BILL ANALYSIS SENATE JUDICIARY COMMITTEE Senator Ellen M. Corbett, Chair 2009-2010 Regular Session AB 2158 (Hagman) As Amended May 18, 2010 Hearing Date: June 22, 2010 Fiscal: No Urgency: No TW:jd SUBJECT Corporations: Bylaws: Board of Director Meetings DESCRIPTION This bill would remove the sunset on existing provisions of law requiring an interested or common director of a corporation to disclose all material facts in transactions in which the interested or common director has a self-interest, thereby making these provisions of law permanent. BACKGROUND Directors of corporations may become personally interested in transactions involving the corporation. An example of this is when the director loans the corporation money. The board of directors would vote on whether the corporation should take a loan from the loaning director, who would have a personal interest as to whether the corporation takes the loan and how much interest could be charged for the loan. Prior to 2005, the board of directors of the corporation, including the interested director, could sign a written consent voting in favor of the loan transaction. Litigation arose by shareholders alleging that interested directors were not properly disclosing their personal interest in the transaction with the corporation. An example of this situation is when the interested director of Corporation A owns shares of Corporation B. The board of directors of Corporation A is unaware that the interested director has a financial interest in the transaction based upon his or her relation to Corporation B. The interested director may have touted the advantages of the transaction (more) AB 2158 (Hagman) Page 2 of ? between the corporations for the purpose of benefiting the director rather than benefiting Corporation A. Based on the information received by the interested director, the board of directors of Corporation A vote in favor of the transaction with Corporation B, potentially to the detriment of Corporation A. SB 119 (Ackerman, Chapter 102, Statutes of 2005) addressed these issues stemming from the self-interested director. SB 119 required the interested director to make appropriate disclosures of his or her interest in the transaction prior to the board of directors' vote. When this committee heard SB 119, it amended the bill to include a sunset date of December 31, 2010, in order to revisit whether the disclosure requirements were working effectively. This bill originally contained revisions to the Corporations Code regarding close corporations. Those provisions were deleted and the bill would make permanent the existing transaction disclosure requirements by an interested director. CHANGES TO EXISTING LAW Existing law provides that a transaction involving an interested director is not void or voidable due to the presence of the interested director during the vote on the transaction as long as the self-interested director discloses his or her interest in the transaction. (Corp. Code Secs. 310, 5233, 7233, 9243, 12373.) Existing law permits a board of directors to take any action without a formal meeting, provided all the members of the board consent in writing. The action taken by written consent is given the force and effect as if it was unanimously approved by the directors. (Corp. Code Secs. 307, 5211, 7211, 9211, 12351.) Existing law , until December 31, 2010, provides that for actions by written consent involving an interested or common director, the interested or common director must disclose his or her interest in the transaction pursuant to the requirements under Corporations Code Section 310. (Corp. Code Sec. 307(b).) Existing law , until December 31, 2010, requires the interested or common director to disclose his or her interest to the noninterested or noncommon directors prior to the execution of written consents regarding the transaction. (Corp. Code Sec. 307(b).) AB 2158 (Hagman) Page 3 of ? Existing law , until December 31, 2010, requires the written consent to conspicuously state the required disclosure of interest by the interested or common director. (Corp. Code Sec. 307(b).) Existing law , until December 31, 2010, requires that in order for the transaction to be approved by the board of directors, there must be sufficient written consents excluding those submitted by the interested or common directors. (Corp. Code Sec. 307(b).) This bill would delete the December 31, 2010 sunset, thereby making permanent existing laws regulating written consents regarding interested or common directors. COMMENT 1. Stated need for the bill The author writes: A "close corporation," also known as "closely held corporation," is a corporation with no established market for shares and restrictions on the transfer of shares. It is characterized by having few shareholders (a maximum of 35) who are active in the management of their business. Current law, under Section 307 of the Corporations Code, allows board members and shareholders of a closely held corporation to decide on a transaction without a board meeting if all board members consent in writing to that action. The written consents in order to be effective must be unanimous. However, under Section 310 of the Corporations Code a transaction could be considered void or voidable if one of the directors has a financial interest in the transaction or is a board member of a corporation with which this corporation was involved in a transaction. If either of these scenarios apply the board director would be considered an "interested" director and would need to disclose his/her interest. Since a transaction could be contested or impaired as a result of an interested director approving it, interested directors are reluctant to sign on to a written consent. Without their approval, however, the written consents cannot be effective AB 2158 (Hagman) Page 4 of ? Code Section 307(b) was enacted to resolve this issue. According to it the interested director can disclose his/her interest in the transaction (as required by Section 310) and also abstain from approving the transaction, with the written consents being effective if the majority of the non-interested directors approved the transaction. The sponsor of this bill, the Business Law Section - Corporation Committee of the State Bar, discusses the need for this bill as follows: Section 307(b) allows an interested director to sign on to a written consent so it can be effective - written consents must be unanimous. The interested director, however, can also disclose her interest in the transaction and also abstain from the approval of the transaction. The provision is a helpful tool for corporations to allow for written consents otherwise to be used in connection with the approval of interested director transactions. Otherwise, directors sometimes are unwilling to sign on to a written consent if they have an interest in the transaction. This provision was introduced from input by the Corporations Committee. [SB 119] was amended to include a sunset of December 31, 2010. Practitioners continue to believe that this is a helpful provision and hope that it does not disappear from the code at the end of this year. When the sunset was discussed by the Corporations Committee at its last meeting, no member of the Committee was aware of any negative impacts of keeping Section 307(b) as currently in effect. 2. Effect of sunset clause on the regulation of interested directors This bill seeks to make permanent the provisions under existing law, Corporations Code Section 307(b), by removing the December 31, 2010 sunset clause which was added to make certain that provisions of the bill did not result in unintended consequences with respect to the disclosure requirements by interested or common directors. Existing law, enacted by SB 119 (Ackerman, Chapter 102, Statutes of 2005), was created to codify the existing practice under Corporations Code Section 310, whereby interested and common directors were required to disclose their interest pertaining to pending transactions of the corporation. AB 2158 (Hagman) Page 5 of ? However, there was no definitive statute regarding disclosure requirements pertaining to written consents. When no formal meeting was held regarding the transaction, the board could vote through written consent. It was uncertain if a shareholder later could challenge a written consent vote based on the failure to comply with the procedures for self-interest disclosure provided by Corporations Code Section 310. Once this statute sunsets, the prior statute will become effective. The prior statute contains no cross-reference to Corporations Code Section 310 requiring interested or common directors to disclose their self-interest in the corporation's transactions. It would then, again, be unclear as to whether shareholders later could challenge written consent votes based on self-interest disclosure. Given that the sunset was added to make certain no unintended consequences resulted from the regulations specified in SB 119, and there have been no reports of problems with these regulations or negative impacts, it appears to be appropriate to remove the sunset thereby making the provisions of existing law permanent. Support : Secretary of State Opposition : None Known HISTORY Source : Business Law Section - Corporations Committee of the State Bar of California Related Pending Legislation : None Known Prior Legislation : See Background. Prior Vote : Assembly Banking and Finance Committee (Ayes 11, Noes 0) Assembly Floor (Ayes 77, Noes 0) ************** AB 2158 (Hagman) Page 6 of ?