016 investors with validly issued common stock. Those solutions are beyond the scope of this article.
Lessons: Formal legal opinions – particularly those regarding validity of stock issuance – are serious undertakings and merit careful attention. Be aware that corporation statutes are amended and revised. Provisions in effect today were not necessarily in effect last year or five years ago. Also be aware that a provision in the bylaws or Articles of Incorporation may be “wrong” or overridden by “correct” statutes or court decisions. Provisions in Articles of Incorporation or bylaws adopted decades ago may have been overridden by statutory changes. Check to see what statutes were in effect for the key transactions that are the subject of any opinion.[8]
Taking Stock (in Florida) #2:
Facts: Home Healthcare Helpers of Florida, Inc. is a Florida public corporation (NASDAQ HHFL) that provides in home personal aides to clients who have mobility challenges (mostly older clients or younger clients rehabilitating from illness or surgery). HHFL was founded by Edward Vanity in the mid-1960s. In the past three years, under the leadership of Vanity’s daughter Vera Vanity, HHFL’s business and profitability have taken off exponentially. The public stock price has risen from $2.00 per share in 2010 to $22 per share in recent trades. HHFL’s five-member Board of Directors is comprised of one independent director, Mark Meticulous the HHFL CFO, Vera, Vera’s father Edward and Daniel Distant, an early investor and friend of the founder. For the past several years, Distant missed more than half of the HHFL Board meetings; when he did attend, Distant said very little.
Meticulous drafted most of the company’s SEC filings; Meticulous’ drafts were reviewed by HHFL’s counsel or CPAs before filing with the SEC. Both the CPAs and SEC counsel were well regarded firms. Meticulous also kept the minutes for Board and committee meetings. An independent professional transfer agent maintained HHFL’s stock records. Vera’s father Edward continued as CEO until his death in late 2019. Vera succeeded him as CEO, a position she held as our story unfolded.
A few months after Vera became CEO, Daniel Distant presented her with a crumpled letter from Edward Vanity to Daniel Distant, dated June 19, 2012. The body of the letter began with summary of their long personal and business relationship. The next paragraph consisted of one sentence: “Because of all you have done for HHFL, for the next 10 years, you will have the right to buy up to 100,000 shares of HHFL stock from the company for $2.00 per share, today’s closing price in the NASDAQ Market.” The signature on the letter, “Edward Vanity, CEO,” appeared to be genuine.
Vera was stunned. She knew nothing about any such arrangement with Daniel Distant. CFO Meticulous searched the corporate records and, of course, the minute books and the transfer agent’s stock records. There was no record of the Board approving any option along the terms in Edward Vanity’s letter. There were multiple public company reporting requirements pursuant to which the rights granted in the letter should have been reported. In its annual Form 10-Ks and proxy statements HHFL reported on the stock owned by the directors (including options) and also on any options granted during the year. As a public company director, Distant filled out and signed an annual questionnaire that requested he provide information about stock holdings and option grants. Finally, Distant was obligated to report stock ownership and option grants and changes in such ownership on SEC Forms 3, 4 and 5. Since 1972, there were many SEC filings concerning HHFL, but none of them included any information about Distant’s right to buy 100,000 shares for $2.00 per share.
After a few discussions, it was clear that Distant was intent on cashing in on the windfall the letter provided. Distant demanded $1,500,000 to surrender the option. Settlement negotiations broke down. Distant announced he was exercising his rights and presented a check for $200,000. HHFL declined to honor the option. Distant filed suit to force HHFL to recognize the option and issue stock to him.
Issue: Our firm is defending HHFL and its directors and officers in Distant’s litigation. Robert Star in the litigation practice group is tasked to see what I think about HHFL’s obligations under the letter. “Does HHFL have to honor the 2012 letter and issue the stock?” Robert asks.
Solution: No, Bob, HHFL does not have to issue the stock. HHFL has a good defense. In most jurisdictions, including Florida and Delaware, action by the Board of Directors is required in order to validly approve the issuance of stock and options to purchase stock.[9] The record shows no such approval.
In Florida, under the law currently in effect, the Board may delegate certain of its stock issuance powers to an officer or Board committee with only one member.[10] When the 2012 letter was given to Distant, Boards of Directors were generally not permitted to broadly delegate all their stock and option issuance powers to a committee and the law generally required any committee to have at least two members. However, Boards were given the power to delegate the granting and negotiating of certain terms of stock options to one officer but only “within limits specifically prescribed by the board.”[11] There is no evidence that the HHFL Board attempted or intended to delegate stock or option granting authority to Edward Vanity as contemplated by the law then in effect.
Edward Vanity could well have been able to order/persuade the Board to grant the option included in the 2012 letter. There is no evidence that he obtained Board approval in 2012 or subsequently. In the absence of the required Board action, the 2012 letter does not obligate HHFL to issue any stock to Distant. Arguably, it would be a breach of fiduciary duty and corporate waste for the Board to sell stock for $2.00 per share when such shares were trading at $22.00 per share. HHFL should return Distant’s check. Absent facts not disclosed above, it does not appear that Distant will have a successful argument at law or in equity to support a court ruling to honor the purchase rights in the 2012 letter. Whether the estate of Edward Vanity may have exposure to Distant under the terms of the letter is beyond the scope of this story.
Lessons: Whether you are proposing to be the grantor or the recipient of options to purchase securities be aware of the statutory requirements and adhere to them assiduously. It is easy to overlook crucial business and legal “details.” There are also serious federal income tax issues for both grantor and grantee to consider. Practice tip: Check the terms and conditions of public company stock options plans, granting instruments and SEC Rule 428 prospectuses.
Taking Stock (in Florida) #3:
Facts: Business Consultants of Florida, Inc. (BCF), a longtime firm client, is a professional services business consulting firm incorporated in Florida in 1995. Successful consultants are offered the opportunity to purchase 25,000 shares of BCF stock at book value ($10 per share based on the last fiscal year). When consultants leave BCF, they are required to sell their stock back to the company at the book value then in effect. Over the past three years, the company has brought in 40 new shareholder consultants and 10 shareholder consultants have left and sold their stock back to the company. Currently, there are 70 BCF shareholder consultants.
Initially, BCF’s Articles of Incorporation authorized 500,000 shares of common stock. In 2010, after approvals from the BCF Board and shareholders, the firm filed an Amendment to the Articles of Incorporation increasing the authorized stock from 500,000 to 1,000,000 shares. BCF maintained its own minute books and stock records, including documenting sales and repurchases. In 2016, it became clear that BCF might soon run out of authorized stock as the total number of consultants approached 40. BCF’s CFO copied the forms used to increase the authorized capitalization in 2010, providing for an increase from 1,000,000 shares to 2,000,000 shares. The amendment was first approved by the BCF Board and then by BCF’s shareholders.
This year BCF’s entered into an agreement of merger by which BCF will be acquired by private equity investors for $70 million. With 1,750,000 shares outstanding, the per share purchase price is $40 per share, quite a bump from $10 per share book value. Our firm has been tasked to assist BCF in completing the buyer’s pre-closing diligence investigations. Third year associate Anthony Ardent has reviewed BCF’s minute books and stock records. Ardent is glowing in his reports about BCF’s well maintained corporate records, particularly for the stock sale and repurchase transactions.
Issue: On the day Ardent is finishing his review, he arrives at my office door to ask about a small problem: the minute books include the Board and shareholder approvals of the 2016 amendment to the Articles of Incorporation increasing the authorized stock to 2,000,000 shares, but Ardent hasn’t been able to locate a copy of the amendment as filed with the Department of State. A check on the Florida Department of State shows no filing of the 2016 amendment increasing the authorized capital to 2,000,000 shares. Ardent notes that BCF’s financial statements show BCF with 2,000,000 shares of common stock authorized and 1,750,000 shares outstanding held by 70 consultant shareholders. Several increasingly anxious phone calls with BCF’s CFO follow. By the end of the day, BCF’s CFO admits that he just forgot to file the amendment in 2016 but will do so the next business day, making sure to instruct the Department of State people to make the filing retroactively effective to 2016.
Unfortunately, Chapter 607 will not allow an amendment to articles of incorporation to be accorded several years’ retroactive e effectiveness. BCF lacked the legal power to issue more than 1,000,000 shares of common stock. Issuances above that amount were not validly issued BCF common stock, even if both BCF and the purchasing/selling consultant thought the stock was real and valid. Error correcting filings are permitted to be made at any time under the current provisions of Chapter 607. These provisions are of little use in the BCF fact situation, however, because no filing of any kind was made in 2016 that could be “corrected” with a current filing under the new law. [12]
Starting on Solutions: Specific to the pending BCF merger, there are multiple issues to consider, starting with how to present the problem to the BCF consultants and the prospective purchaser. In addition, the firm will not be able to provide a standard closing legal opinion about the validity of BCF’s outstanding stock and “vote” of the shareholders’ anticipated approval of the merger. How will holders of the invalidly issued stock be treated? Should they allowed to vote on the merger? Will holders of “real” BCF stock want a greater share of the $70 million merger consideration than is accorded to the holders of the invalidly issued stock? Will holders of the invalidly issued stock hold up the merger until they are treated as well as the real shareholders? Do the CFO or BCF’s directors have personal liability to BCF for the failure to file the 2016 amendment?
We advise the CFO to compile a list of all persons receiving stock from BCF or selling stock back to BCF when there were more than 1,000,00 shares outstanding.[13] The next steps include devising a form of consent and release that will be presented to all shareholders (i) explaining the facts and principal deficiencies in the status of some stock, (ii) informing each shareholder that the shareholder should consider consulting independent counsel, (iii) consenting to identical treatment in the merger for all shareholders and (iv) waiving any rights to object to the failure to file the 2016 amendment and the resulting issues with BCF stock.
Lessons: Better attorney-client communications might have avoided the 2016 amendment problem. All attorneys should keep informed about their clients’ businesses. It should be standard practice to make periodic no-charge phone calls to your point of contact at continuing business clients – “Just calling to see how you and the company are doing.” In addition, there are good reasons for even highly sophisticated clients to have periodic “corporate governance checkups.” In the case of BCF, the relationship attorney should have given front burner status to issues regarding BCF’s stock sales and repurchases and the possible need for a charter amendment. It cannot be said with certainty that periodic phone calls or a checkup review would have prevented the problem with the 2016 failure to file the amendment. The absence of such communications denied the law firm a chance to have prevented the 2016 amendment problem.
To be continued in Corporate Governance Tales From (Virtual) Open Door Encounters – Part 2.
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[1] Although ubiquitous in use, the term “corporate governance” does not appear to have a widely accepted precise definition. Some popular sources with extensive online glossaries of business terms do not include a definition of “corporate governance.” Other sources provide generally similar but not identical definitions. For a definition and discussion of corporate governance, see James McRitchie, Corporate Governance Defined: Not So Easily at http://corpgov.net/library/corporate-governance-defined/ (last visited August 19, 2020).
[2] Many of the corporate governance considerations have identical or similar cognates applicable to other artificial entities, including limited liability companies and limited partnerships. For convenience, the discussions in this article have been limited to corporations.
[3] Sherwin Palmer Simmons (1931-2006), one of the founders of the law firm now known as Trenam Law, nationally prominent tax and business transactions attorney.
[4] As established in case law and the provisions of modern corporate statutes, the business judgment rule operates to protect the decisions of boards of directors from most “second guessing” litigation with a presumption that corporate actions are valid, provided three conditions are satisfied: (i) there is no fraud, (ii) the directors are “disinterested” vis-à-vis the transaction (i.e., there are no direct or indirect director conflicts of interest) and (iii) the directors were fully informed about the material facts regarding the matter. Generally, conflict-of-interest transactions are not afforded the protection of the business judgment rule.
[5] In Florida, Section 607.0832, et seq., Florida Statutes. In Delaware, Section 144 et seq. Delaware General Corporation Law (DGCL); under DGCL conflict-of-interest transactions are reviewed under the “total fairness” test.
[6] Gary I. Teblum, Co-Chair of the Drafting Subcommittee of the Florida Bar Business Law Section proposing revisions to the Florida Business Corporation Act. Information on the Drafting Subcommittee’s work is available on the Florida Bar’s website here (last visited August 27, 2020).
[7] Section 607.0825(1)(e) as in effect in 2015.
[8] The current version of Chapter 607 became effective January 1, 2020; previous major revisions to Chapter 607 generally became effective in 1990 and 1975, respectively.
[9] Sections 607.0621 and 607.0624, Florida Statutes. Sections 151, 152, 153, 157, 161 and 166, DGCL.
[10] Section 607.0624(3), Florida Statutes.
[11] Section 607.0825(1)(e) and Section 607.0825(3) (each as in effect until January 1, 2020),
[12] Sections 204 and 205 of the Delaware General Corporation Law provide remedies with retroactive effect for certain defective filings. Chapter 607, Florida Statutes, currently does not include comparable provisions. Currently, Section 607.0124 generally provides for retroactive effective dates when filings are made to correct a document including “an inaccuracy, containing false, misleading or fraudulent information, [or that was] defectively executed . . . or the electronic transmission . . . was defective.” Under the predecessor to the current provision, corrective filings had to be made within 30 days of the defective filing. There is no filing time deadline under the current law; corrective filings may be made at any time.
[13] Separately, we advise the CFO and each of the directors that the firm does not represent any of them individually in connection with the 2016 amendment and resulting issues and that each of them should consult with their own counsel.
