Selected 2017 Developments in Corporate Law

• Jurisdiction: California,United States
• Author: William Ross and Richard G. Burt
• Publication year: 2018
• Citation: Vol. 2018

Selected 2017 Developments in Corporate Law

William Ross and Richard G. Burt

William Ross, a member and an immediate past Co-Chair of the Corporations Committee of the Business Law Section of the California Lawyers Association, is of counsel to the firm of Hirschfeld Kraemer LLP. He is a transactional attorney with expertise in mergers and acquisitions and corporate governance matters for both for-profit and nonprofit entities.

Richard Burt practices law in San Jose, California. He is a co-author of the CEB handbook, Forming and Operating California Limited Liability Companies. He is also the author of a number of articles for the California Business Law Reporter, Business Law News, and e-Bulletins issued by the Corporations Committee. He served two terms on the Corporations Committee of the Business Law Section of the State Bar of California, where he was for a number of years Vice-Chair, Judicial Developments. He also served three terms on the Partnerships and Limited Liability Companies Committee.

The following article summarizes selected California legislative, regulatory, and case law developments in 2017, as well as certain significant actions undertaken by or relating to the U.S. Securities and Exchange Commission (the "SEC") in 2017.

Changes to the Corporations Code Relating to Bankrupt Corporations Filing for Dissolution

Effective January 1, 2018, section 1401 of the California Corporations Code was amended and section 1401.5 was added to authorize a trustee, liquidating agent, responsible officer, or other representative appointed by the court, in connection with a bankruptcy proceeding that has been initiated, to execute and file with the California Secretary of State a certificate of dissolution when the corporation has been completely wound up.¹

Changes to Section 2000 of the California Corporations Code Relating to Dissolution

Effective January 1, 2018, section 2000 of the California Corporations Code was amended.² Prior to the changes, section 2000 provided that, subject to any contrary provision in the articles of incorporation, in a suit for involuntary dissolution or a proceeding for voluntary dissolution initiated by shareholders owning 50% of the voting power, the corporation—or if it does not elect to purchase—the holders of 50% or more of the voting power, may avoid the dissolution of the corporation and appointment of a receiver by purchasing for cash the shares owned by the plaintiff or shareholders initiating the proceeding at their fair value. As amended, the statute now provides that the relevant provisions in the articles of incorporation may include a reference to a separate written agreement between two or more shareholders pertaining to the purchase of the shares, thereby obviating the requirement that such provisions be set forth in the articles.

California Department of Business Oversight Issues Final Regulations Implementing New Exemption from Broker-Dealer Requirements for Finders

Effective January 1, 2016, a new exemption from the broker-dealer requirements was created for certain individuals acting as finders, codified in section 25206.1 of the California Corporations Code.³ Among the conditions that must be satisfied to use the exemption are the following:

• the finder must be an individual;
• the size of the offering must not exceed $15 million;
• the finder can only make introductions to accredited investors;
• the finder cannot participate in negotiating any of the terms of the offering; and
• the finder must file with the California Department of Business Oversight ("DBO") an initial statement of information (with a $300 filing fee) and annual renewal statements (with a $275 renewal fee).

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On June 20, 2017, the DBO issued final regulations under the Corporate Securities Law of 1968 to implement the new law.⁴

California Case Law in 2017

Swart Enterprises, Inc. v. Franchise Tax Board (Jan. 12, 2017)⁵

In this case, a California court of appeal held that an out-of-state corporation whose sole connection with California was a 0.2% ownership interest in a manager-managed California limited liability company was not obligated to file a California corporate franchise tax return and pay the $800 minimum franchise tax due on that return.

Franchise Tax

California imposes a franchise tax on every corporation that is incorporated in California, qualified to transact business in California, or actively doing business in California. The minimum liability for all corporations subject to the tax is $800 per year.

An out-of-state (or "foreign") corporation is subject to the California franchise tax if it is "doing business" within California, whether or not it is incorporated, organized, qualified, or registered under California law.⁶ The phrase "doing business," for purposes of the franchise tax, means "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit."⁷

Factual Background

Swart Enterprises, Inc. ("Swart") was a small family-owned corporation that operated a sixty-acre farm in Kansas, where it occasionally fed cattle for beef sales in Nebraska. Its place of business and headquarters were located in Iowa. Swart had no physical presence in California, such as real or personal property or employees; it did not sell or market products or services to California. Swart was incorporated in Iowa and was not registered with the California Secretary of State to transact intrastate business in California.

In 2007, Swart invested $50,000 in Cypress Equipment Fund XII, LLC ("Cypress LLC") and acquired a 0.2% membership interest, Swart's sole connection with California. Cypress LLC was manager-managed, as opposed to member-managed. Under Cypress LLC's articles of organization and operating agreement, the sole manager of the company was given "full, exclusive and complete authority in the management and control of the business of the Fund."

Swart was not involved in any way in Cypress LLC's operations or management. In fact, members other than the manager were prohibited from taking part in the conduct or operation of the company. Members had no authority to execute an instrument on behalf of Cypress LLC or to otherwise act in any way on its behalf.

The Franchise Tax Board (FTB) concluded Swart was doing business in California based on the facts that it held an ownership interest in Cypress LLC, and that Cypress LLC, which was doing business in California, had elected to be treated as a partnership for purposes of federal income taxes. The FTB demanded that Swart file a California corporate franchise tax return and pay the $800 minimum franchise tax due on that return. Swart paid the tax (and penalties and interest). It then contested the obligation and sued for a refund.

Analysis

The court of appeal rejected the argument that the LLC's election to be classified as a partnership for federal income tax purposes resulted in all members of the LLC being considered general partners for all tax purposes.

The court of appeal cited the Order of the State Board of Equalization in In re Appeal of Amman & Schmid Finance AG⁸for the proposition that the business activities of a partnership cannot be attributed to limited partners. In Amman & Schmid, foreign corporations that were limited partners in partnerships were held not to be doing business in California simply because the general partners were doing business in California on behalf of the partnerships.

The Attorney General attempted to distinguish a limited partnership interest from a membership interest in a manager-managed limited liability company and cited California Franchise Tax Board ("FTB") Legal Ruling 2014-01.⁹ The court of appeal disagreed with the analysis in the FTB's ruling, and noted that the ruling contradicted a position previously taken by the FTB in Technical Advice Memorandum No. 200658.¹⁰

The court of appeal held that a corporation that passively holds a 0.2% membership interest in a manager-managed LLC, with no right to act for or control the LLC, is not "doing business" in California and therefore is not required to file a California corporate tax return or pay the California minimum franchise tax.

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Statutory Amendment

As described below, the definition of "doing business" in Revenue and Tax Code section 23101 was expanded, effective 2011, but because the franchise tax at issue in the case was imposed for Swart's tax year ending June 30, 2010, the statutory expansion of the definition of "doing business" did not apply to Swart.

For tax years beginning in or after 2011, Revenue and Tax Code section 23101(b) declares a taxpayer to be doing business in California if the taxpayer's sales, property, or compensation paid exceed certain limits set forth in the statute (with the dollar amounts to be revised annually by the FTB).

If the taxpayer's California sales for the taxable year exceed the lesser of $500,000 or 25% of the taxpayer's total sales, the taxpayer is doing business in California. For this purpose, sales of the taxpayer include sales by an agent or independent contractor of the taxpayer.

If the taxpayer's real property and tangible personal property in California exceed the lesser of $50,000 or 25% of the taxpayer's total real property and tangible personal property, the taxpayer is doing business in California.

If the amount of compensation paid in California by the taxpayer exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer, the taxpayer is doing business in California.

It is doubtful that the expansion of the definition of "doing business" would have changed the result in Swart, but the expanded definition could ensnare out-of-state entities that are not actively engaging in any transaction in California for the purpose of financial or pecuniary gain or profit.

Western Surety Co. v. La Cumbre Office Partners, LLC (Feb. 2, 2017)¹¹

In this case a California court of appeal held that a California limited liability company was bound by an indemnity agreement that was outside...