BILL ANALYSIS �
SENATE JUDICIARY COMMITTEE
Senator Noreen Evans, Chair
2011-2012 Regular Session
AB 2260 (Hagman)
As Amended March 29, 2012
Hearing Date: July 3, 2012
Fiscal: No
Urgency: No
RD
SUBJECT
Foreign Corporations
DESCRIPTION
Existing law applies specified provisions of California's
corporations law to specified foreign corporations (corporations
incorporated outside of California) that meet certain criteria.
This bill would repeal that section and instead provide that the
chapter on foreign corporations in California's General
Corporation Law shall not be construed to authorize the state to
regulate the organization or internal affairs of a foreign
corporation qualified to do business in this state, except as
specified.
BACKGROUND
In the United States, a corporation is free to incorporate in
any state that it wants. Where it plans to do its business, or
where its organizers or shareholders reside has no bearing on
what state it can incorporate in. As a result, a corporation
can operate the majority of its business and have a majority of
its shareholders in California, but if it is incorporated in
another state, it falls under the category of a foreign
corporation. Domestic corporations are those corporations
incorporated in this state; corporations that have incorporated
under the laws of another state are, therefore, foreign
corporations. Most states in the country follow the general
conflict of laws principle that the internal affairs of a
corporation are governed by the laws of its state of
(more)
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incorporation. Section 2115 of California's General
Corporations Law, when it was adopted in 1975, represented a
departure from that principle with its purpose being to protect
California shareholders.
In consideration of the fact that some corporations are foreign
corporations but both do their business in California and have
their shareholders in California, Section 2115 allows specified
California laws to apply to this subset of foreign corporations.
More specifically, the section requires these foreign
corporations with specified minimum contacts in California to
comply with certain provisions of the General Corporation Law
for the protection of California creditors and shareholders.
Subdivision (b) of Section 2115 lists 23 specific sections and
four chapters of the Corporations Code that are applicable to
foreign corporations that meet both of the following
requirements: (1) more than 50 percent of the outstanding voting
securities are held by persons having addresses in California;
and (2) more than 50 percent of the corporation's business is in
California. (Such corporations are at times referred to as
quasi-foreign or pseudo-foreign corporations.) These 23
sections contain fundamental provisions of the Corporations Code
for business corporations, including such matters as voting in
the election of directors, removal of directors, directors'
standard of care, liability of directors for unlawful
distributions, dissenters' rights in mergers, rights of
inspection and various other matters. Corporations that might
otherwise qualify but are statutorily exempt from these
requirements include publicly-traded corporations, among others.
This bill, sponsored by the Corporations Committee of the
California State Bar, would repeal Section 2115 and instead
provide that, except for the section on director liability for
violations of official duty, as specified, Chapter 21 (on
foreign corporations) shall not be construed to authorize the
state to regulate the organization or internal affairs of a
foreign corporation qualified to do business in this state.
CHANGES TO EXISTING LAW
Existing law , the General Corporations Law's chapter on foreign
corporations, Chapter 21, applies only to foreign corporations
transacting intrastate business, except as otherwise expressly
provided. (Corp. Code Sec. 2100.)
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Existing law defines "domestic corporation" as a corporation
formed under the laws of this state. (Corp. Code Sec. 167.)
Existing law defines "foreign corporation" as any corporation
other than a domestic corporation and, when used in specified
sections of law, including Chapter 21 on foreign corporations,
includes a foreign association, unless otherwise stated.
Existing law provides that "foreign corporation" as used in
Chapter 21 does not include a corporation or association
chartered under federal law. (Corp. Code Sec. 171.)
Existing law prohibits any foreign corporation from transacting
intrastate business without having first obtained from the
Secretary of State a certificate of qualification, as specified.
(Corp. Code Sec. 2015.)
Existing law provides that a corporation is subject to certain
provisions of California law concerning, among other things,
corporate reorganizations and mergers, liability, distributions,
and shareholder rights, if both: (1) more than 50 percent of the
outstanding voting securities of a foreign corporation are held
by persons having addresses in California; and (2) more than 50
percent of its business is in California. (Corp. Code Sec.
2115.)
Existing law exempts the following foreign corporations from
Section 2115's requirements:
foreign business trusts;
corporations listed on National Securities Exchanges;
corporations with securities qualified for national trading;
wholly owned subsidiaries of excluded corporations (if all the
corporation's voting shares, except directors' qualifying
shares) are owned directly or indirectly by a corporation that
is itself not subject to the provisions); and
nonprofit corporations. (Corp. Code Sec. 2115(a), (c).)
Existing law provides that the directors of a foreign
corporation transacting intrastate business are liable to the
corporation, its shareholders, creditors, receiver, liquidator
or trustee in bankruptcy for the making of unauthorized
dividends, purchase of shares or distribution of assets or false
certificates, reports or public notices or other violation of
official duty according to any applicable laws of the state or
place of incorporation or organization, whether committed or
done in this state or elsewhere. Existing law provides that
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such liability may be enforced in the courts of this state.
(Corp. Code Sec. 2116.)
This bill would repeal Section 2115 and instead provide that,
except as otherwise provided in Section 2116 above, Chapter 21
(the chapter on foreign corporations in California's General
Corporation Law) shall not be construed to authorize the state
to regulate the organization or internal affairs of a foreign
corporation qualified to do business in this state.
This bill would make other conforming changes.
COMMENT
1. Stated need for the bill
According to the author:
Historically, corporations have not encountered conflicts
between state laws. Controversies have been resolved . . .
involving a corporation's internal affairs by applying the law
of the state that created the corporation, irrespective of
where that corporation is located or does business. This
principle, known as the Internal Affairs Doctrine, is an
established principle underlying the American free enterprise
system, a state has an interest in promoting stable
relationships, among parties involved in the corporations it
charters, as well as in ensuring that investors have an
effective voice in corporate affairs. California has created
statutes that conflict with the Internal Affairs Doctrine for
certain foreign corporations, i.e., corporations created under
the laws of other states by enacting Section 2115 can have
significant impacts.
. . . Assembly Bill 2260 takes the proactive step of
repealing Section 2115 before the federal courts strike it
down and the state is forced to spend additional taxpayer
dollars defending and regulation that keeps companies out of
California. All this section of code accomplishes is
confusing well established national corporate governance law.
Why would a company take the chance of subjecting itself to
the extra regulation? We are seeing the results of this type
of short sighted and arrogant legislation every time a company
works to ensure that the "property" and "payroll" triggers are
never met. Thus, a new plant will be built, and new jobs will
be created but not in California.
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2. Section 2115 and the Internal Affairs doctrine
Section 2115 applies a limited number and type of California
laws to foreign corporations that meet specified requirements.
Namely, Section 2115 applies certain fundamental provisions of
California corporations law to a foreign corporation only if (1)
more than 50 percent of the outstanding voting securities of a
foreign corporation are held by persons having addresses in
California; and (2) more than 50 percent of its business is in
California. With respect to the second factor, "business" is
measured using the corporation's in-state property assets, sales
revenue, and payroll allocations (Corp. Code Sec. 2115
(a)(1))-things that any corporation doing business in California
must calculate in order to pay their annual franchise tax.
Thus, while the section applies to "foreign corporations," in
actuality, it applies only to quasi-foreign corporations or
pseudo-foreign corporations; if a corporation is truly
"foreign," and has insufficient or no ties whatsoever to
California, Section 2115's requirements cannot reach that
corporation. At the same time, it is unclear how many foreign
corporations actually meet the prerequisites to the application
of Section 2115.
This bill would repeal Section 2115, in part because the
proponents of the bill believe that this section will eventually
be deemed unconstitutional, and because they believe this
section keeps companies out of California.
a. The Delaware advantage and California's attempt to
protect its shareholders and creditors
Delaware is in many respects, this country's preeminent
corporate haven. About 60 percent of all publicly-traded
American corporations are chartered there and over 80 percent
of all out-of-state incorporations of such firms are in
Delaware. It, for all intents and purposes, "dominates the
'market' for incorporations of publicly-traded firms."
(Glynn, Delaware's VantagePoint the Empire Strikes Back in the
Post-Post-Enron Era (2008) 120 Nw. U.L. Rev. 91, 98-99.) The
state's approach to regulation of the corporations it has
attracted in turn attracts even more corporations: it has no
agency or other executive apparatus that directly regulates
corporate governance or securities. As noted by one legal
scholar, "�o]f course, whether Delaware's largely permissive
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brand of corporate law is superior - for shareholders and not
just management - has been the subject of the decades-old
race-to-the-bottom versus race-to-the-top debate." (Id. at
99.)
Unsurprisingly, the Delaware courts have not received
California's Corporations Code Section 2115 well. The
California Legislature enacted Section 2115 in 1975 to allow
the state, effective January 1, 1977, to regulate all
corporations that conduct a majority of their business in
California, as specified, even if they are incorporated
elsewhere and technically considered foreign corporations. As
noted in a legislative committee comment, the statute is not
meant to replace the regulatory rights of the incorporating
state, or to require compliance with the General Corporation
Law of this state over the laws of the state of incorporation,
"even though all of its shareholders reside in this state and
it carriers on all of its business within this state." Rather
the purpose of enacting Section 2115 was "for the protection
for California creditors and shareholders," with respect to
only those foreign corporations that have specified minimum
contacts with this state. Given the vast number of these
publicly-traded corporations that choose to take advantage of
the favorable laws of Delaware by incorporating there, even
when they do most of their business in another state, such as
California, and their shareholders are mostly from that other
state, as a matter of public policy, it does not appear
unreasonable for California to make the conscious decision to
protect its shareholders and creditors in some limited
fashion.
It has been commented that the conflict between these two
states, Delaware and California, is noteworthy because "they
are two of the most significant jurisdictions in the
development of corporate law-more than sixty percent of all
Fortune 500 companies are incorporated in Delaware, for
example, and approximately twenty percent are headquartered in
California." (Stevens, Internal Affairs Doctrine: California
Versus Delaware in a Fight for the Right to Regulate Foreign
Corporations (2007) 48 B.C.L. Rev. 1047, 1049.) Even though a
recent Delaware case, VantagePoint Venture Partners 1996 v.
Examen, Inc. (2005) 871 A.2d 1108 took the occasion to declare
California's statute unconstitutional on appeal (the Court of
Chancery, the lower court, had reached the same decision
without reaching that question), that decision has no bearing
in the courts of this state and the constitutionality of the
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statute. (See Comment 2c below, for more discussion on the
statute's constitutionality.) Arguably, the constitutionality
of a California statute is question for the California courts,
applicable federal courts, and potentially the U.S. Supreme
Court. This bill would, however, seek to repeal Section 2115
before it is overturned, presuming that it would be in fact be
overturned eventually.
b. Internal Affairs doctrine, generally
The Internal Affairs doctrine is a conflict of laws principle
that in many ways operates as a choice of law rule which deals
with the issue of what law applies to the case at hand when
there is a conflict of laws. A court can theoretically have
jurisdiction, and yet have to apply the laws of another state
under choice of law rules. The Internal Affairs doctrine
recognizes that only one state should have the authority to
regulate a corporation's internal affairs, those matters
peculiar to the relationships among or between the corporation
and its officers, directors and shareholders, because
otherwise a corporation could be faced with conflicting
demands. (Restatement (Second) Conflict of Laws Sec. 302.)
While earlier cases adhered more to the strict view that a
court would not entertain an action involving the internal
affairs of a foreign corporation, the modern rule is that a
court will exercise jurisdiction unless it is an inappropriate
or inconvenient forum for the trial of the action. When the
court does take jurisdiction, it will usually apply the law of
the state of incorporation. In some situations however, a
court may, in the interest of justice, exercise jurisdiction
over internal affairs and apply local rule. Another basis for
taking jurisdiction over actions involving internal affairs is
presented where the foreign corporation, though incorporated
elsewhere, actually makes the local state its principal place
of business and has records and offices there. (9 Witkin Sum.
Cal. Law Sec. 239.) Section 2115, which this bill seeks to
repeal, represents California's exception to the traditional
Internal Affairs doctrine and operates to allow California, in
limited fashion, to regulate the subset of foreign
corporations that do a majority of their business here and
have a majority of its shareholders here.
If this bill were to repeal this statute, none of the
specified provisions of law would apply to such corporations
that are so substantially tied to this state but that have
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incorporated elsewhere. If enacted, this bill would expressly
prohibit other sections of California law relating to foreign
corporations from being construed to authorize the state to
regulate the organization or internal affairs of a foreign
corporation qualified to do business in this state. The
stated exception to that "hands off" approach would be Section
2116, which provides for the liability of the directors of a
foreign corporation transacting intrastate business under
specified circumstances.
By removing application of California law to those specified
corporations, this bill could arguably create an uneven
playing field among California corporations that incorporate
here, and corporations that rely on California's shareholders
and market, but that incorporate elsewhere. While proponents
argue that it would attract more business here, it arguably
also has the effect of incentivizing corporations to not
incorporate in California, leaving this state without the
ability to ensure its residents, who might often be the
shareholders or creditors of these corporations. It is not
clear why a business would choose to incorporate in California
if it is guaranteed that it can do all of its business here,
while also taking advantage of the favorable laws of a state
such as Delaware.
c. Constitutionality of Section 2115-California's narrow
exception to the Internal Affairs doctrine
The sponsor of this bill writes that ". . . Assembly Bill 2260
takes the proactive step of repealing Section 2115 before the
federal courts strike it down and the state is forced to spend
additional taxpayer dollars defending and regulation that
keeps companies out of California. All this section of code
accomplishes is confusing well established national corporate
governance law."
In background materials provided by the author, the author
quotes from Justice Lewis F. Powell in the United States
Supreme Court case of CTS Corp. v. Dynamics Corp. of America
(1987) 481 U.S. 69 as follows with respect to the Internal
Affairs Doctrine: "It is thus an accepted part of the
business landscape in this country for States to create
corporations, to prescribe their powers, and to define the
rights that are acquired by purchasing their shares. A State
has an interest in promoting stable relationships among
parties involved in the corporations it charters, as well as
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in ensuring that investors have an effective voice in
corporate affairs."
Staff notes that this, as a stand-alone statement, is valid.
However, being taken out of context, it over looks several
things: first, the Court in CTS Corp. neither decided, nor
provided support for the proposition that another state may
never regulate the internal affairs of a firm chartered
elsewhere. It merely reaffirmed the authority of the state of
incorporation to regulate. Second, the constitutionality of
the statute in question, Section 2115 of the California
Corporations Code, was not at issue in the case. Third, staff
is unaware of any U.S. Supreme Court case that directly
determined either of these points such that it would firmly
suggest that Section 2115 is unconstitutional, though a few
cases are regularly cited to for generally upholding the
principle of the Internal Affairs doctrine. Furthermore, the
issue for the constitutionality of this section is ultimately
one for the courts.
As a matter of public policy, while a state certainly has a
significant interest in regulating corporations that it
charters and promoting stable relationships among parties
involved in those domestic corporations, it is not unthinkable
that a sister state might also have a significant interest in
protecting shareholders of that corporation who are
overwhelming residents of the sister state-particularly where
the corporation is only a corporation of that first state on
paper and does most of its actual business in that sister
state.
As noted by a letter submitted by an individual with an
extensive background in corporations law in California state
government, in opposition to this bill:
For nearly a century, the California Constitution enshrined
the basic principle that foreign corporations should be
treated on part with California: "No Corporation organized
outside the limits of this State shall be allowed to
transact business within this State on more favorable
conditions than are prescribed by law to similar
corporations organized under the laws of this State." Cal.
Const. Art. XII, Sec. 15 (repealed �in 1972]). As the
eminent Jurist Benjamin Cardozo wrote in 1915, "In these
days, when countless corporations, organized on paper in
neighboring states, live and move and have their being in
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New York, a sound public policy demands that our
Legislature be invested with this measure of control."
German-American Coffee Co. v. Diehl, 216 NY 57, 64 (1915).
When the legislature enacted the current General
Corporation Law more than three decades ago, it retained
this important principle in Corporations Code Section 2115.
Elimination of Section 2115 would constitute a fundamental
departure from California's historical position that it has
a fundamental interest in ensuring basic shareholder rights
when a majority of a corporations' owners and a majority of
its business activities are founded in this state. . . .
Again, while the issue of constitutionality is one for the
courts, Staff notes that a California appellate court has at
least on one occasion examined and rejected major
constitutional challenges to Section 2115, holding that it
violates neither the Full Faith and Credit Clause, nor the
Commerce Clause, nor the Due Process or Equal Protection
clauses of the 14th Amendment. (See Wilson v.
Louisiana-Pacific Resources, Inc. (1982) 138 Cal.App.3d 216;
California courts have applied Section 2115 on numerous
occasions in the years since.) Notably, that case involved an
action by a shareholder against a Utah corporation that met
the prerequisites of Section 2115 and, except for being
domiciled in Utah had no business connection with that
state-California was its principle place of business, where it
held its meetings with shareholders and directors, and where
all of its employees and bank accounts were located. As to
the commerce clause challenge specifically, where generally a
state statute affecting interstate commerce will be upheld if
the local purpose is clearly legitimate and is not clearly
excessive, the court found that the same requirements that
applied to the covered foreign corporations applied to
domestic corporations and "to the extent that the cumulative
voting requirement imposed by Section 2115 upon pseudo-foreign
corporations is shown to have any effect upon interstate
commerce, the effect is incidental, and minimal in relation to
the purpose which that requirement is designed to achieve."
(Id. at 228.)
1. No ability to regulate organization or internal affairs of a
foreign corporation
In place of the current Section 2115, the bill would instead
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provide that the chapter on foreign corporations shall not be
construed to authorize the state to regulate the organization or
internal affairs of a foreign corporation qualified to do
business in this state, except as otherwise provided in Section
2116 of the Corporations Code. Section 2116 provides that the
directors of a foreign corporation transacting intrastate
business are liable to the corporation, its shareholders,
creditors, receiver, liquidator or trustee in bankruptcy for the
making of unauthorized dividends, purchase of shares or
distribution of assets or false certificates, reports or public
notices or other violation of official duty according to any
applicable laws of the state or place of incorporation or
organization, whether committed or done in this state or
elsewhere. Existing law provides that such liability may be
enforced in the courts of this state. (Corp. Code Sec. 2116.)
What this language means by "regulate," or the "organization" or
"internal affairs" of a foreign corporation is unknown. Whether
or not something relates to internal affairs is something that
can be debated. For example, while shareholder rights could
generally be portrayed as being related to internal affairs, the
right of mere inspection does not necessarily involve the
internal affairs of the corporation. "�T]he inspection of
shareholder lists is a right incidental to the ownership of
stock, affects the relationship between corporation and
shareholder, and is thus subject to regulation by statute where
the corporation does business." Valtz v. Penta Inv. Corp.
(1983) 139 Cal.App.3d 803, 807 (the court ultimately held that
the public policy of California is to place no proper-purpose
restriction on a shareholder's right of inspection and the
California courts must enforce that policy despite Penta's
Delaware incorporation).
Ultimately, prohibiting the state from taking even reasonable
steps to require certain acts from these foreign corporations,
as this bill might arguably do, could lead to an uneven playing
field among corporations that do business in California and
provide yet another incentive for corporations to incorporate
outside of California.
Support : None Known
Opposition : One individual
HISTORY
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Source : Corporations Section of the California State Bar
Related Pending Legislation : None Known
Prior Legislation : None Known
Prior Vote :
Assembly Floor (Ayes 75, Noes 0)
Assembly Banking & Finance Committee (Ayes 11, Noes 0)
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