Selected Developments in Business Law — Organizing Corporations in California

Courtesy of CEB, we are bringing you selected legal developments in areas of California business law that are covered by CEB’s publications.  This month’s feature is from the January 2023 update to Organizing Corporations in California.  References are to the book’s section numbers.  The most significant legal developments affecting corporate formation practice in California since the last update include developments in such important topic areas as board diversity requirements, director inspection rights, the Corporate Transparency Act, crowdfunding, jurisdiction, and more.  Read More.

January 2023 Update

In two recent cases, the Los Angeles Superior Court invalidated Corp C §§301.3 and 301.4 (which require diversity on boards of public companies headquartered in California) on grounds that the statutes are unconstitutional. See Crest v Padilla (LA Super Ct, Apr. 1, 2022, 20 STCV 3751); Crest v Padilla (LA Super Ct, May 13, 2022, No. 19 STCV 27561). Both trial courts concluded that the statutes treat similarly situated individuals—qualified potential corporate board members—differently based on their membership (or lack thereof) in certain listed racial, sexual orientation, and gender identity groups. The trial courts held that the use of suspect categories was not justified by any compelling interest, and because the statutes were not narrowly tailored to serve the interests offered, the statutes therefore violate the equal protection clause of the California Constitution (Cal Const art 1, §7). The California Secretary of State has announced California’s plans to appeal the SB 826 decision. See §§1.82, 2.113A, 5.46A, 9.1.

In Blizzard Energy, Inc. v Schaefers (2021) 71 CA5th 832, 853, a case involving so-called reverse veil-piercing, the court held that an LLC could be added as an alter ego of the judgment debtor, finding that there was substantial evidence of a unity of interest and ownership between the two. The case was remanded because an innocent third party claim by the debtor’s spouse required further consideration. See §1A.25.

In Fowler v Golden Pac. Bancorp, Inc. (2022) 80 CA5th 205, the court held that a director’s involvement in litigation with the corporation did not defeat the director’s inspection rights. The court further held that a director’s inspection rights could be curtailed only in extreme circumstances, which require a showing of intent to use the information to commit a tort against the corporation that could not easily be remedied in a damages action. See §2.156.

The Corporate Transparency Act (CTA) (Pub L 116–283, 134 Stat 4604) provides that it will become effective when implementing regulations are finalized by the Secretary of the Treasury. 31 USC §5336(b)(5). The first set of final regulations was issued on September 30, 2022, and is codified in 31 CFR pt 1010. See 87 Fed Reg 59498. Two more sets of regulations are in the works. Under 31 CFR §1010.380(a), “reporting companies” (as defined in 31 USC §5336(a)(11) and 31 CFR §1010.380(c)) created before January 1, 2024, have until January 1, 2025, to submit the required reports to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of the Treasury, while entities formed on or after January 1, 2024, must submit reports within 30 calendar days of the time they are formed or registered. Any change in ownership of the entity or in other information reported must be reported within 30 calendar days after the change. 31 USC §5336(b)(1); 31 CFR §1010.380(a). See §2B.1.

As of January 1, 2022, California offers a crowdfunding exemption under Corp C §25102(r). The new law enables issuers to raise up to $300,000 on a funding portal conforming with federal Regulation CF (17 CFR §§227.100–227.206), without a financial statement review. Importantly, because the new California law is a blue-sky exemption that relies on federal Rule 147A (17 CFR §230.147A), it preserves for a follow-on federal Regulation CF offering the audit exception for first-time users of Regulation CF. To be eligible for the crowdfunding exemption, (1) the issuer must be a California corporation or a foreign corporation subject to Corp C §2115; (2) the offering must follow the requirements of federal Regulation CF (except that aggregate amount of securities sold by the issuer during the 12-month period preceding the date of offering, including the securities offered in such transaction, must not exceed $300,000); (3) the issuer need only include accounting statements certified by management rather than a review by an independent public accountant; (4) the issuer must take reasonable steps to ensure that each purchaser who is a natural person and not an accredited investor is able to evaluate the merits and risks of the prospective investment; (5) the issuer must give the purchaser a 3-day right to rescind any investment; (6) the issuer must not, itself or through any third party not licensed as a broker-dealer, conduct any direct solicitation of the securities; and (7) the issuer must not require any investor to waive jury trials, be bound by law other than California, or file or resolve a claim or dispute in a forum other than California. See §4.27A.

Since 2012, issuers commonly conduct private securities offerings and public crowdfunded offerings of up to $5 million by complying with federal registration exemptions under Regulation D and Regulation CF, which preempt California state qualification requirements. It is important to note, however, that state notice filing requirements are not preempted, so issuers relying on Rule 506(b) of Regulation D must file a copy of their Form D with the California Department of Financial Protection and Innovation. Corp C §25102.1(d). See §4.38.

Effective January 1, 2022, an award of reasonable attorney fees is mandatory to an investor plaintiff who prevails in an action under Corp C §25401 or §25503 against a defendant that fails to comply with the applicable qualification requirement. See §§4.171–4.172, 4.176.

In Daimler Trucks N. Am. LLC v Superior Court (2022) 80 CA5th 946, 958, the court held that a nonresident defendant had systematically served the California market by advertising, selling, and servicing trucks in California; therefore, minimum contacts had been shown. See §5.79.

In LG Chem, Ltd. v Superior Court (2022) 80 CA5th 348, 365, the court found that the consumer’s negligence and product liability claims did not arise from or relate to the manufacturer’s sales in California; thus, there was no specific personal jurisdiction. See §5.79.

In SK Trading Int’l Co., Ltd. v Superior Court (2022) 77 CA5th 378, an action alleging oil and gas firms conspired to manipulate the California gasoline market, the court of appeal held that the trial court properly exercised specific personal jurisdiction over a nonresident parent corporation. The activities that its subsidiary undertook on the parent’s behalf were purposefully directed toward California for the purpose of engaging in economic activity with California residents. Thus, they could be attributed to the parent for purposes of personal jurisdiction, even apart from the specific requirements of the theories of alter ego or agency, because there was evidence indicating that the parent’s officers had been directly involved in creating the policies that were alleged to constitute an anticompetitive scheme. Minimum contacts had therefore been shown. See §5.79.

In Seafarers Pension Plan v Bradway (7th Cir 2022) 23 F4th 714, the plaintiff shareholder filed a derivative suit on behalf of the Boeing Company under §14(a) of the Securities Exchange Act of 1934 (15 USC §78n(a)(1)), alleging that Boeing’s directors and officers made materially false and misleading public statements about the development and operation of the 737 MAX in Boeing’s proxy materials. The district court applied a Boeing bylaw that gave the company the right to insist that any derivative actions be filed in the Delaware Court of Chancery and dismissed the case. The Seventh Circuit reversed, holding that the Exchange Act gives federal courts exclusive jurisdiction over actions under it; therefore, applying the forum selection bylaw would mean that plaintiff’s derivative action could not be heard in any forum. See §5.83A.

On October 7, 2021, the Governor signed into law AB 488 (Stats 2021, ch 616), which establishes that charitable fundraising platforms are trustees for charitable purposes subject to the Attorney General’s supervision. The new law will take effect on January 1, 2023. According to the definition to be codified under new Govt C §12599.9(a), “charitable fundraising platforms” will include any corporation that uses the internet to provide an internet website, service, or other platform to persons in California through which it performs, permits, or otherwise enables acts of charitable solicitation to occur. See §8.20A.