Did you think the majority rules in California? Think Again – Cumulative Voting is the law for all California corporations

Conventional wisdom dictates that the majority shareholder of a board of directors has the ability to elect the majority of the board. Board rooms across California assume this majority rules result without realizing that 1) cumulative voting changes the entire game; and 2) cumulative voting is the law for all corporations in California that are not publicly traded.

Cumulative Voting: The Basics

The number of votes available to a shareholder in a given election is equal to the number of shares owned by the shareholder multiplied by the number of positions up for vote.  Cumulative voting is a process of voting that allows a shareholder to cast all her votes toward a single nominee, or split her votes among several nominees in any proportion she chooses.  By contrast, under conventional voting, shareholders may not cast more than one vote per share to any single nominee. 

First, we will look at the results of an election under a conventional voting scheme.   Let us assume that two shareholders, Susan and Tom, are voting in an election for a three director board.   Susan, as the majority shareholder, holds 500 shares.  While she would have 1,500 votes total (3 X 500 shares), Susan would be limited to 500 votes per nominee.  Tom, as the minority shareholder, holds 300 shares.  While he would have 900 votes total (3 x 300 shares), Tom would be limited to 300 votes per nominee.   

Thus, the election would proceed as follows, with the director nominees listed across the top and the shareholder voters listed down the left-hand side:

Figure 1:  Results in a Conventional Voting Scheme

The result is that Susan as the majority shareholder is able to elect Jane, Jessica and Janis on the Board of Directors, thereby controlling all positions on the Board.   Tom is completely shut out of the election because at most, he could only apply 300 votes toward each of his nominees, which will always be defeated by Susan’s 500 votes per nominee.  The majority, as represented by Susan, always wins in this scenario.

 Under a cumulative voting scheme, however, the minority shareholder position is strengthened.  Tom could “cumulate” all 900 of his votes toward one nominee, 450 each to two nominees, or allocate his votes in any combination of his preference.  The result is that Tom has a stronger chance of being able to elect at least one out of the three directors through cumulative voting:

 Figure 2:  Results in a Cumulative Voting Scheme

In addition to providing Tom a better chance of obtaining representation on the board of directors, cumulative voting creates incentives for Susan and Tom to negotiate their votes for the most optimal outcome according to their strongest preferences.  For example, let us assume that while Susan does not prefer Jim to be on the board of directors over her slate of nominees, she is dead set against John’s candidacy.  Likewise, while Tom does not prefer Janis to be on the board of directors over his top three choices, he is absolutely against Jessica’s candidacy.  Susan and Tom can negotiate to vote their strong preferences (or negative preferences).  Thus, Susan and Tom’s most disliked nominees, John and Jessica respectively, do not make it onto the board as a result of a strategic allocation of votes:

 Figure 3:  Results of Negotiated Voting in a Cumulative Voting Scheme

Cumulative Voting:  It’s the law!

In California, cumulative voting is a statutory right for shareholders of non-publicly traded corporations.  By default, cumulative voting is available to shareholder elections of directors and it need not be specified in the articles or bylaws.  Further, cumulative voting cannot be denied in the articles or bylaws as a matter of public policy (Corp. Code §708(a)).   Only publicly traded corporations may opt out of the requirement (Corp. Code §301.5(a)).

The rationale behind cumulative voting is that the process translates into more proportional representation of the shareholders on the board of directors, giving minority shareholders the opportunity to exert influence on management  through the election of directors who support their interests and priorities. 

No Opt-Out Provision

You might think about incorporating in a different state to avoid the cumulative voting requreiment altogether.  Think again.  California law prohibits an out of state corporation from opting out of cumulative voting by amending its articles or bylaws.  (Corp. Code §708(a)).   Cumulative voting even applies to certain foreign corporations if more than half of their shareholders live in California and they do most of their business here.  (see Wilson v. Louisiana-Pacific Resources, Inc. 138 CA3d 216 (1982); Corp. Code Section 2115).  For an explanation of what constitutes a “pseudo-foreign” corporation, see http://www.eminutesonline.com/what-is-a-pseudo-foreign-corporation/.

What Is a Pseudo Foreign Corporation?

Generally, a corporation is subject to the laws of the state in which the corporation was formed. Consequently, incorporating in Delaware, for example, is a common practice as businesses “shop” for the most favorable state corporate law advantages.

Straight forward, right?  Think again. 

If branded a “pseudo foreign” corporation, California will apply California law to the company, regardless of where the corporation is formed.

Two Tests Must be Satisfied

California applies two tests for foreign, non-public, corporations that if met, would subject a foreign corporation to California law as a pseudo foreign corporation (see Corp Code §2115(b)):

1)       The “Tax-Factor” Test: Is the proportion of the corporation’s property, payroll, and sales in California compared to the company’s total property, payroll, and sales more than 50 percent during its latest full income year?  (see Corp Code §2115(a)(1)). 

2)       The “Shareholder Residence” Test: Is the corporation’s outstanding voting securities held of record by persons having California addresses more than 50 percent?  (see Corp Code §2115(a)(2)).

If both tests are met (i.e., more than half of the shareholders live in California and most of the company’s business is conducted in California), California will consider the corporation a “pseudo foreign” corporation and will treat it, for certain purposes of fundamental importance to California, as if it had incorporated in California in the first place. 

This means that the corporation would be subject to a “menu” of key California laws that are rooted in public policy concerns, including among others (See Corp C §2115(b)):

• annual election of directors (Section 301)
• removal of directors without cause (Section 303)
• directors’ standard of care (Section 309)
• indemnification of directors, officers, and others (Section 317)
• shareholder’s right to cumulate votes at any election of directors (Section 708, subdivisions (a), (b), and (c))

Basically, California is trying to exert its public policies (most designed to protect minority shareholders) on corporations that are doing business in California even if the corporation has attempted to avoid California law by incorporating elsewhere.  If you want to shop around for the best corporate law and do business in California, beware that California law may trump the law of the home state of a corporation.  To learn more about the one reason that corporations are nonetheless well served to incorporate in Delaware – mobility, watch “What is the benefit of incorporating in Delaware”, http://www.eminutesonline.com/what-is-the-benefit-of-incorporating-in-delaware-watch-video/, or read “Delaware: Jurisdiction of Choice for a Mobile Generation”, http://www.eminutesonline.com/delaware-jurisdiction-of-choice-for-mobile-generation/.

Delaware Wrinkle & its Consequences

California courts have upheld Corp. Code Section 2115.  See., e.g., Wilson v Louisiana-Pacific Resources, Inc. (1982) 138 CA3d 216.  (Court upheld constitutionality of Corp C §2115 and imposed cumulative voting for directors on pseudo foreign Utah corporation).   However, the Delaware Supreme Court has repudiated the statute provision in VantagePoint Venture Partners 1996 v. Examen, Inc.,  871 A.2d 1108 (Del. 2005) (“VantagePoint”).  The court in VantagePoint affirmed the Delaware Court of Chancery ruling, relying on conflicts of law principles and the Commerce Clause of the U.S. Constitution to dismiss Section 2115 of the California corporate code.  The issue of which state law applies to a pseudo foreign corporation in California may ultimately turn on who wins the race to the courthouse in forum shopping.  In the meantime, the opposing opinions regarding Section 2115 from the California and Delaware courts will continue to leave uncertainty for foreign corporations with meaningful business in California.

How to Form a Corporation that will Act as a SAG Signatory

When a production company wishes to employ Screen Actors Guild (SAG) performers, the company must agree to follow various SAG rules related to the employment to SAG performers. By doing so, the corporation becomes a SAG “signatory”. This article outlines the corporate actions that must be taken by a production company that wishes to become a SAG signatory.

Step One.  First, a corporation must agree to abide by the terms of the Producers-Screen Actors Guild 2002 Codified Industrial and Educational Contract and the 2008-2009 Extension to the 2005 Memorandum of Agreement (collectively, the “SAG Agreement”).  In California, this can be accomplished by (1) the corporation entering into the Agreement, and (2) the shareholders and directors authorizing the corporation to do so.  SAG requires “incumbency” provisions in its resolutions (i.e., a specific corporate resolution that identifies the person who is authorized to sign the SAG Agreement on behalf of the corporation).  A copy of the SAG Agreement is contained in the following packet of materials, Full Ind Sig Forms (e-mail).  For a form of Joint Written Consent of the Shareholders and Board of Directors, see jtwrittenconsent. 

Step Two.  For corporations, the production company should complete the SAG Company Information Sheet.  Doing so will require a copy of the company’s Articles of Incorporation, as well as the names and addresses of the officers of the corporation (i.e., President, Secretary, Treasurer, and Vice Presidents, if any).  A California corporation must have a President, Secretary and Treasurer. For more information, watch this video “What Officers Are Required?” http://www.eminutesonline.com/what-officers-are-required-watch-video/

When a performer joins SAG, she is required to comply with Global Rule One, which states that “No member shall work as a performer or make an agreement to work as a performer for any producer who has not executed a basic minimum agreement with the Guild which is in full force and effect.” By becoming a SAG “signatory”, a production company is permitted to hire SAG members for its projects, and, in exchange, obligates itself to comply with SAG policies (e.g., nondiscrimination), pay certain taxes and make various contributions on behalf of SAG members participating in the company’s projects (e.g., Social Security, tax withholdings, unemployment insurance and disability insurance payments, and payments to the Screen Actors Guild-Producer Pension and Health Plans).

Similar authorization and documentation is required for limited liability companies (LLCs) and limited partnerships (LPs) that wish to become SAG Signatories.   For more information about the basic differences between LLCs and corporation, watch this video “Should I form a LLC?” http://www.eminutesonline.com/should-i-form-an-llc/

Hey Director: Think Twice Before Dissolving

One word of advice for a corporate director who sits on a board of a faltering corporation that is considering dissolving before the end of the year: resign. And do so long before the vote to dissolve. That’s because directors of California corporations may have personal liability following the dissolution.

California law imposes personal liability on shareholders of dissolved corporations for four years following the corporate dissolution.  See, http://www.eminutesonline.com/zombie-corporations-in-california-personal-liability-lives-on-for-four-years-after-corporate-dissolution/.  But the liability of the shareholders is limited to the amount the shareholder actually received at the time of the dissolution.  

Unlike shareholders, even directors who receive nothing whatsoever at the time of dissolution are personally liable (jointly and severally with the corporation) if they approve the distribution of assets to shareholders without first satisfying the liabilities of the corporation that are known at the time of dissolution. See, California Corporations Code Section 316(a)(2).   California law provides that the director is personally liable up to the amount of the illegal distribution (or if the illegal distribution consists of property, the fair market value of that property at the time of the illegal distribution) plus any accrued interest  from the date of the distribution, together with all reasonably incurred costs of appraisal or other valuation, if any, of that property or loss suffered by the corporation as a result of the improper distribution. See, California Corporations Code Section 316(C). 

The moral of the story: be very careful if you are a director of a corporation considering dissolution, especially when the corporation intends to dissolve without providing for all of its debts.

What You Need to Know About Incorporating in California at the End of the Year

Entrepreneurs who are planning to incorporate at the end of the year are usually focused on positioning the new business to kick off the year with a big bang! Rather than form the new business on the first business day of the year (January 4, 2010), California entrepreneurs can file their Articles before year end, so long as they do not actually do business in 2009.

Year End Tax Waiver Gives Incorporating Entrepreneurs Head Start on 2010 Plans

California Rev & Tax Code Section 23114 gives entrepreneurs a head start on their business plans for the new year by enabling them to file their Articles before year end without being obligated to file a tax return for the current tax year.  To satisfy the rule, a new corporation must meet both of the following requirements:

1. The tax year is 15 days or less;  and
2. The corporation did no business during the 15 days.

The date stamped on the Articles of Incorporation by the California Secretary of State (SOS) is the date that determines when the corporation is formed for purposes of the rule.   The California SOS passes this date to the FTB to use as a the corporation’s date of incorporation.    In our firm, to avoid confusion, we will file “year-end” Articles on December 18, 2009.

California Gives Tax Freebie for New Business Startups

There’s more good news.  In California, a corporation’s first year’s minimum franchise tax ($800) is waived (See, California Rev & Tax Code Sec. 23153(f).  See, http://www.ftb.ca.gov/law/Technical_Advice_Memorandums/2002/20020138.pdf

Between now and year end, entrepreneurs who are getting their corporations formed for start ups that might not actually start up until 2010 are well served to consider whether a little patience can save a few bucks.  Instead of filing the Articles now, unless the business requires it, preparing all of the documents and holding off on the actual filing until December 18, 2009, can result in considerable savings.

Warning: California Businesses Bombarded with Bogus Solicitations

Many California business owners have been bombarded with notices suggesting that if they do not send money to the “Corporate Compliance Board”, or similarly named nonexistent government agency, their corporation or LLC will be hit with fees and fines. In response, the California Secretary of State has issued an Alert. See, http://www.sos.ca.gov/business/be/alert-misleading-solicitations.htm

These are bogus solicitations and do not require any action on the part of the company. The solicitations request that a fee be returned, along with a completed form to ensure that the company will remain in compliance with California law. The companies responsible for the solicitations are not affiliated with the California Secretary of State’s office and may not be handling the filings properly.

There are many versions of the solicitation, but they all appear very similar to the Secretary of State’s Statement of Information form. In addition to their official-looking appearance, they usually contain the company’s file number or corporate number. In many cases, the corporate number on the solicitation does not match the actual file number for the company assigned by the Secretary of State. Further, the solicitations indicate an arbitrary due date. In California, all Statements of Information are due on the last day of the month of formation. They will never be due on a date other than the last day of a month.

If you have any doubt whether a form is a solicitation, you should contact your corporate attorney. If you have remitted payment in response to one of these solicitations, you should immediately make sure that your company is actually in compliance with its filings. The Secretary of State has requested that those who received a bogus solicitation contact the California Attorney General’s office at the California Department of Justice, Public Inquiry Unit, P.O. Box 944255, Sacramento, California 94244-2550 or through the California Attorney General’s website at www.ag.ca.gov/consumers/general.php. The telephone number for the Public Inquiry Unit is (800) 952-5225 (toll free in California) or (916) 322-3360.

Motion Picture Exemption for the Nevada Business License

Recently, Nevada changed its procedure for collecting business license fees, resulting in nearly every Nevada entity paying $200 each year for a Nevada Business License.  See, http://www.eminutesonline.com/200-more-reasons-to-choose-delaware-over-nevada/.  The $200 fee for the license, now due at the time of filing of the Annual List, is another added hoop to the bureaucracy of maintaining an entity in Nevada.

Under the new law, however, Nevada corporations whose primary purpose is to create or produce “motion pictures” are exempt from fee.  “Motion pictures,” are broadly defined by NRS 231.020 as “feature films, movies made for broadcast on television and programs made for broadcast on television in episodes.” If the primary purpose of a company falls under this category, the Annual List must be filed stating the specific exemption. The Nevada Business License will then be generated at the time the Annual List is filed without the required fee.

Dear New York: Would you please simplify your dissolution process? (Four Steps to Dissolving in NY)

While California has simplified its process for dissolving a corporation, New York has retained its cumbersome process.  As so many entrepreneurs face the reality of taking their small businesses off life support following the Great Recession, the time is now for New York to simplify its outdated process.

Effective September 29, 2006, California did away the requirement that all corporations submit a tax clearance certificate issued by the Franchise Tax Board along with Certificate of Dissolution. The change provides companies with an efficient dissolution process which usually takes about 7-10 days from start to finish. Unfortunately, not all jurisdictions have followed California’s example. In New York, business entities may voluntarily dissolve only after the New York State Department of Taxation and Finance gives the entity permission to do so.  Companies must obtain the consent of the State Tax Commission from the New York State Department of Taxation and Finance prior to submitting the Certificate of Dissolution to the Department of State for filing.

The overall process can be divided into four steps.

Step 1: Requesting Consent to Dissolve from the New York State Department of Taxation and Finance 

The first step is to contact the New York State Department of Taxation and Finance to request permission to dissolve. Only an officer of the company may make the request by calling (1-800-327-9688) or placing a letter.

Step 2: New York State Department of Taxation and Finance Reviews the Company’s Tax File

Once the request to dissolve or surrender has bee received, the Department will determine if a final corporation tax return has been filed. The company can use the tax form it normally uses for its annual returns, but must mark an X in the box marked Final at the top of the return. The Department will also determine if the corporation is up-to-date with its returns and taxes. This includes any taxes and returns due for any part of a year in which the corporation was in existence.

If the corporation has filed all its returns and paid all its taxes and maintenance fees, the Department issues a written consent to dissolve the corporation with 7 to 10 business days. If there are outstanding issues, the Department will send a letter informing the company what needs to be done before it  can give consent to dissolve.

Step 3: Certificate of Dissolution from the Department of State

Next, the company will need to have a Certificate of Dissolution prepared and executed by an officer of the company.

Step 4: Certificate of Dissolution from the Department of State

Once the Company has obtained the Department of Taxation and Finance’s consent and prepared the Certificate of Dissolution, both need to be filed with the Department of State.

While this process can be burdensome, maintaining the company’s good standing by filing returns and paying taxes will make the dissolution process much more efficient.

Can Your California LLC Avoid the Annual $800 Franchise Tax?

When a newly formed LLC elects to dissolve, on the other hand, the process is far simpler and the LLC does not need to pay the $800 annual Franchise Tax if certain requirements are met. A newly formed LLC can file a Certificate of Cancellation Short Form (LLC-4/8) and the $800 Franchise Tax will be waived if the following requirements are met:

1. The Certificate of Cancellation is being filed within 12 months from the date the Articles of Organization were filed with the Secretary of State;
2. The LLC has no debts or liabilities (other than tax liabilities);
3. The assets of the LLC have been distributed to the person entitled thereto, or no assets have been acquired; 
4. The final tax return or a final annual tax return has been or will be filed with the Franchise Tax Board; 
5. The domestic LLC has not conducted any business from the time of filing the Articles of Organization (including opening of a bank account and depositing any funds into such bank account); 
6. A Majority of the Managers or Members voted to dissolve the entity; and
7. Any investments received from investors have been returned to those investors.

A Musical Guide to the End of Corporate Existence

When the shareholders of a corporation, or the members of an LLC, decide that the entity will stop actively engaging in business, they have a choice to make: officially dissolve the entity in accordance with statutory requirements, or simply do nothing, and instead let the entity “die on the vine” by failing to comply with annual filing requirements and file tax returns. While letting the entity slowly wither away may have some appeal in the short term, ultimately, it’s an unwise strategy. Read more

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