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DO NON-VOTING SHARES IN CALIFORNIA CORPORATIONS HAVE VOTING RIGHTS?

By Rajnish Puri

Small business owners – new and established – often inquire about the pros and cons of creating voting and non-voting forms of equity. Naturally, the primary motivation behind the inquiry is to limit the number of persons who can influence business decisions.  This article examines the relevant issues to consider when issuing non-voting shares in the context of California corporations.

New businesses, when deciding on the form of legal entity for their existence – a corporation, limited liability company, partnership or other – consider a variety of factors. The analysis typically includes an examination of issues pertaining to tax implications, the ability to attract investors, simplicity of corporate documents, effective governance models, and the flexibility of establishing employee incentive plans.  Management and control of business affairs is a theme that connects most issues and, therefore, gets a strong consideration in the decision making process.  Interestingly, having the ability to control a business is not just confined to new enterprises; it comes up regularly throughout the life cycle of any organization and most certainly at moments of transition such as recapitalization (raising new capital or rearranging the deck of existing investors), succession planning (transferring ownership to the next generation that would include actively and passively involved family members), and the sale of a business (who decides whether or not to sell), to name a few. This issue, when examined in the context of a corporation, often raises the idea of establishing voting and non-voting shares.  Having the two categories of shares, in many instances, makes sense – the premise being that the ability to vote on company affairs be restricted to a select few who have primary responsibility for growing the business compared to those who remain passive investors or hold a minority position. But, just because a category of shares is labeled non-voting, does it take away all of the voting rights of a shareholder owning such shares? Not in the case of shareholders of corporations organized in California. Therefore, if one is not aware of the rules dealing with this subject, granting non-voting shares might inadvertently create the very rights that were intended to be prevented.

The Rule. California law, specifically Section 400(a) of California General Corporations Code (CGCL), allows corporations to issue one or more classes or series of shares that can have “full, limited or no voting rights.”  However, as a condition to issuing shares with limited or no voting rights, corporations must ensure that there exists a class or series of shares that has full voting rights.  Based on existing law, holders of non-voting shares are precluded from voting on routine corporate matters like the election of directors or other material transactions requiring shareholder approval, thereby eliminating their voice from management and control.

The Traps. Despite the obvious non-voting label, CGCL creates two exceptions, which, if overlooked and left unaddressed, could potentially give the non-voting shareholders a veto right in certain critical situations. Section 903(a), which describes the procedures of amending a corporation’s articles of incorporation, requires that certain amendments must be approved by holders of outstanding shares of a class, “whether or not such class is entitled to vote” as per the articles.  This exception could pose a problem when a corporation seeks to raise new capital and create new classes of shares that often trigger the need to amend the articles, and the terms are not favorable to the holders of non-voting shares.

A similar situation arises in the context of corporate reorganizations – a term defined under Section 181 to include a variety of merger transactions – which call for shareholder approvals. Section 1201(a) states that the principal terms of a reorganization must be approved by holders of “each class” of shares.  While the rules provide some comfort by noting that different series within the same class do not constitute different classes for purposes of the required approval – thereby allowing the (majority) voting stock to control the approval process notwithstanding the (minority) non-voting position – there could be situations, particularly in closely held businesses, where the voting and non-voting shares represent equal ownership of the business.  Effectively, under certain circumstances, the holders of non-voting shares might have the ability to block an amendment to the articles or a reorganization.

The Solution. What is otherwise expressly prohibited under CGCL can be mitigated by having contractual commitments between shareholders.   As a condition to granting non-voting shares to shareholders, the holders of voting shares can require the holders of non-voting shares to agree in advance to vote along with the holders of voting shares in reorganization transactions and other specified situations involving the corporation.  The agreement among shareholders could also provide for serious consequences of a breach by a party of its obligations under the agreement, which, if structured carefully, would serve as a  strong deterrent.  Such agreements can be set forth in voting agreements among shareholders, which are permitted under CGCL Section 706.

In conclusion, it is important to consider the limitations of non-voting shares and address them to ensure there are no surprises at critical moments of an organization’s life cycle.

Hope you found the above discussion helpful. In my upcoming posts, I plan to share with the readers practical knowledge and trends on a variety of corporate finance topics applicable to early stage and established businesses.  Stay tuned for another conversation on ClarkTalk!!

Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog.   If you wish to consult with the author of this post or another attorney at Clark & Trevithick, please contact Raj Puri by email at rpuri@clarktrev.com or telephonically by calling the author at (213) 341-1322.

 

 

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Computer Services Provider Not Liable For Member Ratings

By David S. Olson, Esq.

In a decision issued on September 12, 2016, Kimzey v. Yelp! Inc., the Ninth Circuit Court of Appeals upheld a federal district court’s dismissal of a Complaint against Yelp! Inc.  The Complaint sought to hold Yelp responsible for negative reviews posted on http://www.Yelp.com about the plaintiff’s locksmith business.  The plaintiff alleged that Yelp created and developed content, including by way of its star-rating system that assigns businesses overall star ratings based on Yelps’ user’s ratings.

While noting that the plaintiff’s contention had “superficial appeal,” the Ninth Circuit relied on Section 230 of the Communications Decency Act (CDA) in affirming the dismissal of the Complaint. That Act immunizes providers of interactive computer services against liability arising from content created by third parties.  The Ninth Circuit rejected the contention that Yelp’s star rating system transformed Yelp into an author as the Yelp star-rating system relied on rating inputs from third party reviewers, which Yelp then simply reduced into a single, aggregate metric.  The Court stated that Yelp’s star-rating system is a neutral tool operating on voluntary inputs and thus protected under the CDA.

Thank you for joining us on CIarkTalk! We look forward to seeing you again on this forum.  Please note that views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog.  If you have any questions, please feel free to contact the author by email at dolson@clarktrev.com or telephonically by calling (213) 629-5700.

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EMPLOYEE COMMUTING CAN BE HAZARDOUS TO EMPLOYER’S HEALTH

By Leonard Brazil

An employee has a desk job so he rarely leaves work in the course and scope of his employment. Over the course of his 15 years with the company, he has used his own car to visit a customer on just a handful of occasions.  One day during his commute home after a full day in the office, the employee runs a red light and, tragically, kills a pedestrian.  The deceased’s representative files a wrongful death suit against the employee and the employer.  The company’s first reaction is the employee was driving home after completing a full day of work and was not driving in the course and scope of his employment so it cannot possibly be liable for the accident.  However, the answer is not so clear-cut.

California law provides that employers are vicariously liable for tortious acts (i.e., negligent driving) committed by their employees during the course and scope of their employment. The general rule is employers are not vicariously liable for tortious acts committed by employees while they commute to and from work as part of their daily commute because it is considered to be outside the course and scope of their employment.  However, there is an exception to the general rule.

If an employer benefits from an employee commuting to or from work in his own vehicle, the commute may become part of that person’s workday rendering the employer liable for the accident occurring on the commute home. The determining factor is whether the employee having his vehicle available during work hours provides an incidental benefit to the employer.  If so, the employer may be liable for the accident.  For example, if an employer approves or requires an employee to make his vehicle available for business use as a condition of employment, doing so provides an incidental benefit to the employer; thus, the employee may be deemed to be in the course and scope of employment during the commute to or from home even if the employee uses the vehicle for work reasons only on an infrequent basis.  The rationale behind the law is to reallocate the inherent risk which arises from an employee’s commute from the innocent injured person to the employer when the vehicle is used for business purposes, whether required by the job or routinely used.

What Should An Employer Do

  1. If you have company vehicles, have your employees drive them exclusively for work related activities to avoid liability for accidents which occur while they commute in their personal vehicles. Also have such employees included under the company’s insurance policy.

2. If employees use their personal vehicle for work-related reasons:

 (a) Check with your insurance broker to be sure you have adequate policy limits.

 (b) Require such employees to provide proof of insurance with adequate policy limits and require them to immediately inform you if there is any change in coverage.

3. Require employees who drive a vehicle for work related reasons to provide proof of a valid driver’s license and immediately inform you if the license is suspended or revoked.

Thank you for joining us on CIarkTalk! We look forward to seeing you again on this forum. Please note that views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog. If you have any questions about this article, please feel free to contact Leonard Brazil by e-mail at lbrazil@clarktrev.com or Deborah Petito at dpetito@clarktrev.com or telephonically by calling the author at (213) 629-5700.

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REGULATION A+ AND PREPARING THE MINI-IPO

By Peter V. Hogan

Business is booming but do you find yourself in need of additional capital to expand operations? Private companies that need capital should evaluate whether Regulation A+ is a viable option to raise money and if the compliance associated with utilizing Regulation A+ is worth the time and effort. Regulation A+ went into effect in June of 2015, spurred by the JOBS Act, and private companies are hoping to utilize the new rules to raise capital from small investors within the general public, not just from accredited and institutional investors. Regulation A+ attempts to make it easier for these smaller companies to raise capital by increasing the potential pool of investors and limiting the amount of disclosure requirements. Under Regulation A+, small companies can raise up to $50 million in a 12-month period in new capital through what’s being called a “Mini-IPO”. In evaluating the pros and cons of doing a “Mini-IPO”, a company must look at the key features of a Regulation A+ offering.

1. Determining Eligibility

Regulation A+ is available only to companies organized in and with their principal place of business in the United States or Canada. Generally, Regulation A+ is not available to companies that are already public reporting companies or “shell” companies with no specific business plan. Additionally, companies that issue fractional undivided interests in oil or gas rights or similar interests in other mineral rights are not eligible to utilize Regulation A+. Companies that are subject to “bad actor” disqualifications, where the company or other relevant persons (such as underwriters, placement agents and the officers, directors and significant shareholders of the company) have experienced a disqualifying event, such as being convicted of securities fraud or other violations of law, also are prohibited from raising money under Regulation A+.

2. Preparation of Audited Financial Statements

Companies looking to raise money via Regulation A+ will need to file an offering statement with the Securities and Exchange Commission. A Tier 1 offering consists of securities offerings of up to $20 million in a 12-month period, with no more than $6 million in offers by selling security-holders that are affiliates of the company, whereas a Tier 2 offering consists of offerings of up to $50 million in a 12-month period, with no more than $15 million in offers by selling security-holders that are affiliates of the company. A Tier 2 offering also requires that the company file audited financial statements for the last two years. Hiring  an experienced auditor is imperative, since the SEC has routinely rejected many initial Regulation A+ filings based on incorrect financial statements. Since preparation of Regulation A+ financial statements take a considerable amount of time and effort, working with an experienced accountant and auditor are critical to expedite the process.

3. The Offering Statement

Companies will also need to work with experienced securities counsel to draft and prepare the offering statement that will be filed with the SEC and comply with ongoing reporting requirements under Tier 2 offerings. The offering statement has three parts: Part I requires basic issuer information such as the securities being offered, the jurisdiction where the securities will be offered, and the recent sale of securities by the issuer. Part II of the offering statement requires financial statements as well as business, management, and other substantive disclosures. Part III contains exhibits and related documents to be filed based on the company’s determination of pertinent documentation including exhibits that should be filed on a confidential basis with the SEC in order to protect the company’s trade secrets, pricing, etc. Utilizing a team approach, the chief financial officer, auditor and securities counsel can work together to draft the offering statement without interrupting the day-to-day business of the company. The same approach should be used to complete any ongoing reporting obligations under Tier 2.

A private company that is looking to raise capital through a Regulation A+ offering needs to understand the timing and expense associated with such an offering. The earlier you obtain experienced securities counsel and an experienced auditor to help you prepare the offering statement, the quicker you can get your offering statement into the hands of the SEC to be qualified and raising funds. Please contact me by e-mail at phogan@clarktrev.com or call me direct at 213-341-1385 if you would like further information on Regulation A+ as well as the timing and costs associated with such a transaction.

Thank you for joining us on ClarkTalk! We look forward to seeing you again on this forum. Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered above.