Perspective on the New California Ratification Law Based on California Corporate and Delaware Ratification Practices

• Publication year: 2023
• Author: Written by Julia Reigel, Jack McBride, Angie Flaherty, and Nate Emeritz

PERSPECTIVE ON THE NEW CALIFORNIA RATIFICATION LAW BASED ON CALIFORNIA CORPORATE AND DELAWARE RATIFICATION PRACTICES

Written by Julia Reigel, Jack McBride, Angie Flaherty, and Nate Emeritz^*

California has adopted a ratification and validation statute, section 119 of the California General Corporation Law ("GCL") (Cal. Corp. Code § 119), which became effective January 1, 2023.¹ Section 119 provides for corporate ratification and judicial validation of noncompliant corporate actions, as an analogue to sections 204 and 205 of the Delaware General Corporation Law (Del. Code Ann. tit. 8, §§ 204-205, referred to herein collectively as the "Delaware Law"). Based on our experience with the GCL, the Delaware Law, and relevant California and Delaware case law, this article is intended to provide thoughts for consideration regarding the development of law and practice around section 119.

CONTEXT FOR SECTION 119 AND STATUTORY RATIFICATION

Section 119 has been added to the GCL to address shortcomings regarding common law ratification as a remedy for resolving void and voidable corporate issues.² Following Delaware's adoption of the Delaware Law in 2013, other states enacted similar statutes for corporate ratification and judicial validation of invalid corporate actions.³ Although these statutes reflect a range of policy and drafting choices, they also reflect similarity in the underlying issues being addressed and primary operative features. We expect that an understanding of the Delaware Law will, therefore, be critical to informing implementation, interpretation, and development of section 119.

Noncompliant Corporate Actions in California Corporate Practice. A "corporate action," which is susceptible of ratification under section 119, is an act taken by directors, shareholders, or otherwise by or on behalf of the corporation, which was not taken in compliance with the GCL, the corporation's articles of incorporation or bylaws, or a plan or agreement to which the corporation was a party. In corporate practice under California law, noncompliant corporate actions have presented serious issues for a corporation needing to make representations or obtain legal opinions regarding its corporate and capital structures in connection with a significant transaction. In a report on legal opinions, a committee of the California Lawyers Association explained the problems created by noncompliance for "valid issuance" and "due authorization" opinions regarding a corporation's capital structure:

The "validly issued" opinion cannot properly be given if the shares were issued without proper board or shareholder approval, in violation of any shareholders' preemptive rights set forth in the articles, or in excess of the number of authorized shares. While this Report maintains

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a distinction between the "due authorization" and "validly issued" opinions, an opinion giver should not render a "validly issued" opinion if the opinion giver could not also give the "duly authorized" opinion (or appropriately rely on an assumption or an opinion of other counsel as to due authorization), whether or not requested to do so.⁴

Subject to the limitations in opinion giving set forth below, section 119 offers a path forward in such circumstances, which is critical because California law has previously offered few satisfactory approaches to remediating noncompliant corporate actions.

California common law may be inadequate to the task of ratifying void actions, such as a noncompliant stock issuance. Practitioners have used forward mergers to provide an arguably clean corporate slate by establishing a new entity or exchanging shares by operation of the California merger statute. There is uncertainty, however, whether that approach eliminates the taint of invalidity permeating the constituent corporation and its authorization of the merger, even with releases by shareholders and putative shareholders. Corporations have also petitioned the courts to quiet title as to noncompliant actions or stock, but that approach focuses on litigation risk and not remediation of any noncompliance or defective authorization. Indeed, it was similar issues that caused Delaware and other states to adopt corporate ratification and judicial validation statutes.⁵ Accordingly, the touchstones for an effective ratification regime under both the Delaware Law and section 119 are to ensure, to the greatest extent possible, certainty, retroactivity, and equity.

Ratification and Validation Precedent in Delaware Practice. As a general matter, Delaware courts have issued decisions under the Delaware Law containing important insights and interpretive guidance that has greatly advanced the Delaware Law from a novel statute to a more widely understood and useful tool for Delaware corporate practitioners and stakeholders. In light of the relative complexity of ratification and validation statutes like section 119 and the similarities of section 119 to the Delaware Law, Delaware case law and practitioner commentary regarding the Delaware Law will provide helpful and persuasive guidance when implementing section 119. There are important distinctions between section 119 and the Delaware Law, as well as between Delaware and California statutory and common law regarding corporations, and those distinctions must be taken into account when considering the applicability of precedent related to the Delaware Law. But legislative commentary on section 119 states that section 119 is based on the Delaware Law and similar statutes from other states, which supports use of the Delaware Law as an appropriate source of guidance.

FOUNDATIONAL MATTERS OF RATIFICATION

Ratification and validation statutes build on a few foundational elements, which limit the scope of the statute, confirm its powerful effect within that limited scope, and provide an essential path for remediation of noncompliant corporate actions. Because these foundational elements apply to both the Delaware Law and section 119, it is appropriate that they result in similar application, interpretation, and development of the prerequisites, effect, and procedure for ratification. Because corporate ratification and judicial validation statutes have been around for less than a decade, experience and precedent from the Delaware Law provide a distinct advantage for understanding section 119 that may help to ensure that its powerful effect is directed toward the intended equitable purposes.

Prerequisites to Statutory Ratification. A Delaware corporation intending to ratify a defective corporate act under the Delaware Law is expected to be validly existing and have a validly constituted board of directors as of the time that the board adopts resolutions approving the ratification.⁶ In some circumstances, a certificate of correction or other measures may be available to shore up the validity of the corporate existence or board.⁷ When the corporation cannot establish that it is validly existing and has a validly constituted board, however, the corporate...