Incorporation law has important legal implications for public companies and their directors, officers, and shareholders. why? This is because the major legal issues affecting corporate governance are typically regulated by the laws of the state of incorporation. Although most companies prefer Delaware, there are many differences between the states, so evaluating the best company for your company requires a case-by-case analysis.
This article focuses on four areas that frequently impact shareholder litigation and provides representative examples of how they vary from state to state.
Book and Records Requests
Stockholders often use their right to request “books and records” to investigate potential wrongdoing. Companies may have several grounds for denying or narrowing their requests depending on the circumstances, and Delaware courts have particularly ruled in favor of companies on this point.
Additionally, states may vary as to which stockholders have the right to file requests for books and records. While many states allow any shareholder of record to do so, other states, such as Nevada, North Carolina, and Texas, have additional ownership requirements (i.e., percentage ownership and length of time the shares are held) to require testing.
Certain states further limit the records that can be obtained. For example, Texas excludes unofficial electronic communications (emails, text messages, etc.) from books and records requests unless they are based on corporate law. Delaware recently amended its law to similarly limit the definition of “books and records” to defined categories of records. Nevada, on the other hand, limits claims to accounting books and financial records and exempts public companies from inspection permit requirements if they have met certain federal reporting requirements in the previous year.
representative litigation process
The procedures for representative lawsuits vary, including the requirements for “pre-litigation claims.” Georgia, North Carolina and Texas are among about 20 “universal demand” jurisdictions that require shareholders to make demands to boards and give them an opportunity to investigate before filing a lawsuit. By contrast, Delaware, Florida, New York, and Nevada allow shareholders to sue with or without demands against the board, arguing that the lack of an independent board makes it futile to sue. Regardless of which framework applies, failure to meet these basic procedural requirements can lead to dismissal.
substantive legal rules
Although states often apply similar substantive legal standards, there are differences. For example, the Business Judgment Rule (BJR), available in some form in every state, can protect directors and officers from liability based on the presumption that their decisions were made in good faith, with due care, and in the best interest of the company. However, how BJR is applied varies by state. Many states, including Georgia, North Carolina, and Delaware, require shareholders to show gross negligence to overcome BJR. Nevada and Texas typically require a higher level of misconduct, such as willful misconduct, fraud, or willful violation of law.
Fiduciary duties may also vary. Most states recognize a duty of care and loyalty to officers and directors (although they are often worded differently). Texas also recognizes the duty of obedience, or the duty not to engage in “ultra vires,” such as acting beyond the scope of one's authority. Delaware also recognizes a duty of supervision that is part of the duty of loyalty, which can give rise to liability (a “Caremark claim”). California and North Carolina have recognized Caremark's claims, but many states have yet to specifically address the issue.
Compensation and exemption
The ability to indemnify and exempt directors and officers from liability also depends on state law. States often limit the ability of corporations to exempt directors from duty of care claims and do not allow exemptions for breaches of fiduciary duties. However, Nevada's indemnity and indemnity law is not limited to duty of care claims, but provides these protections broadly unless the violation is due to fraud, intentional misconduct, or knowing violation of law.
As these examples illustrate, when it comes to corporate governance, it is important to hire an attorney who is knowledgeable about state-specific nuances and the legal rights and protections available in that state.
