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The Texas Business Organizations Code (BOC) – which governs Texas’ for-profit and nonprofit corporations, limited liability companies, partnerships, and other business organizations was significantly amended by four pieces of legislation in 2019. In addition, an important change to the Texas Business & Commerce Code affecting domestic and foreign corporations, LLCs, LPs, and LLPs was enacted. In all, almost 100 sections of law were amended, added or repealed. All amendments are effective September 1, 2019.
This white paper will look at some of the important changes made. For more details consult the bills and the relevant sections of Texas law.
Senate Bill 1971 amended BOC provisions relating to, among other things, voting agreements, two-step offer-mergers, ratification of defective acts, notices of redemption, shareholder lists, and nonprofit corporation directors. The amendments include the following:
1. Share Transfer Records – Sec. 21.002 was amended to add a definition of “share transfer records”. As defined, the term includes records maintained via electronic recordkeeping pursuant to Sec. 3.151.
2. Shareholder List – Sec. 21.372 was amended to provide that the list of shareholders entitled to vote at a meeting “shall be prepared by or on behalf of the corporation". This amendment clarifies that a corporation may use a third-party transfer agent or electronic data system.
3. Voting Agreements – Sec. 6.252 was amended to clarify that the section applies to voting agreements not set forth in the entity’s governing documents, to provide that the entity may – but is not required – to deposit the agreement at its principal executive office or registered office, and to clarify the circumstances in which the voting agreement is specifically enforceable against the owner of the interest subject to the agreement and against subsequent owners.
Sec. 6.252 was also amended to provide that the section does not impair the entity’s right to treat a record owner as entitled to vote the ownership interest standing in the owner’s name or accept the owner’s vote.
4. Two-Step Offer-Merger – Sec. 21.459, which authorizes a two-step offer-merger transaction in which shareholder approval of the back end merger is not required, was amended in several respects. Some of these changes are intended to conform the section to amendments made to Sec. 251(h) of the Delaware General Corporation Law – the section of law upon which Sec. 21.459 is based.
The amendments include, but are not limited to (1) adding several new definitions, (2) clarifying that the target need only have one class or series of shares traded on a national securities exchange or held by more than 2,000 record holders immediately before approval of the merger, (3) clarifying that only shares within the same class or series of the target must receive the same consideration in the first step offer and back end merger, and (4) clarifying when rollover shares and shares owned by qualified affiliates may be treated as owned by the acquirer to satisfy the minimum ownership requirement.
5. Dissenter’s Rights For Two-Step Merger – Sec. 10.354 was amended to deny an owner the right to dissent from a Sec. 21.459 offer-merger if the ownership interest is listed on a national securities exchange or held of record by at least 2,000 owners and certain other requirements are met. This amendment thus provides that the “market-out” exception to the availability of dissenter’s rights, which applies to other mergers, also applies to Sec. 21.459 mergers.
6. Ratification of Defective Acts by For-Profit Corporation – Secs. 21.901, 21.905, and 21.911 were amended to clarify provisions governing the ratification of defective acts by for-profit corporations. Some changes were intended to make these sections more aligned with the provisions of the Delaware GCL upon which the Texas provisions are based. Among other things the amendments (1) clarify that a defective act includes any act or transaction purportedly taken within the corporation’s power to take without regard to the failure of authorization, (2) provide that a failure of authorization includes the failure to authorize or effect an act or transaction in compliance with the disclosure set forth in any proxy or consent solicitation statement to the extent the failure would render the act or transaction void, and (3) clarify that the defective act need not be submitted to the shareholders for approval if, as of the record date for determining the shareholders entitled to vote on ratification, there are no valid shares outstanding and entitled to vote- even if there are putative shares. Further amendments clarify the rules regarding the providing of notice to shareholders.
7. Notice of Redemption – Sec. 21.305 was amended to provide that a notice of redemption shall be sent no later than the 21st day or earlier than the 60th day before the redemption date “unless otherwise provided by the terms of the class or series of shares contained in the certificate of formation". Thus, by adding the phrase in quotations, this amendment provides that the time period restrictions may be varied as provided.
8. Nonprofit Corporation Directors – Sec. 22.001 was amended to add a definition of “director”. As defined, “director” means a person who is a member of the board of directors regardless of the name or title used to designate the person and does not include a person designated as a director, ex officio, honorary or other type of director if the person is not entitled to vote as director.
Sec. 22.210 was amended to clarify that the certificate of formation may provide a non-director the right to receive notice of and to attend board meetings but that having such rights does not give the person the authority, duties or liabilities of a director and the person is not a governing person of the corporation.
Senate Bill 1969 adds a new Subchapter J to Chapter 22 of BOC – the chapter governing nonprofit corporations. Subchapter J provides for the ratification of defective corporate acts of a nonprofit corporation. These provisions are modeled after the BOC provisions relating to the ratification of defective acts by for-profit corporations and to the ratification provisions of the Model Nonprofit Corporation Act. The amendments include the following:
1. Defective Act Defined – Sec. 22.501 defines a “defective act” as an election or appointment of directors that is void or voidable due to a failure of authorization or any act or transaction purportedly taken by or on behalf of the corporation that is, and at the time the act or transaction was purportedly taken would have been, within the power of a corporation to take under the corporate statute but is void or voidable due to a failure of authorization.
2. Failure of Authorization Defined – Sec. 22.501 defines “failure of authorization” as (1) the failure to authorize or effect an act or transaction in compliance with the provisions of the corporate statute, governing documents, a corporate resolution, a plan or agreement to which the corporation is a party if and to the extent the failure would render the act or transaction void or voidable or (2) the failure of the board of directors or an officer to authorize or approve an act or transaction taken by or on behalf of the corporation that required the prior authorization or approval of the board of directors or the officer.
3. Adoption of Resolution – Sec. 22.503 provides that to ratify a defective act, the board of directors shall adopt a resolution, or if the corporation is managed by members, the members shall adopt a resolution stating the defective act or acts to be ratified, the date of each defective act or acts, the nature of the failure of authorization, and that the resolution was duly approved.
Sec. 22.504 provides for the quorum and voting requirements for adoption of the resolution.
4. Approval by Members – Secs. 22.505 – 22.507 address approval of the ratification if the corporation has members with voting rights.
5. Certificate of Validation – Sec. 22.508 requires the corporation to file a certificate of validation with respect to the defective act if the defective act ratified would have required the filing of an instrument or other document with the filing office.
6. Effect of Ratification – Sec. 22.509 provides that when ratification becomes effective the defective act ratified may not be considered void or voidable as a result of the failure of authorization and the effect shall be retroactive to the time of the defective act.
7. Notice to Members – Sec. 22.510 addresses the providing of notice to members if the corporation is managed by members or has members with voting rights.
8. Non-Exclusivity of Subchapter J – Sec. 22.511 provides that Subchapter J is not the exclusive means of ratifying or validating a defective act.
9. District Court Proceedings Regarding the Validity of Defective Corporate Acts - Sec. 22.512 provides that the corporation, a successor entity, a board member or other fiduciary, a member with voting rights, or a record member with voting rights at the time of ratification can apply to the district court and the court may, among other actions, (1) determine the validity and effectiveness of any defective act ratified pursuant to Subchapter J, (2) determine the validity and effectiveness of the ratification of any defective act, (3) determine the validity and effectiveness of a defective act not ratified, or (4) determine the validity of any corporate act or transaction.
Senate Bill 1859 amended BOC regarding, among other things, recordkeeping, effectiveness of filings, winding up of a series, creditor actions against partners, and indemnification of partners. The amendments include the following:
1. Electronic Data System Defined – Sec. 1.002 was amended to provide that “electronic data system” means an electronic network or database and includes a distributed electronic network or database including one that employs blockchain or distributed ledger technology.
In addition, the definition of “electronic transmission” was revised to provide that it includes communication by use of or participation in one or more electronic data systems.
2. Recordkeeping – Sec. 3.151 was amended to provide that the books, records, minutes and ownership or membership records of a filing entity may be maintained by or on behalf of the entity or by means of an information storage device or method or one or more electronic data systems, provided that the books, records, or minutes can be converted into written form within a reasonable time. In addition, Secs. 101.501 and 153.551 were amended to clarify that all books and records required to be maintained by an LLC and LP may be maintained in any form and manner permitted by Sec. 3.151.
3. Notice To Owner of Uncertificated Interests – Sec. 3.205 was amended to provide that the notice to an owner of uncertificated ownership interests required by the section may be given by electronic transmission.
4. Delayed Effectiveness of Certain Filings – Secs. 4.052-4.056 were amended to clarify and expand the options for the delayed effectiveness of a filing instrument. If the effectiveness of a filing instrument is to be delayed, the instrument may take effect (1) at a specified date, (2) at a specified date and time, (3) on the occurrence of a specified future event or fact, including an act of any person, or (4) after the occurrence of a future event or fact, including the act of any person, at a specified date and time, or after the passage of a specified period of time. (Delayed effective dates continue to be limited to 90 days after the date the instrument is signed.)
A filing instrument that is to take effect on or after the occurrence of a future event or fact takes effect on (1) the date, or the date and time, at which the event or fact occurs or is waived or (2) the specified date, the specified date and time, or the passage of the specified period of time after the occurrence or waiver of the event or fact. Conforming amendments address the information required to be set forth in the instrument regarding the event or fact that will cause it to take effect, the statement required to be filed with the Secretary of State regarding the event or fact, and the Secretary of State’s acknowledgment of that filing.
5. LLC – Decrease in Number of Managers – Sec. 101.302 was amended to delete language providing that an amendment to the LLC’s operating agreement could not decrease the number of managers if the decrease shortened the term of an incumbent manager.
6. LLC Inspection of Records – Sec. 101.503 was amended to provide that an LLC’s liability for refusing a valid request to examine and copy records applies to an assignee of a membership interest.
7. LLC - Winding Up of Series by Court Order – Sec. 101.621 was amended to provide that a district court may order the winding up of a series if the court determines the economic purpose of the series is likely to be unreasonably frustrated or another member associated with the series has engaged in conduct relating to the series’ business that makes it not reasonably practicable to carry on the business with that member.
8. Claims Against Partners – Sec. 152.306 was amended to clarify when a creditor may proceed against one or more partners to satisfy a judgment based on a claim against the partnership.
9. Indemnification of Withdrawn Partner – Sec. 152.606 was amended to clarify that a partnership is required to indemnify a withdrawn partner whose interest is redeemed against all partnership obligations, whether incurred before or after the date of withdrawal - except for an obligation incurred by an act of the withdrawn partner under Sec. 152.504 (regarding a withdrawn partner causing the partnership to incur liability to a person without notice the partner had withdrawn and who believes the partner was a partner).
House Bill 3603 amends the BOC provisions governing derivative proceedings on behalf of for-profit corporations, LLCs, and LPs. The amendments, in addition to making certain substantive changes, are intended to make the provisions governing derivative proceedings similar for all three entity types. The most significant change is to the LP provisions as those differed significantly from those for corporations and LLCs. The amendments include the following:
1. Limited Partnership Derivative Proceedings – Sec. 153.402 was amended to provide that a limited partner may not institute or maintain a derivative proceeding unless the limited partner was a limited partner at the time of the act or omission complained of or became a limited partner by operation of law from a general or limited partner at the time of the act or omission and can fairly and adequately represent the limited partnership’s interests.
Sec. 153.403 was amended to provide that a limited partner may not institute a derivative proceeding until the 91st day after the date a written demand is filed with the LP containing specified information about the claim or challenge and requesting the LP to take suitable action. The waiting period is not required or is terminated if the limited partner has been notified the demand was rejected or the LP is or would be suffering irreparable injury. Previously the section provided that the complaint could set forth reasons for not making a demand. That language was deleted. Thus, demand is required in all cases.
Sec. 153.404 details who may determine how to proceed on the allegations made in the demand. Sec. 153.405 addresses how the LP may obtain a stay of a derivative proceeding. Sec. 153.408 is added to provide that a court shall dismiss a derivative proceeding on a motion by the LP if the person or group described in Sec. 153.404 determines in good faith, after conducting a reasonable inquiry, and based on factors they deemed appropriate, that continuation is not in the LP’s best interests.
Sec. 153.410 is added to provide that a derivative proceeding may not be discontinued or settled without court approval.
2. Standing Following a Conversion – Secs. 21.552, 101.452, and 153.402 were amended to clarify the right to bring or maintain a derivative proceeding by a shareholder, member or limited partner of a converted entity.
3. Applicability to Foreign Entities – Secs. 21.555, 221.556, 21.561, 21.562, 101.455, 101.456, 101.461, 101.462, 101.462, and Sec. 153.412 were amended to clarify the applicability of the provisions governing derivative proceedings to foreign corporations, LLCs, and LPs.
4. Applicability to Closely Held Entities - Secs. 21.563, 101.463, and 153.413 were amended to provide that the exceptions to the procedural requirements for bringing derivative proceedings for shareholders, members, and limited partners of closely held corporations, LLCs, and LPs only apply to a claim against a director, officer, or shareholder of the corporation, governing person, member or officer of the LLC, or general partner, limited partner or officer of the LP.
5. Determination by Governing Persons – Secs. 101.454 and 153.404 were amended to clarify that where an entity is a governing person of an LLC or LP, or there are one or more entities that own a governing person entity of the LLC or LP, the determination of how to proceed on allegations in a demand or petition is to be made by disinterested and independent individuals acting as direct or indirect governing persons of the LLC or LP.
6. Effective Date – House Bill 3603 provides that the changes in law made by the bill apply only to derivative proceedings instituted on or after September 1, 2019. A derivative proceeding instituted before September 1, 2019, is governed by the law in effect on the date of institution.
House Bill 3609 amended Sec. 71.103 of the Business & Commerce Code to provide that a corporation, LP, LLP, LLC or foreign filing entity required to file an assumed name certificate shall file the certificate in the office of the Secretary of State. Previously, the assumed certificate also had to be filed with the county clerk. This local filing requirement was repealed for these entities, which means they are not required to file with the county clerk offices(s) for terminations, amendments, assignments or renewals. In addition, those entities are not required to remove their filing from the county records.
This white paper has highlighted some of the important amendments to Texas’ business organization laws enacted in 2019. Business lawyers, owners, managers, investors and others interested in Texas entities may wish to review the legislation discussed here in their entirety to see all of the changes made.
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