Flexible purpose corporations are corporations formed under Title I, Division 1.5 of the California Corporations Code, Section 2500 et seq.  This means that FPCs are not formed under the General Corporation Law (Title I, Division 1). While it appears that the legislature contemplated conversion of a GCL corporation into a FP corporation, it failed to provide the actual authority to effect the conversion.

Chapter 11.5 of the GCL was added in 2002 to authorize the conversion of a GCL corporation into a “domestic other business entity” as defined in Section 167.7.  The authorizing statute in Section 1151.  Other statutes within Chapter 11.5 specify the mechanics of the conversion process.  When the legislature enacted the flexible purpose corporation law, it amended two of the procedural statutes (Section 1152 and 1155) but failed to amend Section 1151 to authorize conversions into FP corporations.

While this is a significant omission, it seems fairly clear that the legislature thought that GCL corporations could convert into FP corporations.  Otherwise, it would not have added a new paragraph (d) to Section 1152 that begins with “if the corporation is converting into a flexible purpose corporation . . .”.

Nonetheless, it remains to be seen whether the Secretary of State’s office will file conversion documents or whether the courts will recognize a conversion.

“Agency capture,” as explained by legal scholars, is the undesirable scenario where the regulated industry gains influence over the regulators, and the regulators end up serving the interests of the industry, rather than the general public.

While it is true that the classic theory of agency capture focuses on capture by the regulated industry, other interests may try to capture an agency’s regulatory agenda as well.

Last week, a group of 14 pension funds and fund sponsors wrote this letter to the Securities and Exchange Commission.  The group is promoting the following six initiatives:

• Revival of the Investor Advisory Committee and appointment of the Investor Advocate.
• Renewal of  rule making for universal proxy access.
• Adoption of final rules on the remaining executive compensation reforms under the Dodd-Frank Wall Street Reform and Consumer Protection Act;
• Continuation of work on International Financial Reporting Standards.
• Provision of an accountable and transparent ratings system.
• Integration of relevant environmental, social, governance (otherwise known as sustainability issues) and diversity reporting into financial reporting frameworks.

While in college, I had the good fortune to meet Chief Judge Levin Campbell of the First Circuit Court of Appeals.  At the time, I had no thought of law school and only vaguest notion of what a federal circuit court judge did.  Nonetheless, two common life experiences linked us – we had attended the same high school and and college (although decades apart).  Thus, coming across an opinion by Judge Campbell never fails to re-awaken fond memories.

Even more recently, the California Secretary of State announced that another initiative measure has been cleared for signature collection.  Below is the Attorney General’s official title and summary:

POLITICAL CONTRIBUTIONS AND EXPENDITURES BY CORPORATIONS.  SHAREHOLDER APPROVAL. INITIATIVE STATUTE. Prohibits corporations and other business entities from making contributions or expenditures for political activities without shareholders’ prior informed approval.  Reduces the total amount of any contribution or expenditure approved by the percentage of shares not voted for approval.  Defines political activities to include those related to candidates, ballot measures, issue advocacy, political parties, committees, voter registration, or any other political or legislative causes.  Imposes criminal penalties for violations against persons spending, consenting to, or receiving prohibited contributions or expenditures. Requires detailed reporting to shareholders.  Summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government: Increased annual state enforcement costs of potentially several hundred thousand dollars, partially offset by increased fine revenues.

In January, the Securities and Exchange Commission adopted an amendment to Rule 146 under Section 18 of the Securities Act of 1933 to designate certain securities listed, or authorized for listing, on BATS Exchange, Inc. as covered securities for purposes of Section 18 of the Securities Act.  Covered securities under Section 18 of the Securities Act are not subject to state law qualification or registration requirements.  The SEC’s recent action follows its approval last summer of  rules for the qualification, listing, and delisting of companies on the BATS Exchange. 

The SEC also updated certain references in Rule 146. I was the only person to comment on the rule.  Here is the SEC’s polite response:

The commenter concurred with the Commission that Rule 146(b)(1)(iv) should be updated to reflect the term “NASDAQ OMX PHLX LLC” instead of “the Philadelphia Stock Exchange, Inc.”  The commenter also requested that the Commission review the current standards of the PHLX with respect to the listing and trading of securities to determine whether the current listing standards of PHLX are substantially similar to standards of Named Market.  The Commission has carefully considered the comment letter, and believes that the request of the commenter with regard to the listing standards of Phlx is beyond the scope of the Commission’s proposed rule.  However, the Commission notes that, via its oversight, inspection and enforcement functions, it regularly monitors the operations of registered exchanges and their compliance with the securities laws and rules applicable to them.

C&DIs reflect the views of the Corp Fin staff.  Although the SEC’s website claims that C&DIs are not rules, regulations, or statements of the SEC, I question whether that is strictly accurate.  Section 551(4) of the Administrative Procedure Act defines “rule” to mean ”the whole or a part of an agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy . . .”. 

Whether C&DIs constitute rules within the meaning of the APA, a more important policy question is whether the SEC should comply with the notice and comment rule making procedures of the APA (Section 553) when adopting new interpretations.   The reality is that lawyers tend to view staff interpretations as authoritative, if not binding.  While the notice and comment procedures mandated by the APA impose significant burdens on agencies, there are important benefits to following the rule making rules.  These include:

• Improved decisionmaking – The SEC can make more informed decisions when it receives input from the public.  When the SEC uses notice and comment rulemaking, it often changes its position based on public comments.
• Increased transparency – The public is given notice of what the SEC intends to do rather than presented with a fait accompli.  Further, the public can see the comments submitted and considered by the SEC.  New interpretations will not just suddenly appear and the public can see who and what influenced the SEC’s position.
• Increased accountability – The APA, other statutes and executive orders impose standards on agency rules.  In recent years, the courts have struck down several SEC rules for failure to comply with the APA.  See, e.g., Business Roundtable v. S.E.C., 647 F.3d 1144 (2011), American Equity Investment Life Insurance Company v. S.E.C., 613 F.3d 166 (D.C. Cir.2010), and Chamber of Commerce v. S.E.C., 412 F.3d 133 (D.C. Cir.2005).

California has its own Administrative Procedure Act that imposes even more stringent requirements on agency rule making.  An agency rule that is adopted without compliance with the APA is commonly referred to as an “underground regulation” and may not be enforced:

No state agency shall issue, utilize, enforce, or attempt to enforce any guideline, criterion, bulletin, manual, instruction, order, standard of general application, or other rule, which is a “regulation” under the APA unless it has been adopted as a regulation and filed with the Secretary of State pursuant to the APA.  Government Code Section 11340.5(a)

California, moreover, does not exempt interpretative rules and general statements of policy from the notice and comment requirements of the APA as does Section 553(b)(3)(A) of the federal APA. 

when a plaintiff seeks to depose a corporate president or other official at the highest level of corporate management, and that official moves for a protective order to prohibit the deposition, the trial court should first determine whether the plaintiff has shown good cause that the official has unique or superior personal knowledge of discoverable information.  If not, as will presumably often be the case in the instance of a large national or international corporation, the trial court should issue the protective order and first require the plaintiff to obtain the necessary discovery through less intrusive methods.  These would include interrogatories directed to the high-level official to explore the state of his or her knowledge or involvement in plaintiff’s case; the deposition of lower level employees with appropriate knowledge and involvement in the subject matter of the litigation; and the organizational deposition of the corporation itself, which will require the corporation to produce for deposition the most qualified officer or employee to testify on its behalf as to the specified matters to be raised at the deposition. ([Cal.Code Civ. Proc.] § 2025, subd. (d)(6).)  Should these avenues be exhausted, and the plaintiff make a colorable showing of good cause that the high-level official possesses necessary information to the case, the trial court may then lift the protective order and allow the deposition to proceed.

Recently, a bank has filed a petition for review with the California Supreme Court that raises the question of whether a director is “an official at the highest level of corporate management” within the meaning of the Liberty Mutual holding.  The California Bankers Association has submitted this amicus curiae letter in support of the petition.  Although this petition involves a bank, the question should be of interest to directors of all corporations.

Benefit Corporations

Section 14602 of the Corporations Code requires that the articles of incorporation must state that “the corporation is a benefit corporation” and must identify “any specific public benefit adopted pursuant to Section 14610″.  Some incorporators may conclude that this is all that is required.  However, the articles must also include the general purpose statement required of all corporations pursuant to Section 202(b).

Confusingly, the articles should not include a statement that the corporation has the purpose of “creating general public benefit” even though Section 14610(a) requires that all benefit corporations have that purpose.  The reason is that Section 202(b) provides that the articles of incorporation may not set forth any further or additional statement with respect to the purposes or powers of a corporation except by way of limitation or as expressly required by California law (other than the General Corporation Law) or any other statute or regulation.

Flexible Purpose Corporations

The name of a flexible purpose corporation must include the words “flexible purpose corporation” or an abbreviation of those words (such as “FCP”).  The articles must include a statement that the corporation “is organized as a flexible purpose corporation under the Corporate Flexibility Act of 2011″.

These aren’t all of the rules pertaining to either entity.  If you happen to run into other issues or problems incorporating under either law, please let me know.

It’s no secret that a great many corporations located in California are incorporated in Delaware.  Is the fact of Delaware incorporation sufficient to uphold a Delaware choice of law?  In Ruiz v. Affinity Logistics Corp., (9th Cir. Case No. 10-55581, Feb. 8, 2012), the Court of Appeals said no. 

The case involved an “Independent Truckman’s Agreement and an Equipment Lease Agreement.  These agreements purported to establish an independent contractor relationship and stipulated that Georgia law applied (the state in which the defendant was incorporated and had its principal office).  The plaintiff claimed that California law should be applied and that the agreement established an employer/employee relationship.

Citing Nedlloyd Lines B.V. v. Superior Court, 834 P.2d 1148 (Cal. 1992), the Court of Appeals found that California courts will apply the parties’ choice of law unless the analytical approach set forth in Section 187(2) of the Restatement (Second) of Conflict of Laws dictates a different result.  While the Court found that as a threshold matter the chosen state had a substantial relationship (by virtue of the defendant’s incorporation and principal office location), the analysis should not end there.*  A court should next ask whether the chosen state’s law is “contrary to a fundamental policy of California” and whether California has a materially greater interest in resolution of the issue.  Applying this rubric, the Court invalidated the parties’ contractual choice of law.

The Court’s opinion glosses over a key analytical point.  Section 187 deals with two different situations.  Subdivision (1) concerns issues that the parties to a contract could have resolved by specific reference in the contract.  For these type of issues, a court is not required to address the two additional questions above.  Subdivision (2) concerns issues that parties could not have resolved through an explicit contractual provision.  For example, an incompetent party can’t agree that it is competent.  The Ninth Circuit’s opinion provides no analysis as to why it thought that Subdivision (2) applied (and thus further questions must be asked and answered). 

Choice of law provisions can be found in a wide variety of other employment related agreements and arrangements (such as equity compensation plans, equity award agreements, trade secret and confidentiality agreements).  This case serves as a warning that incorporation in Delaware may be insufficient to uphold the selection of Delaware law.

For another recent post on choice of law issues, see Court Rules Choice Of Law Provision Takes Precedence Over Internal Affairs Doctrine.

____________________

*Although the Court specifically notes that Affiinity’s principal place of business is in Marrietta, Georgia, the Court later makes the following inconsistent  statement “The only connection with Georgia is that Georgia is where Affinity is incorporated.”

 We agree with the petitioners and hold the Commission acted arbitrarily and capriciously for having failed once again—as it did most recently in American Equity Investment Life Insurance Company v. SEC, 613 F.3d 166, 167-68 (D.C.Cir.2010), and before that in Chamber of Commerce, 412 F.3d at 136—adequately to assess the economic effects of a new rule.  Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.

Business Roundtable v. SEC, 647 F. 3d 1144 (D.C. Cir. 2011).  These decisions seem to invite further challenges to federal rulemaking.  In fact, Broc Romanek wrote in December about a lawsuit filed against the Commodity Futures Trading Commission alleging that among other things the CFTC failed to conduct an adequate cost-benefit analysis in adopting rules that limit positions that investors may take in certain commodities. (Broc posted this update on the suit earlier this week.)

Do California agencies do a better job in assessing the economic impact of their rules?  According to the California Office of Administrative Law, the agency charged with reviewing proposed rulemaking packages, the answer is no.  In written testimony to the Little Hoover Commission last year, two OAL officials gave this blunt appraisal:

“The economic impact analysis required by the California Administrative Procedure Act is illusory and ineffective because it allows an agency to make a perfunctory, after-the-fact, assessment of impact that is more symbolic than real . . . .  Consequently, it is not effective in achieving the purpose of informing the decision-making process with empirical knowledge to make the process more transparent and accountable.”

 Quoted in Better Regulation: Improving California’s Rulemaking Process (2011).

Very late in last year’s session, the legislature took action to address some of these concerns by enacting SB 617 (Calderon) to impose additional requirements on state agency rulemaking.  We’ll have to wait and see whether these new requirements will change economic impact analysis from “illusory and ineffective” to “real and effective”.

As required by the California Administrative Procedure Act, the Commissioner mailed notice of the proposed rule amendments in December of last year.  However, “tomorrow, and tomorrow, and tomorrow, creeps in this petty pace from day to day”.  With the new year, Senate Bill 617 (Calderon), Chapter 496, Statutes of 2011, took effect.  This bill amended the APA to impose new requirements on notices of rulemaking action and initial statements of reasons.  As a result, the Notice of Rulemaking Action published by the Department in January, 2012 was different from that mailed in December, 2011.  Here is the revised notice of rulemaking as published in the California Regulatory Notice Register (aka “Z-Register”) in January. (If you’re not familiar with the Z-Register, see “What is, What Will Be & What’s Passed – The CCR, Z-Register and Register“. 

The changes in the Notice of  Rulemaking Action are as follows:

• An evaluation of whether the proposed regulation is inconsistent or incompatible with existing state regulations was included.
• An economic impact analysis statement requirement pursuant to Government Code section 11346.3(b) was included.

The following amendments were made to the Initial Statement of Reasons:

• An economic impact analysis statement was added, pursuant to Government Code section 11346.3(b).
• Information regarding the studies, reports, and documents relied upon was clarified, pursuant to Government Code sections 11346.2(b)(3) and 11347.3(b)(7).

 As a result of these changes, the Commissioner has announced that the comment period with respect to Rule 260.204.9 has been extended to March 25, 2012.