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CALIFORNIA CORPORATE & SECURITIES LAW

How California Made Mergers Potentially More Difficult

The last two sentences of Section 1101 of the Corporations Code can be an unwonted surprise to some practitioners.  They are intended to ensure fair treatment of shareholders in a merger by imposing two requirements:

  • Each share of the same class or series of any constituent corporation must be treated equally with respect to the distribution of cash, rights, securities or other property.  There are several exceptions to this equal treatment mandate.  First, it doesn’t apply to the cancellation of shares held by a constituent corporation or its parent or a wholly owned subsidiary of either in another constituent corporation.  Second, equal treatment isn’t required if all shareholders of the class or series consent.  Third, fractional shares may be cashed out as provided in Section 407 of the Corporations Code.
  • The nonredeemable common shares or nonredeemable equity securities of a constituent corporation may be converted only into nonredeemable common shares of the surviving corporation or a parent party if a constituent corporation or its parent owns, directly or indirectly, prior to the merger shares of another constituent corporation representing more than 50% of the voting power of the other constituent corporation prior to the merger.  This requirement doesn’t apply to a short-form merger or the merger of a corporation into its subsidiary in which it owns at least 90% of the outstanding shares of each class.  Also, the requirement may be avoided if all the shareholders of the class consent.  Finally, fractional shares may be cashed out as provided in Section 407 of the Corporations Code.

Similar requirements with respect to interspecies mergers are found in Corporations Code Section 1113(c).

These requirements potentially give minority shareholders the power to veto a fair merger.  Accordingly, the legislature provided in Section 1101.1 of the Corporations Code that these two requirements would not apply to any transaction if the Commissioner of Business Oversight (or certain other specified regulators) approved the terms and conditions of the transaction pursuant to Corporations Code Section 25142 (or specified statutes applicable to the other specified regulators).

Last year, however, the legislature eliminated this fairness hearing exception by amending Section 1101.1.  2015 Cal. Stats., ch. 190, § 7.  Now, Section 1101.1 provides that Section 1101(b) doesn’t apply to any transaction approved by the Commissioner in a fairness hearing.  It is hard to divine any logical rationale for such an exception because Section 1101(b) simply provides that the agreement of merger must specify the amendments to the articles incorporation of the surviving corporation to be effected in the merger.  The mystery is further compounded by the fact that the legislature did not eliminate the fairness hearing exception with respect to Section 1113(c).  The bill effecting the change (AB 1517) was authored by the Assembly Committee on Banking and Finance.  Typically, committee bills are technical, non-policy bills.  I didn’t see anything in any of the committee or floor analysis that explains the reason for this rather significant change to the law.

While this change may seem to be of concern only to California corporations, readers should note that so-called pseudo-foreign corporations subject to Corporations Code Section 2115 are subject to the last two sentences of Section 1101.

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