Alerts and Updates
Del. Supreme Court Declares Cal. Statute Invalid, Citing Internal Affairs Doctrine
July 11, 2005
California "Quasi-California Corporation" Statute Applying California Corporate Code to Delaware Corporations Is Unconstitutional
Section 2115 of the California Corporations Code (CCC§2115) requires a corporation with significant California contacts - sometimes referred to as a "quasi-California corporation" - to comply with certain provisions of the California Corporations Code even if the corporation is incorporated in another state, such as Delaware. In VantagePoint Venture Partners v. Examen, Inc. (871 A 2d 1108, 2005 Del. LEXIS 179, decided May 5, 2005), however, the Delaware Supreme Court ruled that CCC§2115 is unconstitutional, and that the Delaware General Corporation Law (the "GCL") exclusively governs the internal corporate affairs of a Delaware corporation.
Background
CCC§2115 mandates application of certain enumerated provisions of California's corporation law to the internal affairs of foreign corporations if more than one-half of a foreign corporation's outstanding voting securities is held of record by persons having addresses in California and specified property, payroll and sales factor tests are satisfied. If CCC§2115 is deemed to apply, then California law provides that many aspects of a foreign corporation's internal affairs will be governed by California corporate law to the exclusion of the law of the state of incorporation.1
On February 17, 2005, Examen, Inc., a privately held Delaware corporation, entered into a merger agreement with a Delaware subsidiary of Reed Elsevier Inc. Under the GCL, such a merger would not entitle the holders of a class or series of Examen stock to a separate class vote; but, if Examen were deemed to be a quasi-California corporation under CCC§2115, then a separate class vote to approve the merger would be required under Section 1201(a) of the California Corporations Code. On March 3, 2005, Examen sought a declaratory judgment from the Delaware Chancery Court that VantagePoint, a venture capital investor that owned more than 83 percent of the outstanding Series A Preferred Stock of Examen, was not entitled to a separate class vote on the proposed merger. VantagePoint promptly filed suit in the California Superior Court seeking a declaration that it was entitled to a separate class vote based on CCC§2115 (on the theory that Examen's significant California contacts made it a "quasi-California corporation"). After the Delaware Chancery Court agreed to expedite the case before it, the California court stayed the California proceeding pending the ruling from the Delaware Chancery Court. The Delaware Chancery Court ruled (on March 29, 2005) that the GCL, to the exclusion of California law, would apply to the shareholder vote requirement, under the internal affairs doctrine described by the Delaware Supreme Court in its 1987 decision, McDermott Inc. v. Lewis. VantagePoint appealed to the Delaware Supreme Court.
Delaware Supreme Court Ruling
The Delaware Supreme Court affirmed the ruling of the Delaware Chancery Court. The Court relied on the internal affairs doctrine enunciated by the U.S. Supreme Court in CTS Corp. v. Dynamics Corp of Am. (1987), where the Supreme Court held that it is "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." The Delaware Supreme Court noted that the internal affairs doctrine is a long-standing choice of law principle that recognizes that only one state, the state of incorporation, has the authority to regulate a corporation's internal affairs, i.e., "those matters that pertain to the relationships among and between the corporation and its officers, directors and shareholders."
The Court went on to explain that the internal affairs doctrine is more than a conflicts of law principle. Rather, it is also mandated by constitutional principles under the Due Process Clause of the Fourteenth Amendment, except in rare situations where the law of the state of incorporation is inconsistent with national policy on foreign or interstate commerce. The Delaware Supreme Court held that disputes concerning shareholders' right to vote fall squarely within the purview of the internal affairs doctrine. The Court also remarked that VantagePoint had not cited a single California Supreme Court decision that had applied CCC§2115 to shareholder voting of a corporation incorporated in a state other than California.
In its analysis of CCC§2115, the Delaware Supreme Court commented that the internal affairs doctrine is based on the need for uniformity, certainty, stability and predictability. The certainty and predictability of the internal affairs doctrine "protects the justified expectations of the parties with interests in the corporation." Further, the Court stressed that the very nature of CCC§2115 was anything but certain or predictable, as the criteria for determining whether a corporation is subject to CCC§2115 are ever changing because the question of whether the various tests are satisfied to subject a non-California corporation to CCC§2115 often varies from year to year, and even throughout the same year. The Court stated that the application of CCC§2115 was "apt to produce inequalities, intolerable confusion, and uncertainty and intrude into the domain of other states that have a superior claim to regulate the same subject matter."
Is the Quasi-California Corporation Dead?
The Delaware Supreme Court's opinion, and in particular its reliance on the U.S. Supreme Court's endorsement of the internal affairs doctrine in CTS Corp., should provide reassurance to Delaware businesses and their counsel that Delaware courts will apply the GCL to a Delaware corporation's internal affairs, notwithstanding the corporate laws of other states.2 Unfortunately, however, the Delaware Supreme Court's decision still leaves the uncertainty of whether other state courts will follow Delaware's lead for corporations incorporated in other states and which do business in California. In particular, because California courts have not yet invalidated CCC§2115, the possibility remains that a lawsuit involving CCC§2115 could have a different outcome in a different state. Thus, VantagePoint gives comfort with respect to Delaware corporations, but uncertainty remains regarding whether corporations from other states will need to comply with the requirements of the California Corporations Code.
For Further Information
For more information or if you have any questions about this Alert, please contact Michael Margulis, David Kaufman, any of the other attorneys in our Corporate Practice Group, or the attorney in the firm with whom you are regularly in contact.
1 Specifically, if CCC§2115 is deemed to apply, then California law purports to govern the annual election of directors; removal of directors without cause; removal of directors by court proceedings; the filing of director vacancies where less than a majority in office are elected by shareholders; the director's standard of care; the liability of directors for unlawful distributions; indemnification of directors, officers and others; limitations on corporate distributions in cash or property; the liability of shareholders who receive unlawful distributions; the requirement for annual shareholders' meetings and remedies for the same if not timely held; shareholders' entitlement to cumulative voting; the conditions when a supermajority vote is required; limitations on the sale of assets; limitations on mergers; limitations on conversions; requirements on conversions; the limitations and conditions for reorganization (including the requirement for class voting); dissenter's rights; records and reports; actions by the Attorney General; and inspection rights.
2 In the California Superior Court case filed by VantagePoint, seeking a declaration that a separate class vote was required under CCC§2115, a demurrer (motion to dismiss) is pending and presently scheduled for July 28, 2005.
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