Does a negative “Say on Pay” vote trigger a breach of fiduciary duty claim?

The Dodd-Frank Act, passed in 2010, includes the so-called “Say on Pay” provision for publicly traded companies. This provision requires that, at least once every three years, the shareholders of a publicly traded company must vote on its executive compensation arrangements. In addition, the shareholders also vote at least once every six years on the frequency of the “say on pay” vote.  Shareholders are able to elect whether the vote will happen once every one, two, or three years.  In most companies, the shareholders have chosen to have the “say on pay” vote conducted annually.  Publicly traded companies are also required  to disclose, in any proxy solicitation asking for the approval of a merger, acquisition, or other sale of the company, any compensation from “golden parachutes” that would be triggered.  Shareholders also have a chance to “approve” (or not approve) such golden parachute payments. [Read more…]

One More Reason to Comply with Securities Laws: Potential Loss of Your IP

As I’ve mentioned before, it’s very important for growing companies to comply with securities laws, even during the initial seed and friends and family rounds of financing. The possibility of lawsuits and even fines and other criminal penalties give founders a strong incentive to comply with the law. But there’s another consequence that could result from non-compliant sales of securities: loss of the company’s IP. [Read more…]

Even in deals with “yourself,” you still need proper legal documents.

One situation I often encounter with small businesses is that sometimes they don’t always document the transactions they enter into with their owners and other related parties. For instance, let’s say that two owners of a corporation decide that their corporation needs more funding. However, they don’t want to invest more equity into the business. [Read more…]

Should new business owners incorporate in Nevada?

Previously, I wrote about the pros and cons of incorporating in Delaware as a small business owner. My conclusion was that, for most small companies, the disadvantages outweigh any advantages. In this piece, I’ll cover my thoughts on another state that is frequently pitched as a good place for incorporation: Nevada.

Like Delaware, Nevada has a special court system for litigating business disputes. Nevada promotes its so-called “Business Court” as efficient and fast in its case management. However, Nevada’s Business Court doesn’t issue written opinions or binding precedent, so it does not provide the predictability that Delaware provides. In addition, as with being incorporated in Delaware, if your business is physically located in a state other than Nevada, the supposed efficiencies are probably outweighed by the hassle of having to litigate cases in a far away state. Therefore, for most business owners, I do not see Nevada’s Business Court as being a major benefit.

The second big selling point to incorporating in Nevada is that Nevada supposedly has greater protections for shareholders against a “piercing the corporate veil” action. Piercing the corporate veil involves holding the owners of a corporation or limited liability company liable for the debts of the company. Generally, piercing the corporate veil can only be done in extreme situations such as when the shareholder commits fraud or when the corporation is deemed the “alter ego” of the shareholder. The standard for successfully piercing the corporate veil in Nevada may be stricter than in your home state. However, it is important to note that if a lawsuit takes place in your home state or in some other state besides Nevada, conflicts of laws principles may cause the law of a state other than Nevada to control whether a piercing the corporate veil action would be successful. In other words, judges often have a lot of discretion as to which state’s laws apply in multi-state cases and often begin with the assumption that the law of the forum applies unless a party can show that another state’s laws have greater contacts or interests in the case. In fact, while Nevada corporations are often promoted as being particularly useful to business owners in California, California has been one of the most aggressive states in applying its own corporate laws to businesses incorporated elsewhere but doing business in California. Therefore, my recommendation is to use your own state’s incorporation statute and take effective precautions against liability, which includes observing all corporate formalities and making sure that you and your company have adequate liability insurance coverage.

Nevada corporations are also promoted for their asset protection abilities. Nevada law provides that the sole remedy available to creditors of owners of Nevada closely held corporations and LLCs is a charging order. A charging order is an order by the court directed to the company ordering the company to send all distributions and dividends that would have gone to the shareholder/owner/debtor to the judgment holder instead. This limitation can make it more difficult for a creditor to collect on their judgment because the creditor will not be able to force the debtor to sell his stock or ownership interest in the company. Usually, after a creditor obtains a judgment against a debtor, the creditor is entitled to sell the debtor’s personal property to satisfy that judgment. However, if the creditor’s sole remedy is a charging order, then the creditor is entitled to whatever distributions or dividends are produced from the ownership interest (if any at all), but the creditor cannot transfer or sell that ownership interest. Having this protection can give a debtor more leverage in negotiating a settlement. However, the charging order limitation is not unique to Nevada. Most states’ LLC statutes provide that the sole remedy to a creditor of a member is a charging order. It is true that Nevada has extended the charging order limitation to situations that other states have not, namely to closely held corporations and single member LLCs. However, as in the case of piercing the corporate veil, you cannot be sure that your own home state won’t go ahead and apply its own law to the situation, notwithstanding whatever Nevada law states. My colleague Jeff Vandrew wrote recently about this issue and has some suggestions for alternative asset protection precautions that can be taken using your own home state’s LLC statute. These precautions are far more likely to accomplish your asset protection goals than simply incorporating in Nevada and hoping that the judge applies Nevada law.

As with Delaware, I don’t think there is much advantage for most businesses to incorporating in Nevada, as opposed to the business owner’s home state. You will end up incurring double the fees, because you will have to pay Nevada’s fees and then pay your own states fees to obtain authorization for your Nevada entity to do business in your own state. Despite this additional cost and complication, it is uncertain whether you will see any of the benefits, such as greater asset protection and liability protection, that are often promised in connection with incorporation in Nevada. As always, your final choice in entity selection should be based on your own specific situation. Therefore, before making any final decisions on your form of business, you should speak with your attorney.

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Bill Introduced in Congress to Permit Private Companies to Stay Private for Longer

Representative David Schweikert (R-AZ) recently introduced a bill called the “Private Company Flexibility and Growth Act,” which promises to allow private companies to remain private for a longer period of time.  Currently, if on the last day of a company’s fiscal year, any class of securities of the company is held of record by 500 or more shareholders and the company has total assets of more than $10 million, then it must register under the Securities Exchange Act of 1934.  This brings upon it a multitude of responsibilities and obligations including filing annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and meeting proxy regulation requirements.  With these added obligations, most companies will simply choose to go public (i.e. engage in an IPO), since they might as well gain the advantages of the public markets given that they will now be dealing with all of the compliance expenses that come along with them.  An example of a company that is likely dealing with this issue now is Facebook.  It has been widely reported that it is either past the 500 shareholder limit or soon will be, since its shares are held by many employees, some of which may have sold their shares to other parties.  Many people believe that Facebook has no desire to go public, but will likely be forced to do so early next year.  Is that fair? [Read more…]