A COMPARATIVE STUDY OF THE CORPORATE AND … · A COMPARATIVE STUDY OF THE CORPORATE AND LLC LAWS...

A COMPARATIVE STUDY OF THE CORPORATE AND LLC LAWS

OF NORTH CAROLINA AND DELAWARE

BUSINESS LAW SECTION

OF

THE NORTH CAROLINA BAR ASSOCIATION

Committee Members

Team Leaders:

Benjamin W. Baldwin, Co-Chairman Robinson, Bradshaw & Hinson, P.A. – Charlotte

Kevin A. Prakke, Co-Chairman Williams Mullen, P.C. – Raleigh

John W. Babcock Wall Esleeck Babcock LLP – Winston-Salem

Jennifer M. Ball

Hutchison Law Group PLLC – Raleigh Dumont Clarke, IV

Moore & Van Allen PLLC – Charlotte Christopher E. Fulmer

The Fulmer Law Firm, P.C. – Raleigh Merrill M. Mason

Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. – Raleigh

Stephen K. Rhyne K&L Gates – Charlotte

Jason J. Solomon

Alston & Bird, LLP – Charlotte Charlotte L. Tart

Wyrick Robbins Yates & Ponton, LLP – Raleigh

Melanie S. Tuttle

Schell Bray Aycock Abel & Livingston, PLLC – Greensboro

This study was produced primarily by members of the North Carolina State Bar (as opposed to

members of the Delaware Bar). Accordingly, practitioners are advised to involve Delaware

counsel where appropriate to advise clients as to matters of Delaware law, and to avoid conduct

constituting the unauthorized practice of law in the State of Delaware.

Team Members and Contributors:

Athanasios E. Agelakopoulos Kilpatrick Stockton, LLP – Atlanta, GA

Kevin A. Altman Attorney at Law – Winston-Salem

Carl S. Beattie Robinson, Bradshaw & Hinson, P.A. – Charlotte

John E. Blair, Jr. K&L Gates – Charlotte

W. Ellis Boyle Womble Carlyle Sandridge & Rice PLLC – Winston-Salem

David S. Caplan Law Offices of David S. Caplan – Durham

Donna Ray Chmura Sands Anderson Marks & Miller – Morrisville/Raleigh

Philip S. Chubb Shumaker, Loop & Kendrick, LLP – Charlotte

David B. Clement Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. – Raleigh

Joe B. Cogdell, Jr. Womble Carlyle Sandridge & Rice PLLC – Charlotte

D. Scott Coward K&L Gates – Raleigh

David P. Creekman Wyrick Robbins Yates & Ponton LLP – Raleigh

Michael J. Denny K&L Gates – Charlotte

Michael L. Drye Womble Carlyle Sandridge & Rice PLLC – Winston-Salem

Pamela S. Duffy Wishart, Norris, Henninger & Pittman, P.A. – Burlington

M. Frances Durden Roberts & Stevens, P.A. – Asheville

Matthew B. Efird Robinson, Bradshaw & Hinson, P.A. – Charlotte

Timothy R. Ferguson Life Sciences Law, PLLC – Chapel Hill

Joseph A. Fernandez Moore & Van Allen PLLC – Charlotte

Blake S. Frickes Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. – Raleigh

J. Carter Grant Schell Bray Aycock Abel & Livingston, PLLC – Greensboro

Jonathan A. Greene Gaeta & Eveson, P.A. – Raleigh

Daniel C. Gunter III Raleigh

Vida C. Harvey Robinson, Bradshaw & Hinson, P.A. – Charlotte

Seth M. Huffstetler Robinson, Bradshaw & Hinson, P.A. – Charlotte

Sumit K. Jain Block, Crouch, Keeter Behm & Sayed, LLP – Wilmington

Stuart H. Johnson Robinson, Bradshaw & Hinson, P.A. – Charlotte

April E. Kight Schell Bray Aycock Abel & Livingston, PLLC – Greensboro

Emily King Hutchison Law Group PLLC – Raleigh

Jeri. L. Kumar Jeri L. Kumar Law Firm – Asheville

Bonnie J. Little Brustein & Mansevit – Washington, DC

Lauren B. Loftis University of North Carolina School of Law

Jason Martinez Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. – Raleigh

Larry D. McBennett Everett, Gaskins, Hancock & Stevens, LLP – Raleigh

Carolyn P. Meade Moore & Van Allen PLLC – Charlotte

David T. Miller Robinson, Bradshaw & Hinson, P.A. – Charlotte

Neil M. Miller Robinson, Bradshaw & Hinson, P.A. – Charlotte

Linda K. Montgomery Robinson, Bradshaw & Hinson, P.A. – Charlotte

Fred P. Parker, IV James McElroy & Diehl, P.A. – Charlotte

Matthew Pawling Alston & Bird LLP – Charlotte

Deborah A. Pike Highwoods Properties, Inc. – Raleigh

E. Knox Proctor V Ward and Smith, P.A. – New Bern

Donald R. Rawlins The Rawlins Law Firm, P.C. – Charlotte

Michelle Reyes Moore & Van Allen PLLC – Charlotte

Thomas D. Ricks Alexander Ricks PLLC – Charlotte

Ty E. Shaffer Robinson, Bradshaw & Hinson, P.A. – Charlotte

Adam B. Snyder Wyrick Robbins Yates & Ponton LLP – Raleigh

Shandra Stout Womble Carlyle Sandridge & Rice PLLC – Winston-Salem

Donald R. Teeter, Jr. Williams Mullen, P.C. – Raleigh

Amalie L. Tuffin Hutchison Law Group PLLC – Raleigh

Daniel B. Vorhaus Robinson, Bradshaw & Hinson, P.A. – Charlotte

Brian E. Wise Wyrick Robbins Yates & Ponton LLP – Raleigh

Alan Woodlief Elon University School of Law – Greensboro

Richard C. Worf, Jr. Robinson, Bradshaw & Hinson, P.A. – Charlotte

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A COMPARATIVE STUDY OF THE CORPORATE AND LLC LAWS

OF NORTH CAROLINA AND DELAWARE

Preface........................................................................................................................................... vi

I. COMPARISON OF JUDICIARY SYSTEMS................................................................1

A. Introduction........................................................................................................................1 B. Structure and Personnel of the Courts ............................................................................2

1. North Carolina Business Court ................................................................................2 2. Delaware Chancery Court........................................................................................3

C. Jurisdiction .........................................................................................................................4 1. North Carolina Business Court ................................................................................4 2. Delaware Chancery Court........................................................................................6

D. Case Management and Disposition ..................................................................................8 1. North Carolina Business Court ................................................................................8 2. Delaware Chancery Court......................................................................................10

E. Conclusion ........................................................................................................................11

II. TAX CONSIDERATIONS..............................................................................................12

A. Importance of Where Operations Conducted...............................................................12 1. North Carolina Corporate Income Tax ..................................................................12 2. Delaware Corporate Income Tax ...........................................................................12 3. North Carolina Franchise Tax................................................................................13 4. Delaware Franchise Tax ........................................................................................13

B. Tax if Corporation Conducts Business in North Carolina ..........................................14 1. North Carolina Corporations..................................................................................14 2. Delaware Corporations ..........................................................................................14

C. Tax if Corporation Conducts Business in Delaware.....................................................15 1. Delaware Corporations ..........................................................................................15 2. North Carolina Corporations..................................................................................15

D. Other Kinds of Taxes.......................................................................................................15 1. Sales and Use Tax..................................................................................................15 2. Gross Receipts Tax ................................................................................................16 3. Property Tax...........................................................................................................17 4. Corporate Filing Fees.............................................................................................19 5. Specific Taxes........................................................................................................19 6. Tax Incentives........................................................................................................20

III. STATUTORY COMPARISON......................................................................................21

A. Preliminary Matters ........................................................................................................21 1. Filing Requirements and Dealing with the Secretary of State...............................21

B. Incorporation Matters .....................................................................................................23 1. Purposes and Powers..............................................................................................23

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2. Procedures; Contents of Articles and Certificates of Incorporation ......................25 3. Corporate Name.....................................................................................................27 4. Registered Office and Agent..................................................................................29 5. Bylaw Adoption and Amendments........................................................................31

C. Issuance of Shares ............................................................................................................33 1. General ...................................................................................................................33 2. Valid Consideration for Shares; Partially Paid Shares ..........................................34 3. Stock Options and Convertible Securities .............................................................35 4. Transfer Restrictions..............................................................................................35 5. Certificated and Uncertificated Shares ..................................................................36

D. Corporate Authorization and Meetings, Director Elections and Committees ...........37 1. Shareholder Approvals and Meetings....................................................................37 2. Director Elections, Resignation and Removal .......................................................40 3. Director Approvals, Meetings and Quorum...........................................................42 4. Committees of the Board .......................................................................................43

E. Director Duties and Liabilities........................................................................................44 1. Limitation of Director Liability .............................................................................44 2. Indemnification ......................................................................................................45 3. Interested Director Transactions ............................................................................50 4. Liability for Unlawful Distributions ......................................................................51 5. Reliance on Reports and Opinions.........................................................................52 6. Inspection of Records ............................................................................................52

F. Shareholder Voting Rights and Actions ........................................................................52 1. Quorum ..................................................................................................................52 2. Voting Rights .........................................................................................................53 3. Proxies....................................................................................................................55 4. Cumulative Voting.................................................................................................57 5. Action by Shareholders Without a Meeting...........................................................59 6. Voting of Shares Held in Trust ..............................................................................61 7. Voting by Group or Class ......................................................................................61 8. Inspectors of Election ............................................................................................63 9. Special Meetings....................................................................................................64 10. Shareholder Lists and Access to Other Information ..............................................64 11. Shareholder Liability .............................................................................................65 12. Shareholder Preemptive Rights..............................................................................66 13. Voting Rights in Respect of Debt Securities .........................................................67

G. Business Combinations and Structural Changes (Mergers, Sale of Assets, and

Entity Conversions) .........................................................................................................67 1. Types of Business Combinations...........................................................................67 2. Summary of Available Transaction Structures ......................................................68 3. Specific Transaction Types....................................................................................69 4. General Procedures Regarding Mergers and Share Exchanges .............................76 5. Approval/Vote Requirements Regarding Mergers and Share Exchanges .............84 6. Effect of Mergers, Etc., on Constituents................................................................89 7. Sales of All or Substantially All Assets.................................................................94 8. Entity Conversions.................................................................................................96

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9. Dissenters’ Rights and Exclusivity of Remedy ...................................................108

H. Dividends and Distributions .........................................................................................118 1. General .................................................................................................................118 2. Surplus .................................................................................................................118 3. Solvency Requirements .......................................................................................119 4. Nimble Dividends ................................................................................................120 5. Share Purchases ...................................................................................................120 6. Dates for Determination of Surplus and Solvency ..............................................122 7. Director Liability for Unlawful Distributions......................................................123 8. Right to Compel Dividends .................................................................................124

I. Shareholder Agreements ...............................................................................................128 1. Purposes of Shareholder Agreements ..................................................................128 2. Voting Arrangements...........................................................................................128

J. Close Corporations ........................................................................................................131 1. Characteristics of a Close Corporation ................................................................131 2. Formation.............................................................................................................132 3. Voting ..................................................................................................................133 4. Transfer Restrictions............................................................................................133 5. Termination of Close Corporation Status ............................................................134 6. Deadlock ..............................................................................................................134 7. Dissolution ...........................................................................................................137

K. Public Corporations.......................................................................................................137 1. Shareholder Rights Plans .....................................................................................137 2. State Anti-Takeover Legislation ..........................................................................141 3. Majority Voting Standards in the Election of Directors ......................................149 4. 2009 DGCL Amendments ...................................................................................150

L. Derivative Lawsuits .......................................................................................................152 1. Derivative v. Individual or Direct Claims............................................................152 2. Standing ...............................................................................................................155 3. Demand ................................................................................................................155 4. Stay of the Proceedings........................................................................................156 5. Dismissal..............................................................................................................157 6. Director Independence .........................................................................................158 7. Attorney-Client Privilege.....................................................................................159 8. Discontinuance or Settlement ..............................................................................159 9. Expenses ..............................................................................................................159

M. Dissolutions.....................................................................................................................160 1. Voluntary Dissolution..........................................................................................160 2. Involuntary Dissolution .......................................................................................165

IV. FIDUCIARY DUTIES GENERALLY ........................................................................168

A. Fiduciary Duties of Directors........................................................................................168 1. General Principles................................................................................................168 2. Choice of Law......................................................................................................168 3. Director Fiduciary Duties Under North Carolina Law ........................................168 4. Director Fiduciary Duties Under Delaware Law.................................................175

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5. Business Judgment Rule ......................................................................................181

B. Fiduciary Duties of Corporate Officers .......................................................................182 1. Introduction..........................................................................................................182 2. Fiduciary Duties of Officers Generally................................................................183 3. Duty to Inquire.....................................................................................................184 4. Corporate Opportunities.......................................................................................185 5. Reliance on Others...............................................................................................185 6. Business Judgment Rule ......................................................................................186 7. Exculpation ..........................................................................................................186

C. Fiduciary Duties of Shareholders .................................................................................187 1. Generally..............................................................................................................187 2. Derivative v. Individual/Direct Claims................................................................189 3. Standards for Judicial Dissolution .......................................................................189

V. LIMITED LIABILITY COMPANIES ........................................................................192

A. Formation and Organizational Matters.......................................................................192 1. Filing Requirements.............................................................................................192 2. Operating Agreements and Limited Liability Company Agreements .................196 3. Purposes and Powers............................................................................................199 4. Admission of Members/Managers .......................................................................199

B. Member Withdrawal / Resignation..............................................................................200 1. Assignment or Pledge of Member’s Interest .......................................................201 2. Rights of Assignee ...............................................................................................201 3. Residual Liability of Assignor .............................................................................202 4. Dissolution, Generally .........................................................................................202 5. Judicial Dissolution..............................................................................................203 6. Comparing the DLLCA and the NCLLCA..........................................................205 7. Administrative Dissolution ..................................................................................205 8. Winding Up..........................................................................................................206 9. Miscellaneous ......................................................................................................207 10. Distribution of Assets ..........................................................................................208

C. Claims against a Dissolved LLC and Residual Liability of the Dissolved LLC.......208 D. Rights of Members.........................................................................................................210

1. Voting Rights of Members and Managers ...........................................................210 2. Series of Interests.................................................................................................210 3. Access to Records of LLC ...................................................................................211 4. Restrictions on Distributions................................................................................211 5. Liability for Wrongful Distributions....................................................................212

E. Management/Agency .....................................................................................................212 1. Fiduciary Duties of Managers..............................................................................212 2. Authority of Members and Managers ..................................................................213 3. Delegation of Authority .......................................................................................214 4. Apparent Authority ..............................................................................................214 5. Removal/Resignation of Managers......................................................................214

F. Merger.............................................................................................................................214 1. Approval ..............................................................................................................215

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2. Termination..........................................................................................................215 3. Appraisal Rights...................................................................................................216 4. Contents of Merger Plan or Agreement ...............................................................216 5. Certificate or Articles of Merger..........................................................................216

G. Conversion ......................................................................................................................217 1. Conversion to a Domestic LLC ...........................................................................217 2. Conversion from a Domestic LLC.......................................................................218 3. Termination of Conversion ..................................................................................218

H. Piercing the Veil and Alter Ego ....................................................................................219 I. Indemnification and Exculpation .................................................................................221 J. Derivative Actions..........................................................................................................223

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Preface

Practitioners in North Carolina often confront issues of Delaware law (whether in deciding where to incorporate a client’s business, or in advising an existing Delaware entity with respect to a particular transaction, or in the course of representing a North Carolina entity that is adverse in a transaction to a Delaware entity, to name just a few such instances). There are of course many useful resources available to North Carolina lawyers that separately (and comprehensively) address North Carolina and Delaware corporate law (for example, Robinson

on North Carolina Corporation Law, and Folk on the Delaware General Corporation Law), but nowhere is there a work that attempts to cover (and to compare and contrast) the corporate laws of both states. That is the purpose of this study.

This study, which has been produced under the auspices of the Business Law Section of the North Carolina Bar Association (the “Business Section”), is the result of a volunteer effort on the part of many individuals. As such, the constraints involved have made it impossible to produce a work that is definitively deep and comprehensive, with a thorough and complete comparison of each and every facet of the laws of these two states. We have, however, striven to provide practitioners with a broad overview of North Carolina and Delaware corporate laws, and we hope that this study, at a minimum, provides practitioners with at least some orientation and a good starting point for their analyses of their North Carolina/Delaware issues.

Note that because the use of limited liability companies (referred to throughout the study as “LLCs”) has become increasingly popular, the study includes a section, at the end, dealing with the North Carolina and Delaware LLC statutes. The study does not address partnership law (general or limited), nonprofit entities or any other types of entities, other than corporations and LLCs.

Please note that, while the drafters have endeavored to ensure the accuracy and completeness of the caselaw and other authorities referenced herein, this study speaks as of the date set forth on its cover page. Although the Business Section intends to provide periodic updates to the study, to the extent feasible, to reflect changes in the law and accepted practices relating thereto, practitioners should be aware of these limitations and should undertake their own due diligence (including the Shepardizing of applicable authorities, as appropriate) to determine any subsequent changes to the laws in North Carolina or Delaware that might impact the findings and comparisons outlined herein. Again, this study is intended to serve primarily as a starting point reference tool, to be supplemented by each practitioner’s own legal inquiry and analysis.

The following drafting conventions may be helpful to the reader:

1. Various statutes are referred to in abbreviated form. Consult the table following this preface for a key to those abbreviations.

2. When used in this study, the term “charter” refers to an entity’s articles of incorporation, certificate of incorporation or articles of organization, as applicable.

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3. The North Carolina statute refers to “shareholders,” while the Delaware statute refers to “stockholders.” The text generally adopts this terminology, but when it is inconvenient to do so, or when addressing an issue in the abstract, the study will use the term “shareholders” generically, to refer to both.

4. General references to “Chapter 55” are references to Chapter 55 of the

North Carolina General Statutes, or the North Carolina Business Corporation Act (the “NCBCA”). References thereto in the text generally omit the “55” (so that, for example, North Carolina General Statutes Section 55-1-01 would be referred to as “NCBCA Section 1-01”). Likewise, references in the text to North Carolina’s Limited Liability Company Act (contained in Chapter 57C of the North Carolina General Statutes) omit the “57C” (so that, for example, North Carolina General Statutes Section 57C-1-01 would be referred to as “NCLLCA Section 1-01”).

5. References to the “Revised Model Act” are references to the Model

Business Corporation Act, adopted by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association (Third Edition, revised through 2002).

Finally, the North Carolina Bar Association’s Business Law Section wishes once again to

thank all of the many volunteers who have participated in this study for their time and prodigious effort in helping to complete it, and in addition all of the law firms and other colleagues who have indulged and supported those volunteers in this regard since the inception of this project two years ago.

We hope this study is helpful to all of you, and we welcome your comments and input.

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TABLE OF ABBREVIATIONS

Abbreviation Refers to Relevant Legal Citation

NCBCA North Carolina Business Corporation Act

N.C. Gen. Stat. Chapter 55

DGCL Delaware General Corporation Law

Del. Code Ann. tit. 8, Chapter 1

NCLLCA North Carolina Limited Liability Company Act

N.C. Gen. Stat. Chapter 57C

DLLCA Delaware Limited Liability Company Act


DRULPA Delaware Revised Uniform Limited Partnership Act


1

I. COMPARISON OF JUDICIARY SYSTEMS

A. Introduction

The Delaware Court of Chancery enjoys a reputation as one of the preeminent forums for business litigation in the United States. This reputation may be traced not only to its role as caretaker of Delaware’s business law, but also to its practices and procedure. A single judge hears each case from beginning to end, finds both law and facts without a jury under equitable procedure and issues a written opinion upon final disposition. This has three beneficial effects. First, it generates a body of written precedent that lends stability, predictability and rationality to Delaware’s business law.1 Second, the judges develop expertise in adjudicating complex business disputes. Finally, this expertise and the flexibility of equitable procedure allow judges to devise ways to promote expeditious and efficient resolution of such cases. These three effects in turn reinforce each other. Litigants who bring cases to chancery because of its stable precedent, expert judges, and expeditious resolution generate more precedent, more expertise, and a continuing incentive for parties to use the court.

Other jurisdictions have recognized chancery’s positive impact on the quality of both judicial administration and substantive law in the state of Delaware, and have sought to replicate those effects within their own judicial systems. In 1996, North Carolina established the North Carolina Business Court (the “Business Court”) as a specialized forum for complex business disputes. The Committee that recommended formation of the Court expressed the desire to emulate chancery in all three respects: written trial court precedent, trial-bench expertise and expeditious case management.2

North Carolina is, however, constitutionally obligated to pursue these goals within the framework of common law procedure, which includes the right to jury trial.3 Following is a discussion of how the North Carolina Business Court has met this challenge and of the contrasts between the Business Court’s common law procedure and the equitable procedure used by chancery, all under three headings: (1) the structure and personnel of the courts; (2) their jurisdiction; and (3) case management and disposition.

1 See Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of

Chancery § 1.01 (2008). 2 See Final Report and Recommendation of the Chief Justice’s Commission on the Future of the North Carolina Business Court (October 28, 2004), available at http://www.ncbusinesscourt.net/ref/Final%20Commission%20Report.htm (recounting this history) (hereinafter, “2004 Report”). 3 N.C. Const. Art. I, § 25.

This study was produced primarily by members of the North Carolina State Bar (as opposed to

members of the Delaware Bar). Accordingly, practitioners are advised to involve Delaware

counsel where appropriate to advise clients as to matters of Delaware law, and to avoid conduct

constituting the unauthorized practice of law in the State of Delaware.

2

B. Structure and Personnel of the Courts

1. North Carolina Business Court

Structurally, the North Carolina Business Court is not really a separate court at all, but rather a set of superior court judges specializing in complex business cases. The term “Business Court” therefore actually refers to these judges, their specialized docket and the system for assigning cases to their docket. Because it is just another part of the superior court, the Business Court operates under the regular North Carolina Rules of Civil Procedure, along with special Business Court rules. It is a court of both law and equity. The court can conduct jury trials, render judgments for money damages, and provide equitable relief in appropriate cases. Unlike other superior courts, the Business Court’s docket is limited to complex business disputes.

The stated goal of the specialized forum is threefold: to promote the development of expertise on the bench in adjudicating complex business disputes; to encourage the development of a more substantial body of trial court opinions on important questions of business law; and to provide a relatively expeditious procedure for resolving complex business disputes, which are often document and discovery intensive.4 All three are features of the Delaware Court of Chancery, and were explicitly mentioned by the Commission that recommended creation of the forum.5

To achieve these goals, the North Carolina Business Court differs from a normal superior court in two principal respects. First, the judge is required to write written opinions upon final disposition of most cases.6 This requirement is intended to generate a body of written trial court level precedent on North Carolina business law. Second, the Business Court is staffed by a limited corps of judges who, unlike other superior court judges, hear all motions in the case from the time the case is assigned to the Business Court until final disposition. This promotes expedition because a single judge can closely supervise the case from start to finish, and the parties need not reacquaint several judges with the facts. It also ensures that the Business Court judges develop expertise in adjudicating complex business disputes.

The enabling statute for the Business Court gives the governor the authority to nominate Business Court judges from the pool of preauthorized special superior court judges. There are currently three special superior court judges assigned to hear complex business cases: Judge Ben Tennille, Judge Albert Diaz and Judge John Jolly. Judge Tennille serves as chief judge. These three judges handle all North Carolina Business Court cases, but may also be assigned exceptional cases and hear normal civil or criminal cases if their schedules permit. Judge Tennille is based in Greensboro; Judge Jolly in Raleigh; and Judge Diaz in Charlotte.

4 2004 Report, supra note 2. 5 Id. 6 Superior and District Courts Rule 2.1(d).

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Their courtrooms are located, respectively, at Elon University School of Law, leased space at Campbell Law School in downtown Raleigh, and the Mecklenburg County Courthouse.7

Because Business Court judges come from the pool of special superior court judges, they are appointed by the governor.8 In this respect, the Business Court judges are similar to the chancellor and vice-chancellors on the Delaware chancery court, who are appointed by the Delaware governor and confirmed by the Senate. Business Court judges serve for a fixed term of five years.9

As with any superior court, the route for appeal from a decision of the North Carolina Business Court is to the North Carolina Court of Appeals and then to the North Carolina Supreme Court, pursuant to normal rules of appellate practice and procedure.

2. Delaware Chancery Court

Unlike the intentionally designed North Carolina Business Court, chancery’s complex business jurisdiction arose simply as one part of the court’s equitable jurisdiction. Delaware’s 1792 Constitution divided judicial business between separate equity and law courts.10 Equitable procedure differs from common law procedure in that trial is always by the judge, and the remedies are normally equitable ones, such as injunctions, specific performance, and restitution.11

As a traditional court of equity, chancery hears many non-business cases, including those involving trusts or guardianships. Nor does chancery hear all business disputes in Delaware. If the plaintiff is seeking a traditionally legal remedy, it goes to the law courts, which can hold jury trials. The status of chancery as a preeminent business court instead stems from its special role as caretaker of Delaware corporate law; its practice of rendering written opinions that lend stability to the law; and the flexible case management that equitable procedure and the lack of jury trial permit. When Delaware adopted a relatively liberal corporations statute in the late nineteenth century—which soon led to Delaware becoming the most popular state for incorporation—chancery began to develop a body of written precedent that increased the stability and predictability of Delaware’s corporate law and enhanced the attractiveness of the forum.12 Litigants brought more cases to chancery, developing the expertise of the bench and generating written opinions that could guide future courts, all of which encouraged future litigants to resort to the forum.

Today chancery is still a trial court with exclusive jurisdiction over equitable causes of action and equitable remedies. It has all the equity jurisdiction that the British Court of

7 Report on Activities of the North Carolina Business Court 2006-2008, available at http://www.ncbusinesscourt.net/New/links/2008%20Report%20to%20General%20Assembly.Final.doc (hereinafter “2008 Report”). 8 N.C. Gen. Stat. § 7A-45.3. 9 Id. 10 Donald E. Parsons, Jr. & Joseph R. Slights, III, The History of Delaware’s Business Courts, available at http://courts.delaware.gov/Courts/Court%20of%20Chancery/?history.htm. 11 Id. There are certain circumstances where chancery can award money damages, as discussed more fully below. 12 Id.

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Chancery possessed in 1776, plus statutory jurisdiction conferred since that time.13 On the law side, the Delaware Superior Court has jurisdiction over business matters where the plaintiff seeks only money damages. Unlike the North Carolina Business Court, which is simply a specialized superior court, there is a single level of appeal from the chancery court, to the Delaware Supreme Court.

Five judges sit in chancery: the chancellor and four vice-chancellors.14 Each of the five has the authority to conduct bench trials. The governor appoints the chancellor and vice-chancellors for twelve-year terms, subject to confirmation by a majority of the senate.15

C. Jurisdiction


As discussed above, the Business Court is not actually a separate court, but rather a mechanism for assigning cases to certain special superior court judges. No case commences in the Business Court. It must be filed in one of the 100 North Carolina counties, and then transferred there. Even when a case has been assigned to the Business Court, it remains pending in the county where originally filed. Accordingly, when we speak of the Business Court’s “jurisdiction,” we mean only this method of assigning cases to these special superior court judges.

Consistent with the purposes behind the Business Court, its jurisdiction is limited to the category of complex business cases. The Court’s subject matter jurisdiction falls into two categories: mandatory complex business cases (“mandatory jurisdiction”), and discretionary cases (“discretionary jurisdiction”).

Under the mandatory jurisdiction, Business Court jurisdiction is presumed in certain subject matter areas, allowing litigants to employ a streamlined removal procedure.16 These subject matter areas are:

� the law of corporations;

� securities law;

13 Id. 14 Del. Code Ann. tit. 8, § 307. 15 Del. Code Ann. tit. 8, § 1909. 16 Effective January 1, 2006, Rule 2.1 of the General Rules of Practice for the Superior and District Courts was altered by North Carolina General Statutes Section 7A-45.4 to provide for such automatic assignment of such cases to the Business Court. The automatic assignment rule contains strict timing and filing requirements. A plaintiff or third-party plaintiff wishing to have a case assigned to the Business Court must file a “Notice of Designation” within 30 days of filing the complaint. An intervening party must file simultaneous with the motion to intervene. A defendant (and any other party) must file the notice within 30 days of being served with the initial pleading seeking relief against that party. The notice must be filed with the superior court in the county where the action was filed and must be served on all opposing parties or counsel, the chief judge for the Business Court and the chief justice of the North Carolina Supreme Court. A non-refundable $200 filing fee must be paid to the Clerk of Court for the court where the notice is being filed. Once the notice is filed, the case is automatically and immediately in the Business Court until it is either resolved or its designation is denied after being opposed. The new automatic assignment rule is not exclusive; cases may still be assigned to the Business Court via the traditional Rule 2.1 motion procedure.

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� antitrust law;

� state trademark and unfair competition law;

� intellectual property law;

� the internet, electronic commerce, and biotechnology; and

� tax law (when the dispute has been the subject of a contested case commenced at the office of administrative hearings).

If a party believes in good faith that the case raises a material issue related to one of these subject matter areas—whether on the face of the complaint, in a defense, or under any other pleading—it may file a “Notice of Designation” and serve the notice on all parties, the senior special superior court judge for the Business Court (currently Judge Tennille), and the chief justice. The notice should contain an explanation of why the case should be assigned to and retained by the Business Court. The chief justice (pursuant to Rule 2.1 of the General Rules of Practice for the Superior and District Courts) then makes a preliminary decision whether to approve the removal. If he or she does approve, then the case has been provisionally removed to the Business Court. The chief judge of the Business Court then determines whether or not the case should be remanded to superior court.

In making this determination, the chief judge’s inquiry ranges beyond whether the case involves an enumerated subject matter area. Under Business Court Rule 3.2, the judge considers multiple other factors bearing on whether the case is an appropriate candidate for Business Court resolution, including “(i) the amount in issue, (ii) the novelty of the issues, (iii) the degree to which the interests of justice will be advanced by adjudication of the action under the Business Court’s rules and procedures, and (iv) any other potential impacts on the parties or the Court that would be associated with retention of the action.” The chief judge’s decision may be appealed to the chief justice of the North Carolina Supreme Court. Once the Business Court has decided to retain jurisdiction, the senior judge assigns the case to one of the Business Court judges. That judge supervises the case until final disposition.

The statute sets forth certain deadlines that a removing party must meet if it is to claim the benefit of mandatory jurisdiction. The plaintiff must file the Notice of Designation when it files the complaint; an intervenor, at the time the motion for permission to intervene is filed; and any other party, within 30 days of receipt of service of the pleading seeking relief from that party. Any party may file an opposition within thirty days of the Notice of Designation, and the party that filed the notice has fifteen days to respond.

If a party does not meet the timing requirements in the mandatory jurisdiction statute, or if the case does not raise an issue related to one of the statutory subject matter areas, then the only path to the Business Court is through the discretionary jurisdiction. Rule 2.1 of the General Rules of Practice for the Superior and District Courts describes this jurisdiction. The Rule provides that “complex business” cases and “exceptional” cases may be assigned to a North Carolina Business Court judge. Complex business cases may only be assigned to a Business Court judge, while exceptional cases may be assigned to any special superior court judge. The

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terms “exceptional” and “complex business” are left undefined, to permit flexible discretionary assignment of cases to the Business Court.

To invoke the discretionary jurisdiction, a party must apply to the senior resident superior court judge, chief district court judge, or presiding superior court judge, who has the discretion to recommend to the chief justice that the case be designated “exceptional” or “complex business” and assigned to the Business Court.17 Any of those judges may also make such a recommendation ex mero motu. The chief justice then is to consider “the number and diverse interests of the parties; the amount and nature of anticipated pretrial discovery and motions; whether the parties voluntarily agree to waive venue for hearing pretrial motions; the complexity of the evidentiary matters and legal issues involved; whether it will promote the efficient administration of justice; and such other matters as the chief justice shall deem appropriate.” If the chief justice agrees that the case should be assigned to the Business Court, he or she sends the case to the chief judge, who then assigns it to one of the Business Court judges. As a practical matter, this process can take time. Where time is of the essence, successful invocation of the discretionary jurisdiction will often require the agreement of all parties.

Currently, the majority of cases on the Business Court docket fall within the mandatory jurisdiction of the court. As of the initial publication of this study, 100 cases are classified as mandatory complex business; 42 as discretionary complex business under Rule 2.1; and 31 as discretionary exceptional under Rule 2.1.18

Once the Business Court has obtained jurisdiction of the case, the case is for all purposes in the Business Court until final disposition. All motions must be filed with the Business Court. The court of filing no longer has jurisdiction, and the appeal from the Business Court is directly to the North Carolina Court of Appeals.


In contrast to the relatively delimited complex business jurisdiction of the Business Court, chancery has jurisdiction over a broad range of equitable matters. It has jurisdiction over “all matters and causes in equity.”19 The court also “shall not have jurisdiction to determine any matter wherein sufficient remedy may be had by common law, or statute, before any other court or jurisdiction.”20

These statutes have given rise to two main varieties of chancery jurisdiction. First, the court has jurisdiction over all traditionally equitable causes of action.21 These are causes of action that originally developed in the English Court of Chancery and were not recognized at common law, and include cases involving trusts, fiduciary duties in corporations and other relationships, and guardianships. In Delaware, these equitable causes of action may only be heard in chancery. Accordingly, in these cases, chancery has the power to grant any remedy, including a traditionally legal one, and has jurisdiction even if the plaintiff is only seeking money

17 Superior and District Courts Rule 2.1. 18 2008 Report, supra note 7. 19 Del. Code Ann. tit. 8, § 341. 20 Del. Code Ann. tit. 8, § 342. 21 Wolfe, Jr. & Pittenger, supra note 1, § 2.03.

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damages.22 Certain statutes have clarified or augmented this traditional kind of jurisdiction, providing, for example, that chancery has jurisdiction over suits involving director and officer indemnification; actions to compel the corporation to hold the annual stockholders meeting; suits seeking appraisal of the fair value of corporate stock; and cases requiring interpretation of the certificate of incorporation or bylaws of a Delaware corporation.23

In addition to jurisdiction over equitable causes of action, chancery has jurisdiction over cases where the plaintiff seeks an equitable remedy or where the remedy at law is inadequate.24 For example, chancery has jurisdiction over common law tort or contract cases where the plaintiff is seeking a traditional equitable remedy such as injunctive relief, specific performance, or restitution. Chancery also has jurisdiction over other cases where the legal remedy would be inadequate, as where complete relief would require a multiplicity of suits, the defendant is insolvent, the legal remedy is impracticable or speculative, or the subject matter of the case is unique.25

The superior court, by contrast, has jurisdiction over common law causes of action where the plaintiff is seeking a legal remedy. Chancery will transfer a case to superior court if it determines that the remedies sought are not appropriate for that forum, and vice versa.26 If chancery has jurisdiction over part of a controversy because of an equitable cause of action or an equitable remedy, however, it has ancillary jurisdiction to decide all issues in the case and provide a complete remedy—even if the court would have no jurisdiction over certain claims standing alone.27 This ensures that plaintiffs do not need to file suits in both chancery and superior court in order to obtain complete relief.

This jurisdictional framework means that chancery actually may order the payment of money in a variety of circumstances. First, certain equitable remedies require the payment of money, including restitution, rescissory damages in certain contexts, accounting under some circumstances, and constructive trust.28 Chancery also has the authority to award money damages where the cause of action is an equitable one. Finally, it may award money damages when it has ancillary jurisdiction over a claim seeking a legal remedy.29

As noted above, chancery is not exclusively a business court, and its docket is not limited to business cases. Chancery hears any case within the equitable jurisdiction of the British Court of Chancery in 1776, including corporate matters, trusts, estates, guardianship, fiduciary duties, purchase and sale of land, title to real estate, and general commercial and contractual matters. Within the category of “business cases,” its jurisdiction extends well beyond “complex” business cases: rather, it hears all such cases involving an equitable cause of action, equitable remedy, or ancillary jurisdiction. Nor does chancery have jurisdiction over all “complex”

22 See Harmon v. Masoneilan Int’l, Inc., 442 A.2d 487 (Del. 1982). 23 Wolfe, Jr. & Pittenger, supra note 1, § 1.03. 24 Wolfe, Jr. & Pittenger, supra note 1, § 2.03. 25 Id. 26 Wolfe, Jr. & Pittenger, supra note 1, § 2.04. 27 Id. 28 Wolfe, Jr. & Pittenger, supra note 1, § 12.04. 29 Id.

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business cases. The superior court has exclusive jurisdiction over legal causes of action where the plaintiff only seeks a legal remedy.

In addition to its traditional and statutory equitable jurisdiction, chancery has in recent years received some new kinds of jurisdiction by statute. It may acquire jurisdiction over certain technology disputes, defined as disputes involving agreements relating to purchase or lease of computer hardware, development or other uses of computer software, complex intellectual property rights, Internet web sites and so on.30 Chancery has jurisdiction over such a dispute if the parties consent; at least one party is a business entity formed under Delaware law or with a principal place of business there; no party is a consumer; and (if the dispute solely involves money damages) the amount in controversy is no less than $1 million. In this class of cases, the court is not limited to granting equitable remedies, but equitable procedures, including bench trial, do apply.

Chancery also has jurisdiction to preside over certain mediations. The parties must have consented; at least one party must be a business entity formed under Delaware law or with a principal place of business there; no party can be a consumer; and, if the dispute solely involves money damages, the amount in controversy must be no less than $1 million.31

With the foregoing exceptions, chancery is a court of equity, operating as the trial court in cases involving equitable causes of action or equitable remedies.

D. Case Management and Disposition


The specialized nature of the Business Court’s docket has enabled the development of rules that are specially tailored for resolving complex business disputes. The court is constitutionally constrained from impairing the right to jury trial, and therefore cannot enjoy some of the procedural efficiencies present in a system where the judge is sole decisionmaker.32 Nevertheless, within the limits imposed by common law procedure, the Court has made great strides toward promoting expeditious and efficient resolution of complex business disputes.

A case, once in the Business Court, is there for all purposes, and all motions must be filed with the Business Court.33 A party that wishes to remove a case to the Business Court is not required to waive jury trial or stipulate to venue in Charlotte, Raleigh, or Greensboro.34 Despite the location of the physical “business courts” in Charlotte, Greensboro, and Raleigh, if the case proceeds to trial, the trial will ordinarily be held in the county of filing. If the trial is a jury trial, the jury will be selected in the normal course through the county venire. The Business

30 Del. Code Ann. tit. 8, § 346. 31 Del. Code Ann. tit. 8, § 347. 32 N.C. Const. Art. I, § 25. 33 N.C. Business Court Frequently Asked Questions, available at http://www.ncbusinesscourt.net/FAQ/business_court_frequently_asked_.htm. 34 Judge Albert Diaz & A. Jordan Sykes, The New North Carolina Business Court, The North Carolina State Bar Journal (Spring 2008).

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Court also has no amount in controversy requirement, although the amount in controversy can be considered in determining whether the case is an appropriate candidate for Business Court resolution.35

The most important procedural innovation in the Business Court is to assign cases to a single presiding judge who hears the case from assignment until final disposition. Normal superior court cases use a rotation system where many different superior court judges may hear pretrial motions. By contrast, a single Business Court judge presides over both pretrial and trial. This increases efficiency because the parties need not reacquaint several judges with a long and complex account of the facts. It also helps to ensure that Business Court judges develop expertise in complex business cases.

Another Business Court feature promoting efficient resolution is mandatory scheduling. Within thirty days of the filing of assignment or designation in the Business Court, the parties are required by Business Court Rule 17.1 to hold a “Case Management Meeting.” The topics that the parties must address include the length of discovery; the number of depositions; the preliminary schedule; motions; principal legal and factual issues in dispute; document retention and preservation; electronic discovery (including the potential need for cost-shifting, agreement as to format, and protocol); and other discovery and scheduling issues. Business Court Rule 17.2 then requires the parties to file a Case Management Report setting out the views of the parties on each enumerated issue.

After this report is filed, the court will convene a Case Management Conference to hear the views of counsel on the various issues. Following this conference, the parties are required to propose a Case Management Order. Once finalized, this order governs all pertinent scheduling issues until final disposition, unless a party shows good cause for a deviation.

Other features of Business Court practice also encourage efficient discovery. Generally, the Business Court expects discovery to be completed within nine months.36 The Business Court rules require the parties to attempt consensual resolution of discovery disputes before bringing them to the court. The parties must file a certification that they have conferred before the court will consider such a dispute.37 The court will agree to resolve the dispute without briefing via teleconference or videoconference if the parties agree to talk for less than thirty minutes; alternatively, the court will resolve the dispute without briefing in court if the parties agree to talk for no more than an hour.38

Finally, the Business Court employs advanced technology that also promotes efficient resolution of disputes. The parties may consent to electronic filing and case management. The courtrooms in Charlotte, Greensboro, and Raleigh feature state-of-the-art

35 See Business Court Rule 3.2. This rule strictly applies only to the chief judge’s evaluation of mandatory jurisdiction, but Superior and District Courts Rule 2.1(e) allows the chief justice to consider “such other matters as the Chief Justice shall deem appropriate” when deciding whether to accept a recommendation to designate a case “complex business” or “exceptional.” 36 Business Court Rule 18.2. 37 Business Court Rule 18.6. 38 Business Court Rule 18.7.

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display technology. The court also offers the opportunity to use videoconferencing to conduct certain proceedings.39

The right to a jury in a Business Court trial is governed by normal principles of North Carolina law. Whenever the judge makes a final disposition without a jury—whether after bench trial or by motion—he or she is required to write an opinion.40 This requirement approximates as nearly as possible the chancery court practice of written opinions upon final disposition, and furthers the goal of encouraging the explication of North Carolina business law.


The equitable procedure followed in chancery has allowed the maximum degree of procedural flexibility and expedition. Because the judge finds both law and facts, he or she has maximum control over case management, discovery and trial. These features allow chancery to quickly adjudicate business disputes where time is of the essence, including cases involving mergers and takeover defenses.

A chancery judge will grant a motion for summary proceedings in any case for good cause.41 These proceedings are characterized by a compressed timeframe, shorter discovery and a narrower factual scope.42 Delaware provides for certain summary proceedings by statute. These statutory provisions apply, for example, to cases involving a corporation’s duty to advance expenses to a director or officer, proceedings to compel the holding of an annual shareholder meeting, actions to compel inspection of corporate books and records, and actions to resolve disputed director elections.43

Chancery has a reputation for speed in other areas as well. The court will routinely expedite requests for preliminary injunctive relief in the form of a temporary restraining order or preliminary injunction.44 A request for a preliminary injunction will often contain a motion to expedite proceedings by accelerating discovery, moving up the time to respond to the complaint.45 The court will, however, usually hear from the defendant before granting a motion to expedite.46 Because the court always sits without a jury, it is capable of expediting trial or consolidating a trial on the merits with a hearing on the request for a preliminary injunction.47 Even the decision to expedite may involve an early look at the merits of the case. Although the court in considering such a motion most often focuses on whether a party

39 See 2008 Report, supra note 7. 40 Superior and District Courts Rule 2.1(b). Technically, this rule applies only if the case is “complex business” within the meaning of the rule. If the case is “exceptional,” the judge may write an opinion, but has the discretion not to do so. Exceptional cases, however, generally constitute the smallest part of the Business Court’s docket. 41 Wolfe, Jr. & Pittenger, supra note 1, § 8.01. 42 Id. 43 Wolfe, Jr. & Pittenger, supra note 1, §§ 8.02, 8.04, 8.06 and 8.08. 44 Wolfe, Jr. & Pittenger, supra note 1, § 10.01. 45 Wolfe, Jr. & Pittenger, supra note 1, § 10.04. 46 Id. 47 Id.

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would suffer irreparable injury in the absence of expedition, the inquiry sometimes involves a preliminary determination of the party’s likelihood of success on the merits.48

These features of the chancery court, all made possible by equitable procedure, are the ones least capable of replication in common law systems such as North Carolina’s. The Business Court has, however, within the limits the state constitution places on it, developed an admirable record of expeditious resolution of complex business cases. The expertise that the Business Court judges have developed, the one-judge system, and mandatory scheduling have all contributed to this result.

E. Conclusion

The North Carolina Business Court shows that many of the most attractive features of the Delaware Court of Chancery can be successfully translated to a common law system. Through the practices of written opinions, case management by a single judge, and the development of a bench with experience adjudicating business disputes, the Business Court has begun to develop a substantial body of trial-level business law precedent and promoted the uniform and expeditious resolution of complex disputes. All of this should lead to a virtuous cycle that will continue to enhance the attractiveness of the forum. Practitioners facing forum-selection issues should, however, remain attentive to the substantial differences in procedure and practice between the common-law Business Court and the equitable court of chancery.

48 Wolfe, Jr. & Pittenger, supra note 1, § 10.07.

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II. TAX CONSIDERATIONS

A. Importance of Where Operations Conducted

This section will examine the major tax considerations applicable to corporations incorporating in either North Carolina or Delaware. The tax considerations will differ depending upon whether a corporation conducts operations in the state of incorporation or conducts operations outside of the state of incorporation. The comparisons set forth below generally cover only income and franchise taxes, and do not involve sales, gross receipts, property or other similar taxes (some of which are covered, however, below in Section II.D. of this study).

1. North Carolina Corporate Income Tax

North Carolina has a corporate income tax, and per North Carolina General Statutes Section 105-130.1 it is generally imposed on the net income of both domestic corporations and foreign corporations which conduct business in North Carolina.49 The rate of tax on a corporation’s net income is 6.9%. For tax years beginning on or after January 1, 2009 and before January 1, 2011, corporations subject to corporate income tax must pay an income tax surcharge of 3% on their North Carolina income tax due before deducting any tax credits or payments. A corporation that is engaged in multi-state business activity must apportion to North Carolina all apportionable income using a four-factor formula consisting of the sum of the property factor, the payroll factor and twice the sales factor, divided by four.50 North Carolina does not have a “throwback” rule51 involving sales shipped to other states.

2. Delaware Corporate Income Tax

Delaware has a corporate income tax on corporations, and it is generally imposed on corporations that conduct business in Delaware. Under 30 Delaware Code Section 1902 et seq., the corporate income tax is 8.7% of a corporation’s net income.52 Corporations that engage in multi-state business activity must apportion net income to Delaware based on an equally weighted three-factor formula involving property, wages, and sales. Delaware does not have a “throwback” rule involving sales shipped to other states. Under 30 Delaware Code Section 1902(b)(6), corporations that have a statutory office in Delaware but do not conduct any business in Delaware are exempt from the Delaware corporate income tax.

49 Net income for North Carolina corporate income tax purposes is a corporation’s federal taxable income adjusted to include and exclude, as appropriate, the items described in North Carolina General Statutes Sections 105-130.5. and 105-130.2(5c). 50 N.C. Gen. Stat. § 105-130.4(i). 51 One method for attributing interstate sales to a specific state is a destination test. Under a sales destination test, sales are attributable to a state when goods are shipped into or delivered to customers in the state. A throwback rule would attribute a sale back to the state of origination instead of attributing it to the state of destination, if the seller is not taxable in the state of destination. 52 Net income for Delaware corporate income tax purposes is a corporation’s federal taxable income adjusted to include and exclude the items described in 30 Delaware Code Section 1903(a).

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3. North Carolina Franchise Tax

North Carolina has a franchise tax which generally applies to all corporations incorporated in North Carolina and all foreign corporations with a Certificate of Authority to do business in North Carolina or which are in fact doing business in North Carolina.53 The basis of North Carolina’s franchise tax is a corporation’s total or allocated capital stock, surplus and undivided profits. Corporations engaging in multi-state business activity are required to allocate a portion of their capital stock, surplus and undivided profits to North Carolina by using the fractions they apply in apportioning their income for North Carolina income tax purposes.54 If a corporation believes that the foregoing apportionment method subjects a greater portion of its capital stock, surplus and undivided profits to tax than is attributable to North Carolina business, the corporation may request permission from the North Carolina Department of Revenue to use an alternative method. The burden of proof is on the corporation to prove the requested alternative method is more appropriate than the statutory method.

After determining the basis of the franchise tax as described above, a corporation must compare it to two other amounts to determine the taxable franchise base: (i) 55% of the corporation’s appraised ad valorem tax value of all tangible property in North Carolina and (ii) the corporation’s actual investment in tangible property in North Carolina. A corporation must use the highest of these three amounts as its taxable franchise base.55 North Carolina’s franchise tax is computed by applying the rate of $1.50 per $1,000 to the corporation’s taxable franchise base. The minimum North Carolina franchise tax payable annually is $35.

4. Delaware Franchise Tax

Delaware has a franchise tax that generally applies to all corporations incorporated in Delaware. Under 8 Delaware Code Section 503, a corporation’s Delaware franchise tax will be the lesser of the two amounts calculated using the authorized shares method and the assumed par value capital method. The minimum Delaware franchise tax payable annually is $75, and the maximum franchise tax payable annually is $180,000. For corporations having no par value stock, the authorized shares method will always result in the lesser tax.

Using the authorized shares method, Delaware franchise tax is calculated as follows:

� 5,000 shares or less – $75

� 5,001 – 10,000 shares – $150

� Each additional 10,000 shares or portion thereof – $75

The assumed par value capital method takes into account all of a corporation’s issued shares (including treasury shares) and total gross assets, and uses a tax rate of $350 per

53 N.C. Gen. Stat. § 105-122. 54 N.C. Gen. Stat. § 105-122(c1)(1). 55 N.C. Gen. Stat. § 105-122(d).

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million or portion of a million. Using the assumed par value capital method, Delaware franchise tax is calculated as follows:

(a) Divide the corporation’s total gross assets by its total issued shares, carrying the quotient to six decimal places. The result is the corporation’s “assumed par value.”

(b) Multiply the assumed par value by the number of authorized shares having a par value of less than the assumed par value.

(c) Multiply the number of authorized shares with a par value greater than the assumed par value by their respective par value.

(d) Add the results of (b) and (c) above. The result is the corporation’s assumed par value capital.

(e) Compute the corporation’s franchise tax by dividing the assumed par value capital, rounded up to the next million if it is over $1,000,000, by 1,000,000 and then multiply by $350.

B. Tax if Corporation Conducts Business in North Carolina

If the corporation conducts business in North Carolina, then the following tax considerations generally will apply.

1. North Carolina Corporations

If the corporation is incorporated in North Carolina, the following taxes will generally be imposed:

(a) North Carolina corporate income tax of 6.9% of the corporation’s net income allocable to North Carolina (plus a 3% surtax for 2009 and 2010); and

(b) North Carolina franchise tax at the rate of $1.50 per $1,000 of taxable franchise base as described above.

2. Delaware Corporations

If the corporation is incorporated in Delaware, the following taxes will generally be imposed:

(a) North Carolina corporate income tax of 6.9% of the corporation’s net income allocable to North Carolina (plus a 3% surtax for 2009 and 2010);

(b) North Carolina franchise tax at the rate of $1.50 per $1,000 of taxable franchise base allocable to North Carolina as described above; and

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(c) The corporation will have to qualify to do business in North Carolina as a foreign corporation ($250 one-time fee).

C. Tax if Corporation Conducts Business in Delaware

If the corporation conducts business in Delaware, then the following tax considerations will generally apply.

1. Delaware Corporations

If the corporation is incorporated in Delaware, the following taxes will generally be imposed:

(a) Delaware corporate income tax of 8.7% of the corporation’s net income allocable to Delaware; and

(b) Delaware franchise tax equal to the lesser of the two amounts computed by utilizing the authorized shares method and assumed par value capital method as described above.

2. North Carolina Corporations

If the corporation is incorporated in North Carolina, the following taxes will generally be imposed:

(a) Delaware corporate income tax of 8.7% of the corporation’s net income allocable to Delaware;

(b) The corporation will have to qualify to do business in Delaware as a foreign corporation ($245 one-time fee); and

(c) The corporation would not be subject to Delaware franchise tax (though not assessed franchise tax, foreign corporations are required to file a Delaware annual report with a filing fee of $125).

D. Other Kinds of Taxes

1. Sales and Use Tax

a) North Carolina

The current sales and use tax rate56 is a combined state and local rate of 7.75% for all counties except Alexander, Catawba, Cumberland, Haywood, Martin, Pitt, Sampson and Surry at 8.00% and Mecklenburg at 8.25%.57 Businesses engaged in (i) selling tangible personal property at retail, (ii) renting or leasing tangible personal property in the state,

56 As of 02/08/10. 57 Includes a local sales tax of 0.5% for public transportation.

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or (iii) operating a laundry, dry cleaning, hotel, motel or similar business in North Carolina must collect and remit sales tax on behalf of the consumer (since tax is imposed on consumer). For North Carolina businesses making purchases outside of North Carolina, the use tax may apply unless an exemption applies (e.g., a sale for resale). An offset is permitted against any sales tax charged and collected by such other state. A casual and isolated sales exemption exists to exempt the sale of a business from sales and use tax (except for sales of inventory and certain other assets).

Filing frequency is as follows:

� taxpayers with total tax liability consistently less than $100 per month file quarterly returns with the approval of the secretary of state;

� taxpayers with total tax liability consistently less than $10,000 per month file monthly returns on or before the 20th day of the succeeding calendar month; and

� taxpayers who are consistently liable for $10,000 or more per month must make a monthly prepayment for the following month when filing their monthly return on or before the 20th day of the succeeding calendar month.

b) Delaware

Delaware currently has no general sales or use tax, though Delaware does impose a gross receipts tax on some businesses. This tax works like a sales tax but is imposed on the business rather than the consumer, as described in Section 2.b) below.

2. Gross Receipts Tax

a) North Carolina

North Carolina currently has no gross receipts tax, though North Carolina does impose sales and use tax that is collected by certain businesses. This tax works like a gross receipts tax but is imposed on the consumer rather than the business.

b) Delaware

Delaware has a manufacturers’ and merchants’ license tax that is assessed against gross sales of the following types of businesses:

� contractors;

� manufacturers;

� wholesalers;

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� food processors;

� commercial feed dealers;

� retailers;

� restaurant retailers;

� grocery supermarkets;

� farm machinery dealers;

� lessors of tangible personal property;

� commercial lessors; and

� occupational/professional/general services.

The rates vary for each of these businesses and, unlike a sales or use tax, the tax is imposed on the business rather than the consumer. Generally, there is an annual fee (currently about $75) associated with the gross receipts tax, and the tax rates on the gross receipts range from 0.1037% to 2.0736% and may require that a minimum be met before the tax is imposed.58

3. Property Tax

a) North Carolina

All real and personal property is subject to taxation and is assessed based on 100% of appraised value. This includes all machinery and equipment. Taxes are imposed and collected by cities and counties, and there is no state level property tax imposed. Every business is required to list its tangible personal property during January with the county assessor of the county in which the property is located. In order to receive the standard forms and other listing information, businesses should contact the county assessor to make sure they are on the roster of taxpayers or “tax roll.”

Property tax rates vary from county to county and from town to town. County rates for 2009-2010 ranged from 23¢ to $1.02 per $100 of appraised valuation. Cities and towns levy taxes above the county tax and their rates ranged from 0¢ to 82¢ per $100 in 2009-2010. A number of school districts have tax levies separate from the county rate, and these rates range from 2¢ to 21¢ per $100. Some fire districts also have separate tax levies apart from the county rates and these rates range from 1¢ to 54.6¢ per $100. There are few special district taxes apart from school levies and rural fire district levies that apply in addition to county and city and

58 As of 12/12/08.

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town levies. However, in much of North Carolina, only county-wide rates apply outside of cities and towns.59

There are a few exemptions and exclusions of note to manufacturers, retailers, and wholesalers, including, but not limited to, the following: 60

� manufacturers’ inventories;

� contractors’ inventories;

� livestock, poultry, and feed used in production of livestock and poultry;

� inventories of retail and wholesale merchants;

� computer software (other than embedded software and capitalized software purchased or licensed from an unrelated entity);

� certain imported property awaiting further shipment;

� certain “bill and hold” goods manufactured in North Carolina and held by the manufacturer for shipment to a nonresident;

� motor vehicle chassis belonging to nonresidents which enter the State temporarily for the purpose of having a body mounted thereon;

� nuclear materials held for the purpose of, or in the process of, manufacture or processing, or held by the manufacturer for delivery;

� improvements on brownfields properties (partially excluded);

� certain property used to reduce air or water pollution;

� personal property used exclusively for the prevention or reduction of dust in textile plants; and

� certain equipment or facilities installed for the purpose of recycling solid waste or resource recovery from solid waste.

b) Delaware

All real property in the state is subject to tax unless specifically exempt. Personal property, tangible and intangible property is exempt. Real estate is subject to county,

59 See http://www.dornc.com/taxes/property/rates.html (preliminary report for 2009-2010) for property tax rate information as of 02/08/10. 60 See generally N.C. Gen. Stat., Chapter 105, Article 12.

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school district, vocational school district, and municipal property taxes. There is no state level property tax. With a few limited exceptions, tax rates are the same for all types of property including residential, industrial, and commercial. The three Delaware counties have different dates of assessment; they tax a different proportion of that assessment (50%, 60% or 100% depending upon the county), and they tax at different rates. Municipal and school district rates also vary throughout the state.

Property tax rates vary from county to county and from town to town. County rates for 2009-2010 ranged from 24.36¢ to 70.18¢ per $100 of appraised valuation. Cities and towns levy taxes above the county tax and their rates ranged from 0¢ to $2.93 per $100 in 2009-2010. There are also rates for schools, libraries and vo-tech and the total assessments generally ranged from $0 to $3.51 per $100 of assessed value.61

4. Corporate Filing Fees

a) North Carolina

A fee of $125 is payable to the office of the secretary of state upon filing articles of incorporation, and there is a fee of $250 for application for certificate of authority on foreign companies only. In addition, an annual report fee may be paid with the corporation’s income and franchise tax return or may be filed and paid electronically with the secretary of state. If the fee is paid with the return, the filing fee is $25, but is $18 if filed electronically.

b) Delaware

A minimum fee of $89 is payable to the Department of State upon filing the certificate of incorporation and there is a fee of $245 for application for foreign qualification on foreign companies qualifying to do business in Delaware. The annual license fee is $75 for most businesses.

5. Specific Taxes

In addition to the above-mentioned taxes, there are a number of industry or activity specific taxes in each state that may apply to particular businesses. A comprehensive review of each of these taxes is beyond the scope of this study, but included below is a list of some of the types of taxes that could apply to a particular business.

a) North Carolina

� Electricity and Telecommunications Sales and Use Tax;

� Video Programming Service Sales and Use Tax;

� Liquor Sales and Use Tax;

61 See http://www.dedo.delaware.gov/pdfs/main_root/publications/2009-2010PropertyTaxReport.pdf for property tax rate information as of 09/23/2009.

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� Manufacturing Fuel and Certain Machinery and Equipment;

� Motor Vehicle Lease and Rental Tax (Alternate Highway Use Tax);

� Scrap Tire Disposal Tax;

� White Goods Disposal Tax;

� Dry-Cleaning Solvent Tax;

� Solid Waste Disposal Tax; and

� Real Estate Transfer Tax (excise tax is levied on transfers of real estate at the rate of $1 of each $500, or fraction thereof, of the consideration or value of the property conveyed and, in addition, seven counties – Dare, Camden, Chowan, Currituck, Pasquotank, Perquimans, and Washington – are authorized to levy a local real estate transfer tax of $1 per $100 of the full consideration).

b) Delaware

� Commodities Taxes on Cigarettes/Tobacco Products;

� Commodities Taxes on Public Accommodations;

� Realty Transfer Tax;

� Excise Tax on Alcoholic Beverages;

� Retail Tire License and Scrap Tire Fee; and

� Retail Crime Fee.

6. Tax Incentives

In addition to the differences in taxation set forth above, each state also has a number of different tax incentives available to businesses at any given time. These incentives may take the form of credits, rebates, reduced rates or some other incentive plan and may change frequently.

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III. STATUTORY COMPARISON

A. Preliminary Matters

1. Filing Requirements and Dealing with the Secretary of State

Practically speaking, the general filing requirements in North Carolina and Delaware are not dramatically different. Although the NCBCA expressly addresses certain matters as to which the DGCL is silent,62 the two jurisdictions operate similarly as to matters of routine filings and day-to-day dealings.

Under the NCBCA, any document required or permitted to be filed with the secretary of state must be filed in accordance with Chapter 55D of the General Statutes.63 A document submitted by a North Carolina corporation must be executed by: (i) the chair of the corporation’s board of directors, its president or an officer; (ii) an incorporator (if the directors have not been selected or the corporation has not been formed); or (iii) a fiduciary (if the corporation is in the hands of a receiver, trustee or other court-appointed fiduciary).64

Under the DGCL, documents filed with the secretary of state must be filed in accordance with Section 103. As in North Carolina, the filing requirements depend on the timing of the filing. Before the election of the initial board of directors (if the directors were not named in the certificate of incorporation), any filing with the secretary of state shall be signed by the incorporator, unless the incorporator is unavailable, in which case any person on whose behalf the incorporator was acting may sign, provided that (i) the filing states the reasons that the incorporator is unavailable, (ii) the filing specifies that the incorporator had been acting on such person’s behalf and (iii) such person’s signature on the filing is otherwise authorized.65 After the initial directors are elected or named, instruments may be signed by any of the following: (i) an authorized officer, (ii) a majority of the directors (or the directors designated by the board), (iii)

62 For example, the NCBCA specifically designates certain forms that the secretary of state may promulgate and authorizes the secretary of state to make their use mandatory. These forms are as follows: (1) applications for certificates of existence (which as a practical matter is most often requested online), (2) a foreign corporation’s application for a certificate of authority to transact business in North Carolina and (3) a foreign corporation’s application for a certificate of withdrawal. As of the initial publication of this study, forms (2) and (3) have been promulgated but are not mandatory. N.C. Gen. Stat. § 55-1-21(a). The NCBCA also permits the secretary of state to promulgate other forms required or permitted to be filed, but their use is not mandatory. N.C. Gen. Stat. § 55-1-21(b). Moreover, note that the form of annual report promulgated by the secretary of state had previously been included in the list of forms in NCBCA Section 1-21(a) that the secretary of state could make mandatory, but now is definitively prescribed as mandatory by both the secretary of state and the North Carolina Department of Revenue. N.C. Gen. Stat. § 55-16-22. 63 Chapter 55D provides, among other things, that documents entitled to be filed with the secretary of state shall comply with the requirements set forth therein (which requirements include that documents shall be typewritten, in English, executed by an authorized person (with the person’s signing capacity so indicated) and in the form prescribed by the secretary of state, to the extent such office has designated such form as a mandatory). 64 N.C. Gen. Stat. § 55-1-20. 65 Del. Code Ann. tit. 8, § 103(a)(1).

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the holders of a majority of all outstanding shares of stock, or (iv) the holders of all outstanding shares of stock.66

NCBCA Section 1-22 and DGCL Section 391 set forth the fees required when delivering specific documents to the relevant jurisdiction’s secretary of state.

The NCBCA provides that anyone may apply to the secretary of state for a certificate of existence for a domestic North Carolina corporation or a certificate of authority for a foreign corporation.67 That section of the statute also describes the contents of each such certificate, and indicates that any such certificate may be relied on as conclusive evidence of existence or authorization to transact business in North Carolina, as appropriate.68

The DGCL has no similar provision, but Section 371 does set forth the requirements for obtaining a certificate of authority to transact business in Delaware as a foreign corporation, as does Section 5-03 of the NCBCA (as to certificates of authority of foreign corporations to transact business in North Carolina). The requirements under the two statutes are similar, but they differ in certain respects.

First, the NCBCA requires the submission of an “application” (such as in the form promulgated by the secretary of state) setting forth (i) the foreign corporation’s name (which shall comply with the name requirements set forth in Article 3 of Section 55D of the General Statutes69), (ii) its state of incorporation, (iii) its date of incorporation and period of duration, (iv) its street (and, if different, mailing) address and county of its principal office, (v) the street (and if different, mailing) address of its registered office in North Carolina (together with the county thereof and the name of the registered agent) and (vi) the name and business addresses of the corporation’s officers.70 Moreover, the North Carolina application should be delivered with a certificate of existence or equivalent document authenticated by the secretary of state of the jurisdiction in which the foreign corporation is incorporated. The DGCL, meanwhile, requires a statement of an authorized officer of the foreign corporation setting forth (i) the name and address of its registered agent in Delaware, (ii) a statement, as of a date not earlier than 6 months prior to the filing date, of the assets and liabilities of the corporation, and (iii) the business it proposes to do in Delaware, and (iv) a statement that it is authorized to do that business in the jurisdiction of its incorporation.71

In certain instances, the DGCL may require that an instrument filed with the secretary of state be “acknowledged,” which requirement may be satisfied by either (i) a formal acknowledgement by the signatory before an authorized person who takes acknowledgment of

66 Del. Code Ann. tit. 8, § 103(a)(2). 67 N.C. Gen. Stat. § 55-1-28. 68 Id. 69 The DGCL similarly requires that the foreign corporation’s name be distinguishable from the names of other entities of record in Delaware. Del. Code Ann. tit. 8, § 371(c). 70 N.C. Gen. Stat. § 55-15-03. 71 Del. Code Ann. tit. 8, § 371.

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such deeds or (ii) the signature of the person signing the instrument.72 By contrast, North Carolina does not require acknowledgement of documents filed with the secretary of state.73

The relevant statutes of both North Carolina and Delaware (i) permit the filing of documents via facsimile or electronically transmitted signature;74 (ii) provide that upon delivery of the filing and payment of all required fees, such filing shall be effective, subject to the ability of the submitting party to provide for a delayed effective date (which may not be later than 90 days following submission);75 and (iii) provide mechanisms for correction of erroneous filings.76

In addition, the DGCL provides that (i) if the transaction relating to a particular filing which provides for a future effective date is terminated, a certificate of termination or amendment of the original instrument can be filed prior to the future effective date in order to terminate or amend the original filing;77 and (ii) if a filing is delayed as a consequence of an attack on, or an armed conflict, riot or insurrection or other civil commotion, in the United States or a locality in which the secretary of state conducts business or in which the tender of the filing and payment of fees is attempted to be made,78 then upon certain circumstances the secretary of state may make the filing effective as of the originally intended effective date.79 The NCBCA, meanwhile, does not contain equivalent provisions.

B. Incorporation Matters

1. Purposes and Powers

Pursuant to the NCBCA, all North Carolina corporations have the purpose of engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation (and the NCBCA does not require that the articles of incorporation state the corporation’s purpose).80 If the corporation engages in a business subject to regulation under another North Carolina statute, it may incorporate under the NCBCA only if incorporation is permitted under the other statute and the corporation complies with any limitations of such statute.81

72 Del. Code Ann. tit. 8, § 103(a)(2). Even where this latter approach is relied upon, such signature constitutes affirmation, under penalty of perjury, that the instrument is the signatory’s or the corporation’s act and deed and that the facts stated therein are true. Id. 73 North Carolina General Statutes Section 55D-18 does provide, however, that a person commits a misdemeanor if the person signs a document the person knows is false in any material respect with intent that the document be delivered to the secretary of state for filing. Thus, the substance of North Carolina and Delaware is essentially the same in this regard. 74 N.C. Gen. Stat. § 55D-10(b)(6); Del. Code Ann. tit. 8, § 103(h). 75 N.C. Gen. Stat. §§ 55D-10 and 55D-13; Del. Code Ann. tit. 8, §§ 103(c) and 103(d). 76 N.C. Gen. Stat. § 55D-14; Del. Code Ann. tit. 8, § 103(f). In addition, DGCL Section 103(c)(4) enables the secretary of state, upon request, to suspend an erroneous filing for up to 5 business days and upon receipt of a correct filing within such period, to designate the original filing date as the effective date. 77 Del. Code Ann. tit. 8, § 103(d). 78 The statute also similarly addresses power outages and weather-related conditions. Del. Code Ann. tit. 8, § 103(i). 79 Id. 80 N.C. Gen. Stat. § 55-3-01(a). For additional discussion, see Section II.B.2. of this study, below. 81 N.C. Gen. Stat. § 55-3-01(b).

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The DGCL, unlike the NCBCA, does require that the certificate of incorporation state the corporation’s purpose, but the DGCL also expressly provides that a sufficient purpose for a Delaware corporation is to engage in any lawful act or activity for which corporations may be organized under the DGCL, and by making such a statement in the certificate of incorporation, all lawful acts and activities shall be within the purposes of the corporation, except for any express limitations.82

The NCBCA also provides that all North Carolina corporations, unless otherwise specified in their articles of incorporation, have perpetual duration and succession in their corporate names, as well as the same powers as an individual to do all things necessary or convenient to conduct their businesses. The statute sets forth a list of corporate activities that are expressly permitted (such as to sue or be sued, to purchase and hold real and personal property, to enter into contracts, to make charitable donations, etc.).83

Section 102(b) of the DGCL similarly provides for perpetual duration of the corporation (unless otherwise set forth in the certificate of incorporation), and the DGCL generally authorizes a corporation, its officers, directors and shareholders84 shall possess and may exercise all the powers and privileges granted by the DGCL or any other law or the certificate of incorporation, and any powers incidental thereto, if necessary or convenient to the corporation’s business and purpose as set forth in the certificate of incorporation.85 The DGCL also contains a list of specific powers of all Delaware corporations that is similar to the NCBCA’s list. The DGCL, however, specifically empowers a Delaware corporation to (i) renounce, in its certificate of incorporation or by action of its board of directors, any interest of the corporation in, or in being offered an opportunity to participate in, any specified business opportunities that are presented to the corporation or its officers, directors or stockholders;86 and (ii) guarantee, acquire, hold, use, transfer, dispose of, lend, pledge or otherwise deal in bonds and other obligations of, or shares or other securities or interests in, or issued by, any other domestic or foreign entity or person or by any governmental agency. A Delaware corporation that owns any such securities may exercise all the rights, powers, and privileges of ownership, including the right to vote.87

The NCBCA and DGCL provide for comparable emergency powers in cases where a quorum of the corporation’s directors cannot be readily assembled because of a catastrophic event.88 In such case, the board of directors may, among other things, take the following actions: (i) modify the lines of succession to accommodate the incapacity of any director, officer, employee or agent; (ii) relocate the principal office, designate alternative principal offices or regional offices, or authorize the officers to do so; (iii) give notice of a board meeting only to those board members capable of being reached, and in whatever form practicable, including publication and radio; and (iv) deem officers at such a meeting to be

82 Del. Code Ann. tit. 8, § 102(a)(3). 83 N.C. Gen. Stat. § 55-3-02(a). 84 Note that North Carolina’s statutory language in this regard is limited to the corporation. Id. 85 Del. Code Ann. tit. 8, § 121(a). 86 Del. Code Ann. tit. 8, § 122. 87 Del. Code Ann. tit. 8, § 123. 88 N.C. Gen. Stat. § 55-3-03; Del. Code Ann. tit. 8, § 110.

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directors for purposes of the meeting if necessary to achieve a quorum.89 In North Carolina, action taken in good faith during such an emergency to further the ordinary business affairs of the corporation will bind the corporation, and the fact that any such action is taken by special procedures may not be used to impose liability on a corporate director, officer, employee, or agent; meanwhile, in Delaware, no officer, director or employee acting in accordance with any emergency bylaws shall be liable except for wilful misconduct.90

In certain cases, the validity of a corporate action may be challenged on the grounds that the corporation did not have the power to take such action. In North Carolina, such a challenge may only be made in one of three circumstances: (1) when a shareholder brings a proceeding against the corporation to enjoin the act; (2) in a proceeding by the corporation against a current or former officer, director, employee or agent of the corporation; or (3) in a proceeding brought by the state’s attorney general.91 The DGCL similarly provides that lack of corporate power to take an action can be asserted only by a shareholder, the corporation (against an incumbent or former officer or director) or the attorney general.92 In both states, at a proceeding brought by a shareholder, the challenged act may be enjoined or set aside if equitable and if all affected persons are parties to the proceeding, and the court may award damages for loss suffered by the corporation or another party because of enjoining the unauthorized act.93

The DGCL expressly identifies certain activities that Delaware corporations may not engage in, or that are more restricted. DGCL Section 125 states that corporations cannot confer academic or honorary degrees, or conduct a private business or trade school, unless the certificate of incorporation so provides and is endorsed by the Delaware Department of Education, although there are specific exemptions therein for Delaware corporations conducting a law school. DGCL Section 126 explicitly denies banking power to corporations, and DGCL Section 127 requires private foundations organized as Delaware corporations to abide by specific provisions of the Internal Revenue Code, unless the certificate of incorporation provides otherwise. The provision of the NCBCA most analogous to the foregoing is NCBCA Section 3-01(b), which provides that a North Carolina corporation engaging in a business that is subject to regulation under another North Carolina statute may incorporate under Chapter 55 only if permitted by, and subject to all limitations of, the other statute.

2. Procedures; Contents of Articles and Certificates of Incorporation

To begin its corporate existence, each North Carolina corporation must file articles of incorporation with the secretary of state. The articles of incorporation must set forth the following: the corporate name; the number of shares the corporation is authorized to issue; the street address and mailing address (if different) of the corporation’s initial registered office, the county in which the registered agent is located and the name of the initial registered agent; the street address and mailing address (if different) of the corporation’s principal office, if any,

89 N.C. Gen. Stat. § 55-3-03(a); Del. Code Ann. tit. 8, § 110. 90 N.C. Gen. Stat. § 55-3-03(c); Del. Code Ann. tit. 8, § 110(d). 91 N.C. Gen. Stat. § 55-3-04(b). 92 Del. Code Ann. tit. 8, §124. 93 N.C. Gen. Stat. § 55-3-03(c); Del. Code Ann. tit. 8, § 124(1).

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and the county in which the principal office is located; and the name and address of each incorporator.94

NCBCA Section 2-02(b) also provides that the articles of incorporation may (but need not) include (a) any provisions that are either required or permitted by the NCBCA to be in the bylaws of the corporation or (b) any of the following: the names and addresses of the individuals who are to serve as the initial directors; the purpose or purposes for which the corporation is organized; provisions aimed at managing the business of and regulating the affairs of the corporation; provisions that define, limit, and regulate the powers of the corporation, its board, or its shareholders; par value for the shares of the company (which, as discussed in Section III.C.1. of this study, is not required); imposition of personal liability on the shareholders for the debts of the corporation (to a specified extent and upon specified conditions); and any limitation on the duration of the corporation.95

If a North Carolina corporation’s capital stock shall be divided into classes, the articles of incorporation must set forth the characteristics of those various classes.96 In addition, if the corporation shall have preemptive rights97 or cumulative voting,98 or in the case of a public corporation, if the incorporators desire that the corporation opt out of North Carolina’s Shareholder Protection Act and Control Share Acquisition Act,99 the articles of incorporation must so indicate.

Finally, if the corporation’s directors are to have the benefit of a provision limiting or eliminating personal liability for monetary damages for breach of fiduciary duty as directors100 (or, alternatively, if the incorporators intend to limit the directors’ statutory indemnification rights101 or any court-ordered indemnification102), then the articles of incorporation must so indicate.103

In Delaware, the instrument that commences the existence of the corporation is called the “certificate of incorporation” rather than “articles of incorporation.” This document is filed with the Division of Corporations in the Department of State in Delaware.104 Under the DGCL, the certificate of incorporation must set forth the following: the name of the corporation; the address of the corporation’s registered office in Delaware and name of its registered agent at that address; the nature of the business or its purpose; a summary of the capitalization of the corporation, including the designations and powers, preferences and rights, and the

94 N.C. Gen. Stat. § 55-2-02(a)(1) – (4). 95 N.C. Gen. Stat. § 55-2-02(b)(2). 96 N.C. Gen. Stat. § 55-6-01 and 55-6-02. 97 N.C. Gen. Stat. § 55-6-30. Note that non-public North Carolina corporations incorporated before July 1, 1990 have preemptive rights unless the articles of incorporation provide otherwise. 98 N.C. Gen. Stat. § 55-7-28. 99 N.C. Gen. Stat. § 55-9-05 and 55-9A-09. Note that the NCBCA permits subsequent amendments to the bylaws to effect opt-outs under certain circumstances. Id. 100 N.C. Gen. Stat. § 55-2-02(b)(3). 101 N.C. Gen. Stat. § 55-8-52. 102 N.C. Gen. Stat. § 55-8-54. 103 For a more complete discussion of the limiting of personal liability of directors, see Section III. E. of this study, below. 104 Del. Code Ann. tit. 8, § 101(a).

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qualifications, limitations or restrictions with respect to all classes of stock; the name and mailing address of all incorporators; and the names of the initial directors if the powers of the incorporator terminate upon filing.105

As with the NCBCA, the DGCL enumerates a number of items that may (but need not, unless the specific circumstances of the corporation so require) be included in the certificate of incorporation, as follows: provisions for the management of the business or any provision creating, defining, limiting and regulating powers of the corporation, directors stockholders, any class of the stockholders (as long as these provisions are not contrary to the laws of Delaware); preemptive rights; supermajority voting provisions; provisions limiting the duration of the corporation’s existence; provisions imposing personal liability for the debts of the corporation on its stockholders to a specified extent and upon specified conditions; provisions eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director;106 and provisions permitting court-supervised compromises and arrangements between the corporation and its creditors or stockholders in connection with a reorganization (and empowering the Chancery Court of Delaware to order a meeting in connection with such compromise or arrangement).107

3. Corporate Name

North Carolina law provides that the name of each domestic corporation shall contain the word “corporation,” “incorporated,” “company,” or “limited” or the abbreviation “corp.,” “inc.,” “co.” or “ltd.”108 Further, a corporate name may not contain language stating or implying that the corporation is organized for a purpose other than as permitted by its articles of incorporation and by NCBCA Section 3-01. Section 3-01 in general allows a corporation to be organized for any lawful purpose, subject to any restrictions imposed by statute or regulation on corporations that are engaged in businesses that are subject to regulation under state law.109 A domestic corporation is also permitted to operate under an assumed name by filing a certificate with the register of deeds in each county in which the business is operating, which certificate states both the name under which the business is to be conducted and the name and address of the owner(s) of the business.110

In addition, the name of a domestic corporation must be distinguishable upon the records of the secretary of state from the name of any other business entity organized in North Carolina or properly authorized to transact business in North Carolina.111 The name must also be distinguishable from any name reserved or registered for use in the state (as discussed below) as well as from any fictitious name adopted by a foreign entity authorized to transact business in

105 Del. Code Ann. tit. 8, § 102(a)(1) – (6). 106 For a more complete discussion of the limiting of personal liability of directors, see Section III. E. of this study, below. 107 Del. Code Ann. tit. 8, § 102(b)(1) – (7). In addition, DGCL Section 214 states that the certificate of incorporation may provide for cumulative voting. 108 N.C. Gen. Stat. § 55D-20(a)(1). 109 N.C. Gen. Stat. § 55-3-01. 110 N.C. Gen. Stat. §§ 55D-20(d) and 66-68(a). 111 N.C. Gen. Stat. § 55D-21(b)(1).

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North Carolina.112 A non-distinguishable name may be used only if: (i) the other person who has or uses the name consents in writing to the use of the name by the new applicant, and also agrees in writing to change its name to a distinguishable name; or (ii) the final judgment of a court of competent jurisdiction establishes the applicant’s right to use the requested name in North Carolina.113

Under North Carolina law, the name of a dissolved entity may not be used by another entity until certain time periods have elapsed, depending on the type of dissolution involved. In the case of a voluntary dissolution, another company may use the name after 120 days have elapsed.114 In the case of a judicial dissolution, the waiting period is 120 days from the later of the date the judgment has become final or the effective date of the dissolution.115 In the case of an administrative dissolution, five years must elapse before another corporation is free to use the name.116

North Carolina law allows an applicant to reserve, for a nonrenewable 120-day period, the exclusive use of a corporate name by filing with the secretary of state an application that sets forth the name and address of the applicant and the proposed name.117 In addition, any person acquiring the goodwill of a corporation that was organized in or authorized to conduct business in North Carolina may reserve for a 10-year period the exclusive right to any name that became available as a result of the acquisition.118 Finally, a foreign corporation may register its name (modified as necessary to be compliant with the requirements described above) by filing an application setting forth its name, its state or country and date of incorporation, and a brief description of its business, along with a certificate of existence from its jurisdiction of incorporation, with the secretary of state.119 This registers the name for use in North Carolina until the end of the year in which the registration was filed; the registration can be renewed in succeeding calendar years.120 The effect of the registration is to allow a foreign corporation to preserve the right to use its name in the event it later decides to become qualified to transact business in the state.121

Delaware’s rules regarding corporate names are more flexible than are North Carolina’s. A corporate name in Delaware must contain one of the words “association,” “company,” “corporation,” “club,” “foundation,” “fund,” “institute,” “society,” “union,” “syndicate” or “limited,” or abbreviations thereof, or words of like import of foreign countries or jurisdictions, as long as such words are written in roman characters or letters.122 In addition, the secretary of state may waive the requirement for including such a word in the name of any corporation where the name does not appear to be that of a natural person and the corporation

112 N.C. Gen. Stat. § 55D-21(b)(2) and (3). 113 N.C. Gen. Stat. § 55D-21(c). 114 N.C. Gen. Stat. § 55D-21(d)(1). 115 N.C. Gen. Stat. § 55D-21(d)(3). 116 N.C. Gen. Stat. § 55D-21(d)(2). 117 N.C. Gen. Stat. § 55D-23(a). 118 N.C. Gen. Stat. § 55D-23(c). 119 N.C. Gen. Stat. § 55D-24(a) and (b). 120 N.C. Gen. Stat. § 55D-24(c) and (d). 121 Official Comment to former N.C. Gen. Stat. § 55-4-03, now codified at N.C. Gen. Stat. § 55D-24. 122 Del. Code Ann. tit. 8, § 102(a)(1).

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certifies that it has assets of at least $10,000,000.123 As in North Carolina, each corporate name must be distinguishable from names of existing entities organized or authorized to transact business in Delaware, as well as from names reserved for use in Delaware, unless the person reserving such name authorizes the new corporation to use such reserved name.124 Unlike North Carolina, Delaware does not have a specific statutory provision addressing when the name of a dissolved corporation again becomes available for use in the state.

A person wishing to reserve a corporate name may file an application to do so with the secretary of state by or on behalf of: (i) any person intending to or contemplating incorporating in Delaware; (ii) any domestic corporation or foreign corporation authorized to do business in Delaware intending to or contemplating changing its name; (iii) any foreign corporation intending or contemplating qualifying to do business in Delaware under such name; or (iv) any person contemplating forming a foreign corporation and qualifying it to do business in Delaware.125 The reservation is good for 120 days and may be renewed for successive 120-day periods.126 This is different from the North Carolina rule, which only allows extended reservation or registration periods for foreign corporations actually in existence. The registration may also be transferred to any person by filing a notice of transfer with the secretary of state.127

4. Registered Office and Agent

North Carolina law requires that each domestic corporation, as well as each foreign corporation authorized to transact business in North Carolina, must continuously maintain a registered office in the state, which may be the same as its place of business.128 Each such corporation must also continuously maintain a registered agent in the state, which must be either: (i) an individual whose business office in the state is identical to the registered office; (ii) a domestic corporation, nonprofit corporation or limited liability company whose business office in the state is identical with the registered office; or (iii) a foreign corporation, nonprofit corporation or limited liability company authorized to transact business in the state whose business office is identical with the registered office.129 Under North Carolina law, the sole duty of the registered agent is to forward to the corporation, at its last known address, any notice, process or demand that is served on the registered agent.130

A North Carolina corporation may change its registered office and/or registered agent by delivering a statement of change for filing with the secretary of state. The statement of change must include all of the following information: (i) the name of the entity; (ii) the street address, mailing address and county of the existing registered office; (iii) the street address, mailing address and county of the new registered office; (iv) the name of its current registered agent; (v) the name of the new registered agent and the agent’s written consent to so serve; and (vi) a statement that the address of the registered office and the business address of the registered

123 Del. Code Ann. tit. 8, § 102(a)(1). 124 Del. Code Ann. tit. 8, § 102(a)(1). 125 Del. Code Ann. tit. 8, § 102(e). 126 Del. Code Ann. tit. 8, § 102(e). 127 Del. Code Ann. tit. 8, § 102(e). 128 N.C. Gen. Stat. § 55D-30(a)(1). 129 N.C. Gen. Stat. § 55D-30(a)(2). 130 N.C. Gen. Stat. § 55D-30(b).

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agent will be identical.131 Alternatively, the corporation may change its registered office or registered agent by including this same information in its annual report filed with the secretary of state’s office.132 A registered agent may change its business address (and thus the address of the corporation’s registered office) by notifying the corporation in writing of the change and by filing a statement of change containing the information described above.133

A person or entity serving as the registered agent for a North Carolina corporation may resign by filing a statement of resignation with the secretary of state’s office. This statement must include a certification that the agent has provided written notice of the resignation to the corporation.134 The agency appointment is terminated on the 31st day after the statement of resignation is filed with the secretary of state.135 If a successor registered agent is not appointed, the secretary of state becomes the corporation’s agent for service of process.136

As in North Carolina, each Delaware corporation must maintain in the state a registered agent, which may be the corporation itself, an individual resident in Delaware, a Delaware business entity, or a foreign business entity, as long as the registered agent maintains a business office in the state which is generally open or, if an individual, is generally present at a designated location in Delaware sufficiently often to accept service of process and otherwise perform the functions of a registered agent.137 Foreign entities that serve as Delaware registered agents must also be authorized to transact business in Delaware.138 Similar to North Carolina’s requirements, a Delaware registered agent is required to accept service of process and other communications directed at corporations for which it serves as registered agent and to forward the same to such corporations.139 A Delaware registered agent is also required to forward to any corporation for which it serves as registered agent the annual report required to be filed in with the secretary of state, or an electronic copy of the same in a form satisfactory to the secretary of state.140 Delaware, unlike North Carolina, also has a specific set of statutory requirements applicable to “commercial registered agents” (those who serve as registered agent for more than 50 entities), which requirements contain specific provisions related to presence in the state, maintenance of a business license and other similar matters.141

A Delaware corporation may change its registered agent by resolution of the board of directors naming the new registered agent and setting forth the agent’s registered address (including city, street, number, and county) and subsequently filing with the secretary of state a certificate setting forth such information.142 This is slightly different from North Carolina, which does not expressly require a board resolution to make this change. As in North Carolina, a Delaware registered agent may change its registered address (and thus the registered office of the

131 N.C. Gen. Stat. § 55D-31(a). 132 N.C. Gen. Stat. § 55D-31(c). 133 N.C. Gen. Stat. § 55D-31(b). 134 N.C. Gen. Stat. § 55D-32(a). 135 N.C. Gen. Stat. § 55D-32(b). 136 N.C. Gen. Stat. § 55D-33(b). 137 Del. Code Ann. tit. 8, § 132(a) and (b)(1). 138 Del. Code Ann. tit. 8, § 132(b)(2). 139 Del. Code Ann. tit. 8, § 132(b)(3). 140 Del. Code Ann. tit. 8, § 132(b)(4). 141 Del. Code Ann. tit. 8, § 132(c). 142 Del. Code Ann. tit. 8, § 133.

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corporations for which it serves as agent) by filing a certificate with the secretary of state setting forth the new address and the effective date of the change.143 Delaware’s statute also contains similar provisions in the event a registered agent changes its name, requiring the agent to file a certificate reflecting the name change for each corporation for which it serves as registered agent.144

A Delaware registered agent may resign and, as part of the resignation, appoint a successor registered agent by filing a certificate to that effect with the secretary of state, which must be accompanied by a statement from the corporation ratifying and approving the change.145 Alternatively, if the registered agent fails to appoint a successor, the resignation does not become effective until 30 days after the certificate reflecting the resignation is filed with the secretary of state. The certificate must contain a statement to the effect that written notice of the resignation was given to the affected corporation at least 30 days before the resignation was filed with the secretary of state.146 (North Carolina does not require this additional 30 day waiting period before filing the resignation.) The corporation must name a new registered agent in accordance with the requirements of DGCL Section 133 within 30 days after the above-described resignation is filed, and if the agent is not so named, the secretary of state shall declare its charter forfeited (if a domestic corporation) or shall forfeit its authority to do business in Delaware (if a foreign corporation).147 As in North Carolina, the secretary of state in Delaware then becomes the corporation’s agent for service of process.148

5. Bylaw Adoption and Amendments

The NCBCA provides that the corporation’s initial bylaws shall be adopted by the incorporators or, if named in the articles of incorporation, the board of directors of the corporation.149 The initial bylaws “may contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with law or the articles of incorporation.”150

In general, the NCBCA provides that bylaws may be amended or repealed by the board of directors unless otherwise provided in either the articles of incorporation or the bylaws themselves, with some key exceptions discussed below.151 In addition, a corporation’s shareholders may adopt, amend, or repeal the corporation’s bylaws, even in cases where the board of directors has the same power.152

There are two important exceptions to the general North Carolina rule that the board of directors may amend or repeal the corporation’s bylaws. First, a bylaw that has been

143 Del. Code Ann. tit. 8, § 134(a). 144 Del. Code Ann. tit. 8, § 134(b). 145 Del. Code Ann. tit. 8, § 135. 146 Del. Code Ann. tit. 8, § 136(a). 147 Del. Code Ann. tit. 8, § 136(b). 148 Del. Code Ann. tit. 8, § 136(c) and § 321. 149 The North Carolina Commentary to this section suggests that the use of the word “shall” in the section is not intended to imply that a North Carolina corporation that has not adopted bylaws is not a valid corporation. 150 N.C. Gen. Stat. § 55-2-06. 151 N.C. Gen. Stat. § 55-10-20(a). 152 N.C. Gen. Stat. § 55-10-20(b).

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adopted, amended, or repealed by the shareholders may not be readopted, amended, or repealed by the board unless either the articles of incorporation or a bylaw adopted by the shareholders authorizes the board of directors to adopt, amend, or repeal either that specific bylaw or the bylaws generally.153 Second, a bylaw that fixes a greater quorum or voting requirement for the board of directors may be amended or repealed: (i) if originally adopted by the shareholders, only by the shareholders unless the bylaw specifically provides that it may be amended or repealed by a specified vote of the board of directors (the bylaw may also require that it be repealed only by a specified vote of the shareholders); and (ii) if originally adopted by the board of directors, by either the board of directors or the shareholders.154 One should note, in this regard, that bylaws providing for an increased quorum or voting requirement may be adopted only by a vote of at least a majority of the board of directors then in office (i.e., the majority of a quorum will not suffice) and may not then be amended by a vote of the directors that is less than the quorum or vote prescribed therein.155 The purpose of these provisions is to allow for supermajority voting requirements that cannot simply be amended or repealed by a majority of the shareholders or by a majority of the board of directors.156

The DGCL provides that the original or other bylaws of a corporation may be adopted, amended or repealed by the incorporators, by the initial directors if the board was named in the certificate of incorporation, or by the board of directors if done before the corporation has received payment for any of its stock.157 Otherwise, the DGCL reserves the power to adopt, amend, and repeal the bylaws to the shareholders entitled to vote unless the certificate of incorporation specifically confers these powers on the board of directors.158 The default rule in Delaware, therefore, is the opposite of North Carolina’s default rule that the directors automatically have the power to adopt, amend, and repeal bylaws unless otherwise stated in the articles of organization. However, unlike the NCBCA, under the DGCL there are no statutory limitations on the directors’ powers to adopt, amend, or repeal bylaws if that power has been conferred upon them in the certificate of incorporation. Note that the fact that the certificate confers this power on the board of directors does not limit the powers of the shareholders under Section 109(a) to adopt, amend or repeal bylaws.159

Similar to North Carolina, the bylaws of a Delaware corporation may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to “the

153 N.C. Gen. Stat. § 55-10-20(a). 154 N.C. Gen. Stat. § 55-10-22(a) and (b). 155 N.C. Gen. Stat. § 55-10-22(c). 156 Official Comment to N.C. Gen. Stat. § 55-10-22. 157 Del. Code Ann. tit. 8, § 109(a). 158 Del. Code Ann. tit. 8, § 109(a). 159 A recent case decided by the Delaware Supreme Court suggests that the authority of the shareholders to adopt, amend, or repeal the bylaws of a Delaware corporation under Section 109(a) is limited by the authority of the board of directors to manage the business and affairs of the corporation under Section 141(a). CA, Inc. v. AFSCME

Employees Pension Plan, No. 329, 2008 (Del. August 15, 2008). In this case, a shareholder proposal was submitted requesting that the corporation’s bylaws be amended to cause the directors to reimburse shareholders for reasonable expenses incurred in a successful contested election for short slate directors. The court held that the proposed amendment, although permitted under the shareholders’ authority to amend the bylaws, would impermissibly restrict the board’s fiduciary duties, as the board’s inability to determine the validity of an expense reimbursement request would preclude the board from discharging its duties of loyalty and due care. The court thus determined that any such provision should instead be made in the company’s certificate of incorporation.

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business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers, or employees.”160

C. Issuance of Shares

1. General

a) Terminology

The NCBCA generally follows the Model Business Corporations Act’s practice of referring to “shares” of a corporation, instead of the more traditional “stock,” “shares of stock” or “capital stock” of the corporation, as used in Delaware. Likewise, the owners of a North Carolina corporation are its “shareholders,” and not its “stockholders.” The traditional terminology, however, is still used in a small number of sections where language from the prior version of the Business Corporation Act was carried forward in lieu of, or in addition to, the MBCA language.

b) Share Designations and Powers

The articles of incorporation of a North Carolina corporation must specify “the classes of shares and the number of shares of each class that the corporation is authorized to issue.”161 Each class and series of shares must have a “distinguishing designation,” unless only a single class or series is authorized.162 In addition, before any share of a class or series may be issued by the corporation, the articles must specify the “preferences, limitations and relative rights” of that class or series.163

Under North Carolina law, the right to vote and the right to receive the remainder of the corporation’s assets upon its dissolution may be subdivided among the various classes of the corporation’s stock, so long as some class or classes will share in full shareholder voting rights and some class or classes will share in the residual of the corporation’s assets.164 Each such class must not only be authorized by the articles of incorporation, but must also have outstanding shares.165

The articles of incorporation of a North Carolina corporation may also give the directors the power to determine the preferences, limitations, and relative rights of a class or series of shares, provided that they do so before any shares of the class or series are issued.166 To do so, the directors must adopt and file with the secretary of state Articles of

160 Del. Code Ann. tit. 8, § 109(b). 161 N.C. Gen. Stat. § 55-6-01(a). 162 N.C. Gen. Stat. § 55-6-01(a). 163 N.C. Gen. Stat. § 55-6-01(a). 164 N.C. Gen. Stat. § 55-6-01(c). 165 N.C. Gen. Stat. § 55-6-03(c). 166 N.C. Gen. Stat. § 55-6-02.

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Amendment that specify the relative terms of the class or series.167 The shares may be issued only after this amendment is filed.168

These provisions differ from those of Delaware in several ways. First, under the DGCL, if the board of directors has the power to specify the terms of a class or series of stock, the board need only pass a resolution and file a certificate of designation with the secretary of state – the Certificate of Incorporation is not amended.169 Second, if a North Carolina corporation is authorized to have two or more classes of shares, the articles must specify the relative rights of the two classes to vote and to receive distributions.170 Under Delaware law, unless the Certificate of Incorporation states otherwise, the holders of common stock will receive all the residual assets of the corporation upon dissolution; the holders of preferred stock will only receive a portion of the residual assets if the Certificate of Incorporation specifically provides that they will.171

c) Par Value

North Carolina has abandoned the traditional concepts of the “par value” of a share and of the “stated capital” and “capital surplus” of the corporation. Under Delaware Law, a corporation’s shares may, but are not required to, have a par value.172

d) Mechanics of Issuance

As in Delaware, North Carolina law provides that the board of directors of a corporation must authorize the issuance of the corporation’s shares.173 However, North Carolina law also allows the Articles of Incorporation to reserve to the shareholders the right to authorize the issuance of shares.174 At most, a Delaware corporation’s certificate of incorporation may reserve to the stockholders the right to determine the consideration for the issuance of shares; the board of directors has exclusive authority to authorize the issuance of the stock.175

2. Valid Consideration for Shares; Partially Paid Shares

Under both Delaware and North Carolina law, any tangible or intangible property or any benefit to the corporation, including services already performed or other securities of the corporation, will be valid consideration for the issuance of shares.176 As North Carolina has abandoned the concept of the “par value” of shares, North Carolina law does not require that the consideration be worth at least the par value of the shares, as Delaware law does.177

167 N.C. Gen. Stat. § 55-6-02(b). 168 Id. 169 Del. Code Ann. tit. 8, § 151(g). 170 N.C. Gen. Stat. § 55-6-01(a). 171 Del. Code Ann. tit. 8, § 281(a)(4) & (b); § 151(d). 172 Del. Code Ann. tit. 8, § 151(a). 173 N.C. Gen. Stat. § 55-6-21(b); Del. Code Ann. tit. 8, § 152. 174 N.C. Gen. Stat. § 55-6-21(a). 175 Del. Code Ann. tit. 8, § 152. 176 N.C. Gen. Stat. § 55-6-21(b); Del. Code Ann. tit. 8, § 152. 177 Del. Code Ann. tit. 8, § 153(a).

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The board of directors of a North Carolina corporation must specifically determine that the consideration received is adequate; in Delaware, the board need only determine the form and amount of consideration.178

3. Stock Options and Convertible Securities

Under both Delaware and North Carolina law, a corporation may issue options, warrants or other rights to purchase the corporation’s shares and securities convertible into stock.179 In either state, the terms of the award, their form and the consideration to be received upon exercise of the right are determined by the corporation’s board of directors.180 Unlike in Delaware, however, the board of a North Carolina corporation may not delegate the ability to issue stock options to an officer of the Company. Instead, a North Carolina board may delegate this ability only to a committee of the board.181

4. Transfer Restrictions

North Carolina law permits restrictions on the transfer of shares or other securities to be contained in the articles of incorporation of the company, the bylaws, a shareholders’ agreement or an agreement between the shareholders and the corporation.182 A restriction imposed after shares are already issued will not affect those shares previously issued unless the holders of those shares are parties to an agreement that imposes such restrictions or vote in favor of the restriction.183 To be enforceable, a restriction on transfer must be authorized by law (as discussed below), not unconscionable under the circumstances, and noted on the front or back of the share certificate or contained in the information statement required by statute for uncertificated shares. A shareholder must receive actual, written notice of the restriction for that restriction to be enforceable against that particular shareholder.184

The NCBCA sets forth three permissible reasons for which restrictions on transfer are authorized, including a very broad “catchall.” These are: to maintain the corporation’s status when it is dependent on the number or identity of its shareholders; to preserve exemptions under federal or state securities law; and for any other reasonable purpose.185 North Carolina’s statute specifically authorizes restrictions that: obligate the shareholder to first offer his shares to the corporation or other shareholders before selling; require that the corporation repurchase these shares; require the corporation, the holders of any class of shares or another individual to approve the transfer if it is not manifestly unreasonable to the corporation; prohibit the transfer of the shares to particular persons; and otherwise that are “reasonably related to an authorized purpose.”186 The Official Comments to this section note that because of the breadth of the

178 N.C. Gen. Stat. § 55-6-21(c); Del. Code Ann. tit. 8, § 152. 179 N.C. Gen. Stat. §§ 55-3-02(a)(7) and 55-6-24(a); Del. Code Ann. tit. 8, § 157(a). 180 Compare N.C. Gen. Stat. § 55-6-24(a) with Del. Code Ann. tit. 8, § 157(b). 181 Compare N.C. Gen. Stat. § 55-8-25(d) with Del. Code Ann. tit. 8, § 157(c). 182 N.C. Gen. Stat. § 55-6-27(a). 183 Id. 184 N.C. Gen. Stat. § 55-6-27(b). 185 N.C. Gen. Stat. § 55-6-27(c). 186 N.C. Gen. Stat. § 55-6-27(d)(1) – (5).

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language in the statute, there is very little limitation of the purposes and kinds of transfer restrictions authorized by the NCBCA.

Delaware also allows restrictions on transfer to be contained in the certificate of incorporation of the company, the bylaws, a stockholders’ agreement or an agreement between the stockholders and the corporation. As in North Carolina, these restrictions do not apply to securities issued prior to the company’s adoption of the restriction, unless the holders are parties to the agreement imposing the restriction or vote in favor of it.187 Delaware law indicates that such restrictions should be “conspicuously noted” on the share certificate or notice, in the case of uncertificated shares.188 Delaware law is a bit different from North Carolina law in that it does hold the restriction to be enforceable without conspicuous notice if the holder had actual knowledge of the restriction.189

The restrictions on transfer that are authorized under the Delaware statute are very similar to those authorized under North Carolina law. Delaware specifically allows restrictions that obligate the holder to offer the stock to the company or other holders first, obligate the company or any other holder to purchase the stock before transfer, require the corporation or any class or series of securities to consent to the proposed transfer of the restricted securities or to approve the proposed transferee, obligate the holder to sell any portion of the restricted securities to the corporation or any other holders, and those that prohibit or restrict transfer of the restricted securities to certain people or classes of people.190

Delaware law provides two different purposes of restrictions on transfer that will be “conclusively presumed” to be a reasonable purpose. These are restrictions aimed at maintaining any local, state, federal, or foreign tax advantage and restrictions aimed at maintaining any statutory or regulatory advantage.191 Delaware law does not include a broad “catchall” for a reasonable purpose for a restriction on transfer as does North Carolina law. In fact, Delaware case law has established that the court must make an inquiry into the reasonableness of a restriction whenever that restriction is contested.192 The standard is fairly low, however, and courts rely on language similar to that used in the North Carolina statute, namely to the effect that the restrictions must be reasonable to achieve a legitimate corporate purpose.193

5. Certificated and Uncertificated Shares

The NCBCA provides that shares may, but need not be represented by certificates, and that the rights of the shareholders are identical whether or not their shares are represented by certificates.194 If the corporation does issues a share certificate, it must include the name of the issuing corporation organized under North Carolina law; the name of the

187 Del. Code Ann. tit. 8, § 202(b). 188 Del. Code Ann. tit. 8, § 202(a). 189 Id. 190 Del. Code Ann. tit. 8, § 202(c)(1) – (5). 191 Del. Code Ann. tit. 8, § 202(d). 192 Capital Group Cos. v. Armour, 2005 Del. Ch. LEXIS 38 (Mar. 15, 2005). 193 Id. 194 N.C. Gen. Stat. § 55-6-25(a).

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shareholder, and the number and class of shares the certificate represents.195 North Carolina requires that if the corporation is authorized to issue different classes of shares or different series within a class, the designations, rights, preferences, limitations, and variations for each must be summarized on the front or back of each certificate. Alternatively, each certificate may state on its front or back that the corporation will furnish the shareholder with such information in writing and without charge.196 Each certificate must be signed by two officers as designated in the bylaws or by the board, and may bear the corporate seal. Facsimile signatures are acceptable.197 The certificates will be deemed valid regardless of whether the person signing the share certificate no longer holds office when the certificate is issued.198 The board may authorize the issuance of shares without certificates, but the corporation does have an obligation to provide the shareholders with the same information required to be on a certificated share within a reasonable period of time after issuance.199

Delaware law provides that a corporation’s shares shall be represented by certificates, but that the board of directors may resolve that some or all of any or all classes or series of its stock shall be uncertificated.200 If a corporation issues share certificates for a particular class or series of stock and then decides that it wishes for that class or series of stock to be uncertificated, then the board’s resolution shall not apply to those shares represented by an individual certificate until the stockholder surrenders that certificate to the corporation.201 Share certificates must be signed by, or in the name of the corporation, one of the chairperson or vice-chairperson of the board, the president or vice president of the corporation AND one of the secretary, assistant secretary, treasurer or assistant treasurer. As in North Carolina, facsimile signatures are acceptable.202

D. Corporate Authorization and Meetings, Director Elections and Committees

1. Shareholder Approvals and Meetings

See Section III.F. of this study below for a more complete discussion of shareholder voting rights and actions. The following is a more general summary of the more basic issues.

Both Delaware and North Carolina law require an annual meeting of shareholders to elect directors; the failure to hold an annual meeting, however, does not affect otherwise valid corporate action or cause the dissolution of the corporation.203 Both states’ statutes also allow a meeting of shareholders to take place by electronic or remote communication, if authorized by the board of directors, as long as the participants can read or hear the proceedings substantially

195 N.C. Gen. Stat. § 55-6-25(b). 196 N.C. Gen. Stat. § 55-6-25(c). 197 N.C. Gen. Stat. § 55-6-25(d) 198 N.C. Gen. Stat. § 55-6-25(e). 199 N.C. Gen. Stat. § 55-6-26. 200 Del. Code Ann. tit. 8, § 158. 201 Id. 202 Id. 203 N.C. Gen. Stat. § 55-7-01; Del. Code Ann. tit. 8, § 211(b) and 211(c).

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concurrently as they occur and the shareholders are permitted to participate and vote on matters submitted for approval.204

Under North Carolina and Delaware law, notice of a shareholders meeting is required to be given at least 10 days and not more than 60 days prior to the meeting date.205 The board of directors of a Delaware corporation may fix a record date to determine what stockholders are entitled to notice of a stockholders meeting, which record date shall be not less than 10 days or more than 60 days prior to the meeting date.206 Under North Carolina law, a record date may not be more than 70 days prior to the meeting date (and by virtue of the notice period required by NCBCA Section 7-05(a) the record date may not be less than 10 days prior to such meeting, unless notice is waived).207 If the record date is not specified in the bylaws or fixed by the board, then the record date under both North Carolina and Delaware law would be the date before the first notice is delivered to shareholders.208

Under North Carolina law, if a meeting is adjourned to a different time or place, and the new time or place are announced at the meeting that is adjourned, no additional notice is required to be given, unless the bylaws so require or unless it is necessary to fix a new record date for the adjourned meeting.209 If a new record date must be fixed for the subsequent meeting, notice of such meeting must be given to persons who are shareholders as of the new record date. Adjournment without notice is permitted for up to 120 days after the original meeting.210 Delaware is generally consistent with the foregoing, except that a new notice must be delivered to all stockholders entitled to vote at the subsequent meeting if the earlier meeting is adjourned for more than 30 days, or if a new record date is fixed by the board.211

Under both North Carolina and Delaware law, the general rule is that unless required by the bylaws or articles or certificate of incorporation, notice of an annual meeting does not need to include a description of the purpose of the meeting. If it is a special meeting, though, then the notice must include a description of the purpose of the meeting.212 There are certain exceptions under both the NCBCA and the DGCL, however. Generally, a notice of an annual meeting of a North Carolina or (except as noted below) a Delaware corporation must include the following, to the extent any such matters are on the agenda: (i) any amendments to the articles of incorporation;213 (ii) any merger or any sale of assets requiring shareholder approval;214 (iii) any removal of a director;215 (iv) any voluntary dissolution of the corporation;216 and (v) any granting of rights under North Carolina’s Control Share Acquisition Act.217

204 N.C. Gen. Stat. § 55-7-08; Del. Code Ann. tit. 8, § 211(a)(2). 205 N.C. Gen. Stat. § 55-7-05(a); Del. Code Ann. tit. 8, § 222(b). 206 Del. Code Ann. tit. 8, § 213. 207 N.C. Gen. Stat. § 55-7-07. 208 N.C. Gen. Stat. § 55-7-05(d); Del. Code Ann. tit. 8, § 213(a). 209 N.C. Gen. Stat. § 55-7-05. 210 N.C. Gen. Stat. § 55-7-07(d). 211 Del. Code Ann. tit. 8, § 222(c). Note that the board “may fix a new record date for the adjourned meeting” under DGCL Section 213(a). 212 N.C. Gen. Stat. § 55-7-05(b); Del. Code Ann. tit. 8, § 222(a). 213 N.C. Gen. Stat. § 55-10-03(d); Del. Code Ann. tit. 8, § 242(b). 214 N.C. Gen. Stat. § 55-11-03(d); N.C. Gen. Stat. § 55-12-02(d); Del. Code Ann. tit. 8, § 251(c); Del. Code Ann. tit. 8, § 271(a).

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North Carolina law requires that a list of shareholders entitled to vote at any shareholder meeting be available for inspection by any shareholder beginning two business days after notice of the meeting is given.218 Under Delaware law, a list of stockholders is required to be available for inspection by stockholders at least 10 days prior to the meeting.219 Both statutes provide for a remedy for shareholders who are improperly denied access to the shareholder list. Accordingly, North Carolina and Delaware courts are authorized by statute to compel the corporation to permit the examination and to issue orders postponing the meeting, pending review of the shareholder list by the aggrieved shareholder.220 By way of contrast, the NCBCA does not require the corporation to provide access to the shareholder list during the meeting to persons attending the meeting remotely or electronically,221 while the DGCL does.222

A more detailed treatment of shareholder proxies and action by written consent can be found in Section III.F. of this study, but generally, both North Carolina and Delaware permit shareholders to vote by proxy at a shareholders meeting and also enable the annual election of directors and other actions requiring shareholder approval to occur by written consent, subject to certain limitations.223

Both states have provisions for a court-ordered annual shareholders meeting. Under Delaware law, if an annual shareholders meeting has not occurred within 30 days of the date designated for the meeting or if no date has been designated for 13 months after the last meeting, then any shareholder or director may ask the court of chancery to order that the meeting be held.224 Under North Carolina law, the superior court of the county where the corporation’s principal office is located may order the meeting to be held: (1) on the request of any shareholder if the meeting has not been held within 15 months after the last annual meeting; or (2) on the request of a shareholder who has signed a demand for a special meeting in accordance with the requirements of NCBCA Section 7-02, if the corporation has not called the meeting as required by law.

Both states make provision for special shareholders meetings as called by the board or as provided in the certificate or articles of incorporation or bylaws. The NCBCA, however, specifically allows special meetings to be called, if the corporation is not a public corporation, by shareholders holding shares representing at least ten percent (10%) of the votes entitled to be cast on any issue at the meeting.225

Generally, both North Carolina and Delaware law require shareholder approval for: (1) an amendment to the articles or certificate of incorporation; (2) certain plans of merger or

215 N.C. Gen. Stat. § 55-8-08(d). Note that this exception is contemplated by the NCBCA but not the DGCL. 216 N.C. Gen. Stat. § 55-14-02(d); see Del. Code Ann. tit. 8, § 275(a). 217 N.C. Gen. Stat. § 55-9A-04. This exception is of course limited to North Carolina corporations. 218 N.C. Gen. Stat. § 55-7-20(b). 219 Del. Code Ann. tit. 8, § 219(a). 220 N.C. Gen. Stat. § 55-7-20(d); Del. Code Ann. tit. 8, § 219(b). Note, however, that Delaware’s statute (unlike North Carolina’s) permits the court to issue any other orders deemed appropriate by the court. Id. 221 N.C. Gen. Stat. § 55-7-20(c). 222 Del. Code Ann. tit. 8, § 219(a). 223 N.C. Gen. Stat. § 55-7-04(a); Del. Code Ann. tit. 8, § 228(a). 224 Del. Code Ann. tit. 8, § 211(c). 225 N.C. Gen. Stat. § 55-7-02(a).

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conversion; (3) the sale, lease or exchange of all or substantially all of the assets of the corporation; or (4) a plan of dissolution. See above (in this Section III.D.1.) for a discussion of the notice requirements pertaining to such matters.

2. Director Elections, Resignation and Removal

Under both North Carolina and Delaware law, a corporation must generally have a board of directors consisting of at least one individual. Both states permit, however, a corporation to dispense with or limit the board of directors. In Delaware that result can be accomplished only in the certificate of incorporation, while in North Carolina it can be accomplished in the articles of incorporation or through a valid shareholders agreement.226

Delaware law provides that the number of directors shall be fixed by, or in the manner provided in, the bylaws, unless the certificate of incorporation fixes the number. North Carolina law provides that the number of directors must be specified in, or fixed in accordance with, either the articles of incorporation or bylaws. The laws of both states allow the articles or certificate of incorporation or bylaws to prescribe qualifications for directors.227

Both Delaware and North Carolina law provide as a default standard that directors be elected by a plurality of the votes of shares present in person or by proxy at the shareholders meeting (assuming the presence of a quorum). Delaware law provides that the standard for electing directors can be changed by specifying a different standard in either the certificate of incorporation or bylaws. Under North Carolina law, the standard for electing directors may be changed only by specifying a different standard in the articles of incorporation or in a valid shareholders agreement.228

Both North Carolina and Delaware law allow for the articles or certificate of incorporation to divide the shares into classes or series, with the election of all or a specified number of directors by the holders of one or more authorized classes or series of shares.229

Staggered terms for directors are permitted in the articles or certificate of incorporation or bylaws of a corporation under both North Carolina and Delaware law.230 North Carolina law no longer requires, as it did for many years, that a corporation have nine or more directors for a staggered board.

If a vacancy occurs on a board of directors, including a vacancy resulting from an increase in the number of directors, both states provide that the vacancy may be filled by a majority of the directors then in office unless the certificate or articles of incorporation (or, in the case of Delaware, the bylaws) provide otherwise. If a Delaware corporation has a staggered board, the director appointed to fill a vacancy holds office until the next election of the class for which he or she was chosen.231 North Carolina law treats a director appointed to fill a vacancy on

226 Del. Code Ann. tit. 8, § 141(a); N.C. Gen. Stat. § 55-8-01. 227 Del. Code Ann. tit. 8, § 141(b); N.C. Gen. Stat. § 55-8-03. 228 Del. Code Ann. tit. 8, § 216(3); N.C. Gen. Stat. § 55-7-28. 229 Del. Code Ann. tit. 8, § 216; N.C. Gen. Stat. § 55-7-25. 230 Del. Code Ann. tit. 8, §141(d); N.C. Gen. Stat. § 55-8-06. 231 Del. Code Ann. tit. 8, § 223(b).

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a staggered board differently, however, by providing that the term of a director elected to fill a vacancy expires at the next shareholders meeting at which directors are elected.232 Consequently, the director appointed to fill a vacancy on a staggered board of a North Carolina corporation must stand for election by the shareholders for the balance of the term of members of that class at the next shareholders meeting.

A director of a Delaware and a North Carolina corporation may resign at any time. In North Carolina, the director may do so by “communicating” his or her resignation to the board of directors, its chair, or the corporation.233 In Delaware, however, the director may resign only upon notice “given in writing” or by electronic transmission to the corporation. Delaware specifically allows a resignation that is conditioned upon the director failing to receive a specified vote for reelection as a director to be made irrevocable.234

The shareholders of a North Carolina corporation may remove a director with or without cause unless otherwise provided in the articles of incorporation.235 If the North Carolina corporation does not have cumulative voting, a director may be removed only if the number of votes cast to remove him exceeds the number of votes cast not to remove him. In Delaware, directors may be removed with or without cause by the holders of a majority of the shares then entitled to vote at an election of directors unless the board of directors is classified, in which case, unless the certificate of incorporation provides otherwise, directors may only be removed for cause.236 If a corporation has cumulative voting, the laws of both states prohibit the removal of a director (in Delaware, unless the removal is with cause) if the number of votes sufficient to elect the director under cumulative voting is voted against the director’s removal, unless the entire board is being removed.237

The NCBCA requires that, where the removal of one or more directors is the purpose (or one of the purposes) of a shareholders meeting, the notice of such meeting shall specify such purpose.238 The DGCL contains no such requirement.

The NCBCA has a provision for the removal of a director by the superior court of the county where the corporation’s principal office (or if none in North Carolina, then its registered office) is located in a proceeding commenced either by the corporation or shareholders holding at least 10% of the outstanding shares of any class. The court must find that: (1) the director engaged in fraudulent or dishonest conduct or gross abuse of authority or discretion, with respect to the corporation; and (2) that removal is in the best interests of the corporation. If the court finds just cause to remove a director, the court may also bar the reelection of the director for a period prescribed by the court.239

232 N.C. Gen. Stat. § 55-8-06(d). 233 N.C. Gen. Stat. § 55-8-07(a). 234 Del. Code Ann. tit. 8, § 141(b). 235 N.C. Gen. Stat. § 55-8-08. 236 Del. Code Ann. tit. 8, § 141(k). 237 Del. Code Ann. tit. 8, § 141(k)(2); N.C. Gen. Stat. § 55-8-08. 238 N.C. Gen. Stat. § 55-8-08(d). 239 N.C. Gen. Stat. § 55-8-09.

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Delaware’s version of this provision (which became law as part of the 2009 amendments to the DGCL) works differently, such that if a director has been convicted of a felony in connection with his or her director duties, or if there has been a prior judgment on the merits by a court of competent jurisdiction that a director has committed a breach of the duty of loyalty to the corporation, then, upon application by the corporation (or derivatively in the right of the corporation by any stockholder), the court of chancery may remove such director from office if the Court determines that the director did not act in good faith in performing the acts resulting in the prior conviction or judgment and judicial removal is necessary to avoid irreparable harm to the corporation. In connection with such removal, the court may make such orders as are necessary to effect such removal.240

3. Director Approvals, Meetings and Quorum

Under both North Carolina and Delaware law, the business and affairs of a corporation are managed by or under the direction of its board of directors. Generally, the board of directors will elect the officers of a corporation at an annual or regular meeting. Special meetings of the board may also occur, if necessary. North Carolina law provides that special meetings of the board may be called by the president of the corporation or any two directors, unless otherwise provided in the bylaws.241

Delaware law does not specify any requirements for notice of a regular or special meeting of directors; however, North Carolina law provides that: (1) unless the articles of incorporation or bylaws provide otherwise, no notice is required for a regular meeting; and (2) special meetings of the board shall be held on such notice as is provided in the articles of incorporation or bylaws, or in the absence of any such provision, upon not less than five (5) days prior notice sent by any usual means of communication.242 Both states also allow a director to waive notice of a meeting in writing.243 Generally, a director’s attendance and participation in a meeting waives any notice requirement, unless the director objects as to notice at the beginning of the meeting or upon his arrival.244

Under both North Carolina and Delaware law, meetings of the board may occur by conference telephone or other means of communication where all persons participating in the meeting can hear one another.245

Unless the articles or certificate of incorporation or bylaws provide otherwise, under the laws of both states a majority of the total number of directors constitutes a quorum for the transaction of business.246 The laws of both states permit the articles or certificate of incorporation or bylaws to authorize a quorum to consist of not less than one-third (1/3) of the

240 Del. Code Ann. tit. 8, § 225(c). 241 N.C. Gen. Stat. § 55-8-20(c). 242 N.C. Gen. Stat. § 55-8-22(b). 243 N.C. Gen. Stat. § 55-8-23(a); Del. Code Ann. tit. 8, § 229. 244 N.C. Gen. Stat. § 55-8-23(b); Del. Code Ann. tit. 8, § 229. 245 N.C. Gen. Stat. § 55-8-20(b); Del. Code Ann. tit. 8, § 141(i). 246 N.C. Gen. Stat. § 55-8-24(a); Del. Code Ann. tit. 8, § 141(b).

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total number of directors (unless there is only one director, in which case that one director constitutes a quorum).247

North Carolina law, unlike that of Delaware, specifically provides that a director who is present at a meeting when corporate action is taken is deemed to have assented to the action unless: (1) he objects to holding the meeting due to notice or otherwise at the beginning of the meeting or promptly upon his arrival; (2) his dissent or abstention is entered in the minutes of the meeting; or (3) he files notice of his dissent or abstention with the presiding officer of the meeting before adjournment or with the corporation immediately after the meeting. This right of dissent or abstention is not available to a director who votes in favor of the action at the meeting and then wants to change his mind.248

Unanimous written consent action by the board of directors is permitted in lieu of a meeting under the laws of both states.249

4. Committees of the Board

There are two provisions of Delaware law governing board committees, one for corporations incorporated prior to July 1, 1996,250 and one for corporations incorporated on or after July 1, 1996.251 This study focuses primarily on the provision for corporations incorporated on or after July 1, 1996.

Both North Carolina and Delaware law permit the board of directors to create one or more committees of the board and to appoint one or more directors to serve on a committee.252 North Carolina law specifies that generally the creation of a committee and the appointment of members to it must be approved by the greater of: (1) a majority of all directors in office when the action is taken; or (2) the number of directors constituting a quorum.253

A committee of the board may, to the extent provided in the resolution of the board of directors or in the bylaws (or the articles of incorporation in the case of a North Carolina corporation), exercise the authority of the board of directors,254 with certain exceptions. Both North Carolina and Delaware law prohibit a committee of the board from (i) adopting, amending, or repealing any of the bylaws of the corporation and (ii) approving, adopting, recommending or proposing to the shareholders any action (in Delaware, other than the election or removal of directors) expressly required by law to be submitted to shareholders for approval. North Carolina law also prohibits a committee from doing any of the following: (1) authorizing distributions, except according to a formula or method or within limits prescribed by the board of directors; (2) filling any vacancies on the board or any of its committees; (3) amending the

247 N.C. Gen. Stat. § 55-8-24(b); Del. Code Ann. tit. 8, § 141(b). 248 N.C. Gen. Stat. § 55-8-24(d). 249 N.C. Gen. Stat. § 55-8-21; Del. Code Ann. tit. 8, § 141(f). 250 Del. Code Ann. tit. 8, § 141(c)(1). A corporation incorporated before such date may, however, by a vote of the majority of the whole board, elect to be governed in this respect as if it were incorporated after such date. Id. 251 Del. Code Ann. tit. 8, § 141(c)(2). 252 N.C. Gen. Stat. § 55-8-25; Del. Code Ann. tit. 8, § 141(c). 253 N.C. Gen. Stat. § 55-8-25(b). 254 N.C. Gen. Stat. § 55-8-25(d); Del. Code Ann. tit. 8, § 141(c)(2).

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articles of incorporation pursuant to NCBCA Section 10-02 (Amendment by board of directors); or (4) approving a plan of merger not requiring shareholder approval.255

E. Director Duties and Liabilities

1. Limitation of Director Liability

Both North Carolina and Delaware have enacted statutes applicable to the limitation of director liability. Both states authorize corporations to limit the liability of their directors for breach of duty. In addition, North Carolina has adopted an automatic statutory limitation of director liability that is not limited to breach of duty.

First, NCBCA Section 2-02(b)(3) provides that a North Carolina corporation may include in its articles of incorporation a provision limiting or eliminating the personal liability of any director for money damages arising out of an action for breach of any duty as a director.256 The statute stipulates, however, that no such provision shall be effective with respect to (i) acts or omissions that the director at the time of such breach knew or believed were clearly in conflict with the best interests of the corporation, (ii) any liability under NCBCA Section 8-33 for unlawful distributions from the corporation, (iii) any transaction from which the director derived an improper personal benefit,257 or (iv) acts or omissions occurring prior to the date the provision became effective.

Second, NCBCA Section 8-30(d) provides that a director is not liable for any action taken as a director, or any failure to take any action, if he or she performed the duties of the office in compliance with the standards set forth in the section.258 Section 8-30(a) establishes the general standards of conduct applicable to directors of North Carolina corporations, namely that a director shall discharge his or her duties (i) in good faith, (ii) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances and (iii) in a manner he or she reasonably believes to be in the best interests of the corporation.259

Like the NCBCA, the DGCL contains a provision that allows a corporation to limit the liability of its directors by adopting such a limitation in its certificate of incorporation.260 Section 102(b)(7) of the DGCL permits the limitation or elimination of liability of a director for breaches of fiduciary duty, except under certain circumstances. The DGCL does not permit a corporation to limit or eliminate the liability of a director (i) for breach of the duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) under Section 174 for certain

255 N.C. Gen. Stat. § 55-8-25(e); Del. Code Ann. tit. 8, § 141(c)(2). 256 N.C. Gen. Stat. § 55-2-02(b)(3). Note that the exculpation provision applies to third party actions as well as to direct ones. Note also that it is limited to claims for money damages and does not apply to injunctive or other equitable relief. 257 The term “improper personal benefit” is defined in the statute to exclude the director’s reasonable compensation or other reasonable incidental benefits for or on account of his or her services as a director, officer, employee, contractor, attorney or consultant. Id. 258 N.C. Gen. Stat. § 55-8-30(d). 259 N.C. Gen. Stat. § 55-8-30(a). 260 Del. Code Ann. tit. 8, § 102(b)(7).

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unlawful distributions or (iv) for any transaction from which the director derived an improper personal benefit.261 Thus, the principal differences between the DGCL and the NCBCA in this regard are (i) Delaware’s reference to breach of the duty of loyalty (as opposed to North Carolina’s reference to “acts or omissions that the director at the time of such breach knew or believed were clearly in conflict with the best interests of the corporation”); and (ii) Delaware’s reference to “acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law.”

2. Indemnification

Although a corporation may limit its directors’ liability as discussed above, North Carolina and Delaware both recognize that a director – or an officer, employee or agent of the corporation – may nevertheless be the subject of claims due to his or her actions taken in such role. Both North Carolina and Delaware permit (and in some cases require) a corporation to indemnify its directors, officers, employees and agents (and anyone who has previously held such a role) for liabilities incurred by them by reason of serving as directors or officers of the corporation or of other corporations or entities at the request of the corporation. There are essentially four types of corporate indemnification that may run in favor of a corporation’s personnel: mandatory, permissive, expanded and court-ordered. Both the NCBCA and the DGCL provide for the first three types, while the fourth one is available for North Carolina, but not Delaware, corporations.262

a) Mandatory Indemnification

Mandatory indemnification, as the term implies, is required by law to be provided by the corporation. Under NCBCA Section 8-52, “[u]nless limited by its articles of incorporation, a corporation shall indemnify a director263 who was wholly successful, on the merits or otherwise, in the defense of any proceeding to which he was a party because he is or was a director of the corporation against reasonable expenses incurred by him in connection with the proceeding.” The same rights are extended to officers pursuant to Section 8-56(1).

The DGCL’s wording (set forth in Section 145(c) thereof) is slightly different: “To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding [by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise], or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection therewith.”

261 Id. Unlike the corresponding provision of the NCBCA, this term is not defined to exclude reasonable compensation and other incidental benefits. 262 For a discussion of the corporation’s advancing of litigation expenses to indemnified corporate personnel, see the final paragraph of this Section III.E.2., below. 263 This term is defined in NCBCA Section 8-50(b)(2), the broadening effect of which is similar to the language describing the scope of mandatory indemnification to be provided by a Delaware corporation under Section 145(c) of the DGCL, set forth in the paragraph following the text supported by this note.

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Thus, the North Carolina and Delaware statutes governing mandatory indemnification protect both directors and officers (but not other personnel), and the scope of the protection is the same. The principal difference between the two states’ formulations is the NCBCA’s language enabling the corporation to limit the right in the articles of incorporation.264 The DGCL’s language “[t]o the extent that a . . . director or officer . . . has been successful on the merits or otherwise,” combined with the absence of any exception as contemplated by the certificate of incorporation, suggests that the right in Delaware is absolute (assuming the statutory requirements are otherwise met).

b) Permissive Indemnification

Permissive indemnification is a right that a corporation may, but need not, provide to its personnel. The statutes of both states run in favor of directors, officers and other employees or agents.265 The basic standard for permissive indemnification is nearly identical in North Carolina and Delaware. The first requirement for indemnification to be properly authorized by a corporation is the same in both states, namely that the person shall have conducted himself or herself in good faith.266

The second prong of the test for permissive indemnification differs somewhat between the two states: while in Delaware, the person shall have acted in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation,267 in North Carolina the person must have acted outside his or her official capacity in order to have the benefit of the lower standard of acting in a manner reasonably believed to be “not opposed to the best interests of the corporation.”268

As an additional condition for permissive indemnification in a criminal proceeding, under both the NCBCA and the DGCL, the individual to be indemnified must further have had no reasonable cause to believe his or her conduct was unlawful.269

There is one exception to permissive indemnification that is common to North Carolina and Delaware: both the NCBCA and the DGCL provide that a corporation may not indemnify a director in a derivative suit (one filed against the corporation) where the director was adjudged liable to the corporation.270 The NCBCA, however, contains a second exception

264 N.C. Gen. Stat. § 55-8-52. Note, however, that no such limitation would have retroactive effect. N.C. Gen. Stat. § 55-10-09. 265 Specifically, in both North Carolina and Delaware, present and former directors and officers and other personnel, and persons requested by the corporation to serve as a director or officer or in some other role for another entity, may be so indemnified. N.C. Gen. Stat. § 55-8-50(b)(2); N.C. Gen. Stat. § 55-8-56; Del. Code Ann. tit. 8, § 145(a) and (b). 266 N.C. Gen. Stat. § 55-8-51(a); Del. Code Ann. tit. 8, § 145(a). 267 Del. Code Ann. tit. 8, § 145(a). 268 N.C. Gen. Stat. § 55-8-51(a). Thus, if the person acted in his or her official capacity, he or she must have reasonably believed that his or her conduct was in the corporation’s best interests. 269 N.C. Gen. Stat. § 55-8-51(a); Del. Code Ann. tit. 8, § 145(a). 270 N.C. Gen. Stat. § 55-8-51(d)(1); Del. Code Ann. tit. 8, § 145(b).

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not present in the Delaware statute, for any proceeding where a court finds that the director received improper personal benefit.271

Note that the foregoing standard for director indemnification in North Carolina may permit indemnification even in those instances in which director’s conduct has fallen below the statutory standard of director conduct. Section 8-30 of the NCBCA, which sets general standards of conduct for directors, not only requires that an individual act in good faith and in a manner he or she reasonably believes to be in the best interests of the corporation (the first and second prongs of the indemnification standard), but also requires an individual to take the care that would be taken by an ordinarily prudent person in a like position under similar circumstances.272

Both North Carolina and Delaware impose certain express procedural requirements relative to permissive indemnification. Specifically, no permissive indemnification (unless, in the case of a Delaware corporation, indemnification is ordered by a court) may be provided by the corporation unless it is authorized upon a determination that indemnification is permissible or proper under the circumstances because the person has met the applicable standard of conduct (as described above).273

The two states differ somewhat as to how such determination shall be made (mainly as to quorum requirements, as indicated below). Under the NCBCA, the determination that indemnification is permissible must be made by (i) majority vote of a quorum of directors not parties to the proceeding at issue, (ii) if no quorum exists, by the majority vote of a committee duly designated by the board of directors (including interested directors) where the committee consists solely of two or more directors not party to the proceeding, (iii) if neither of the foregoing are possible, by special legal counsel selected by the board or its committee in the manner prescribed in (i) or (ii), or (iv) by the shareholders (shares owned and voted by interested directors being ineligible for consideration in determining the outcome).274

Under the DGCL,275 the determination that indemnification is proper must be made by (i) by a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum, or (ii) by a committee of such directors designated by majority vote of such directors, even though less than a quorum, or (iii) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or (iv) by the stockholders.276

Note that in 2009, Section 145(f) of the DGCL was amended to provide that a right to indemnification or to advancement of expenses arising under the certificate of incorporation or bylaws may not be impaired by an amendment to such provision after the occurrence of the act or omission that is the subject of the proceeding for which indemnification

271 N.C. Gen. Stat. § 55-8-51(d)(2). 272 N.C. Gen. Stat. § 55-8-30(a). 273 N.C. Gen. Stat. § 55-8-55(a); Del. Code Ann. tit. 8, § 145(d). 274 N.C. Gen. Stat. § 55-8-55. 275 Note that the Delaware statute limits such provision to a case involving a person who is a director or officer at the time of such determination. Del. Code Ann. tit. 8, § 145(d). 276 Id.

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or advancement of expenses is sought, unless the provision in effect at the time of such act or omission explicitly authorizes such impairment after such action or omission has occurred.277 The NCBCA has no such provision.

c) Expanded Indemnification

Both North Carolina and Delaware permit corporations to grant, in addition to the mandatory and permissive indemnification described above, expanded indemnification rights. The NCBCA authorizes a North Carolina corporation, by providing for such rights in its articles of incorporation or bylaws or by contract or resolution, to indemnify any of its directors, officers, employees, or agents against liability and expenses in any proceeding (including any derivative proceeding) arising out of any such person’s status as such or such person’s activities in any of the foregoing capacities.278 Such right is subject to an exception denying protection to any person for liabilities or expenses incurred on account of such person’s activities which were at the time taken known or believed by him to be clearly in conflict with the best interests of the corporation.279

Similarly, the DGCL provides that the mandatory and permissive indemnification rights afforded under DGCL Sections 145(a), (b) and (c) shall not be deemed to be exclusive of any other rights to which person seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in such person’s official capacity and as to action in another capacity while holding such office.280 Based on a comparison of the statutory language defining the scope of such expanded indemnification, Delaware’s statute appears on its face to be slightly more liberal, inasmuch as for a North Carolina corporation the conduct must arise out of the claimant’s status (as director, officer, employee or agent) or such person’s activities in any of the listed capacities, while in Delaware such conduct may arise out of action in another capacity (and thus not necessarily limited to the capacities that are listed) while holding such office. In addition, the DGCL’s right of expanded indemnification is not subject to express statutory exception, as is the NCBCA’s (as described in the immediately preceding paragraph).

Finally as regards expanded indemnification, the NCBCA (unlike the DGCL) expressly provides (i) for indemnification in favor of persons “serving as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise or as a trustee or administrator under an employee benefit plan”;281 (ii) that for public corporations, the approval by the board of directors of any provision in any articles of incorporation, bylaw, contract or resolution shall not be deemed an act in which a director has a conflict of interest;282 and (iii) that for nonpublic corporations, the approval by the board of directors of any provision in any articles of

277 This statutory amendment reverses the result of a 2008 Delaware chancery case, Schoon, et al., v. Troy

Corporation, 948 A.2d 1157 (Del. Ch. 2008). 278 N.C. Gen. Stat. § 55-8-57. 279 Id. 280 Del. Code Ann. tit. 8, § 145(f). 281 N.C. Gen. Stat. § 55-8-57(a). 282 N.C. Gen. Stat. § 55-8-57(b). Consequently, no such articles of incorporation or bylaw provision or contract or resolution shall be void on such grounds. Id.

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incorporation, bylaw, contract or resolution which occurred prior to July 1, 1990, shall not be deemed an act in which a director has a conflict of interest283 Otherwise, for nonpublic North Carolina corporations the provisions of NCBCA Section 8-31 (regarding conflicts of interest of directors) shall apply. Note that both the NCBCA and the DGCL authorize a corporation to purchase and maintain insurance on its personnel, which insurance may apply whether or not the corporation would have the power to so indemnify such persons against such liabilities, to supplement the protections otherwise afforded under the statutes.284

d) Court-ordered Indemnification

Court-ordered indemnification is addressed in NCBCA Section 8-54, and as mentioned above, this type of indemnification is not contemplated by the DGCL. Pursuant to this section, unless the articles of incorporation provide otherwise, a director or officer (but not any other type of personnel) of the corporation who is a party to a proceeding may apply for indemnification to a court, and such court may order indemnification if it determines that the director or officer285 either (i) is entitled to mandatory indemnification (as described above),286or (ii) is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not he met the standard of conduct set forth in NCBCA Section 8-51 or was adjudged liable as described in NCBCA Section 8-51(d).287

As a general matter North Carolina and Delaware are generally consistent in permitting corporations and corporate boards of directors to authorize an advance of expenses prior to full settlement of indemnification claims (or to elect not to advance expenses).288 Of course, the right to indemnification may be practically meaningless to a director, officer or other individual unless such litigation expenses may be advanced by the corporation. Both statutes require an undertaking on the part of the payee to reimburse the corporation unless it is ultimately determined that the payee was properly entitled to be indemnified. Note that one Delaware case has expressly held that the rights to indemnification and advancement of expenses are separate and distinct, and the presence of the former (as provided in a corporation’s bylaws) does not guarantee the latter.289 There are no North Carolina cases addressing this issue, but North Carolina practitioners advocating on behalf of corporate personnel should exercise particular care to ensure that advancement of expenses is covered in the governing documents.290

283 Id. Again, no such articles of incorporation or bylaw provision or contract or resolution shall be void on such grounds. Id. 284 N.C. Gen. Stat. § 55-8-57(c); Del. Code Ann. tit. 8, § 145(g). 285 N.C. Gen. Stat. § 55-8-56. 286 In this case, the court may order the corporation to pay the director's reasonable expenses incurred to obtain court-ordered indemnification. N.C. Gen. Stat. § 55-8-54(1). 287 If he was adjudged so liable, his indemnification is limited to reasonable expenses incurred. N.C. Gen. Stat. § 55-8-54(2). 288 See N.C. Gen. Stat. §§ 55-8-53; N.C. Gen. Stat. §§ 55-8-56(3); Del. Code Ann. tit. 8, § 145(e). 289 See Advanced Mining Systems, Incorporated v. Fricke, 623 A.2d 82 (Del. Ch. 1992). 290 Russell M. Robinson, II, Robinson on North Carolina Corporation Law, § 18.06 (Matthew Bender and Company, Inc., 7th ed. 2007).

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3. Interested Director Transactions

North Carolina and Delaware both recognize the proposition that a transaction between a corporation and one of its directors is not automatically void on the grounds that the director has a conflict of interest.291 Both provide that transactions involving a corporation and an interested director of that corporation are not voidable solely because of the director’s interest in such a transaction292 if any of the following are true: (i) the material facts of the transaction and the director’s interest are disclosed to or are known by the board of directors and the board of directors authorizes the transaction by a majority vote of all disinterested directors, (ii) the material facts of the transaction and the director’s interest are disclosed to or are known by the shareholders and the shareholders entitled to vote approve the transaction, or (iii) the transaction is fair to the corporation.

While the NCBCA and DGCL share the same criteria for determining whether the conditions to avoiding an automatic conclusion that the transaction is void or voidable are satisfied, there are some differences between the statutes.

The principal difference concerns quorum and voting guidelines. Section 144(b) of the DGCL expressly provides that in a vote by the board of directors to authorize an interested transaction, an interested or common director may be counted in establishing the presence of a quorum. The NCBCA, however, does not define a quorum in this context except to say that a quorum is present for purposes of approving an interested director transaction if a majority of disinterested directors vote to authorize, approve or ratify the transaction.293 Thus, while only a majority of disinterested director votes is necessary to authorize an interested transaction in both Delaware and North Carolina, a Delaware corporation would nonetheless be required to establish a quorum (albeit with the benefit of being able to count the interested director(s)).

Second, with regard to a shareholder vote to approve an interested transaction, the NCBCA provides that the shares owned by an interested director or controlled by an entity in which the interested director has a material financial interest or is a general partner may not be counted in the vote.294 In North Carolina, the presence of a majority of the remaining shares entitled to vote constitutes a quorum (so that a majority of the minority could effectively approve of an interested transaction). Section 144 of the DGCL does not provide specific criteria with regard to the shareholders’ vote or quorum requirements in this context.

Third, the Delaware statute covers transactions in which an officer (as well as a director) has an interest, while the North Carolina statute covers only transactions involving directors.

Finally, a more subtle difference between the two statutes relates to the timing of the determination of fairness of the interested director transaction. The DGCL provides that the

291 Del. Code Ann. tit. 8, § 144; N.C. Gen. Stat. § 55-8-31. 292 Note that the Delaware statute addresses transactions in which directors (and officers) have a “financial interest” generally, while the North Carolina refers to “direct” and “indirect interests.” The latter is defined in NCBCA Section 8-31(b). The Delaware statute does not seek to define “financial interest.” 293 N.C. Gen. Stat. § 55-8-31(c). 294 N.C. Gen. Stat. § 55-8-31(d).

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fairness of the transaction must be assessed as of the time the board of directors or shareholders authorized the transaction.295 The NCBCA does not provide for a time parameter during which the fairness criteria should be evaluated, but simply requires that the transaction “was fair” to the corporation.296

4. Liability for Unlawful Distributions

Both North Carolina and Delaware impose personal liability on directors who authorize the payment of distributions to shareholders (including share repurchases) in violation of the statutory standards governing distributions.297 See Section III.H. of this study for a comparison of the standards under North Carolina and Delaware law governing distributions.

Under Delaware law, in the case of any willful or negligent violation of the statutory restriction on payment of distributions, a director may be liable therefor, for a period of six years following payment of the distribution. The scope of liability extends to all directors other than those who expressly dissent.298 The DGCL, however, provides that a director will be fully protected in relying in good faith on the records of the corporation and such other information, opinions, reports and statements presented to the corporation by the corporation’s officers, employees and other persons as to matters that the director reasonably believes are within that person’s professional or expert competence and who have been selected with reasonable care as to the various components of surplus and other funds from which distributions may be paid or made.299 Directors of a Delaware corporation are also entitled to receive contribution from other directors who may be liable for the distribution and are subrogated to the rights of the corporation against shareholders who received the distribution with knowledge that the distribution was unlawful.300

Under the NCBCA, the statute does not refer to the standards of willfulness or negligence (such that it would be easier to plead a case for director liability in the case of a North Carolina corporation). Furthermore, liability for an unlawful distribution extends for only three years and also applies to all directors who voted for or assented to the distribution (assent being presumed if a director is present and does not dissent).301 For a director to be liable for an unlawful distribution, however, it must be established that he did not perform his duties in accordance with NCBCA Section 8-30, which defines the general standard of conduct for directors, and generally protects a director who relies on information, reports, opinions or statements of officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented.

The board of directors of a North Carolina corporation may base a determination that a distribution is not prohibited on financial statements prepared on the basis of accounting

295 Del. Code Ann. tit. 8, § 144(a)(3). 296 N.C. Gen. Stat. § 55-8-31(a)(3). 297 N.C. Gen. Stat. § 55-8-33; Del. Code Ann. tit. 8, § 174. 298 Note that a director who is absent at the meeting at which the distribution is approved may avoid liability only by dissenting after receiving notice of the approval. Del. Code Ann. tit. 8, § 174. 299 Del. Code Ann. tit. 8, § 172. 300 Del. Code Ann. tit. 8, § 174. 301 N.C. Gen. Stat. § 55-8-24(d).

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practices and principles that are reasonable in the circumstances and may determine asset values either on book values or on a fair valuation or other method that is reasonable in the circumstances.302 The DGCL does not have a comparable provision.

As in Delaware, a director of a North Carolina corporation held liable for an unlawful distribution under the NCBCA will be entitled to contribution from the other directors who may be similarly liable as well as reimbursement from each shareholder who received and accepted the distribution knowing it was not permitted.303

5. Reliance on Reports and Opinions

Both North Carolina and Delaware provide that a director in the discharge of his duties and powers may rely on information, opinions and reports presented (or, in the case of North Carolina, prepared) by officers and employees of the corporation. In North Carolina, but not in Delaware, a director must reasonably believe the officer or employee is reliable and competent in the matters presented.304 In both states, a director may rely on other persons (the NCBCA specifically refers to legal counsel and public accountants) as to matters that the director reasonably believes are within that person’s professional or expert competence. In Delaware, the selection of outside advisors must have been made with reasonable care by or on behalf of the corporation.305 Under both North Carolina and Delaware law, directors may rely on a committee of the board of directors, with the caveat in North Carolina being the director must reasonably believe the committee merits confidence.

6. Inspection of Records

Both North Carolina and Delaware provide that a director is entitled to examine the books and records of a corporation for a purpose reasonably related to the director’s position or the performance of his duties as a director.306 NCBCA Section 16-05 specifically provides that a director may “copy” the books and records he is entitled to examine.

F. Shareholder Voting Rights and Actions

1. Quorum

Under North Carolina law, a quorum generally consists of a majority of votes entitled to be cast on a particular matter at a meeting.307 This rule is expressed in the context of a statute that addresses quorum and voting rights for voting groups, which may be established in a North Carolina corporation’s articles of incorporation or bylaws.308 North Carolina law expressly permits different quorum and voting requirements to apply to different matters as they are

302 N.C. Gen. Stat. § 55-6-40(d). 303 N.C. Gen. Stat. § 55-8-33(b). 304 N.C. Gen. Stat. § 55-8-30(b). 305 Del. Code Ann. tit. 8, § 141(e). 306 N.C. Gen. Stat. § 55-16-05; Del. Code Ann. tit. 8, § 220(d). 307 N.C. Gen. Stat. § 55-7-25(a). 308 Id; N.C. Gen. Stat. § 55-7-26.

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presented at a meeting of the shareholders.309 The NCBCA also provides that the articles of incorporation or bylaws may provide for higher quorum requirements than otherwise applicable under the statute.310

The DGCL is not substantively different from the NCBCA with regard to quorum requirements (except in one respect, addressed below). The Delaware statute provides that the certificate of incorporation or bylaws may define what the quorum requirements for a particular matter shall be, and absent any such provision, a quorum shall consist of a majority of shares (both present and represented by proxy) entitled to vote at the shareholders’ meeting, unless the matter is subject to class vote, in which case a quorum of a class shall consist of a majority of shares (both present and represented by proxy) of such class entitled to vote at such meeting.311 Like the NCBCA, the DGCL expressly recognizes that different quorum requirements should be applicable in class voting situations.312

The one substantive distinction as between North Carolina and Delaware concerning quorum requirements is that the DGCL imposes a floor whereby the number of shares constituting a quorum may not be reduced to less than one-third of the shares entitled to vote at the meeting.313 There is no such provision in the NCBCA.314

2. Voting Rights

Under both North Carolina and Delaware law, unless otherwise stated in the articles or certificate of incorporation, each outstanding share is entitled to one vote per share.315 North Carolina’s statute permits the use of voting groups that may vote separately on particular matters, while Delaware law employs the similar concept of class voting.316 Both states enable the corporation to limit or condition (through the articles or certificate of incorporation or bylaws) the voting power of shares depending on those shares’ characteristics (subject to certain statutory limits, such as with respect to certain charter amendments).317 For a more detailed discussion of voting by group or class, see Section III.F.7. of this study, below.

The NCBCA does not recognize the concept of treasury shares. Instead, shares of stock of a North Carolina corporation that are repurchased by the corporation are deemed simply to be authorized but not issued or outstanding.318 This contrasts with the DGCL, under which a Delaware corporation may repurchase or redeem stock and then account for it as treasury

309 N.C. Gen. Stat. § 55-7-25(a); see also Robinson, II, supra note 290, § 8.08. 310 N.C. Gen. Stat. § 55-27(a). 311 Del. Code Ann. tit. 8, § 216. 312 Del. Code Ann. tit. 8, § 216(4). 313 N.C. Gen. Stat. § 55-7-25(a); Del. Code Ann. tit. 8, § 216. 314 Note that prior to 1990, North Carolina law had had the one-third quorum requirement. 315 N.C. Gen. Stat. § 55-7-21(a). Del. Code Ann. tit. 8, § 212(a). 316 See Section III.F.7. of this study for a discussion of voting groups and class voting. 317 N.C. Gen. Stat. § 55-7-22(h); Del. Code Ann. tit. 8, § 212(a). 318 N.C. Gen. Stat. § 55-6-31(a).

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stock.319 Furthermore in Delaware, subject to certain limitations described below, treasury shares may be voted by the corporation.320

An undesirable consequence of treasury stock is the ability it gives to management to entrench itself by causing the corporation to vote such stock in management’s favor. The same objective may theoretically be advanced by issuing shares of the corporation to a subsidiary. Both the NCBCA and the DGCL address this possibility and both prohibit the voting of shares held by another corporation that is itself a majority-owned subsidiary of the corporation whose shares are being voted.321 One distinction as between North Carolina’s and Delaware’s prohibition in this regard is that the NCBCA, unlike the DGCL, contains language allowing a court to permit the voting of these shares in contravention of the express prohibition under “special circumstances” when the court deems that the purpose of the section is not violated.322

In addition, both the NCBCA and DGCL provide that shares that have been called for redemption are not entitled to vote after notice of redemption is made and the redemption price has been set aside.323 Delaware sets this cut-off date as the date notice is “sent” to the holders, whereas North Carolina sets it on the date notice is “given” to the holders (which might imply receipt, as an evidentiary matter).

With respect to the vote required for actions needing the approval of shareholders (other than with respect to the election of directors),324 in both North Carolina and Delaware such matters generally require a majority vote, by straight (as opposed to cumulative) voting, assuming the existence of a quorum (and assuming that the charter or bylaws do not require a different voting threshold). The two states’ laws differ, however, in how they define a “majority.” The NCBCA provides that action on such matter by a voting group is approved if the votes cast within the voting group favoring the action exceed the votes cast opposing the action.325 The DGCL, however, provides that the affirmative vote of the majority of shares present in person or represented by proxy at the meeting and entitled to vote on the subject matter shall be the act of the stockholders.326 Consequently, the effect of abstentions is different as between North Carolina corporations (as to which abstentions do not count at all) and Delaware corporations (as to which abstentions would effectively count as negative votes).

Certain types of actions, however, fall outside of the general rule and by statute require a different voting threshold.327 Under the NCBCA, the following types of transactions

319 Del. Code Ann. tit. 8, § 160. 320 See Edward P. Welch, Andrew J. Turezyn, Robert S. Saunders, Folk on the Delaware General Corporation Law

(Aspen Publishers, 5th Edition, 2009 Supplement), § 160. 321 N.C. Gen. Stat. § 55-7-21; Del. Code Ann. tit. 8, § 160(c). The reason for this prohibition “is to prevent management from using a corporate investment to perpetuate itself in power.” Official Comment to N.C. Gen. Stat. § 55-7-21, ¶ 3. 322 N.C. Gen. Stat. § 55-7-21(b). See also Robinson, II, supra note 290, § 7.06. 323 N.C. Gen. Stat. § 55-7-21(d); Del. Code Ann. tit. 8, § 160(d). 324 As indicated in section III.D.2. of this study, above, the general rule in both North Carolina and Delaware is that directors are elected by a plurality of votes represented in person or by proxy, assuming the existence of a quorum. 325 N.C. Gen. Stat. § 55-7-25(c). 326 Del. Code Ann. tit. 8, § 216(2). 327 See Robinson, II, supra note 290, § 7.05.

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require the affirmative vote of a majority of shares entitled to be cast (and thus, similar to Delaware’s general rule): (i) charter amendments that trigger dissenters’ rights;328 (ii) mergers or share exchanges;329 (iii) asset sales outside the ordinary course of business;330 and (iv) voluntary dissolutions.331 In addition under the NCBCA, special approvals are required to adopt shareholder resolutions approving a conflict-of-interest transaction with an interested director, with respect to transactions subject to North Carolina’s Shareholder Protection Act and Control Share Acquisition Act, and with respect to mergers where a shareholder of a merging corporation will have personal liability for an obligation of the surviving corporation solely as a result of owning shares in the surviving corporation.332

Under the DGCL, certain matters require the vote of a majority of the shares entitled to vote: (i) charter amendments;333 (ii) mergers and consolidations;334 (iii) sales of all or substantially all of the assets of the corporation;335 and (iv) the voluntary dissolution of the corporation.336 In addition, business combinations with interested stockholders must be approved by 66 and 2/3 percent of the outstanding stock that is not held by the interested stockholders.337

3. Proxies

For the purposes of this discussion, the term “proxy” shall be used interchangeably to refer to the grant of authority to vote, the document granting such authority, and to the person to whom the authority is granted, depending on the context of the use of the term.338 Under both North Carolina and Delaware law, shareholders may vote their shares in person or by proxy.339 Consequently, under both states’ laws, the proxy has the same power to vote as that possessed by the shareholder. North Carolina law specifically grants the shareholder the right to limit his or her grant of power through an express statement of any voting directions or limitations on the appointment form itself, and the corporation is then required to calculate the votes consistent with such limitations.340 The DGCL does not have a similar provision.

Under the DGCL, a stockholder may execute a writing authorizing another person or persons to act for such stockholder as proxy. The requirements for execution of such a writing under Delaware law are somewhat loose relative to the requirements applicable to a North Carolina corporation. The DGCL allows such execution to be accomplished by the stockholder or his authorized officer, director, employee or agent signing such writing or causing such person’s signature to be affixed to such writing. NCBCA Section 7-22(b), however, calls for a

328 N.C. Gen. Stat. § 55-10-03(e)(1). 329 N.C. Gen. Stat. § 55-11-03(e). 330 N.C. Gen. Stat. § 55-12-02(e). 331 N.C. Gen. Stat. § 55-14-02(e). 332 See Robinson, II, supra note 290, § 7.05. 333 Del. Code Ann. tit. 8, § 242(b)(1). 334 Id. § 251(c). 335 Id. § 271(a). 336 Id. § 275(b). 337 Id. § 203(a)(3). 338 Note that this nomenclature differs from what is employed in the NCBCA, under which the term “proxy” is limited to the person to whom the authority to vote is granted. See Robinson, II, supra note 290, § 7.07. 339 N.C. Gen. Stat. § 55-7-22(a); Del. Code Ann. tit. 8, § 212(b). 340 N.C. Gen. Stat. § 55-7-22(h).

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similar writing (referred to as an “appointment form”) that, in order to be valid, must be executed by either the shareholder or the shareholder’s attorney-in-fact.341

Delaware law specifically allows proxies to be given via facsimile342 or through electronic transmission, including telegram and cablegram; such transmissions must, however, set forth or be submitted with information from which it can be determined by an inspector or other appropriate party that the transmission is valid. Furthermore, the party making such a determination must specify the information upon which he relied.343 North Carolina law also allows for electronic authorization of proxy, so long as the electronic record bears the shareholder’s electronic signature as well. The North Carolina statute does not expressly require the submission of additional information to support the validity of such electronic records. Shareholders of North Carolina public corporations may also appoint proxies by telephonic transmission even when unaccompanied by any form of written communication, but only under circumstances in which the corporation can reasonably assume that the appointment was authorized by the shareholder.344

Under North Carolina law, proxy appointments shall be valid for only 11 months, unless the appointment form expressly provides a “different” period.345 Delaware law states that no proxy will be valid after three years, unless the proxy provides for a “longer” period.346 The eleven (11) month limitation under North Carolina law, “[E]nsures that in the normal course a new appointment will be solicited at least once every 12 months.”347 Note that the language in NCBCA Section 7-22(c) formerly used the “longer” instead of “different” but was later amended in order to also permit proxy appointments for less than 11 months.348

Proxies under both states’ laws may be made irrevocable by coupling the appointment with an interest and stating that it is irrevocable on the appointment record.349 The North Carolina statute lists some examples of appointments coupled with interests. Those include: (a) a creditor of the corporation who extended credit under terms requiring the appointment; (b) a person who has purchased or has agreed to purchase the shares; (c) a pledgee; (d) an employee whose employment contract requires a proxy appointment; and (e) a party to a valid voting agreement.350 The Delaware statute does not include a list of examples and instead relies on case law to determine what constitutes a sufficient level of interest to support an irrevocable proxy.351 The North Carolina statute also specifically states that an irrevocable proxy shall become revocable when the interest with which it is coupled is extinguished.352 Additionally, the North Carolina statute states that a transferee of shares for value may revoke an

341 N.C. Gen. Stat. § 55-7-22(b). 342 Del. Code Ann. tit. 8, § 212(c)(1). 343 Del. Code Ann. tit. 8, § 212(c)(2). 344 N.C. Gen. Stat. § 55-7-22(b). 345 N.C. Gen. Stat. § 55-7-22(c). 346 Del. Code Ann. tit. 8, § 212(b). 347 Official Comment to N.C. Gen. Stat. § 55-7-22, ¶ 3. 348 North Carolina Commentary to N.C. Gen. Stat. § 55-7-22. 349 N.C. Gen. Stat. § 55-7-22(d); Del. Code Ann. tit. 8, § 212(e). 350 N.C. Gen. Stat. § 55-7-22(d). 351 Del. Code Ann. tit. 8, § 212(e). 352 N.C. Gen. Stat. § 55-7-22(f). An example would be the release of a pledge or repayment of a loan. Official Comment to N.C. Gen. Stat. § 55-7-22 , ¶ 4.

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irrevocable appointment if the transferee was unaware of its existence upon acquisition and such appointment was not noted conspicuously on the certificate representing the shares or on the information statement for shares without certificates.353

With regard to the termination of the proxy’s authority, the North Carolina statute specifically states (unlike the DGCL) that the death or incapacity of the shareholder does not affect the right of the corporation to accept the proxy’s authority unless the secretary of the corporation or other officer or agent authorized to calculate votes is given notice of the death or incapacity before the proxy exercises his authority.354 Finally, according to Model Act Official Comments, and consistent with the common law principles of agency law, a North Carolina revocable appointment may also be terminated, “[E]ither expressly or by implication, as when a shareholder later executes a second appointment form inconsistent with an earlier one, or attends the meeting in person and seeks to vote on his own behalf.”355

See Section III.K.4. of this study, below, for a discussion of the 2009 amendments to the DGCL affecting proxies.

4. Cumulative Voting

Cumulative voting allows a shareholder to accumulate the number of votes he or she would be permitted to cast in favor of (or against) all directors and vote them for (or against) a single director or in any other manner. For example, if 15 directors are to be elected, a shareholder owning 50 shares with one vote per share will have 750 total votes. Such shareholder can cast all of these votes for one candidate, or 50 votes for each of the 15 candidates, or 375 votes for each of two candidates, or 250 votes for each of three candidates, or any other combination that works mathematically.

Neither North Carolina nor Delaware requires a corporation to provide for cumulative voting, but each state permits the articles or certificate of incorporation to provide for cumulative voting in the election of directors.356 The DGCL takes a simple and straightforward approach to cumulative voting and simply authorizes Delaware corporations to provide for such voting in the election of directors. The NCBCA, however, addresses cumulative voting in a more complicated and involved manner, in that it (i) sets forth different rules as to whether and under what circumstances the right applies (depending on when the corporation was incorporated), and (ii) imposes limits on certain measures that could otherwise be taken to counteract the effects of cumulative voting, all as discussed below.

Generally, all that is needed to confer a standard right to cumulate votes is a simple statement in the articles or certificate of incorporation to that effect. The NCBCA prescribes “[a] statement . . . that ‘[all] [a designated voting group of] shareholders are entitled to cumulate their votes for directors’ (or words of similar import),”357 while the DGCL extends the right of cumulative voting to a corporation that has provided in its certificate of incorporation

353 N.C. Gen. Stat. § 55-7-22(g). 354 N.C. Gen. Stat. § 55-7-22(e). 355 Official Comment to N.C. Gen. Stat. § 7-22, ¶ 3. 356 N.C. Gen. Stat. § 55-7-28(b); Del. Code Ann. tit. 8, § 214. 357 N.C. Gen. Stat. § 55-7-28(c).

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“that at all elections of directors of the corporation, or at elections held under specified circumstances, each holder of stock or of any class or classes or of a series or series thereof shall be entitled to as many votes as shall equal the number of votes which (except for such provision as to cumulative voting) such holder would be entitled to cast for the election of directors with respect to such holder’s shares of stock multiplied by the number of directors to be elected by such holder, and that such holder may cast all of such votes for a single director or may distribute them among the number to be voted for, or for any 2 or more of them as such holder may see fit.”358 Again, if the certificate of incorporation of a Delaware corporation so provides, the stockholders will have the right to cumulative voting for directors.

In North Carolina, however, in the absence of such a statement in the articles of incorporation, the determination of whether shareholders nevertheless have mandatory cumulative voting rights may be complicated and will depend on, among other things, whether the corporation was incorporated under the present law, on or after July 1, 1990 (in which case, absent a provision granting the right to cumulative voting in the articles of incorporation, no such right applies), or under the 1957 version of the NCBCA between July 1, 1957 and July 1, 1990, or under prior law before July 1, 1957. A grandfathering provision in the present act has preserved mandatory cumulative voting rights that existed under the prior law, and in this regard there are two different categories of grandfathered rights: (i) one for corporations incorporated between July 1, 1957 and July 1, 1990 and (ii) another for corporations incorporated before July 1, 1957.359

Shareholders of North Carolina corporations incorporated between July 1, 1957 and July 1, 1990, have a right to vote cumulatively for the election of directors, unless the corporation is a public corporation at the time that the stock transfer books are closed or the record date is fixed for the meeting.360 A “public corporation” is defined under NCBCA Section 1-40(18a) as any corporation that has a class of shares registered under Section 12 of the Securities Exchange Act of 1934, as amended.361

Subject to the same exception for public corporations, the shareholders of a North Carolina corporation incorporated before July 1, 1957 have a right to vote cumulatively for the election of directors only if: (i) the articles of incorporation expressly grant such a right; or (ii) at the time of election, the stock transfer book of the corporation discloses (or it otherwise appears) that a single shareholder owns or controls more than one-fourth of the voting shares of the corporation.362 If neither circumstance applies, the directors must be elected by straight voting.363

The effect of cumulative voting may be reduced through (i) the establishment of a staggered board of directors, (ii) a reduction in the size of the board, (iii) removal of directors or (iv) charter amendment. The DGCL does not impose limits on any of the foregoing measures, but the NCBCA (while not limiting the corporation’s ability to stagger its board) does.

358 Del. Code Ann. tit. 8, § 214. 359 N.C. Gen. Stat. § 55-7-28(e). 360 N.C. Gen. Stat. § 55-7-28(e). 361 15 U.S.C. § 78l. 362 N.C. Gen. Stat. § 55-7-28(e)(1). 363 N.C. Gen. Stat. § 55-7-28(e).

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An amendment to a North Carolina corporation’s articles of incorporation eliminating an existing right to cumulative voting will trigger right of dissent and appraisal.364 In addition, grandfathered cumulative voting rights of pre-July 1, 1990 corporations (as described above) may not be limited or denied by an amendment to the articles of incorporation if the number of shares voted against the amendment would be sufficient to elect a director by cumulative voting.365 Furthermore, a pre-July 1, 1990 corporation with grandfathered cumulative voting is prohibited from decreasing the number of directors on the board unless one of the following two conditions is met: (i) the decrease is approved by the shareholders in a vote in which the number of shares entitled to be voted cumulatively that vote against the proposed reduction would not be sufficient to elect a director by cumulative voting;366 or (ii) the reduction is made pursuant to a provision of the articles of incorporation or bylaws fixing a minimum and a maximum number of directors and authorizing the specific number within that range to be fixed or changed from time to time, within the maximum and the minimum, by the shareholders or, unless the articles of incorporation or a valid shareholders’ agreement provides otherwise, by the board.367 Finally, if cumulative voting is in effect, unless the entire board is removed, a director may not be removed if the number of votes against his removal would be sufficient to elect a director under cumulative voting.368

If cumulative voting is potentially available to shareholders of a North Carolina corporation, there are prescribed notice provisions designed to ensure that all shareholders participating in the election understand the rules and to avoid the distortions that may be created when some shareholders vote cumulatively while others do not.369 Specifically, in order for shares to be voted cumulatively, the notice of the particular meeting must state that cumulative voting is authorized, and the shareholder exercising such right must openly announce his or her intention to so vote in the meeting.370

5. Action by Shareholders Without a Meeting

Under both North Carolina and Delaware law, shareholders are permitted to take action by written consent in lieu of a meeting.371 In each state: (i) such consent must be in writing, must bear the date of signature and must set forth the action taken and must be delivered to the corporation before the action will be effective;372 and (ii) such consent will not be effective unless enough unrevoked written consents needed to make the action effective are received by

364 N.C. Gen. Stat. § 55-13-02(a)(4)(iv). 365 N.C. Gen. Stat. § 55-7-28(e). 366 N.C. Gen. Stat. § 55-8-03(b)(1). 367 N.C. Gen. Stat. § 55-8-03(b)(2). 368 N.C. Gen. Stat. § 55-8-08(c). The calculation of how many votes are needed to defeat the removal must be made as if (i) the removal vote occurred in an election to elect the number of directors normally elected by the voting group along with the director whose removal is sought, (ii) the number of votes cast cumulatively against his removal were cast for his election, and (iii) all votes cast for his removal were cast cumulatively and efficiently to elect a number of candidates that would deprive him of election. Official Comment to N.C. Gen. Stat. § 55-8-08. 369 N.C. Gen. Stat. § 55-7-28(d). 370 If such intention is announced, the chair shall declare that all shares entitled to vote have the right to vote cumulatively and shall announce the number of votes represented in person and by proxy, and shall also grant a recess of one to four hours (or such other period of time unanimously agreed upon). Id. 371 N.C. Gen. Stat. § 55-7-04; Del. Code Ann. tit. 8, § 228. 372 N.C. Gen. Stat. § 55-7-04; Del. Code Ann. tit. 8, § 228.

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the corporation within 60 days after the date on which that written consent was signed.373 This means of shareholder approval is unavailable to a North Carolina corporation if it is a public corporation.374

In each state, action in lieu of a meeting may be taken by less than unanimous consent (subject in North Carolina to certain exceptions described more fully below), so long as such action is taken by those shareholders having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted.375 In Delaware, the right to take action by less than unanimous written consent exists unless limited in the certificate of incorporation,376 whereas in North Carolina, the right will not exist unless specifically provided in the articles of incorporation. Note that the standard for action by less than unanimous written consent is higher than the typical standard at a meeting, which for most actions (assuming a quorum) would require only a simple majority of those shareholders actually casting votes.

North Carolina law prohibits action from being taken by less than unanimous consent: (i) to elect directors in lieu of an annual meeting; (ii) to elect directors if cumulative voting is authorized; (iii) to remove a director if cumulative voting is authorized, unless the entire board is to be removed; and (iv) to limit or deny cumulative voting or decrease the number of directors by amendment to the articles of incorporation or bylaws if cumulative voting is mandatory.377 The DGCL lacks the NCBCA’s specific statutory restrictions as applied to cumulative voting, but there is Louisiana caselaw interpreting DGCL Section 228 to mean that the written consent procedure could not be used to remove directors where cumulative voting would have enabled the minority to prevent such removal.378

Under Delaware law, if a written consent action electing directors is less than unanimous, however, then the action can be in lieu of an annual meeting only if all of the board seats to which directors could be elected at an annual meeting are vacant and are filled by the action.379

In each state, when action is taken without a meeting by less than unanimous consent, the corporation must give written notice of the action, within ten days after the action is taken in North Carolina, and “promptly” in Delaware,380 to all non-consenting shareholders who, if the action had been taken at a meeting, would have been entitled to notice of the meeting.381 In North Carolina, unless otherwise specified in the articles of incorporation, when action is taken without a meeting by written consent with respect to certain fundamental matters, the corporation must give to all shareholders who do not consent (nonvoting as well as voting shareholders) written notice of the proposed action at least ten days before the action becomes effective, which

373 N.C. Gen. Stat. § 55-7-04(b); Del. Code Ann. tit. 8, § 228(c). 374 N.C. Gen. Stat. § 55-7-04(a). 375 N.C. Gen. Stat. § 55-7-04; Del. Code Ann. tit. 8, § 228(a). 376 Del. Code Ann. tit. 8, § 228(a). 377 N.C. Gen. Stat. § 55-7-04(a1). 378 Crutcher v. Tufts, 898 So. 2d 529, 534-35 (La. Ct. App. 2005). 379 Del. Code Ann. tit. 8, § 211(b). 380 Del. Code Ann. tit. 8, § 228(d). 381 N.C. Gen. Stat. § 55-7-04(e).

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notice must contain or be accompanied by the same material that would have been required to be sent to any nonvoting shareholders in a notice of meeting at which the proposed action would have been resubmitted.382 Finally, in North Carolina, if shareholder action without a meeting creates a right of dissent and appraisal, the corporation must give the notice required under NCBCA Section 13-20.

6. Voting of Shares Held in Trust

A voting trust, which is a vehicle specifically authorized by statute in Delaware and North Carolina, is a device by which one or more shareholders separate the voting rights of their shares from the ownership, retaining the ownership rights but transferring the voting rights to one or more trustees, to be voted or otherwise represented by such trustees in accordance with a written voting trust agreement.383 Each state requires a writing and that the shares be re-registered in the name of the trust.384

In North Carolina, a voting trust agreement becomes effective on the date the first shares subject to the trust are registered on the books of the corporation in the trustee’s name, and its validity is limited for a period of ten years after that date, unless extended.385 All or some of the parties may extend as to themselves for successive additional terms by signing an extension agreement and obtaining the voting trustee’s written consent (each extension can be for a term of not more than ten years from the date the first shareholder signs the extension agreement).386

In Delaware, however, the voting trustee may vote the stock so issued or transferred during the period specified in the voting trust agreement.387 In Delaware, there is no longer any period of fixed duration limiting by statute the initial and extended terms of voting trusts. Under prior law, voting trusts were enforceable for a period not to exceed ten years.

In North Carolina, the trustee is required to prepare a list of the names and addresses of all owners of beneficial interests in the trust, together with the number and class of shares each transferred to the trust, and deliver copies of the list and the trust agreement to the corporation’s principal offices.388 In Delaware, the trust agreement (and any amendments) must be filed with the registered office of the corporation in Delaware to ensure that all stockholders have the right to inspect it.389

7. Voting by Group or Class

As mentioned above in Section III.F.2., both North Carolina and Delaware law provide that each outstanding share will be entitled to one vote on all matters presented to

382 N.C. Gen. Stat. § 55-7-04(d). 383 N.C. Gen. Stat. § 55-7-30; Del. Code Ann. tit. 8, § 218. 384 N.C. Gen. Stat. § 55-7-30; Del. Code Ann. tit. 8, § 218. 385 N.C. Gen. Stat. § 55-7-30(b). 386 N.C. Gen. Stat. § 55-7-30(c). 387 Del. Code Ann. tit. 8, § 218(a). 388 N.C. Gen. Stat. § 55-7-30(a). 389 Del. Code Ann. tit. 8, § 218(a).

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shareholders unless otherwise provided in the corporation’s charter.390 In addition, whether or not entitled to vote on matters presented to shareholders generally, special class or series voting rights are provided to shareholders in North Carolina and Delaware with respect to certain mergers, share exchanges and charter amendments.391

As indicated above in Section III.F.1, if a separate class or series vote is required, both North Carolina and Delaware provide that a majority of the outstanding shares of such class or series, present in person or represented by proxy, shall constitute a quorum for taking action, unless the corporation’s charter or bylaws provides for a different quorum.392 In Delaware, a corporation’s quorum cannot be specified as less than one-third of the outstanding shares of a class or series. North Carolina law does not contain a similar restriction.393 Both North Carolina and Delaware provide that if a corporation’s charter contains a supermajority voting requirement, such requirement cannot be altered, amended or repealed except pursuant to a supermajority vote at the level specified in the charter.394

Once a quorum is present, North Carolina and Delaware differ as to the required vote to approve a matter. In North Carolina, if a quorum exists, action on a matter (other than the election of directors) by a voting group is approved if the votes cast within the voting group favoring the action exceed the votes cast opposing the action, unless the articles of incorporation, a bylaw adopted by the shareholders, or the NCBCA requires a greater number of affirmative votes.395 Thus, if there are abstentions, a matter theoretically could still be approved by the shareholders of a North Carolina corporation even if less than fifty percent (50%) of the shares constituting the quorum voted to approve the matter. By contrast, in Delaware, in all matters other than the election of directors, the affirmative vote of the majority of the shares constituting the quorum is required.396

In North Carolina, a class is entitled to a separate class vote with respect to a charter amendment that would: (1) increase or decrease the aggregate number of authorized shares of the class; (2) effect an exchange or reclassification of all or part of the shares of the class into shares of another class; (3) effect an exchange or reclassification, or create the right of exchange, of all or part of the shares of another class into shares of the class; (4) change the designation, rights, preferences, or limitations of all or part of the shares of the class; (5) change the shares of all or part of the class into a different number of shares of the same class; (6) create a new class of shares having rights or preferences with respect to distributions or to dissolution that are prior, superior, or substantially equal to the shares of the class; (7) increase the rights, preferences, or number of authorized shares of any class that, after giving effect to the amendment, have rights or preferences with respect to distributions or to dissolution that are prior, superior, or substantially equal to the shares of the class; (8) limit or deny an existing preemptive right of all or part of the shares of the class; (9) cancel or otherwise affect rights to

390 N.C. Gen. Stat. § 55-7-21(a); Del. Code Ann. tit. 8, § 212(a). 391 For a discussion of the flexibility afforded by group (ass opposed to class) voting, see Robinson, II, supra note 290, § 7.02. 392 N.C. Gen. Stat. § 55-7-25(a); Del. Code Ann. tit. 8, § 216(4). 393 N.C. Gen. Stat. § 55-7-25(a); Del. Code Ann. tit. 8, § 216). 394 N.C. Gen. Stat. § 55-7-27(b); Del. Code Ann. tit. 8, § 242(b)(4). 395 N.C. Gen. Stat. § 55-7-25(c). 396 Del. Code Ann. tit. 8, § 216(4).

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distributions or dividends that have accumulated but not yet been declared on all or part of the shares of the class; or (10) change the corporation into a nonprofit corporation or a cooperative organization.397 This entitlement is mandatory and may not be limited by any charter or bylaw provision. A separate class vote is also required on any plan of share exchange by each class or series to be acquired in the exchange or on any plan of merger that contains a provision that, if contained in a proposed amendment to the articles of incorporation, would require action by one or more separate voting groups on the proposed amendment under NCBCA Section 10-04(a), except where the consideration to be received in exchange for the shares of that voting group consists solely of cash.398

By contrast, in Delaware, the types of amendments for which a class vote is required are more limited. A class vote is required only if a charter amendment would increase or decrease the aggregate number of authorized shares of such class, increase or decrease the par value of the shares of such class, or alter or change the powers, preferences, or special rights of the shares of such class so as to affect them adversely.399 Thus, in Delaware, a class must be adversely affected by a change to its rights and preferences before being entitled to a class vote, while in North Carolina, any such change, even if not adverse, requires a class vote. Note that unlike North Carolina shareholders under NCBCA Section 10-04(a)(6), Delaware stockholders are not entitled to a class vote upon the creation of senior or pari passu classes. Stockholders of a Delaware corporation are entitled to a class vote on a plan of merger that contains one of the types of amendments to the corporation’s certificate of incorporation listed in DGCL Section 242(b)(2).400

If a class vote is otherwise required, both North Carolina and Delaware provide that a class or series is entitled to vote on the matter even though the shares are otherwise nonvoting under the corporation’s charter.401

Under the DGCL, the number of authorized shares of any class or classes of stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the stock of the corporation entitled to vote, if so provided in the original certificate of incorporation, in any amendment thereto which created such class or classes of stock or which was adopted prior to the issuance of any shares of such class or classes of stock, or in any amendment thereto which was authorized by a resolution or resolutions adopted by the affirmative vote of the holders of a majority of such class or classes of stock.402 The NCBCA has no counterpart to this provision.

8. Inspectors of Election

Under DGCL Section 231, public corporations are required to appoint one or more inspectors of election to act at a stockholders’ meeting and to make a written report of

397 N.C. Gen. Stat. § 55-10-04(a). 398 N.C. Gen. Stat. § 55-11-03(f). 399 Del. Code Ann. tit. 8, § 242(b)(2). 400 This proposition is supposed to be true, although (unlike the case under the NCBCA) it is not expressly supported by any manifest language in the Delaware merger statute (Del. Code Ann. tit. 8, § 251) or in § 216. 401 N.C. Gen. Stat. § 55-10-04(d); Del. Code Ann. tit. 8, § 242(b)(2). 402 Del. Code Ann. tit. 8, § 242(b)(2).

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proceedings.403 The duties of the inspectors include (i) ascertaining the number of shares outstanding and the voting power of each; (ii) determining the shares represented at a meeting and the validity of proxies and ballots; (iii) counting all votes and ballots; (iv) determining and retaining for a reasonable period a record of the disposition of any challenges made to any determination by the inspectors; and (v) certifying their determination of the number of shares represented at the meeting, and their count of all votes and ballots.404 Delaware corporations must announce at the meeting the date and time of the opening and the closing of the polls for each matter upon which the stockholders will vote at the meeting, and the inspectors may not accept any ballot, proxies or votes, nor any revocations thereof or changes thereto, after the closing of the polls unless the court of chancery upon application by a stockholder shall determine otherwise.405 North Carolina has no counterpart to DGCL Section 231.

9. Special Meetings

In the case of a North Carolina corporation that is not a public corporation, the corporation must hold a special meeting of shareholders within thirty (30) days after its secretary receives one or more written demands for the meeting, which demand(s) must describe the purpose or purposes for which the special meeting is to be held, from holders of at least ten percent (10%) of all the votes entitled to be cast on any issue proposed to be considered at the proposed special meeting.406 The DGCL does not provide stockholders with an express right to call a special meeting of stockholders.407

10. Shareholder Lists and Access to Other Information

Under the NCBCA, any shareholder who has held his shares for at least six months or who holds at least 5% of all of the outstanding shares of a corporation (a “qualified shareholder”) will have the right to inspect and copy, during regular business hours at the corporation’s principal office, provided he or she gives the corporation written notice of his or her demand at least five business days before the date on which he or she wishes to inspect and copy, the following records: (i) the articles or restated articles of incorporations and amendments; (ii) bylaws or restated bylaws and all amendments; (iii) resolutions adopted by the board of directors creating one or more classes or series of shares, and fixing their relative rights, preferences, and limitations, if the shares issued to those resolutions are outstanding; (iv) the minutes of all shareholders’ meetings and records of all action taken by the shareholders without a meeting, for the past three years; (v) all written communications to shareholders generally within the past three years and the financial statements required to be made available to the shareholders for the past three years; (vi) a list of the names and business addresses of its current directors and officers; and (vii) its most recent annual report delivered as required by statute.408

403 Del. Code Ann. tit. 8, § 231(a). 404 Del. Code Ann. tit. 8, § 231(b). 405 Del. Code Ann. tit. 8, § 231(c). 406 N.C. Gen. Stat. § 55-7-02(a)(2). 407 Del. Code Ann. tit. 8, § 211(d). Rather, special meetings may be called only by the board of directors or by such person(s) authorized by the certificate of incorporation or bylaws. Id. This is also the means by which a North Carolina corporation may hold a special meeting, assuming the corporation doesn’t invoke NCBCA Section 7-02(a)(2). N.C. Gen. Stat. § 55-7-02(a)(1). 408 N.C. Gen. Stat. § 55-16-02(a).

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The shareholder may inspect additional corporate if (i) the shareholder’s demand is made in good faith and for a proper purpose; (ii) the shareholder’s demand describes with reasonable particularity his purpose and the records he desires to inspect; (iii) the records are directly connected with his purpose; and (iv) the shareholder gives written notice as previously described.409 If the foregoing requirements are met, a qualified shareholder may inspect any of the following records: (i) records of any final action taken with or without a meeting by the board of directors, or by a committee while acting in place of the board of directors, minutes of any meeting of the shareholders and records of action take by the shareholders and records of action taken by the shareholders without a meeting, to the extent not subject to inspection under NCBCA Section 16-02(a); (ii) accounting records of the corporation; and (iii) the record of shareholders, subject to certain restrictions for public corporations.410

Delaware law does not impose a minimum share ownership or period of ownership condition on the right of a stockholder to inspect the stock ledger and other books and records of a corporation for a proper purpose.411 A proper purpose is defined in Delaware as a purpose reasonably related to the person’s interest as a stockholder.

Both the NCBCA and DGCL afford directors similar inspection rights412 and contemplate judicial remedies for shareholders whose demands are wrongfully disallowed.413

11. Shareholder Liability

Both the NCBCA and DGCL recognize the fundamental tenet that a corporation’s shareholder generally shall have the benefit of limited liability and will not be held liable for the debts of the corporations solely by reason of being a shareholder.414 Notwithstanding this general principle, the law of both states will support, in certain circumstances, the disregarding of the corporate entity.

The NCBCA expressly provides that (unless otherwise provided in the corporation’s charter) a shareholder purchasing shares from the corporation shall have no liability to the corporation or its creditors except to pay the subscription price or unless the shareholder creates such liability by his own acts or conduct.415 North Carolina has adopted the “instrumentality” rule to determine whether the shareholder has created such liability by his own acts or conduct, thus making it appropriate for a court to disregard the corporate entity, or “pierce the corporate veil” of a North Carolina corporation. This rule is not a simple mechanical test and requires proof that the corporation, in order for the corporate entity to be disregarded, is a “mere instrumentality” of another entity or person(s) based on all of the facts and circumstances.

North Carolina’s instrumentality rule requires the presence of three basic elements: (i) the complete domination (regarding finances, corporate policy and practice) of the

409 N.C. Gen. Stat. § 55-16-02(c). 410 N.C. Gen. Stat. § 55-16-02(b). 411 Del. Code Ann. tit. 8, § 220. 412 N.C. Gen. Stat. § 55-16-05; Del. Code Ann. tit. 8, § 220(d). 413 N.C. Gen. Stat. § 55-16-04; Del. Code Ann. tit. 8, § 220(c). 414 N.C. Gen. Stat. § 55-6-22; Del. Code Ann. tit. 8, § 102(b)(6). 415 N.C. Gen. Stat. § 55-6-22.

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corporation by the person(s) or entity exercising control; (ii) the use of such control to perpetuate a fraud or other wrong in violation of the rights of a third party; and (iii) proximate cause between such domination and the injury or loss instigating the claim. In assessing whether the first element is satisfied, courts consider four factors in particular: (i) inadequate capitalization of the corporation; (ii) lack of compliance with or disregard of corporate formalities; (iii) complete control of the corporation such that it lacks its own identity; and (iv) excessive fragmentation of a single business enterprise into separate corporations.416 The foregoing factors are just that—factors to be considered, and though these happen to be the most frequently encountered factors, other factors might be considered as well.417

Though veil-piercing of a North Carolina corporation involves a heavy burden for a complainant, the burden regarding a Delaware corporation is heavier, as very few Delaware cases have allowed this remedy. Traditionally, Delaware courts have required a showing of fraud, as expressed in one recent Delaware case (and one of the very few that support the piercing of the corporate veil of a Delaware corporation): “[T]he evaluation of corporate formalities must be performed in conjunction with consideration of any fraudulent action committed under the guise of the corporate form.”418 (Note that the factors cited in the opinion in support of the finding of fraud were as follows: (i) a lack of proper corporate formalities, (ii) the continuation of the business of the corporation after the corporation had been declared inoperative for failure to pay taxes, (iii) the fact that the defendant had made certain misrepresentations in an earlier, related proceeding, and (iv) the degree of injustice to the complainant if the corporate status were to be respected.)419

12. Shareholder Preemptive Rights

Both North Carolina and Delaware law provide that shareholders of the corporation shall not have preemptive rights to acquire newly issued shares of a corporation unless set forth in the corporation’s charter.420 The NCBCA provides, however, that shareholders of any North Carolina corporation incorporated prior to July 1, 1990 (other than a public company) shall have preemptive rights unless the articles of incorporation provide otherwise.421

Any preemptive rights enjoyed by a shareholder of a North Carolina corporation are subject to the limits set forth in NCBCA Section 6-30(b). Specifically, unless the articles of incorporation otherwise provide, preemptive rights will not extend to: (i) shares issued as compensation to directors, officers, agents or employees, (ii) shares issued upon exercise of options issued to provide compensation to directors, officers, agents or employees, (iii) shares issued within six months of incorporation, or (iv) shares issued for non-monetary consideration

416 See Robinson, II, supra note 290, § 2.10 (discussing, among other things, the leading North Carolina case on veil-piercing, Glenn v. Wagner, 313 N.C. 450, 329 S.E.2d 326 (1985)). 417 Glenn v. Wagner, 313 N.C. at 458, 329 S.E.2d at 322 (cited supra note 416). 418 Midland Interiors, Inc. v. Burleigh, 2006 WL 3783476 (Del.Ch. Dec 19, 2006) (NO. CIV.A. 18544). 419 Id. 420 N.C. Gen. Stat. § 55-6-30; Del. Code Ann. tit. 8, § 102(b)(3). 421 N.C. Gen. Stat. § 55-7-28(e).

http://www.westlaw.com/Find/Default.wl?rs=dfa1.0&vr=2.0&FindType=0&SerialNum=2010973454

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deemed by the corporation’s board to be advantageous to the corporation’s business.422 The DGCL has no counterpart to this provision.

13. Voting Rights in Respect of Debt Securities

Both the NCBCA and the DGCL afford corporations the ability to confer voting rights on holders of debt securities, and generally provide that the charter of the corporation may confer upon the holders of any bonds, debentures or other debt securities issued by the corporation: (i) the power to vote on any matter to the extent provided in the charter; (ii) the right to inspect the corporate books and records; and (iii) any other rights concerning the corporation which its shareholders may have.423 The NCBCA states that “in the determination of votes and voting groups, the holders of such debt obligations shall be treated as shareholders,” while the corresponding section of the DGCL provides that “[i]f the certificate of incorporation so provides, such holders of bonds, debentures or other obligations shall be deemed to be stockholders, and their bonds, debentures or other obligations shall be deemed to be shares of stock, for the purpose of any provision of this chapter which requires the vote of stockholders . . . .”424

G. Business Combinations and Structural Changes (Mergers, Sale of Assets, and

Entity Conversions)

1. Types of Business Combinations

North Carolina and Delaware generally authorize the same types of transactions to effect changes in control of business operations or business structure: mergers in various forms, share exchanges, sales of assets and conversions into different organizational forms.425

The types of transactions and the general requirements for approving and effectuating them are very similar under the North Carolina and Delaware statutes. Both the Delaware and North Carolina statutes allow for similar types of transactions and provide for similar requirements for approving and effectuating the transactions. However, the statutes differ in format.

The North Carolina statute generally devotes separate sections to each aspect of the business change transaction. For example, NCBCA Section 11-01 authorizes mergers and identifies the required contents of a plan of merger, while Section 11-03 outlines the applicable approval requirements for mergers.

422 N.C. Gen. Stat. § 55-6-30(b)(3). 423 N.C. Gen. Stat. § 55-7-21.1; Del. Code Ann. tit. 8, § 221. 424 N.C. Gen. Stat. § 55-7-21.1(1); Del. Code Ann. tit. 8, § 221. See Robinson, II, supra note 290, § 7.08 (at footnote 4), for a discussion of how the North Carolina version of this statute provides a wider range of choice, but requires a greater degree of precision, for drafters of charter provisions in this regard. 425 Delaware recognizes a “consolidation” where two or more existing corporations are merged into an entity formed, as part of the transaction, to be the surviving corporation. See, e.g., Del. Code Ann. tit. 8, § 252(a). North Carolina eliminated this form in 1990 because it was considered obsolete and rarely used. North Carolina Commentary to N.C. Gen. Stat. § 55-11-01. For all practical purposes, the remainder of the discussion of mergers in this section of the study includes consolidations with respect to Delaware law.

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On the other hand, in the DGCL, one section contains the basic structural and procedural requirements for a particular type of transaction. For example, Section 251 of the DGCL sets forth all requirements (plan contents, shareholder approval, filing, etc.) for a merger of two domestic corporations, while Section 252 sets forth the same requirements for a domestic and foreign corporation merger.

2. Summary of Available Transaction Structures

Both North Carolina and Delaware permit the following methods to transfer control of a business or change the business’s structure:

(a) Merger between domestic corporations;

(b) Merger between domestic and foreign corporations;

(c) Merger between different types of entities (e.g. corporation merging with LLC or partnership) (the so-called “cross-entity” or “interspecies” merger);

(d) Merger of controlled subsidiary into parent, and vice versa (the so-called “short form” merger);

(e) 20% dilution mergers;

(f) Sale of all or substantially all assets; and

(g) Conversion from one form (e.g. LLC) to another (e.g. corporation).

Additionally, North Carolina allows for share exchanges,426 and Delaware also allows domestic corporations to consolidate into a new corporation.427

Mergers are discussed in more detail in Sections III.G.3., 4., 5. and 6. of this study. Asset sales are discussed in Section III.G.7., and conversions are discussed in Section III.G.8.

Generally, this study does not discuss the laws governing nonprofit corporations and entities. Both the DGCL and the NCBCA permit mergers between for-profit and nonprofit corporations and allow mergers between business corporations and unincorporated entities. This section will merely mention these provisions at the appropriate places in this summary of the various forms of combinations.

The two statutes use somewhat different terminology to authorize similar combinations involving nonprofit entities. The DGCL allows mergers between business corporations and “joint-stock” or unincorporated associations, thereby authorizing mergers of

426 N.C. Gen. Stat. § 55-11-02. 427 Del. Code Ann. tit. 8, §§ 251, 252. See North Carolina Commentary to N.C. Gen. Stat. § 55-11-01 (regarding the inapplicability of the concept of consolidation under North Carolina law).

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business corporations with unincorporated nonprofit organizations if the business corporation is the surviving entity.428 The NCBCA does not clearly authorize a merger with an unincorporated nonprofit organization.429

The other terminology difference arises because the Delaware statute allows mergers or consolidations of business corporations with “nonstock” corporations. Such nonstock corporations would include nonprofit corporations with members rather than stockholders.430 These mergers have been authorized in North Carolina since 1995, but the North Carolina statute refers directly to mergers between business corporations and nonprofit corporations.431

3. Specific Transaction Types

The remaining portions of this Section III.G. of the study set forth in more detail the specific types of transactions authorized, the applicable voting and approval requirements, a discussion of dissenters’ rights and the exclusivity of the appraisal remedy and the effects of such transactions on the constituent entities. Entity conversions (including a discussion of the voting and approval requirements) are addressed separately in Section III.G.8. below.

a) Mergers between Domestic Corporations

There is little to no difference between the types of mergers permitted in Delaware and North Carolina between domestic corporations. In both states, either corporation involved in the merger (a “constituent corporation”) may survive or disappear following the merger, provided the corporation obtains the appropriate voting approval and makes the required filings. Section 11-01 of the NCBCA governs mergers between North Carolina domestic corporations, while Section 251 of the DGCL governs domestic mergers in Delaware. Delaware still permits “consolidations,” whereby the merger partners disappear into a newly formed consolidated corporation.432

428 Del. Code Ann. tit. 8, §§ 254(a) and (b). That section defines a “joint-stock association” quite broadly as including “any association of the kind commonly known as a joint-stock association or joint-stock company and any unincorporated association, trust or enterprise having members or having outstanding shares of stock or other evidences of financial or beneficial interest therein, whether formed by agreement or under statutory authority or otherwise, but does not include a corporation, partnership or limited liability company.” Combinations with partnerships and LLCs are covered by different Delaware sections: Del. Code Ann. tit. 8, §§ 263 and 264. 429 NCBCA Section 11-09 authorizes the merger of a North Carolina business corporation with a foreign or domestic nonprofit corporation. NCBCA Section 11-10 authorizes merger with an “unincorporated entity.” However, the definition of an unincorporated entity includes only “a domestic or foreign limited liability company, a domestic or foreign limited partnership, a registered limited liability partnership or foreign limited liability partnership as defined in G.S. 59-32, or any other partnership as defined in G.S. 59-36.” Unincorporated nonprofit organizations generally will not fit within these forms, thereby leaving one with the implication that, unlike Delaware, North Carolina law will not permit mergers between its business corporations and unincorporated nonprofits. 430 Del. Code Ann. tit. 8, § 255. Note that the concept of the nonstock corporation is not limited to nonprofits. However, nonstock for-profit entities are rare. In addition, Delaware has two other code sections authorizing mergers between Delaware nonstock-nonprofit corporations and similar corporations organized in other jurisdictions. Del. Code Ann. tit. 8, § 256. It also specifically authorizes mergers between Delaware nonstock corporations and stock corporations, either for-profit or nonprofit. Del. Code Ann. tit. 8, § 257. 431 N.C. Gen. Stat. § 55-11-08. 432 See Del. Code Ann. tit. 8, § 251(a).

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The two statutes permit both forward and reverse triangular mergers, thus allowing the parties to a transaction to achieve certain tax objectives.433 In triangular mergers, a target company merges with a subsidiary of the acquiror in exchange for shares of the parent-acquiror’s stock (and perhaps other consideration). A “forward” merger results in merger of the target into a newly-formed subsidiary of the acquiror. A “reverse” merger results in the newly-formed acquisition subsidiary being merged into the target, with the target’s shareholders exchanging their shares for stock in the acquiror. Subject to tax law restrictions (which are beyond the scope of this study), both states permit various forms of consideration to be paid to the target’s shareholders, such as cash or debt obligations of the new subsidiary or the acquiring parent as well as the acquiror’s stock.

b) Mergers between Domestic and Foreign Corporations

North Carolina and Delaware both permit their domestic corporations to merge with foreign corporations.434 However, only the North Carolina statute permits mergers with non-U.S. corporations. The Delaware statute specifically limits mergers of Delaware corporations with those of “any other state or states of the United States, or of the District of Columbia.”435

Under both Delaware and North Carolina law, the foreign corporation’s governing law must permit the foreign corporation to merge with a corporation foreign to its jurisdiction.436 Thus, North Carolina and Delaware corporations may merge with each other since the two statutes include the necessary authority. However, if a North Carolina or Delaware corporation desires a merger with a corporation organized under the laws of a jurisdiction that does not permit foreign mergers, neither North Carolina nor Delaware would permit such a merger.

The two states also require any surviving foreign corporation to subject itself to local jurisdiction and appoint the applicable North Carolina or Delaware secretary of state as its agent for service of process.437 Other than these factors, the rules for the merger of a North Carolina or Delaware corporation with one from another jurisdiction are substantially the same as for mergers between domestic corporations.

c) Cross-entity or “Interspecies” Mergers

Both the Delaware and North Carolina statutes permit cross-entity mergers, including foreign corporations, professional and nonprofit corporations and limited partnerships, in any possible combination and with any party to the transaction being the surviving entity.

433 See, e.g., Internal Revenue Code § 368(a)(2)(D). 434 N.C. Gen. Stat. § 55-11-07; Del. Code Ann. tit. 8, § 252. 435 Del. Code Ann. tit. 8, § 252(a). 436 N.C. Gen. Stat. § 55-11-07(a)(1); Del. Code Ann. tit. 8, § 252(a). 437 N.C. Gen. Stat. § 55-11-06(a)(7)(c); Del. Code Ann. tit. 8, § 252(d).

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(1) Merger With Unincorporated Entity438

(a) North Carolina

The procedure for a North Carolina corporation participating in a cross-entity merger is essentially the same as for a traditional merger between corporations. Under the cross-entity merger provision, a North Carolina corporation may merge with an unincorporated entity if:

(1) The merger is permitted by the laws of the state or county governing the organization and internal affairs of each other merging business entity;

(2) the board of directors recommend the plan of merger to the shareholders (unless, due to a conflict of interest, the board of directors determines it should make no recommendation, in which event the board must communicate the basis for its lack of recommendation);

(3) The merging corporation holds a shareholders’ meeting, stating in the notice to the shareholders that the purpose, or one of the purposes, of the meeting is to consider the plan of merger;

(4) the plan of merger is approved by (i) a majority vote of all shareholders entitled to vote (unless the articles of incorporation, bylaws of the corporation or proposed plan of merger require a greater vote or a separate vote by voting groups, in which case the cross-entity merger is authorized by the required vote) or as otherwise specified by statute (as in the case of a short form merger) and (ii) by any shareholder of the merging corporation that has or will have personal liability for any existing or future obligation of the resulting business entity; and

(5) the plan of merger contains, inter alia, (i) each merging business entity’s name, type of business entity, and state or country whose laws govern its organization, (ii) the name of the surviving business entity, (iii) the terms and conditions of the merger, (iv) the manner and basis for converting the

438 The term “unincorporated entity” is defined in North Carolina to mean domestic and foreign limited liability companies and domestic and foreign general partnerships and limited partnerships (including domestic and foreign limited liability partnerships) or any other partnership, whether or not formed under North Carolina law. N.C. Gen. Stat. § 55-1-40(24a).

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interests of each merging business entity, and (v) if the surviving business entity is a North Carolina corporation, any amendments to its articles of incorporation that are to be made in connection with the merger.439

Merging business entities that are not corporations must approve the plan of merger in accordance with the applicable laws governing the organization and internal affairs of that entity. North Carolina limited liability companies and partnerships must approve the plan of merger by the unanimous consent of the members or the partners, respectively, unless the articles of organization or written operating agreement of the limited liability company, or a written partnership agreement binding on all partners of the partnership, specifically prescribes some other manner of approval of a merger with the type of business entity contemplated in the plan of merger.440 In the event that the appropriate governing document does not provide for less than unanimous approval of a merger, it may be amended prior to approval of the plan of merger.

After a plan of merger has been approved by each merging North Carolina business entity and each other merging business entity, the surviving business entity shall deliver articles of merger to the secretary of state for filing. Such articles of merger are substantially the same as for a regular merger involving only corporations. If the non-surviving entity is a foreign corporation or other business entity registered to do business in North Carolina, the non-surviving entity must apply with the secretary of state for a certificate of withdrawal. In the event that the surviving business entity is not a North Carolina limited liability company or limited partnership, the surviving business entity will be deemed to agree to appoint the secretary of state as its agent for service of process for enforcement of any obligation of the merging domestic corporation, rights of dissenting shareholders or any obligation of the surviving business entity arising from the merger.441

Cross-entity mergers do not affect the liability or absence of liability of the interest holders in any merging entity. Thus, where a North Carolina limited liability business entity (corporation, limited liability company or limited partnership) merges into a general partnership, the owners of the limited liability entity will maintain their limited liability status with respect to all liabilities and obligations of the limited liability entity arising prior to the effective date of the merger and will become liable (to the extent that their ownership interests are converted in to general partnership interests) as general partners of obligations and liabilities arising after the effective date of the merger.442

(b) Delaware

In Delaware, Sections 251-264 of the DGCL address mergers of corporations with other business entities. The Delaware statutes specifically address

439 N.C. Gen. Stat. § 55-11-10. 440 N.C. Gen. Stat. §§ 57C-9A-21(b), 59-73.31(b), and 59-1071(b). 441 See generally N.C. Gen. Stat. § 55-11-10. 442 Id.

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mergers with joint stock and other associations, and with limited liability companies and partnerships.

Merger with Joint-Stock or Other Association. Section 254 of DGCL provides for mergers between corporations and “joint-stock associations.” The term includes “any association of the kind commonly known as a joint-stock association or joint-stock company and any unincorporated association, trust or enterprise having members or having outstanding shares of stock or other evidence of financial or beneficial interest therein, whether formed by agreement or under statutory authority or otherwise, but does not include a corporation, partnership or limited liability company.”443 Mergers with joint-stock associations must be permitted by the laws under which the joint-stock association was formed and approved in accordance with their articles of association or other instrument containing the provisions by which they are organized or regulated.444 The resulting entity may be organized either as a corporation or as a joint-stock association.

The North Carolina statute has no counterpart to the Delaware statute addressing joint stock associations, which is the primary difference between the North Carolina and Delaware statutes regarding cross-entity mergers.

Merger with Partnership or Limited Liability

Company. DGCL Sections 263 and 264 provide for mergers between corporations and partnerships (including both general and limited) and limited liability companies, respectively. The statutes are substantially similar to the North Carolina statute in most respects; the DGCL, however, explicitly provides that each stockholder of a merging corporation who will become a general partner of the surviving or resulting partnership must approve the agreement of merger.445

d) Parent-Subsidiary Mergers

North Carolina and Delaware both authorize mergers between a corporation and its 90%-owned subsidiary with less restrictive approval requirements than what applies for traditional mergers. These are referred to as “short-form” mergers. North Carolina and Delaware apply the same basic requirements. If the parent owns 90% of each class of the subsidiary’s shares before the merger, either the parent or the subsidiary may survive the merger.446 If the parent company meets this test, neither the shareholders of the parent nor the board nor shareholders of the subsidiary need to approve the merger if the subsidiary merges into the parent. If the parent company merges into the subsidiary, the parent company must first obtain shareholder approval but the subsidiary’s shareholders and board do not need to approve the merger. Either corporation may limit this freedom by imposing specific merger requirements or limitations in the corporation’s articles of incorporation.

443 Del. Code Ann. tit. 8, § 254(a). 444 Del. Code Ann. tit. 8, § 254(d). 445 Del. Code Ann. tit. 8, § 263(c). 446 N.C. Gen. Stat. § 55-11-04; Del. Code Ann. tit. 8, § 253.

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e) Delaware Provision for Effecting Holding Company

Reorganization

DGCL Section 251(g) specifically gives a Delaware corporation the power to reorganize into a holding company without obtaining approval of the corporation’s shareholders. This section permits the formation of a new holding company, accompanied by merger of the existing corporation into a subsidiary of the holding company. Publicly held companies can use this statutory power to avoid the time and expense required to obtain shareholder approval.

The NCBCA does not provide any specific authorization similar to the Delaware statute. Accordingly, such a transaction would require the approval of the existing corporation’s shareholders under the general North Carolina merger or share exchange provisions.

The requirements associated with avoiding shareholder approval focus on preserving the status quo for the ownership and management structure of the existing corporation. For example, the holding company’s certificate of incorporation and bylaws must provide stockholders with the same rights they had under the existing company’s certificate, with certain limited exceptions. As another example, the board of directors of the holding company after the transaction must retain the same members as before the transaction.

f) 20% Dilution Mergers

North Carolina and Delaware also authorize mergers without approval of the surviving corporation’s shareholders if, in essence, those shareholders will be diluted by less than 20% through issuance of shares to parties in connection with the merger.447 Generally, this exception is based on the theory that a dilution of less than 20% constitutes a business decision of management and not a fundamental structural change of the corporation.

Both states use two similar qualifications for dispensing with the shareholder vote: (i) the articles or certificate of incorporation of the new holding company must contain the same terms as the pre-merger corporation; and (ii) the holding company must issue the same shares, with all the same rights, preferences, and privileges, as were outstanding in the pre merger corporation prior to the merger.448

The NCBCA and DGCL do not operate identically in this regard. The NCBCA uses a more complex formula than the DGCL to calculate the 20% dilution. Delaware calculates the percentage based solely on the number of shares of common stock. North Carolina, on the other hand, applies a two-part test. The 20% limit applies to both “voting” and “participating” shares.449 Voting shares provide an unconditional right to elect directors. Therefore, to measure the voting prong of the 20% test, the calculation would need to count common shareholders and holders of preferred stock granted unconditional voting rights. Participating shares provide an unlimited right to participate in dividends and liquidating

447 N.C. Gen. Stat. § 55-11-03(g); Del. Code Ann. tit. 8, § 251(f). 448 N.C. Gen. Stat. §§ 55-11-03(g)(1) and (2); Del. Code Ann. tit. 8, §§ 251(f)(1) & (2). 449 N.C. Gen. Stat. §§ 55-11-03(g)(3) and (4) and §§ 55-11-03 (h)(1) & (2).

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distributions. Generally, this would only include common shares, but if the company has issued participating preferred shares, one should review the preferred share rights before performing the calculation.

Note that, in both states, the calculation of the number of shares to be issued in the merger is made on a fully-diluted basis. The calculation of the number of shares resulting from the merger must include shares issuable on the exercise of options or conversion rights under instruments issued pursuant to the merger.

g) Share Exchanges

The NCBCA authorizes the compulsory acquisition of all shares of a corporation if sufficient shareholders of the target corporation vote to approve the exchange.450 Once properly approved, and subject to statutory dissenters’ rights discussed later in this study,451 the acquiror may compel shareholders of the target corporation to surrender their shares in exchange for consideration (usually, but not always, the acquiror’s shares) from the acquiror. If the majority of the shares of the acquired class vote to accept the exchange, a company generally may acquire all shares of the target.452 After the acquisition, the target company becomes a subsidiary of the acquiror.

On the other hand, the DGCL does not have an equivalent provision. If a majority of stockholders agree to sell their shares, Delaware law provides no procedure to force the minority stockholders to sell their shares, unless the corporations combine by means of a statutory merger or other permissible form of business combination.453

h) Sale of All or Substantially All Assets

Both Delaware and North Carolina permit sales of all or substantially all of a corporation’s assets outside the ordinary course of business if the board recommends such transaction and if the applicable shareholder approval is obtained. Such transactions (including general procedures and approval and voting requirements) are discussed in Section III.G.7. of this study.

i) Entity Conversions

Entity conversions (including general procedures and approval and voting requirements) are discussed in Section III.G.8. of this study.

450 N.C. Gen. Stat. §§ 55-11-02 and 55-11-03. 451 For a discussion of dissenters’ rights, see Section III.G. 9 of this study. 452 See Section III.G.5. of this study for a more detailed discussion of the voting requirement and other procedural requirements for execution of a share exchange. 453 Note, however, DGCL Section 203, which places restrictions on business combinations with “interested stockholders.”

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4. General Procedures Regarding Mergers and Share Exchanges

a) Actions by Board or Governing Body

The NCBCA and the DGCL require the board of directors of a domestic corporation to approve, in the case of a North Carolina corporation, a plan of merger or share exchange, and in the case of a Delaware corporation, an agreement of merger or consolidation.454 While the mechanics of board approval are similar for domestic corporations, North Carolina and Delaware law diverge with regard to foreign corporations and unincorporated entities.

(1) Board Action by Domestic Corporations

Before a merger or share exchange may take place under North Carolina law, the board of directors of each corporation that is party to the merger or the share exchange must adopt, and the shareholders must approve (if required by NCBCA Section 11-03455), a plan of merger or share exchange, as applicable.456

After adopting a plan of merger or share exchange under North Carolina law, both corporations’ boards of directors must submit the plan of merger or share exchange for approval by the corporations’ shareholders.457 For approval of a plan of merger or share exchange, the board of directors must recommend the plan to the shareholders unless it determines that, because of a conflict of interest or other special circumstance, it should make no recommendation, in which case the board of directors must explain to the shareholders its reason for a lack of recommendation.458 The board of directors may condition its submission of the proposed merger or share exchange on any basis.459

Delaware law similarly requires the board of directors of a corporation to approve a merger or consolidation. For mergers or consolidations between two or more domestic corporations, the board of directors of each corporation must adopt a resolution approving an agreement of merger or consolidation and declaring its advisability.460

(2) Board Action for Foreign Corporation461

For foreign corporations, the North Carolina statute does not require any specific board of director action.462 Instead, the NCBCA requires that the foreign

454 See N.C. Gen. Stat. §§ 55-11-01(a) and 55-11-02(a); Del. Code Ann. tit. 8, § 251(a). 455 Generally, NCBCA Section 11-03 requires shareholders to approve a plan of merger. In addition, see Section III.G.5. of this study. 456 N.C. Gen. Stat. §§ 55-11-01(a) and 55-11-02(a). 457 N.C. Gen. Stat. § 55-11-03(a). Unless the articles of incorporation provide otherwise, approval by the surviving corporation’s shareholders of a plan of merger is not required if certain conditions are met. N.C. Gen. Stat. § 11-03(g). In addition, see Section III.G.5. of this study. 458 N.C. Gen. Stat. § 55-11-03(b). 459 N.C. Gen. Stat. § 55-11-03(c). 460 Del. Code Ann. tit. 8, § 251(b). 461 In addition to mergers with foreign corporations, both the North Carolina and Delaware statutes set forth requirements for mergers with non-corporate entities such as partnerships and limited liability companies. See, e.g., Del. Code Ann. tit. 8, § 263 (partnerships); Del. Code Ann. tit. 8, § 264 (limited liability companies); and N.C. Gen. Stat. § 55-11-10 (unincorporated entities).

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corporation comply with the law under which it was formed and with the filing requirements set forth in NCBCA Section 11-05463 if it is the surviving corporation of the merger or acquiring corporation of the share exchange.464 In a share exchange, if the foreign corporation’s shares are acquired, then that corporation and the acquiring domestic corporation, in effecting the share exchange, must comply with the law of the country or state under whose law the foreign corporation was incorporated.465

The DGCL simply requires the adoption, approval, certification and acknowledgment of the agreement of merger or consolidation by each foreign corporation in accordance with the laws under which it was formed.466

(3) Board Action for Parent Corporation in Parent-Subsidiary Merger

Section 11-04 of the NCBCA (by reference in subparagraph (a) to Section 11-01) requires that the board of directors of the parent corporation adopt a plan of merger setting forth the names of the corporations planning to merge, the terms and conditions of the merger and the manner and basis of converting the shares of the subsidiary stock into the consideration to be exchanged therefor.467 However, the statute expressly authorizes the merger without the approval of the board of directors of the subsidiary if the parent corporation owns at least 90% of the outstanding shares of each class of a subsidiary corporation, provided the articles of incorporation of the subsidiary do not provide otherwise and the plan of merger contains no amendment to the articles of incorporation of the subsidiary for which shareholder approval is required.468

For mergers between a parent and its subsidiary, Delaware permits the parent corporation to merge by executing, acknowledging and filing, in accordance with DGCL Section 103, a certificate of its ownership of the subsidiary and merger setting forth a copy of the resolution of its board of directors to so merge and the date of the adoption.469 However, if the parent is not the sole owner of the subsidiary, Delaware requires a much more detailed board resolution. In such a case, the resolution of the board of directors of the parent corporation must state the terms and conditions of the merger, including the securities, cash, property or rights to be issued, paid, delivered or granted by the surviving corporation upon surrender of each share of the subsidiary corporation or corporations not owned by the parent corporation, or the cancellation of some or all of such shares.470 Facts ascertainable outside of such resolution may alter the terms of the resolution, provided that the manner in which such

462 See N.C. Gen. Stat. § 55-11-07(a). 463 NCBCA Section 11-05 sets forth the contents of and filing requirements for the articles of merger or share exchange. In addition, see Section III.G.4.c) of this study. 464 N.C. Gen. Stat. § 55-11-07(a). 465 N.C. Gen. Stat. § 55-11-07(a)(2). 466 Del. Code Ann. tit. 8, § 252(c). 467 For a discussion of the requirements for the plan of merger, see Section III.G.4.b) below. 468 N.C. Gen. Stat. § 55-11-04(a). 469 Del. Code Ann. tit. 8, § 253(a). 470 Id.

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facts shall operate upon the terms of the resolution is clearly and expressly set forth in the resolution.471

If the parent corporation does not survive, Delaware requires the resolution of the board of directors to include provision for the pro rata issuance of stock of the surviving corporation to the holders of the stock of the parent corporation on surrender of any certificates.472

b) Contents of Plan

North Carolina distinguishes between mergers and share exchanges. As a result, the NCBCA separately sets forth requirements for both plans of merger and plans of exchange. The required contents of plans of merger and share exchange are almost identical, except for the mechanics of the transaction.

(1) North Carolina Plan of Merger

Under the NCBCA, a plan of merger must set forth:

(a) The name of each corporation planning to merge and the name of the surviving corporation into which each other corporation plans to merge;

(b) The terms and conditions of the merger; and

(c) the manner and basis of converting the shares of each corporation into shares, obligations, or other securities of the surviving or any other corporation or into cash or other property in whole or part.473

In addition, a plan of merger may set forth any amendments to the articles of incorporation of the surviving corporation and other provisions relating to the merger.474

Other than provisions relating to names of the merging and surviving corporations and any amendments to the surviving corporation’s articles of incorporation, the provisions of the plan of merger may be made dependent on facts objectively ascertainable outside the plan of merger if the plan of merger sets forth the manner in which the facts will operate upon the affected provisions.475 The facts may include any of the following: (i) statistical or market indices, market prices of any security or group of securities, interest rates, currency exchange rates, or similar economic or financial data; (ii) a determination or action by

471 Id. The term “facts” as used in DGCL Section 253(a) includes, but is not limited to, the occurrence of any event, including a determination or action by any person or body, including the corporation. 472 Id. 473 N.C. Gen. Stat. § 55-11-01(b). 474 N.C. Gen. Stat. § 55-11-01(c). 475 N.C. Gen. Stat. § 55-11-01(d).

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the corporation or by any other person, group, or body; or (iii) the terms of, or actions taken under, an agreement to which the corporation is a party, or any other agreement or document.476

(2) North Carolina Plan of Exchange

North Carolina requires a plan of exchange to set forth: (i) the name of the corporation whose shares will be acquired and the name of the acquiring corporation; (ii) the terms and conditions of the exchange; and (iii) the manner and basis of exchanging the shares to be acquired for shares, obligations or other securities of the acquiring or any other corporation or for cash or other property in whole or part.477

Like a plan of merger, a plan of exchange may set forth additional provisions relating to the exchange.478 In addition, the provisions of the plan of share exchange, other than the provision naming the corporation whose shares will be acquired and the acquiring corporation, may be made dependent on facts objectively ascertainable outside the plan of share exchange if the plan sets forth the manner in which the facts will operate upon the affected provisions.479 These facts may include the same information as described above with respect to facts ascertainable outside a plan of merger.480

(3) Delaware Agreement of Merger or Consolidation

Delaware requires an agreement of merger or consolidation to include the following:

(a) the terms and conditions of the merger or consolidation;

(b) the mode of carrying the merger or consolidation into effect;

(c) in the case of a merger, such amendments or changes in the certificate of incorporation of the surviving corporation as are desired to be effected by the merger, or, if no such amendments or changes are desired, a statement that the certificate of incorporation of the surviving corporation shall be its certificate of incorporation;

(d) in the case of a consolidation, that the certificate of incorporation of the resulting corporation shall be as is set forth in an attachment to the agreement;

(e) the manner, if any, of converting the shares of each of the constituent corporations into shares or other securities of

476 Id. 477 N.C. Gen. Stat. § 55-11-02(b). 478 N.C. Gen. Stat. § 55-11-02(c). 479 N.C. Gen. Stat. § 55-11-02(c1). 480 N.C. Gen. Stat. § 55-11-02(c1). For the analogous discussion relating to plans of merger, see supra notes 473–476 and accompanying text.

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the corporation surviving or resulting from the merger or consolidation, or of cancelling some or all of such shares, and, if any shares of any of the constituent corporations are not to remain outstanding, to be converted solely into shares or other securities of the surviving or resulting corporation or to be cancelled, the cash, property, rights or securities of any other corporation or entity which the holders of such shares are to receive in exchange for, or upon conversion of such shares and the surrender of any certificates evidencing them, which cash, property, rights or securities of any other corporation or entity may be in addition to or in lieu of shares or other securities of the surviving or resulting corporation; and

(f) such other details or provisions as are deemed desirable, including, without limiting the generality of the foregoing, a provision for the payment of cash in lieu of the issuance or recognition of fractional shares, interests or rights, or for any other arrangement with respect thereto, consistent with DGCL Section 155.481

As with North Carolina plans of merger, a Delaware agreement of merger may be made dependent upon facts ascertainable outside of the agreement, provided that the manner in which the facts will operate upon the terms of the agreement is clearly and expressly set forth in the agreement.482

c) Filing Requirements

Rather than require the full plan or agreement of merger be filed with the state, both North Carolina and Delaware permit corporations to file an abbreviated articles of merger (North Carolina) or certificate of merger (Delaware).

(1) North Carolina Filing Requirement

After a plan of merger or a plan of share exchange for the acquisition of shares of a domestic corporation has been authorized, the surviving or acquiring corporation must file with the secretary of state articles of merger or share exchange.483 The articles of merger must include:

481 Del. Code Ann. tit. 8, § 251(b). As indicated below, the parties may file an abbreviated certificate of merger pursuant to DGCL Section 251(c). See infra text supported by note 488. 482 Del. Code Ann. tit. 8, § 251(b). The term “facts” includes, but is not limited to, the occurrence of any event, including a determination or action by any person or body, including the corporation. Del. Code Ann. tit. 8, § 251(b). 483 N.C. Gen. Stat. § 55-11-05(a). NCBCA Section 11-05(c) also requires a certificate of merger to be registered as provided in North Carolina General Statutes Section 47-18 (requiring registration of certificates of corporate merger, share exchange, or conversion with the applicable real estate registry).

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(a) the name and state or country of incorporation of each merging corporation;

(b) the name of the merging corporation that will survive the merger and, if the surviving corporation is not authorized to transact business or conduct affairs in North Carolina, a designation of its mailing address and a commitment to file with the secretary of state a statement of any subsequent change in its mailing address;

(c) any amendments to the articles of incorporation of the surviving corporation provided in the plan of merger if the surviving corporation is a domestic corporation; and

(d) a statement that the plan of merger has been approved by each merging corporation in the manner required by law. 484

The articles of share exchange closely mirror articles of merger. Articles of share exchange must set forth:

(a) the name of the corporation whose shares will be acquired;

(b) the name and state or country of incorporation of the acquiring corporation;

(c) a designation of its mailing address and a commitment to file with the secretary of state a statement of any subsequent change in its mailing address if the acquiring corporation is not authorized to transact business or conduct affairs in this State; and

(d) a statement that the plan of share exchange has been approved by the corporation whose shares will be acquired and by the acquiring corporation in the manner required by law. 485

(2) Delaware Filing Requirements

Delaware permits corporations to file either the agreement of merger or consolidation or an abbreviated certificate of merger or consolidation summarizing the transaction.486 If the agreement is filed, it must be done so in accordance with DGCL Section 103.487 Alternatively, the surviving or resulting corporation may file a certificate of merger or consolidation, executed in accordance with Section 103. The certificate must state the following:

484 N.C. Gen. Stat. § 55-11-05(a). 485 Id. 486 Del. Code Ann. tit. 8, § 251(c). 487 Id. Filing requirements under DGCL Section 103 are discussed in Section III.A.1. of this study.

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(a) the name and state of incorporation of each of the constituent corporations;

(b) that an agreement of merger or consolidation has been approved, adopted, executed and acknowledged by each of the constituent corporations in accordance with DGCL Section 251;

(c) the name of the surviving or resulting corporation;

(d) in the case of a merger, such amendments or changes in the certificate of incorporation of the surviving corporation as are desired to be effected by the merger, or, if no such amendments or changes are desired, a statement that the certificate of incorporation of the surviving corporation shall be its certificate of incorporation;

(e) in the case of a consolidation, that the certificate of incorporation of the resulting corporation shall be as set forth in an attachment to the certificate;

(f) that the executed agreement of consolidation or merger is on file at an office of the surviving corporation, stating the address of the office; and

(g) that a copy of the agreement of consolidation or merger will be furnished by the surviving corporation, on request and without cost, to any stockholder of any constituent corporation. 488

d) Effectiveness of Merger

(1) North Carolina

Under the NCBCA, a merger or share exchange becomes effective when the articles of merger or share exchange become effective.489 The corporation may amend the articles of merger or share exchange after the articles have been filed with the secretary of state but before the merger becomes effective.490

If the plan of merger or share exchange is amended after the articles of merger or share exchange have been filed with the state but before the articles of

488 Del. Code Ann. tit. 8, § 251(c). DGCL Section 252 has a similar requirement for mergers between domestic and foreign corporations. However, if the surviving corporation is domestic, the certificate of merger must include the authorized capital stock of each constituent corporation that is not a domestic corporation. If the surviving corporation is foreign, the certificate must contain an agreement regarding service of process in Delaware. See Del. Code Ann. tit. 8, § 252(c) and (d). 489 N.C. Gen. Stat. § 55-11-05(b). 490 N.C. Gen. Stat. § 55-11-05(a1).

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merger or share exchange become effective and any statement in the articles of merger or share exchange becomes incorrect as a result of the amendment, the surviving or acquiring corporation must deliver to the secretary of state for filing prior to the time the articles of merger or share exchange become effective an amendment to the articles of merger or share exchange correcting the incorrect statement.491

If the articles of merger or share exchange are abandoned after the articles of merger or share exchange are filed but before the articles of merger or share exchange become effective, the surviving or acquiring corporation must file with the secretary of state prior to the time the articles of merger or share exchange become effective an amendment reflecting abandonment of the plan of merger or share exchange.492

(2) Delaware

Under the DGCL, an agreement of merger or consolidation, or, alternatively, a certificate of merger or consolidation becomes effective upon its filing date. However, any such agreement or certificate may provide that the agreement does not become effective until a specified time (no later than 90 days after filing) subsequent to the filing date. If the agreement or certificate provides for a future effective date or time and if the transaction is terminated or its terms are amended to change the future effective date or time prior to the future effective date or time, the certificate or agreement will be terminated or amended by filing, prior to the future effective date or time, a certificate of termination or amendment of the original instrument, executed in accordance with DGCL Section 103.493

Delaware law allows any agreement of merger or consolidation to contain a provision that at any time prior to the effective date, the boards of directors of any constituent corporations may amend or terminate the agreement. However, no amendment may (i) alter or change the amount or kind of shares, securities, cash, property or rights to be received in exchange for or on conversion of all or any of the shares of any class or series thereof of such constituent corporation; (ii) alter or change any term of the certificate of incorporation of the surviving corporation to be effected by the merger or consolidation; or (iii) alter or change any of the terms and conditions of the agreement if such alteration or change would adversely affect the holders of any class or series thereof of such constituent corporation. If the agreement of merger or consolidation is amended after it is filed with the secretary of state but before the agreement has become effective, DGCL Section 103 requires a filing of a certificate of merger or consolidation.494

491 Id. 492 Id. 493 Del. Code Ann. tit. 8, § 103(d). 494 Del. Code Ann. tit. 8, § 251(d). DGCL Section 252(d) applies to mergers between domestic and foreign corporations.

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5. Approval/Vote Requirements Regarding Mergers and Share Exchanges

a) North Carolina

(1) Board and Shareholder Approval of the Plan of Merger

In North Carolina, the board of directors of each corporation involved in a merger transaction must adopt a “plan of merger” setting forth certain basic information regarding the transaction as described in Section III.G.4.b) of this study.

Whether or not the shareholders of the merging corporations are required to approve the plan of merger is determined by NCBCA Section 11-03. If a shareholder vote is required, the board must recommend the plan to the shareholders, unless it determines that such a recommendation should not be made due to a conflict of interest or other circumstance. If the board does not recommend the plan of merger to the shareholders, it must explain the reasons why a recommendation was not made.495

Unless provided otherwise in the articles of incorporation, if the following four conditions are present, the shareholders of the surviving corporation are not required to approve the plan of merger:496

(a) The surviving corporation’s articles of incorporation will not be changed, with the exception of certain amendments that may be adopted by the board without shareholder approval pursuant to NCBCA Section 10-02.497

(b) Each shareholder who was a shareholder before the effective date of the transaction will hold the same shares, with identical preferences, limitations, and relative rights, after the transaction.

(c) The number of voting shares498 outstanding after the merger plus the number of shares issuable as a result of the merger will not exceed by more than twenty percent of the number of voting shares of the surviving corporation outstanding prior to the merger.

495 N.C. Gen. Stat. § 55-11-03(b)(1). 496 N.C. Gen. Stat. § 55-11-03(g)(1) – (4). 497 Under the NCBCA, the board of directors may amend the articles of incorporation without the approval of the shareholders (i) to delete the names and addresses of directors or of the initial registered agent or registered office (if a statement of change is on file with the secretary of state); (ii) to effect increases or reductions in the number of authorized shares for certain limited purposes; (iii) to change the corporate name by substituting one common suffix (such as “company” or “limited”) for a similar suffix or abbreviation; (iv) to delete a class of shares as a consequence of NCBCA Section 6-31(b) (when there are no remaining shares of such class outstanding and the charter precludes the reissuance of acquired shares); and (v) to make any other change permitted by the NCBCA to be made without shareholder approval. NCBCA Section 10-02. 498 A “voting share” entitles the holder to vote unconditionally in the election of directors. N.C. Gen. Stat. § 55-11-03(h)(2).

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(d) The number of “participating shares”499 cannot increase by more than twenty percent as a result of the transaction.

If all four conditions are not met, then the shareholders of both the surviving and the disappearing corporations must vote to approve the plan of merger. In general, the plan of merger must be approved by a majority of all votes entitled to be cast, although the articles of incorporation, a bylaw adopted by the shareholders or the board of directors (acting pursuant to NCBCA Section 11-03(c)) may impose a greater vote requirement.500

If a shareholder of one of the merging corporations has or will have personal liability for an existing or future obligation of the surviving corporation solely as a result of owning one or more shares in the surviving corporation, then that shareholder must either vote in favor of the transaction or consent to the transaction in writing.501

(2) Separate Voting by Voting Groups

Under the NCBCA, a “voting group” consists of all the shares of one or more classes or series that are entitled to vote and be counted together on a matter under a corporation’s articles of incorporation or the NCBCA.502 Section III.F.7. of this study addresses voting by voting groups in more detail, but to summarize, under NCBCA Section 10-04, voting groups are entitled to vote separately on certain amendments to the articles of incorporation, including amendments that would increase or decrease the number of authorized shares of the class or that would effect an exchange or reclassification of all or part of the shares of the class into shares of another class.503 Separate voting by voting groups is also required in the case of certain mergers. If the plan of merger contains a provision that, if it were contained in a proposed amendment to the articles of incorporation, would require separate voting under NCBCA Section 10-04, then separate voting is required to approve the plan of merger.504 However,

499 A “participating share” entitles the holder to participate unconditionally in corporate distributions. N.C. Gen. Stat. § 55-11-03(h)(1). 500 N.C. Gen. Stat. § 55-11-03(e). 501 Id. 502 N.C. Gen. Stat. § 55-1-40(26). 503 In all, there are ten types of changes that give rise to voting by voting groups. N.C. Gen. Stat. §§ 55-10-04(a)(1) – (10). These changes are as follows: (1) any increase or decrease the aggregate number of authorized shares of an existing class of stock; (2) any an exchange or reclassification of all or part of the shares of an existing class into shares of another class; (3) any exchange or reclassification of all or part of the shares of another class into shares of an existing class; (4) any change in the designation, rights, preferences, or limitations of all or part of the shares of an existing class; (5) any change the shares of all or part of an existing class into a different number of shares of the same class; (6) any creation of a new class of shares having rights or preferences with respect to distributions or to dissolution that are prior, superior, or substantially equal to the shares of an existing class; (7) any increase in the rights, preferences, or number of authorized shares of any class that, after giving effect to the amendment, have rights or preferences with respect to distributions or to dissolution that are prior, superior, or substantially equal to the shares of an existing class; (8) any limit or denial of an existing preemptive right of all or part of the shares of an existing class; (9) any cancellation or other effect on the rights to distributions or dividends that have accumulated but not yet been declared on all or part of the shares of an existing class ; and (10) any change of the corporation into a nonprofit corporation or a cooperative organization. If a proposed amendment would affect a series of a class of shares in one or more of the foregoing ways, the shares of that series are entitled to vote as a separate voting group on the proposed amendment. A class or series of shares is entitled to the voting rights granted by NCBCA Section 10-04 although the articles of incorporation provide that the shares are nonvoting shares. 504 N.C. Gen. Stat. § 55-11-03(f).

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separate voting is not required if the consideration to be received by members of the voting group consists solely of cash.505

(3) Changes to the Plan of Merger

The board of directors may amend or abandon the plan of merger after shareholder approval without further shareholder action. This must take place before the articles of merger become effective.506

(4) Mergers with Subsidiaries

A different set of rules applies to mergers of subsidiaries into parents or parents into subsidiaries. In order for these rules to apply, the parent corporation must own at least ninety percent of the outstanding shares of each class of the subsidiary.507

Merger of Subsidiary into Parent. To merge a subsidiary into a parent corporation, the board of directors of the parent must adopt a plan of merger. No action need be taken by the board of the subsidiary. Approval of the parent corporation shareholders is not required unless the articles of incorporation require approval or the plan of merger amends the articles in a manner that would require shareholder approval under NCBCA Section 10-03. Unless the subsidiary’s articles of incorporation require approval, subsidiary shareholder approval is not required.508

Merger of Parent into Subsidiary. The shareholders of the parent must approve merger of a parent into a subsidiary. Neither the board of directors nor the shareholders of the subsidiary must approve the merger unless the subsidiary’s articles of incorporation require otherwise or the plan of merger contains amendments to the subsidiary’s articles of incorporation for which shareholder approval is required by NCBCA Section 10-03.509

In either case, if a merger is effected without the approval of the subsidiary’s shareholders, the surviving corporation must notify the shareholders of the transaction within ten days after the effective date of the merger.510

(5) Merger with Unincorporated Entity

In the case of a merger between a business corporation and an unincorporated entity, both the corporation and the unincorporated entity must approve a written plan of merger.511 The approval process for the corporation is the same as that described above.

505 Id. 506 N.C. Gen. Stat. § 55-11-03(i). 507 N.C. Gen. Stat. § 55-11-04(a). 508 Id. 509 Id. 510 N.C. Gen. Stat. § 55-11-04(b). 511 N.C. Gen. Stat. § 55-11-10(c).

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In the case of the unincorporated entity, the law governing the organization and affairs of that entity will determine the approval process.512

(6) Share Exchange

The approval and vote requirements for a share exchange (which transactions are discussed generally in Section III.G.3.g) of this study), whereby a corporation acquires all of the outstanding shares of one or more classes or series of another corporation, are similar to those described above for a merger. The board of directors of each corporation must adopt a plan of share exchange similar to a plan of merger.513 As with a merger, the board must recommend the plan of share exchange to the shareholders. If the board does not recommend the plan, then it must explain why.514 The plan must be approved by each class or series of shares to be acquired in the exchange.515 Thus, only the shareholders of the corporation being acquired are normally entitled to vote in a share exchange.516

b) Delaware

Delaware law allows any two or more Delaware corporations to merge into a single corporation. The surviving corporation can either be one of the corporations participating in the transaction or, in the case of a consolidation, a new corporation formed by the consolidation of the participating corporations.517 North Carolina law no longer provides for this concept of consolidation.518

(1) Board and Shareholder Approval

The board of directors of each Delaware corporation participating in a merger must adopt a resolution approving an “agreement of merger” and declaring its advisability.519 The agreement of merger is analogous to the “plan of merger” required under North Carolina law. The agreement of merger must include information regarding the terms and conditions of the merger, any amendments to the surviving corporation’s certificate of incorporation, the method of converting shares, and other details deemed desirable (including with respect to payment of cash in lieu of fractional shares, as appropriate).520 The agreement of merger must be submitted to the shareholders of each participating corporation at an annual or special meeting, as applicable. An affirmative vote of a majority of the outstanding shares entitled to vote is required to approve the agreement.521

Similar to the NCBCA, under the DGCL shareholders of the surviving corporation do not need to approve the merger if the following conditions are met:

512 N.C. Gen. Stat. § 55-11-10(c)(3). 513 N.C. Gen. Stat. § 55-11-02(a). 514 N.C. Gen. Stat. § 55-11-03(b)(1). 515 N.C. Gen. Stat. § 55-11-03(f)(2). 516 Robinson, II, supra note 290, § 24.03[3]. 517 Del. Code Ann. tit. 8, § 251(a). 518 See North Carolina Commentary to N.C. Gen. Stat. § 55-11-01. 519 Del. Code Ann. tit. 8, § 251(b). 520 Id. 521 Del. Code Ann. tit. 8, § 251(c).

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(a) The agreement of merger does not amend in any respect the surviving corporation’s certificate of incorporation.522

(b) Each share of stock outstanding prior to the merger must be outstanding after the merger.

(c) Either no stock of the surviving corporation is going to be issued in the transaction, or the number of shares to be issued does not exceed twenty percent of the shares outstanding prior to the transaction.523

If a shareholder vote is not taken, the secretary or an assistant secretary of the corporation must certify in the agreement that it has been adopted pursuant to DGCL Section 251(f) and must specify the sentence of DGCL Section 251(f) that the corporation relied upon in making the determination that no vote was required (which statement shall include a certification as to certain underlying facts).524

(2) Holding Company Mergers

Section 251(g) of the DGCL allows parent and subsidiary Delaware corporations to reorganize themselves into a holding company structure without a shareholder vote if a number of provisions are satisfied.525

(3) Mergers with Foreign Corporations

Delaware law allows for the merger or consolidation of a Delaware corporation with one or more foreign corporations if the laws of the other state or states permit the transaction.526 All of the corporations participating in the transaction must enter into an agreement of merger setting forth generally the same types of information required in respect of agreements of merger for domestic corporations (plus such other provisions or facts as shall be required to be set forth in certificates of incorporation by the laws of the state which are stated in the agreement to be the laws that shall govern the surviving or resulting corporation and that can be stated in the case of a merger or consolidation).527 Each of the participating corporations must adopt, approve, certify, execute and acknowledge the agreement in accordance with the laws of the state under which it is formed.

522 This is more restrictive than the parallel North Carolina provision, which permits certain amendments to the articles of incorporation. See N.C. Gen. Stat. § 55-11-03(g)(1). 523 Del. Code Ann. tit. 8, § 251(f). 524 Id. Such underlying facts would include, in the case of a transaction described in the first sentence of Section 251(f), that the conditions set forth in such sentence have been fulfilled, and , in the case of a transaction described in the second sentence of Section 251(f), that no shares of stock of such corporation were issued prior to the adoption by the board of directors of the resolution approving the agreement of merger or consolidation, provided that such certification on the agreement shall not be required if a certificate of merger or consolidation is filed in lieu of filing the agreement. 525 For a more complete discussion, see Section III.G.3.e) of this study. 526 Del. Code Ann. tit. 8, § 252(a). 527 Del. Code Ann. tit. 8, § 252(b).

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(4) Mergers with Subsidiaries

The DGCL (like the NCBCA) provides a streamlined procedure for a parent corporation that owns at least 90% of the outstanding shares of a subsidiary to effect a merger with the subsidiary. To do so, the parent corporation needs only execute, acknowledge and file with the secretary of State a certificate of its ownership and the merger, along with a copy of the board of directors’ resolution authorizing the merger.528

If the parent does not own all of the outstanding stock of all of the merged subsidiary corporations, the resolution of the board of directors of the parent shall state the terms and conditions of the merger (including the securities, cash, property, or rights to be issued, paid, delivered or granted by the surviving corporation upon surrender of each share of the subsidiary corporation or corporations not owned by the parent corporation, or the cancellation of some or all of such shares). If the parent is not the surviving corporation, the resolution shall include provision for the pro rata issuance of stock of the surviving corporation to the holders of the stock of the parent corporation on surrender of any certificates therefor, and the certificate of ownership and merger shall state that the proposed merger has been approved by a majority of the outstanding stock of the parent corporation entitled to vote, or shall state that the proposed merger has been adopted, approved, certified, executed and acknowledged by the parent corporation in accordance with the laws under which it is organized (if the parent is not a Delaware corporation).529

6. Effect of Mergers, Etc., on Constituents

Both the NCBCA and the DGCL address the effects of mergers (and similar transactions) on the constituent parties, and the substance of the laws is largely the same as between the two states.530 The two states’ laws express these principles somewhat differently, however, and in particular the Delaware statute addresses certain aspects as to which the North Carolina statute is silent.

a) North Carolina Effects

(1) Merger

When a merger, a merger with a subsidiary, a merger or share exchange with a foreign corporation, or a merger with a nonprofit corporation takes place in North Carolina, the following events with regard to the constituents to those transactions occur:

(a) Each merging corporation merges into the surviving corporation and the separate existence of each merging corporation, except the surviving corporation, ceases;

528 Del. Code Ann. tit. 8, § 253(a). 529 Id. 530 The portions of the NCBCA addressing the effects of mergers and the like are based on (and track almost exactly) the counterpart provisions of the Revised Model Business Corporation Act of 1984.

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(b) The title to all real estate and other property owned by each merging corporation is vested in the surviving corporation without reversion or impairment;

(c) The surviving corporation retains all liabilities of each merging corporation;

(d) A proceeding pending by or against any merging corporation may be continued as if the merger did not occur or the surviving corporation may be substituted in the proceeding for a merging corporation whose separate existence ceases in the merger; and

(e) If a domestic corporation survives the merger, its articles of incorporation are amended to the extent provided in the articles of merger.531

The shares of each merging corporation that are to be converted into shares, obligations, or other securities of the surviving or any other corporation or into the right to receive cash or other property are converted, and the former holders of the shares are entitled only to the rights provided to them in the plan of merger or, in the case of former holders of shares in a domestic corporation, any right they may have under Article 13 of the NCBCA.532

(2) Foreign Corporation Survivor

Under NCBCA Section 11-06(a)(7), if a foreign corporation or foreign nonprofit corporation survives the merger, it is deemed:

(a) to agree that it will promptly pay to dissenting shareholders of any merging domestic corporation any amount to which they are entitled under the North Carolina dissenters’ rights statute and otherwise to comply with the requirements thereof as if it were a surviving domestic corporation in the merger;

(b) to agree that it may be served with process in North Carolina in any proceeding for enforcement (i) of any obligation of any merging domestic corporation, (ii) of the rights of dissenting shareholders of any merging domestic corporation, and (iii) of any obligation of the surviving foreign corporation or foreign nonprofit corporation arising from the merger; and

531 N.C. Gen. Stat. § 55-11-06. 532 NCBCA Article 13 governs dissenters’ rights.

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(c) to have appointed the North Carolina’s secretary of state as its agent for service of process in any proceeding for enforcement described above.533

(3) Liability of Corporation and Shareholders

The merger does not affect the liability or absence of liability of any holder of shares in a merging corporation for any acts, omissions or obligations of any merging corporation made or incurred prior to the effectiveness of the merger.534

(4) Share Exchanges

When a share exchange for the acquisition of shares of a domestic corporation pursuant to NCBCA Section 11-02535 or Section 11-07536 takes effect:

(a) the shares of the acquired corporation are exchanged as provided in the plan of share exchange, and the former holders of the shares are entitled only to the exchange rights provided in the plan of share exchange or any right they may have under the North Carolina dissenters’ rights statute; and

(b) if the acquiring corporation is not a domestic corporation, it is deemed to agree that it will promptly pay to dissenting shareholders of the acquired corporation any amount to which they are entitled under the North Carolina dissenters’ rights statute and otherwise to comply with the requirements thereof as if it were an acquiring domestic corporation in the share exchange.537

(5) Foreign Corporation Survivor

If the acquiring corporation is not a domestic corporation, the acquiring corporation is deemed (as is the case with any surviving foreign corporation in a merger):

533 Service of process on the secretary of state is made by delivering to, and leaving with, the secretary of state, or with any clerk authorized by the secretary of state to accept service of process, duplicate copies of the process and a fee of $10. See N.C. Gen. Stat. § 55-1-22(b). Upon receipt of service of process on behalf of a surviving foreign corporation or foreign nonprofit corporation, the secretary of state will mail a copy of the process by registered or certified mail, return receipt requested, to the surviving foreign corporation or foreign nonprofit corporation. If the surviving foreign corporation or foreign nonprofit corporation is authorized to transact business or conduct affairs in North Carolina, the address for mailing is its principal office designated in the latest document filed with the secretary of state, or, if there is no principal office on file, its registered office. If the surviving foreign corporation or foreign nonprofit corporation is not authorized to transact business or conduct affairs in North Carolina, the address for mailing shall be the mailing address designated pursuant to NCBCA Section 11-05(a). 534 N.C. Gen. Stat. § 55-11-06(a). 535 N.C. Gen. Stat. § 55-11-02 governs share exchanges. 536 N.C. Gen. Stat. § 55-11-07 governs mergers or share exchanges with foreign corporations. 537 N.C. Gen. Stat. § 55-11-06(b).

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(a) to agree that it may be served with process in North Carolina in any proceeding for enforcement (i) of the rights of dissenting shareholders of the acquired corporation under the North Carolina dissenters’ rights statute and (ii) of any obligation of the acquiring corporation arising from the share exchange; and

(b) to have appointed North Carolina’s secretary of state as its agent for service of process in any proceeding for enforcement described above.538

(6) Other Considerations

In the case of a merger pursuant to NCBCA Section 11-07 (regarding mergers or share exchanges with foreign corporations) or Section 11-09 (regarding mergers with nonprofit corporations), references above to “corporation” include a domestic corporation, a domestic nonprofit corporation, a foreign corporation, and a foreign nonprofit corporation as applicable.539

b) Delaware Effects

(1) Service of Process

The DGCL imposes basically the same service-of-process rules upon foreign surviving or resulting entities resulting from the merger or consolidation of each of the following: domestic or foreign corporations;540 domestic and foreign nonstock corporations;541 domestic corporations and partnerships;542 and domestic corporations and limited liability companies.543 These rules are not materially different from those set forth in the NCBCA.

If the entity surviving or resulting from the merger or consolidation is to be governed by the laws of the District of Columbia or any state or jurisdiction other than Delaware, that entity must agree that it may be served with process in Delaware in any proceeding for enforcement of any obligation of any constituent entity of Delaware, as well as for enforcement of any obligation of the surviving or resulting entity arising from the merger or consolidation, including any suit or other proceeding to enforce the right of any stockholders as determined in appraisal proceedings pursuant to DGCL Section 262, and must irrevocably appoint Delaware’s secretary of state as its agent to accept service of process in any such suit or other proceedings and must specify the address to which a copy of such process will be mailed by the secretary of state. In the event of service upon the secretary of state, the secretary of state will notify the surviving or resulting entity of the service by letter, certified mail, return receipt

538 NCBCA Section 11-06(b)(3) sets forth service-of-process rules in this context identical to those applicable to mergers, as provided in NCBCA Section 11-06(a)(7). See supra note 437. 539 N.C. Gen. Stat. § 55-11-06(c). 540 Del. Code Ann. tit. 8, § 252(d). 541 Del. Code Ann. tit. 8, § 256(d). 542 Del. Code Ann. tit. 8, § 263(d). 543 Del. Code Ann. tit. 8, § 264(d).

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requested, directed to such surviving or resulting entity at its address so specified, unless the surviving or resulting entity has designated in writing to the secretary of state a different address for such purpose, in which case it will be mailed to the last address so designated. The letter will contain a copy of the process and any other papers served on the secretary of state.544

It is the duty of the plaintiff in the event of such service to serve process and any other papers in duplicate, to notify the secretary of state that service is being effected pursuant to the applicable section of the DGCL (i.e., 252(d), 256(d), 263(d) and 264(d)) and to pay the secretary of state $50 for Delaware’s use, which sum will be taxed as part of the costs in the proceeding, if the plaintiff prevails. The secretary of state maintains an alphabetical record of such service setting forth the name of the plaintiff and the defendant, the title, docket number and nature of the proceeding in which process has been served, the fact that service has been effected pursuant to such section of the DGCL, the return date thereof, and the day and hour service was made. The secretary of state is required to retain that information for only five years following the service of process.545

(2) Status, Rights and Liabilities, of Constituent and Surviving or Resulting Corporations Following Merger or Consolidation

When any merger or consolidation becomes effective under Delaware law, for the purposes of Delaware law, the separate existence of all the constituent corporations, or of all such constituent corporations except the one into which the other or others have been merged, ceases and the constituent corporations become a new corporation, or are merged into one of such corporations. The surviving or resulting corporation possesses all the rights, privileges, powers and franchises of a public and of a private nature, and is subject to all the restrictions, disabilities and duties of each the merged or constituent corporations. Thus, all of the following are vested in the surviving or resulting corporation: (i) all of the rights, privileges, powers and franchises of each the merged or constituent corporations; (ii) all property (real, personal and mixed) of each the merged or constituent corporations; (iii) all debts due to any of the merged or constituent corporations; and (iv) stock subscriptions and all other things in action or belonging to each of the merged or constituent corporations.546 These principles are consistent with those set forth in NCBCA Section 11-06.

In the case of a merger of banks or trust companies, without any order or action on the part of any court or otherwise, all appointments, designations, and nominations, and all other rights and interests as trustee, executor, administrator, registrar of stocks and bonds, guardian of estates, assignee, receiver, trustee of estates of mentally ill persons and in every other fiduciary capacity, are automatically vested in the resulting or surviving corporation.547 The NCBCA does not have a corresponding provision.

544 Del. Code Ann. tit. 8, § 252(d). 545 Id. 546 Del. Code Ann. tit. 8, § 259(a). 547 Del. Code Ann. tit. 8, § 259(b). This is subject to the right of a party in interest to apply to an appropriate court for a determination as to whether the resulting or surviving corporation will continue to serve in the same fiduciary capacity as the merged or constituent corporation, or whether a new and different fiduciary should be appointed. Id.

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(3) Powers of Surviving or Resulting Corporations and Issuance of Stock, Bonds or Other Indebtedness

When two or more corporations merge or consolidate, the surviving or resulting corporation may issue bonds or other obligations (whether or not negotiable), in an amount sufficient to provide for all required payments, or obligations it must assume, in order to effect the merger or consolidation. In order to secure payment of any such bonds and obligations, the surviving or resulting corporation may mortgage its corporate franchises and assets. In this regard, the surviving or resulting corporation may issue certificates of its capital stock or uncertificated stock (if so authorized) and other securities to the stockholders of the merged or constituent corporations in exchange or payment for the original shares, in an amount necessary in order to effect the merger or consolidation in the manner and on the terms specified in the agreement.548 The NCBCA does not have a corresponding provision.

(4) Effect of Merger upon Pending Actions

Prosecution of any action, whether administrative, civil, or criminal, against or pending by any corporation that is party to a merger or consolidation will proceed as if the merger or consolidation had not occurred. A substitution of the surviving or resulting corporation may also occur in the action or proceeding. This provision is similar in effect to NCBCA Section 11-06(a)(4).

7. Sales of All or Substantially All Assets

Both Delaware and North Carolina permit sales of all or substantially all of a corporation’s assets outside the ordinary course of business if the board recommends such transaction and if the applicable shareholder approval is obtained.549 The statutory framework and analysis in North Carolina differ somewhat from Delaware, as described below.

NCBCA Sections 12-01 and 12-02 govern asset sales. Section 12-01 provides generally that, absent provision in the articles of incorporation or bylaws to the contrary, by the authority of the board of directors, without shareholder approval: (i) a North Carolina corporation’s assets may be mortgaged or pledged; (ii) all or substantially all of such corporation’s assets may be transferred or sold if “in the usual and regular course of business” 550 (on terms and for consideration as determined by the board); and (iii) such corporation may transfer any or all of its property to a wholly-owned subsidiary of that corporation.551

548 Del. Code Ann. tit. 8, § 260. 549 Note that in both North Carolina and Delaware, any transaction involving the sale or transfer of less than “all or substantially all” of the corporation’s assets will require only the approval of the board of directors, in the same manner as any other routine corporate transaction. This is by virtue of the operative language in Sections 55-12-01 and 02, and Section 271 of the DGCL. See also Official Comment to N.C. Gen. Stat. § 55-12-01. 550 The operative language is difficult to define, and situations invoking this provision are somewhat unusual. Examples might include the disposition of all of the assets of a real estate company, or a disposition by a corporation that was formed for the purpose of liquidating a business. See Official Comment to N.C. Gen. Stat. § 55-12-01. 551 Note that DGCL Section 271(c) also permits transfers to a subsidiary, free of stockholder approval.

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Section 12-02 addresses sales of all or substantially all of a North Carolina corporation’s assets other than in the usual and regular course of business. If such a sale is contemplated, it will require shareholder approval (on the terms and for the consideration determined by the board, all as proposed to the shareholders by the board). The fundamental legal issues, then, are whether (i) the transaction involves “all or substantially all” of the corporation’s assets, and (ii) the transaction is “other than in the usual and regular course of business.” How these terms are defined is a matter of case law, and there is, as yet, no North Carolina case law interpreting them.552

Procedurally, approval of such a transaction for a North Carolina corporation will require the board to recommend the transaction to the shareholders,553 and for a majority of the votes entitled to be cast by all shareholders entitled to vote to approve the transaction (unless a greater vote or unless voting by group is required by the articles of incorporation, the bylaws, the Control Share Acquisition Act or by the board of director as condition of its recommendation as provided in Section 12-02(c)).554 The corporation shall notify each shareholder (whether or not entitled to vote) of the proposed shareholders' meeting in accordance with NCBCA Section 7-05 (i.e., no fewer than 10 nor more than 60 days before the meeting date), and such notice must also state that the purpose, or one of the purposes, of the meeting is to consider the sale, lease, exchange, or other disposition of all, or substantially all, the property of the corporation and contain or be accompanied by a description of the transaction.555

DGCL Section 271 (which generally governs asset sales for Delaware corporations) takes a slightly different approach. Unlike NCBCA Section 12-02, the face of the Delaware statute does not impose an “ordinary course of business” or “usual or regular course of business” test, so if the sale or transfer involves all or substantially all of the corporation’s assets, then stockholder approval will be required.556 Thus, for Delaware corporations, the central legal issue is whether the transaction involves “all or substantially all” of the corporation’s assets.557

This section (unlike the NCBCA) also requires a determination by the board of directors that the terms and conditions (and consideration) relating to the sale are expedient and for the best interests of the corporation.558 Note that, given the language of the statute, it is not

552 Thus, a meaningful treatment of those issues is beyond the scope of this study. For a more meaningful discussion of these matters, see Robinson, II, supra note 290, and R. Franklin Balotti & Jesse A. Finkelstein, The Delaware

Law of Corporations and Business Organizations, § 10.2 (3rd ed. 2008). 553 This is the case unless the board determines that because of a conflict of interest or other special circumstances, it should not recommend the transaction, in which case the basis for the lack of a recommendation must be communicated to the shareholders. N.C. Gen. Stat. § 5-12-02(b)(1). Note also that the board may condition its submission of the transaction to the shareholders on any basis, N.C. Gen. Stat. § 55-12-02(c), which is also the case with respect to article of incorporation amendments and mergers. 554 N.C. Gen. Stat. § 55-12-02(b), (e). 555 N.C. Gen. Stat. § 55-12-02(d). If the transaction would trigger dissenters’ rights (discussed in Section III.G.9. of this study), the notice must so indicate. N.C. Gen. Stat. § 55-13-20(a). 556 But see Edward P. Welch, Andrew J. Turezyn, Robert S. Saunders, supra note 320, § 271.2.1 (discussing how an “ordinary course of business” analysis may come into play in assessing whether “all or substantially all” of the assets are at issue). 557 Again, as noted in note 552 above, an examination of the definition of ‘all or substantially all” is beyond the scope of this study. Note, however, that the leading case on the issue is from Delaware, Gimbel v. Signal Cos., 316 A.2d 599 (Del. Ch. 1974), aff’d, 316 A.2d 619 (Del. 1974). 558 Del. Code Ann. tit. 8, § 271(a).

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necessary for the fundamental decision to enter into the transaction to satisfy this test (as the “best interests” language relates to the board’s determination of the terms and conditions of sale). Thus, the corporation’s right to sell its assets is absolute (subject, of course, to stockholder approval), and is not subject to judicial review.559

Procedurally, the DGCL differs from the NCBCA insofar as (i) the DGCL requires notice of at least 20 days in advance of the applicable stockholders meeting560 and (ii) the DGCL does not require that the notice to the stockholders include any description of the transaction (though such notice shall state that a resolution regarding the sale will be considered).561

In both North Carolina and Delaware, asset sales may be subject to attack by minority shareholders, based on a “de facto merger” theory, in the event an asset sale is effected in violation of fiduciary duty or in violation of the duties of good faith and fairness. There is no North Carolina case so applying this doctrine in favor of a minority shareholder, however.562

Finally with respect to asset sales, the general rule is that, absent special circumstances, the transferee will not be held responsible for the liabilities of the transferor. This rule is subject to essentially the same exceptions under both North Carolina and Delaware law: (i) where the transferee expressly (or by implication) assumes certain liabilities; (ii) where the transaction amounts to a de facto merger; (iii) where the transaction is effected for the purpose of defrauding creditors; and (iv) where the transferee business is a “mere continuation” of the transferor.563

Note that, in any event (and notwithstanding the state of incorporation of the subject corporation), if a corporation’s board of directors wishes to sell the business (or support or oppose a purchase offer), the board must consider and satisfy its fiduciary duties in connection therewith.564

8. Entity Conversions

a) Generally

In recent years, states have enacted statutes permitting business entities to change their formal structure without (i) undergoing the process of merging or selling assets to a new entity with a different form, and (ii) incurring tax and other risks where a transfer of assets

559 See Welch, Turezyn and Saunders, supra note 320, § 271.3.2. 560 Del. Code Ann. tit. 8, § 271(a). By contrast, NCBCA Section 7-05 requires notice of at least 10 but not more than 60 days. 561 Del. Code Ann. tit. 8, § 271(a). 562 See Robinson, II, supra note 290, § 25.04. With respect to Delaware law on de facto mergers, see Welch, Turezyn and Saunders, supra note 320, § 271.10. 563 See Budd Tire Corp. v. Pierce Tire Co., 90 N.C. App. 684, 687, 370 S.E.2d 267, 269 (1988); Elmer v. Tenneco

Resins, Inc., 698 F. Supp. 535 (D. Del. 1988). See also Robinson, II, supra note 290, § 25.05; 564 See the discussion of directors’ fiduciary duties in Section IV.A. of this study. See also Revlon, Inc., et al. v.

MacAndrews, 506 A.2d 173 (Del. 1986) and Balotti & Finkelstein, supra note 552, § 4.20. Of course, these duties apply equally to a board’s consideration of merger possibilities, as well. Also, note the limitations on business combinations with interested stockholders contained in Del. Code Ann. tit. 8, § 203.

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or interests might otherwise be deemed to have occurred. North Carolina and Delaware are among that group of states. For example, in both states, an LLC or partnership may convert to corporate form.565 Likewise, a corporation whose majority owner has acquired all of the corporation’s outstanding capital stock may simplify its existence by converting to a single-member LLC.

In North Carolina, Article 11A of the NCBCA governs these conversions.566 In Delaware, Section 266 of the DGCL governs conversions of corporations to other entities and Section 265 and the DGCL sections relating to each form of entity govern conversions of other entities to corporations.567

b) Conversions of Existing Entities to Corporations

(1) Entities that may Convert to Corporations

North Carolina law permits a “business entity”568 other than a domestic corporation to convert to a domestic corporation if the proposed conversion is permitted by the laws of the state or country governing the converting business entity and the converting business entity complies with the requirements of Article 11A of the NCBCA.569

Delaware law permits an “other entity”570 to convert to a Delaware corporation, if the other entity follows the provisions set out in DGCL Section 265.571

(2) Conversion Plan

North Carolina requires that the converting entity approve a conversion plan before a conversion may occur. Delaware law does not contain a specific conversion plan requirement, but does have analogous requirements, as described below.

The conversion plan that must be approved as a condition to the conversion of a converting entity to a North Carolina corporation must be approved pursuant to the laws of the state or country governing the converting business entity.572 After the approval of the conversion plan, but before articles of incorporation for the resulting domestic corporation

565 See Section V.G. of this study, below, for a discussion, in particular, of conversions involving LLCs. 566 See N.C. Gen. Stat. §§ 55-11A-01 and 55-11A-10. 567 See Del. Code Ann. tit. 8, §§ 903 (general and limited liability partnerships), 17-217, and 17-219 (conversion to or from limited partnership); and Del. Code Ann. tit. 8, §§ 18-214 and 18-216 (conversion to or from LLC form). 568 “Business entity,” as used in Article 11A of the NCBCA, means a domestic corporation a foreign corporation, a domestic or foreign nonprofit corporation, a domestic or foreign limited liability company, a domestic or foreign limited partnership, a registered limited liability partnership, foreign limited liability partnership or any other partnership as defined in North Carolina General Statutes Section 59-36, whether or not formed under the laws of North Carolina. 569 N.C. Gen. Stat. § 55-11A-01. 570 The term “other entity” means a limited liability company, statutory trust, business trust or association, real estate investment trust, common-law trust or any other unincorporated business including a partnership (whether general (including a limited liability partnership) or limited (including a limited liability limited partnership)), or a foreign corporation. Del. Code Ann. tit. 8, § 265(a). 571 Id. § 265(b). 572 N.C. Gen. Stat. § 55-11A-02(a), (b).

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become effective, the conversion plan may be amended or abandoned to the extent permitted by the laws that govern the converting business entity.573 If the converting business entity decides to abandon the conversion plan after the filing of the articles of incorporation with North Carolina’s secretary of state, but before the articles of incorporation become effective, the converting business entity may deliver to the secretary of state, prior to the time the articles of incorporation become effective, an amendment to the articles of incorporation withdrawing the articles of incorporation.574

Under Delaware law, prior to filing a certificate of conversion to the form of a Delaware corporation with Delaware’s secretary of state, the conversion must be approved as provided for in the document, instrument, agreement or other writing which governs the internal affairs of the converting entity and the conduct of its business or by applicable law, as appropriate, and a certificate of incorporation must be approved by the same authorization required to approve the conversion.575

A conversion plan in North Carolina must contain the following items: (i) the name and type of the converting business entity and the state or country whose laws govern its organization and internal affairs; (ii) the name of the resulting domestic corporation; (iii) the terms and conditions of the conversion; and (iv) the manner and basis for converting the interests in the converting business entity into shares, obligations or other securities of the resulting domestic corporation or into cash or other property in whole or in part.576 The plan may contain any other provisions relating to the conversion.577

The provisions of the conversion plan other than as listed in items (i) and (ii) in the immediately preceding paragraph may be made dependent on facts ascertainable outside of the plan so long as the plan sets forth the manner in which the facts will operate upon the affected provisions. Such facts to be taken into account may include: statistical or market indices, market prices of any security or group of securities, interest rates, currency exchange rates, or similar economic or financial data; a determination or action by the converting business entity or by any other person, group, or body; or the terms of, or actions taken under, an agreement to which the converting business entity is a party, or any other agreement or document.578

Note that DGCL Section 265 does not contain specific requirements for a plan of conversion.

(3) Articles of Incorporation and Certificates of Conversion

In North Carolina, after the converting business entity approves a conversion plan, the converting business entity must file articles of incorporation with North Carolina’s secretary of state. Along with the standard information required or permitted by

573 Id. § 55-11A-02(c). 574 N.C. Gen. Stat. § 55-11A-03(b). 575 Del. Code Ann. tit. 8, § 265(h). 576 N.C. Gen. Stat. § 55-11A-02(a). 577 N.C. Gen. Stat. § 55-11A-02 (a1). 578 N.C. Gen. Stat. § 55-11A-02(a2).

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Section 2-02 of the NCBCA,579 the articles of incorporation must contain articles of conversion which state: that the resulting domestic corporation is being formed pursuant to a conversion of a business entity; the name and type of the converting business entity, and the state or country under whose laws it currently exists; and that a conversion plan has been approved by the converting business entity.580

Under North Carolina law, “certificates of conversion” also must be registered pursuant to North Carolina General Statutes Section 47-18.1.581 Note that this is the only mention of “certificates of conversion” in the relevant North Carolina General Statutes. The term is likely intended to refer to “articles of conversion,” but there is no clear authority to this effect.

According to DGCL Section 265(b)(2), the converting entity must have previously executed, acknowledged and filed a certificate of incorporation pursuant to DGCL Section 103.582

In addition, DGCL Section 265(b)(1) requires that the converting entity shall have executed a certificate of conversion and filed it pursuant to DGCL Section 103. The certificate of conversion must state: the date on which and jurisdiction where the other entity was first created, incorporated, formed or otherwise came into being and, if it has changed, its jurisdiction immediately prior to its conversion to a domestic corporation; the name of the other entity immediately prior to the filing of the certificate of conversion; and the name of the corporation as set forth in its certificate of incorporation.583

An authorized person must sign the Delaware certificate of conversion on behalf of the converting entity.584

579 For a discussion of these requirements, see Section III.B.2. of this study. 580 N.C. Gen. Stat. § 55-11A-03(a). 581 This section states that:

(a) If title to real property in this State is vested by operation of law in another entity upon the merger, consolidation, or conversion of an entity, such vesting is effective against lien creditors or purchasers for a valuable consideration from the entity formerly owning the property, only from the time of registration of a certificate thereof as provided in this section, in the county where the land lies, or if the land is located in more than one county, then in each county where any portion of the land lies to be effective as to the land in that county.

(b) The secretary of state shall adopt uniform certificates of merger, consolidation, or conversion, to be furnished for registration, and shall adopt such fees as are necessary for the expense of such certification. If the entity involved is not a domestic entity, a similar certificate by any competent authority in the jurisdiction of incorporation or organization may be registered in accordance with this section.

(c) A certificate of the secretary of state prepared in accordance with this section shall be registered by the register of deeds in the same manner as deeds, and for the same fees, but no formalities as to acknowledgment, probate, or approval by any other officer shall be required. The name of the entity formerly owning the property shall appear in the “Grantor” index, and the name of the entity owning the property by virtue of the merger, consolidation, or conversion shall appear in the “Grantee” index.

582 For a discussion of these requirements, see Section III.B.2. of this study. 583 Del. Code Ann. tit. 8, § 265(c). 584 Del. Code Ann. tit. 8, § 265(i).

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(4) Timing of Conversion

In North Carolina, when the new articles of incorporation become effective, the conversion becomes immediately effective.

In Delaware, upon the effective time of the certificate of conversion and the certificate of incorporation, the converting entity converts to a Delaware corporation and the corporation thereafter is subject to all of the provisions of the DGCL, except that notwithstanding DGCL Section 106, the existence of the corporation commences on the date the converting entity commenced its existence in the jurisdiction in which the converting entity was first created, formed, incorporated or otherwise came into being.585

(5) Effects of Conversion

In North Carolina, the effects of a conversion on the assets and liabilities of the converting business entity are governed by NCBCA Section 11A-04, which states that when the conversion takes effect: the converting business entity ceases its prior form of organization and continues in existence as the resulting domestic corporation; title to all real estate and other property owned by the converting business entity continues vested in the resulting domestic corporation without reversion or impairment; all liabilities of the converting business entity continue as liabilities of the resulting domestic corporation; a proceeding pending by or against the converting business entity may be continued as if the conversion did not occur; and the interests in the converting business entity that are to be converted into shares, obligations, or other securities of the resulting domestic corporation or into the right to receive cash or other property are thereupon so converted, and the former holders of interests in the converting business entity are entitled only to the rights provided in the conversion plan referred to above.

Additionally, a North Carolina conversion does not affect the liability or absence of liability of any holder of an interest in the converting business entity for any acts, omissions, or obligations of the converting business entity made or incurred prior to the effectiveness of the conversion. The cessation of the existence of the converting business entity in its prior form of organization after the conversion also does not constitute a dissolution or termination of the converting business entity.586

Delaware law is not substantively different in this regard. As under North Carolina law, the conversion of any other entity to a Delaware corporation does not affect any obligations or liabilities the other entity incurred prior to its conversion to a Delaware corporation or the personal liability of any person incurred prior to the conversion.587 When the converting entity converts to a Delaware corporation, the DGCL law provides that the Delaware corporation is deemed to be the same entity as the converting entity. When any conversion becomes effective, for the purposes of Delaware law, all of the rights, privileges and powers of the converted entity, and all property, real, personal and mixed, and all debts due to the converted entity, as well as all other things and causes of action belonging to the converted

585 Del. Code Ann. tit. 8, § 265(d). 586 N.C. Gen. Stat. § 55-11A-04. 587 Del. Code Ann. tit. 8, § 265(e).

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entity, remain vested in the Delaware corporation to which the converted entity has converted and become the property of such Delaware corporation. The title to any real property vested by deed or otherwise in the converted entity does not revert nor is impaired in any way, and all rights of creditors and all liens upon any property of the converted entity are preserved unimpaired. All debts, liabilities and duties of the converted entity remain attached to the resulting Delaware corporation, and may be enforced against it to the same extent as if those debts, liabilities and duties had originally been incurred or contracted by it in its capacity as a Delaware corporation. The rights, privileges, powers and interests in property of the converted entity, as well as the debts, liabilities and duties of the converted entity, are not deemed, as a consequence of the conversion, to have been transferred to the resulting Delaware corporation for any purpose of Delaware law.588

Unless otherwise agreed, for purposes of Delaware law or as required under applicable non-Delaware law, the converting entity is not required to wind up its affairs or pay its liabilities and distribute its assets, and the conversion does not constitute a dissolution of the converted entity, but instead constitutes a continuation of the existence of the converted entity in the form of a Delaware corporation.589

As under North Carolina law, in connection with a Delaware conversion, the rights or securities of, or the interests in, the converted entity may be exchanged for or converted into cash, property, or shares of stock, rights or securities of such Delaware corporation or, in addition to or in lieu thereof, may be exchanged for or converted into cash, property, or shares of stock, rights or securities of or interests in another domestic corporation or other entity or may be cancelled.590

c) Conversion of a Corporation

(1) Entities into which a Domestic Corporation May Convert

In North Carolina, the rules governing a conversion of a domestic corporation are similar to the rules governing conversion of another business entity into a domestic corporation. A domestic corporation may convert to a different business entity if the laws of the state or country governing the organization and internal affairs of such other business entity permit conversion and the converting domestic corporation complies with the applicable section of the North Carolina statute.591

In Delaware as well, the rules governing a conversion of a domestic corporation are similar to the rules governing conversion of another entity into a domestic corporation. A Delaware corporation may, upon the authorization of such conversion in accordance with Delaware law, convert to a limited liability company, statutory trust, business trust or association, real estate investment trust, common-law trust or any other unincorporated

588 Del. Code Ann. tit. 8, § 265(f). 589 Del. Code Ann. tit. 8, § 265(g). 590 Del. Code Ann. tit. 8, § 265(j). 591 N.C. Gen. Stat. § 55-11A-10.

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business including a partnership (whether general (including a limited liability partnership) or limited (including a limited liability limited partnership)) or a foreign corporation.592

(2) Conversion Plan

Contents of Conversion Plan. As with conversions into domestic corporations, in North Carolina, a converting domestic corporation must approve a written conversion plan containing: (i) the name of the converting domestic corporation; (ii) the name of the resulting business, its type of business entity, and the state or country whose laws govern its organization and internal affairs; (iii) the terms and conditions of the conversion; and (iv) the manner and basis for converting the shares of the domestic corporation into interests, obligations, or securities of the resulting business entity or into cash or other property in whole or in part.593 The plan may contain other provisions relating to the conversion.594

The provisions of the conversion plan other than as listed as items (i) and (ii) in the immediately preceding paragraph may be made dependent on facts ascertainable outside of the plan so long as the plan sets forth the manner in which the facts will operate upon the affected provisions.595 Such facts may to be taken into account may include: statistical or market indices, market prices of any security or group of securities, interest rates, currency exchange rates, or similar economic or financial data; a determination or action by the converting business entity or by any other person, group, or body; or the terms of, or actions taken under, an agreement to which the converting business entity is a party, or any other agreement or document.596 While not specifically contemplating a “conversion plan,” the DGCL has a similar requirement.597

Approval of Conversion Plan. In North Carolina, the conversion plan is subject to various layers of required approval. Initially, the board of directors of the converting domestic corporation must recommend the conversion plan to the shareholders, unless the board determines that it should make not make such a recommendation.598 The directors may condition its submission of the proposed conversion on any basis.599 In that event, the board must communicate the basis for its lack of a recommendation to the shareholders with the conversion plan.600

Next, the shareholders entitled to vote must approve the plan.601 The converting domestic corporation must notify each shareholder, whether or not entitled to vote, of the proposed shareholders’ meeting in accordance with NCBCA Section 7-05. The

592 Del. Code Ann. tit. 8, § 266(a). 593 N.C. Gen. Stat. § 55-11A-11(a). 594 N.C. Gen. Stat. § 55-11A-11(a1). 595 N.C. Gen. Stat. § 55-11A-11(a2). 596 Id. 597 See Del. Code Ann. tit. 8, § 266. For additional discussion, see note 615 and accompanying text. 598 N.C. Gen. Stat. § 55-11A-11(b). 599 N.C. Gen. Stat. § 55-11A-11(c). 600 N.C. Gen. Stat. § 55-11A-11(b). 601 Id.

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notice must state that the purpose, or one of the purposes, of the meeting is to consider the conversion plan and the notice must be accompanied by a copy of the conversion plan.602

The conversion plan must be approved by each voting group entitled to vote separately on the conversion plan by a majority of all the votes entitled to be cast on the plan by that voting group.603 Other sections of the NCBCA, the articles of incorporation of the converting domestic corporation, or a bylaw adopted by the shareholders or the board of directors, acting pursuant to NCBCA Section 11A-11(c), may require a greater vote or a vote by voting groups. If any shareholder of the converting domestic corporation has or will have personal liability for any existing or future obligation of the resulting business entity solely as a result of holding an interest in the resulting business entity, then, along with the previous requirements, approval of the conversion plan by the converting corporation requires the affirmative vote or written consent of that shareholder.604

Separate voting by voting groups is required on a conversion plan if the plan contains a provision that, if contained in a proposed amendment to articles of incorporation, would require action by one or more separate voting groups on the proposed amendment under NCBCA Section 10-04.605 However, if that separate voting group receives cash as its consideration in exchange for stock, that separate groups does not need to vote.606 After approval of a conversion plan, but before the articles of conversion become effective, the company may amend the conversion plan, or may abandon the conversion plan. These actions remain subject to any contractual rights, as provided in the conversion plan or, if there is no such provision, as determined by the board of directors without further shareholder action.607

The DGCL does not require a distinct “conversion plan,” but rather, the board of directors of the converting domestic corporation must adopt a resolution approving such conversion, specifying the new type of entity resulting from the conversion and recommending the approval of such conversion by the stockholders of the corporation.608 The board then submits the conversion resolution to the stockholders of the corporation at an annual or special meeting. The corporation must mail due notice of the time and purpose of the meeting to stockholders of the corporation at least twenty days before the meeting date. This mailing must be sent to each stockholder (whether voting or nonvoting) at the stockholder’s address of record. At the meeting, the resolution must be considered and a vote taken for its adoption or rejection. If all outstanding shares of stock of the corporation (whether voting or nonvoting) vote for the adoption of the resolution, the conversion is authorized.609 Thus, the DGCL establishes a requirement of unanimous stockholder approval (as opposed to the majority standard applicable to North Carolina corporations as described above). A stockholder vote is not necessary if the

602 N.C. Gen. Stat. § 55-11A-11(d). 603 N.C. Gen. Stat. § 55-11A-11(e). 604 Id. 605 For s summary of N.C. Gen. Stat. § 55-10-04, see supra note 503. 606 N.C. Gen. Stat. § 55-11A-11(f). 607 N.C. Gen. Stat. § 55-11A-11(g). 608 Del. Code Ann. tit. 8, § 266(b). 609 Id.

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resolution of the board of directors approving the conversion precedes any issuance of stock in the domestic corporation.610

(3) Articles of Conversion/Certificates of Conversion

North Carolina. After approving the conversion plan, the converting domestic corporation must file articles of conversion with North Carolina’s secretary of state.611 The articles of conversion must state: the name of the converting domestic corporation; the name of the resulting business entity, its type, the state or country whose laws govern its organization and internal affairs, and, if the resulting business entity is not authorized to transact business or conduct affairs in North Carolina, a designation of its mailing address and a commitment to file with the secretary of state a statement of any subsequent change in its mailing address; and that a plan of conversion has been approved by the converting domestic corporation as required by law.612

If the converting domestic corporation is converting to a business entity whose formation, or whose status as a registered limited liability partnership,613 requires the filing of a document with the secretary of state, then notwithstanding NCBCA Section 11A-12(a), articles of conversion must be included as part of that filed document and must contain the information required by the laws governing the organization and internal affairs of the resulting business entity.614

North Carolina requires registration of “certificates of conversion” pursuant to North Carolina General Statutes Section 47-18.1. As indicated in the discussion above regarding articles of conversion governing conversion of entities to the North Carolina corporate form, this is the only mention of “certificates of conversion” in the relevant sections of the North Carolina General Statutes. This term is likely intended to refer to “articles of conversion,” but there is no clear authority to this effect.

The NCBCA addresses conversion of a domestic corporation to a foreign non-corporate entity through Section 11A-13(b), whereby the resulting entity agrees to be served with process in North Carolina for the enforcement of dissenters’ rights and other obligations of the converting corporation, as well as obligations of the resulting entity, arising from the conversion. The resulting entity is deemed to have appointed the secretary of state as agent for service of process, and subsection (2) of Section 11A-13(b) sets forth certain other procedural rules in this regard.

Delaware. Similarly, if a Delaware corporation converts to another entity organized, formed or created under the laws of a jurisdiction other than Delaware, the corporation must file a certificate of conversion with Delaware’s secretary of state.615 DGCL

610 Del. Code Ann. tit. 8, § 266(i). 611 N.C. Gen. Stat. § 55-11A-12(a). 612 N.C. Gen. Stat. § 55-11A-12(a)(1), (2) and (3). 613 As defined in North Carolina General Statutes Section 59-32. 614 N.C. Gen. Stat. § 55-11A-12(b). 615 Although DGCL Section 266(a) contemplates the conversion of a Delaware corporation to another form of entity that may be either a Delaware domestic entity or a foreign entity, the language of Section 266(c) does not address certificates of conversion applicable to a Delaware corporation that is converting to a domestic entity.

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Section 103 governs the execution of the certificate of conversion, which must certify: the name of the converting domestic corporation, and if it has been changed, the name under which it was originally incorporated; the date of the filing of its original certificate of incorporation with the secretary of state; the name and jurisdiction of the resulting entity; that the conversion has been approved in accordance with DGCL Section 266(c); the agreement of the corporation that it may be served with process in Delaware in any action, suit or proceeding for enforcement of any obligation of the converting domestic corporation arising while it was a Delaware corporation, and that it irrevocably appoints the secretary of state as its agent to accept service of process in any such action, suit or proceeding; and the address to which a copy of such process may be mailed to it by the secretary of state. Subsections (c)(6) and (d) of DGCL Section 266 set forth procedural requirements regarding such service of process that (though somewhat more detailed than North Carolina’s corresponding version616) do not differ significantly from North Carolina’s service of process requirements and procedures.617

(4) Timing of Effectiveness of Conversion

In North Carolina, the conversion will take effect (i) upon the effectiveness of the articles of incorporation, in the case of a non-corporate entity converting into a North Carolina corporation,618 or (ii) when the articles of conversion become effective, in the case of the conversion of a North Carolina corporation into another entity.619 If the plan of conversion is abandoned after the articles of conversion have been filed with North Carolina’s secretary of state but before the articles of conversion become effective, the converting domestic corporation must deliver to the secretary of state, an amendment to the articles of conversion withdrawing the articles of conversion.620 Filing must occur before the date when the articles of conversion become effective.

The DGCL reads and operates somewhat differently in these regards. DGCL Section 103(d) generally governs the timing of effectiveness of documents filed with the secretary of state. Any instrument so filed shall be effective upon its filing date (though any instrument may provide that it is not to become effective until a specified subsequent time, but not later than 90 days after the filing). If any document is filed with a later effective time and the related transaction is terminated (or its terms are amended to change the future effective time prior to the future effective time), the document shall be terminated or amended by the filing of a certificate of termination (or amendment) of the original instrument, executed in accordance with DGCL Section 103(a).

When a Delaware corporation files a certificate of conversion to a non-Delaware entity with Delaware’s secretary of state, or upon the future effective date or time of the certificate of conversion to a non-Delaware entity and when the converting domestic corporation pays the required fees to the secretary of state, the secretary of state will certify that the converting domestic corporation has filed all documents and paid all fees, and thereupon the converting domestic corporation ceases to exist as a Delaware corporation at the time the

616 N.C. Gen. Stat. § 55-11A-13(b)(2). 617 For related discussion, see infra notes 627 and 628 and accompanying text. 618 N.C. Gen. Stat. § 55-11A-03(c). 619 N.C. Gen. Stat. § 55-11A-12(d). 620 N.C. Gen. Stat. § 55-11A-12(c).

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certificate of conversion becomes effective. The certificate of the secretary of state serves as prima facie evidence of the conversion by a converting domestic corporation to a non-Delaware entity.621

(5) Effects of Conversion

The NCBCA and DGCL are not substantially different in describing the legal effects of conversion. Below is a summary of each state’s treatment of the issue.

When conversion of a North Carolina corporation takes effect, several things occur: the converted domestic corporation ceases its prior form of organization and continues in existence as the resulting entity; title to all real estate and other property owned by the converted domestic corporation continues vested in the resulting entity without reversion or impairment; all liabilities of the converted domestic corporation continue as liabilities of the resulting entity; a proceeding pending by or against the converted domestic corporation may be continued as if the conversion did not occur; the shares in the converted domestic corporation that are to be converted into interests, obligations, or securities of the resulting entity or into the right to receive cash or other property are thereupon so converted, and the former shareholders of the converted domestic corporation are entitled only to the rights provided in the plan of conversion or any rights they may have under the North Carolina dissenters’ rights statute;622 and the resulting entity is deemed to agree that it will promptly pay to the dissenting former shareholders of the converted domestic corporation the amount, if any, to which they are entitled under the North Carolina dissenters’ rights statute and otherwise to comply with the requirements of such statute as if it were a corporation.623 This reference to the resulting entity’s responsibility for residual dissenters’ rights obligations is the most salient difference between the NCBCA and DGCL.624

The conversion does not affect the liability or absence of liability of any shareholder of the converted domestic corporation for any acts, omissions or obligations of the converted domestic corporation made or incurred prior to the effectiveness of the conversion. The ending of the converted domestic corporation’s existence in its form as a corporation in the conversion does not constitute a dissolution or termination of the converted domestic corporation.625

If the resulting entity is not a domestic limited liability company or a domestic limited partnership as a result of the conversion, the resulting entity: agrees that it may be served with process in North Carolina for enforcement of any obligation of the converting corporation, the rights of dissenting shareholders of the converting corporation under North Carolina dissenters’ rights statute, and any obligation of the resulting business entity

621 Del. Code Ann. tit. 8, § 266(d). 622 N.C. Gen. Stat. § 55-13. 623 N.C. Gen. Stat. § 55-11A-13(a). 624 There is no case law on the issue, but given the breadth of the DGCL’s language in this regard, there would be an argument that dissenters’ rights obligations would fall within the category of liabilities taken on by the resulting entity by operation of law. 625 Id.

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arising from the conversion;626 and the resulting foreign entity further appoints North Carolina’s secretary of state as its agent for service of process in any such proceeding.627 This particular effect of conversion, as described in NCBCA Section 11A-13(b)(1), is shared by the DGCL, the difference being that in Delaware, this is a matter required to be confirmed and certified in the certificate of conversion. 628

The conversion of a Delaware corporation and the resulting cessation of its existence as a Delaware corporation does not affect any obligations or liabilities the converted domestic corporation incurred prior to its conversion or the personal liability of any person incurred prior to the conversion, nor does it affect the choice of law applicable to the converted domestic corporation with respect to matters arising prior to such conversion.629 Unless otherwise provided in the resolution of conversion, the converted domestic corporation is not required to wind up its affairs or pay its liabilities and distribute its assets, and the conversion does not constitute a dissolution of the converted domestic corporation.630

Shares of stock of the converted Delaware domestic corporation may be exchanged for or converted into cash, property, rights or securities of, or interests in, the resulting entity or, in addition to or in lieu thereof, may be exchanged for or converted into cash, property, shares of stock, rights or securities of, or interests in, another domestic corporation or other entity or may be cancelled.631

When a Delaware corporation converts to another entity or business form, the resulting entity or business form is deemed to be the same entity as the converted domestic corporation. When any conversion becomes effective, all of the rights, privileges and powers of the converted domestic corporation, and all property, real, personal and mixed, and all debts due to the converted domestic corporation, as well as all other things and causes of action belonging to the converted domestic corporation, remain vested in the resulting entity or business form to which the converted domestic corporation has converted and are the property of the resulting entity or business form, and the title to any real property vested by deed or otherwise in the converted domestic corporation does not revert nor is it impaired because of the conversion. However, all rights of creditors and all liens upon any property of the converted domestic corporation are preserved unimpaired, and all debts, liabilities and duties of the converted domestic corporation remain attached to the resulting entity or business form to which

626 N.C. Gen. Stat. § 55-11A-13(b)(1). 627 Service on the secretary of state of any such process may be made by delivering to and leaving with the secretary of state, or with any clerk authorized by the secretary of state to accept service of process, duplicate copies of the process and the fee required by North Carolina General Statutes Section 55-1-22(b). Upon receipt of service of process on behalf of a resulting entity, the secretary of state will immediately mail a copy of the process by registered or certified mail, return receipt requested, to the resulting entity. If the resulting entity is authorized to transact business or conduct affairs in North Carolina, the address for mailing will be its principal office designated in the latest document filed with the secretary of state that is authorized by law to designate the principal office or, if there is no principal office on file, its registered office. If the resulting entity is not authorized to transact business or conduct affairs in North Carolina, the address for mailing will be the mailing address designated in the articles of conversion pursuant to N.C. Gen. Stat. § 55-11A-12(a)(2). 628 Del. Code Ann. tit. 8, § 266(c). For a related discussion, see supra note 617 and accompanying text. 629 Del. Code Ann. tit. 8, § 266(e). 630 Del. Code Ann. tit. 8, § 266(f). 631 Del. Code Ann. tit. 8, § 266(g).

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the converted domestic corporation has converted, and may be enforced against it to the same extent as if said debts, liabilities and duties had originally been incurred or contracted by it in its capacity as the converting other entity or business form. The rights, privileges, powers and interest in property of the converted Delaware domestic corporation, as well as the debts, liabilities and duties of the converted domestic corporation, are not deemed, as a consequence of the conversion, to have been transferred to the resulting entity or business form to which the converted domestic corporation has converted.632

9. Dissenters’ Rights and Exclusivity of Remedy

a) North Carolina

(1) Right to Dissent and Obtain Payment for Shares

In the case of certain corporate actions, the NCBCA allows shareholders affected by the action to dissent and receive the “fair value” of their shares rather than participate in the transaction. The “fair value” that a dissenting shareholder is eligible to receive equals “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.”633 The corporation determines fair value.634 Note that in North Carolina the right of dissent and appraisal is currently afforded to both voting and non-voting shares.635

(2) Corporate Actions Giving Rise to Dissenters’ Rights

Under the NCBCA, six types of corporate action create dissenters’ rights.

Merger. The consummation of a plan of merger to which the corporation is a party will generally give rise to dissenters’ rights. There are two exceptions (in addition to the exception for publicly traded shares as described in Section III.G.9.a)(4) below). First, shareholders do not have a right to dissent and obtain payment if NCBCA Section 11-03(g) does not require initial shareholder approval, as discussed above.636 Second, no dissenters’ rights exist if the shares are redeemable by the corporation at a price that is lesser than or equal to the cash to be received in exchange for such shares.637 If the amount a shareholder will receive for his shares in a transaction is greater than the amount the corporation would have to pay to redeem the shares, there would be no reason for a rational shareholder to object to the

632 Del. Code Ann. tit. 8, § 266(h). 633 N.C. Gen. Stat. § 55-13-01(3). 634 See N.C. Gen. Stat. § 55-13-25(a). 635 For a discussion of the extension of these rights to non-voting shares, see Robinson, II, supra note 290, § 27.02[1], note 2. This aspect of the North Carolina statute is subject to revision, as described below in this section of this study. 636 For a more complete discussion, see Section III.G.5 of this study. 637 N.C. Gen. Stat. § 55-13-02(a)(1).

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transaction. The shareholders of a parent corporation involved in a short-form merger with a subsidiary638 are not eligible for dissenters’ rights.

Share Exchange. The consummation of a plan of share exchange will give rise to dissenters’ rights on the part of shareholders of the corporation whose shares are being acquired in the exchange (even though a shareholder may hold shares of a class different from the class being exchanged). As is the case with mergers, no dissenters’ rights exist if the shares are redeemable by the corporation at a price lesser than or equal to the cash to be received in the exchange.639

Conversion. Dissenters’ rights are triggered by consummation of a plan of conversion pursuant to part 2 of Article 11A of Chapter 55, whereby a North Carolina corporation may convert to a different type of business entity.640

Sale of Assets. Consummation of a sale or exchange of all, or substantially all, of the property of a corporation generally creates dissenters’ rights. This includes a sale in dissolution. If a sale (a) is conducted pursuant to a court order, (b) consists of a transfer by a parent to its wholly owned subsidiary or (c) is under a plan of dissolution where all or substantially all of the net proceeds of the sale are distributed to shareholders within one year after the date of sale,641 dissenters’ rights are not created. Further, no right to dissent exists if the sale or exchange is of the type permitted by NCBCA Section 12-01 (sale of assets in the regular course of business or mortgage of assets).642

Certain Amendments to the Articles of Incorporation. Dissenters’ rights are created in the case of amendments to a corporation’s articles of incorporation that “materially and adversely affect rights in respect of a dissenters’ shares” in one of the following ways:

� Altering or abolishing a preferential right of the shares;

� Creating, altering, or abolishing a right in respect of redemption;

� Altering or abolishing a preemptive right of the holder of the shares to acquire shares or other securities;

� Excluding or limiting the right of the shares to vote on any matter, or to cumulate votes;

638 For a more complete discussion, see Section III.G.3.d of this study. 639 N.C. Gen. Stat. § 55-13-02(a)(2). 640 N.C. Gen. Stat. § 55-13-02(a)(2a). 641 The statute does not address what remedy shareholders may have if the proceeds are not paid out within such period, or if the corporation uses proceeds to repay other obligations (given that the operative language triggering appraisal rights refers to distribution of “all or substantially all of the net proceeds” of the sale). See Robinson, II, supra note 290, § 27.02[3]. 642 N.C. Gen. Stat. § 55-13-02(a)(3).

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� Reducing the number of shares owned by the shareholder to a fraction of a share if the fractional share is to be acquired for cash under NCBCA Section 6-04 (whereby a corporation may pay in money the value of fractions of a share); or

� Changing the corporation into a nonprofit corporation or a cooperative organization.

An amendment permitting action without a meeting to be taken by less than all shareholders entitled to vote, without advance notice, or both, as provided in NCBCA Section 7-04, does not give rise to dissenters’ rights under this section.643

Dissenters’ Rights Granted by the Corporation. Dissenters’ rights exist with respect to any corporate action taken pursuant to a shareholder vote to the extent that such rights are provided by the articles of incorporation, bylaws, or a resolution of the board of directors.644

(3) Exclusivity of Remedy

If a shareholder is entitled to dissent and obtain payment as a result of one of the foregoing corporate actions, then the shareholder is not permitted to challenge the corporate action that gave rise to the dissenters’ rights, unless the action itself was unlawful or fraudulent with respect to the shareholder or the corporation.645 Barring fraud or illegality, dissenters’ rights are the exclusive remedy of a shareholder who is dissatisfied with the transaction and wishes to be paid fair value for his shares.

(4) Exception for Publicly Traded Shares

Notwithstanding the statutory provisions discussed above, a merger, share exchange, or asset sale does not give rise to dissenters’ rights if (1) the affected shares are listed on a national securities exchange or are designated as a national market system security on an interdealer quotation system by the NASD or (2) held by at least 2,000 record shareholders.646 The rationale for this exception is that if these conditions exist, there is a ready, liquid trading market in the shares and shareholders who are dissatisfied with the proposed transaction can receive fair value for their shares simply by selling them on the open market.

There are two circumstances in which this “market out” exclusion is not available: (1) when the articles of incorporation, bylaws, or a board resolution provide otherwise, or (2) when the shareholders are required to accept anything other than cash, shares

643 N.C. Gen. Stat. § 55-13-02(a)(4). 644 N.C. Gen. Stat. § 55-13-02(a)(5). 645 N.C. Gen. Stat. § 55-13-02(b). 646 N.C. Gen. Stat. § 55-13-02(c).

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that are listed on a national exchange or held by at least 2,000 record holders, or both, in exchange for their shares in a merger or share exchange.647

(5) Dissent by Nominees and Beneficial Owners

In general, a record shareholder must assert dissenters’ rights as to all of the shares registered in his name. A record shareholder cannot dissent and demand fair value as to some of his shares and participate in the proposed transaction with respect to others. However, a record shareholder may assert dissenters’ rights as to fewer than all the shares registered in his name if he dissents with respect to all the shares beneficially owned by any one person and notifies the corporation in writing of the name and address of each person on whose behalf he asserts dissenters’ rights.648 This allows a broker or other nominee who holds the interests of many beneficial owners in “street name” to dissent on behalf of those beneficial owners who chose to dissent, while participating in the transaction on behalf of those beneficial owners who elected not to dissent.

A beneficial owner must dissent with respect to all of the shares he beneficially owns. No partial dissent is permitted.649 A beneficial owner may assert dissenters’ rights only with the written consent of the record shareholder who holds the shares on his behalf.650

(6) Procedure for Exercise of Dissenters’ Rights

The North Carolina statute sets forth a very specific procedure to be followed by both the corporation and the dissenting shareholder. Failure to observe this procedure can negate the rights entirely.

Notice of Dissenters’ Rights. The corporation must determine whether a proposed action gives rise to dissenters’ rights. If a proposed action creating dissenters’ rights is submitted to a vote at a shareholders’ meeting, then the notice of meeting must state that shareholders are or may be entitled to dissenters’ rights and must be accompanied by a copy of Article 13 of Chapter 55 regarding dissenters’ rights.651 If the action is taken without a shareholder vote or by shareholder action without a meeting under Section 7-04, then the corporation must notify the shareholders of the action within ten days and send them the dissenters’ notice described above.652 The corporation’s failure to send the required notice of dissenters’ rights does not invalidate the corporate action. It does, however, give a shareholder the right to sue the corporation for damages unless the shareholder voted in favor of the action.653

Notice of Intent to Demand Payment. If an action creating dissenters’ rights is submitted to a vote at a shareholders’ meeting, a shareholder who wishes to

647 Id. Note that North Carolina’s formulation of the exceptions to the “market-out” exception differs somewhat from Delaware’s, as described infra at notes 677–680 and text supported thereby. 648 N.C. Gen. Stat. § 55-13-03(a). See also infra note 674 and text supported thereby. 649 N.C. Gen. Stat. § 55-13-03(b)(2). 650 N.C. Gen. Stat. § 55-13-03(b)(1). 651 N.C. Gen. Stat. § 55-13-20(a). 652 N.C. Gen. Stat. § 55-13-20(b). 653 N.C. Gen. Stat. § 55-13-20(c).

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assert dissenters’ rights must give, and the corporation must actually receive, written notice of the shareholder’s intent to dissent and demand payment for his shares if the action is effectuated. This notice must be received before the vote is taken.654 Furthermore, the dissenting shareholder must not vote his shares in favor of the proposed action.655 A shareholder’s failure to provide the corporation with this notice disqualifies him from receiving payment of fair value for his shares.656 Because the proper exercise of dissenters’ rights creates an unknown post-closing liability, it is common for one or both parties to a merger to condition their obligations to close on no more than a specified percentage of eligible shares exercising dissenters’ rights.

Dissenters’ Notice. If the action giving rise to the dissenters’ rights is approved at a shareholders’ meeting, then the corporation must mail a written dissenters’ notice to all shareholders who notified the corporation of their intent to demand payment. This notice must be sent to the shareholders via registered or certified mail, return receipt requested.657 The corporation must send this notice no later than ten days after shareholder or board approval of the action. The notice must contain the following information:

� Where the payment demand must be sent and where and when certificates for certificated shares must be deposited;

� To what extent transfer of uncertificated shares will be restricted after the payment demand is received;658

� A form for demanding payment;

� The date by which the corporation must receive the payment demand (between thirty and sixty days after the date the dissenters’ notice is mailed); and

� A copy of Article 13 of Chapter 55 of the General Statutes of North Carolina (regarding dissenters’ rights).659

The corporation has sixty days after the date set for demanding payment and depositing share certificates within which to take the proposed action. If the action is not taken within this time frame, then the corporation must return any deposited certificates and release any transfer restrictions placed on uncertificated shares.660

Dissenters’ Duty to Demand Payment. If a shareholder is sent a dissenters’ notice, then he must demand payment and deposit his share certificates in the manner

654 N.C. Gen. Stat. § 55-13-21(a)(1). 655 N.C. Gen. Stat. § 55-13-21(a)(2). 656 N.C. Gen. Stat. § 55-13-21(b). 657 N.C. Gen. Stat. § 55-13-22(a). 658 A corporation may restrict the transfer of uncertificated shares from the date the demand for their payment is received until the proposed corporate action is taken or the restrictions are released due to the corporation’s failure to take action under NCBCA Section 13-26. N.C. Gen. Stat. § 55-13-24. 659 N.C. Gen. Stat. § 55-13-22(b)(1) – (5). 660 N.C. Gen. Stat. § 55-13-26(a).

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set forth in the notice.661 Failure to do so makes a shareholder ineligible to receive payment of fair value for his or her shares.662

Payment. As soon as the corporate action is taken, or within thirty days after receipt of a payment demand from the dissenter, the corporation must pay each dissenter who complied with the requirements described above the amount the corporation estimates to be the fair value of his shares, plus interest accrued to the date of payment.663 The corporation must send the following to the dissenter along with payment:

� The corporation’s balance sheet, income statement, and statement of cash flows as of the end of a fiscal year ending not more than 16 months before the date of payment, plus the latest available interim financial statements;

� An explanation of how the corporation estimated the fair value of the shares;

� An explanation of how the interest was calculated;

� A statement of the dissenters’ right to demand payment if dissatisfied with the amount paid; and

� A copy of Article 13 of Chapter 55 of the General Statutes of North Carolina (regarding dissenters’ rights).664

Dissenters’ Dissatisfaction with Corporation’s Calculations or Failure to Perform. Since it is left in the corporation’s sole discretion to calculate fair value and interest,665 it is perhaps inevitable that some dissenters will disagree with the corporation’s estimate of fair value or calculation of interest due. If:

� the dissenter believes that the amount paid is less than fair value or that the interest has been incorrectly calculated,

� the corporation has failed to make payment altogether, or

� the corporation has failed to return deposited certificates or release the transfer restrictions on uncertificated shares after not taking the proposed action;

661 N.C. Gen. Stat. § 55-13-23(a). 662 N.C. Gen. Stat. § 55-13-23(c). 663 N.C. Gen. Stat. § 55-13-25(a). 664 N.C. Gen. Stat. § 55-13-25(b)(1) – (5). 665 See N.C. Gen. Stat. § 55-13-25(a).

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then a dissenter may notify the corporation of his own estimate of fair value and interest and demand payment of that amount.666 A dissenter has thirty days from the date the corporation made its initial payment or failed to timely perform in order to make such a demand.667

Judicial Appraisal of Shares. If a dissenter’s demand for payment remains unsettled, the dissenter may commence a proceeding against the corporation in the Superior Court Division of the General Court of Justice.668 The court may appoint one or more persons to serve as appraisers to receive evidence and recommend a decision on the question of fair value.669 If the court finds that the corporation did not comply with the statutory requirements outlined above, it may assess legal fees and expenses against the corporation.670

(7) Proposed North Carolina Amendments.

As of the publication of this study, a committee of the Business Section of the North Carolina Bar Association is considering the proposal to the North Carolina General Assembly of certain amendments to Article 13 of the NCBCA, to effect the following changes: (a) to change the applicable nomenclature under the statute, to refer simply to the right of appraisal, as opposed to the rights of dissent and appraisal;671 (b) to limit the right of appraisal to shares with voting rights (which change would result in a contrast to Delaware law, as described below); and (c) modify the requirement regarding the surrender of share certificates following the vote on the underlying transaction.672 Practitioners are advised to research the state of North Carolina law regarding Article 13 of Chapter 55 of the NCBCA before advising clients on matters of dissent and appraisal.

b) Delaware

The Delaware appraisal rights statute is very similar to the North Carolina statute, although its provisions are not (for the most part) quite as detailed. Under Delaware law, most types of mergers and consolidations give rise to appraisal rights pursuant to DGCL Section 262. Appraisal rights are not available for holding company reorganizations or parent-subsidiary mergers in which the parent corporation owns one hundred percent of the subsidiary

666 N.C. Gen. Stat. § 55-13-28(a)(1) – (3). 667 N.C. Gen. Stat. § 55-13-28(b). 668 N.C. Gen. Stat. § 55-13-30(a). This aspect of the statute may raise procedural difficulties. The statute does not require that an appraisal action be commenced in any specific superior court of North Carolina (whereas the DGCL requires that the action be commenced in the court of chancery, and the Revised Model Act requires that the action be commenced in the appropriate court of the county where the corporation’s principal office is located). Since under the NCBCA the superior court may, but is not required to, join all dissenters into a single proceeding, there is a potential for multiple suits in different North Carolina courts (though “[t]he jurisdiction of the superior court in which the proceeding is commenced under . . . is plenary and exclusive”). See N.C. Gen. Stat. § 55-13-30(c),(d). 669 N.C. Gen. Stat. § 55-13-30(d). 670 N.C. Gen. Stat. § 55-13-31(b)(1). 671 The term “dissent” is misleading, given that there is no requirement that a shareholder vote against a transaction in order to preserve a right to an appraisal. The only requirement is that the shareholder not vote in favor of the transaction. N.C. Gen. Stat. § 55-13-21(a)(2). This change would make the North Carolina statute consistent with both the DGCL and the Revised Model Act. 672 In situations involving significant gaps of time between shareholder approval and closing of the transaction, the share surrender requirement raises uncertainties with respect to voting on other matters.

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corporation.673 Such rights are also not available for any shares of stock of the constituent corporation surviving a merger if the merger did not require for its approval the vote of the stockholders of the surviving corporation as provided in Section 251(f) (with respect to short form mergers).

One subtle difference between the DGCL and NCBCA, as it relates to the parties to whom the right of appraisal is extended, concerns the concept of “record owner.” The NCBCA, as discussed above, enables the record shareholder to assert rights of dissent and appraisal on behalf of beneficial owners in whose name the record shareholder holds the shares (for example, in street name). A beneficial owner, in addition, may directly assert dissenters' rights as to shares held on his behalf if he submits to the corporation the record shareholder's written consent to the dissent not later than the time the beneficial shareholder asserts dissenters' rights, and he does so with respect to all shares of which he is the beneficial shareholder. The DGCL, by contrast, directly affords to beneficial holders the right to file a petition for appraisal, but without such stipulations.674

Note that, unlike the NCBCA, the DGCL speaks in terms of the right of appraisal, rather than the right of dissent and appraisal.675 In addition, under the DGCL the right of appraisal is afforded to both voting and non-voting shares (and is thus currently consistent with the NCBCA, at least until the NCBCA undergoes amendment in this respect).676

(1) Exception for Publicly Traded Shares

Like North Carolina, Delaware has a “market-out” exception whereby appraisal rights are not available for shares that are either listed on a national securities exchange or held of record by more than 2,000 holders.677 In addition, as in North Carolina, there are circumstances under Delaware law in which the market-out exception is not available. Appraisal rights are available if the stockholders are required to accept anything in exchange for their shares other than:

� Shares of stock of the corporation surviving the merger or resulting from the consolidation;678

� Shares of stock of a corporation that is either listed on a national securities exchange or held of record by more than 2,000 holders;

� Cash in lieu of fractional shares;679 or

673 Del. Code Ann. tit. 8, § 262(b) and (b)(3). 674 N.C. Gen. Stat. § 55-13-03(a); Del. Code Ann. tit. 8, § 262(e). 675 This aspect of the NCBCA is subject to amendment. See supra notes 671–672 and text supported thereby. 676 See the discussion above regarding certain proposed amendments to Article 13 of Chapter 55 of the NCBCA (at notes 671–672 and text supported thereby). Note also that the DGCL grants nonvoting stockholders the right of appraisal not by expressly including them in the list of stockholders granted that right, but rather by not affirmatively excluding nonvoting stockholders from participating. 677 Del. Code Ann. tit. 8, § 262(b)(1). 678 Note that the NCBCA does not have this exception to the “market-out” exception. See N.C. Gen. Stat. § 55-13-02(c)(2).

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� Any combination of the foregoing.680

(2) Appraisal Rights Granted by the Corporation

A Delaware corporation may provide in its certificate of incorporation that appraisal rights are available as a result of an amendment to its certificate of incorporation, any merger or consolidation involving the corporation, or the sale of all or substantially all of the assets of the corporation.681 Note that, unlike North Carolina, amendments to the certificate of incorporation and sales of assets do not automatically trigger the appraisal remedy in Delaware, as the certificate of incorporation must first grant the appraisal remedy as a condition to availability in such circumstances. As noted above, North Carolina corporations are permitted to create dissenters’ rights through their articles of incorporation, bylaws, and board resolutions, but only with respect to a corporate action taken pursuant to a shareholder vote.682 On the whole, there are more situations that automatically give rise to dissenters’ rights under the North Carolina statute than under the Delaware statute (to be distinguished from rights that arise out of grants in the corporate charter).683

(3) Procedure for Exercise of Appraisal Rights

Both the North Carolina and Delaware statutes provide for the payment of “fair value,” which in both states excludes any value arising from the transaction giving rise to dissenters’ rights.684 The Delaware statute allows either the corporation or an eligible stockholder to commence an appraisal proceeding in the court of chancery whereby the court determines the fair value of the shares (whereas the NCBCA requires that the dissenting shareholder bring the action).685 In North Carolina, fair value is initially determined by the corporation, which must pay dissenters who fulfill the statutory requirements.686 Only after a dissenter’s demand for payment remains unsettled may a dissenting shareholder commence a proceeding against the corporation under the North Carolina statute.687 However, the surviving or resulting corporation in Delaware and dissenting shareholders may reach agreement as to the value of their shares prior to the commencement of an appraisal proceeding.688

Both the DGCL and the NCBCA provide for the payment of interest, along with “fair value.” The DGCL specifically states that “interest from the effective date of the merger through the date of payment of the judgment shall be compounded quarterly and shall accrue at 5% over the Federal Reserve discount rate (including any surcharge) as established from time to time during the period between the effective date of the merger and the

679 The NCBCA includes the exception for cash in lieu of fractional shares, and in addition for cash as consideration generally. Id. 680 Del. Code Ann. tit. 8, § 262(b)(2)(a)–(d). 681 Del. Code Ann. tit. 8, § 262(c). 682 N.C. Gen. Stat. § 55-13-02(a)(5). The comparable provision of the DGCL contains no such express requirement. 683 As discussed above, in North Carolina, dissenters’ rights are created generally in the case of mergers, share exchanges, conversions, sales of assets, and certain amendments to the articles of incorporation. 684 Del. Code Ann. tit. 8, § 262(h); N.C. Gen. Stat. § 55-13-01. 685 Del. Code Ann. tit. 8, § 262(e), (h); N.C. Gen. Stat. § 55-13-30. 686 N.C. Gen. Stat. § 55-13-25(a). 687 N.C. Gen. Stat. § 55-13-30(a). 688 Del. Code Ann. tit. 8, § 262(f).

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date of payment of the judgment.”689 By contrast, the NCBCA does not define how interest is to be calculated.

The procedure followed by both corporations and dissenting shareholders is similar in North Carolina and Delaware. If a proposed merger or consolidation for which appraisal rights are provided for is to be submitted for stockholder approval, a Delaware corporation must send notice to the stockholders at least twenty days prior to the meeting that appraisal rights are available and include a copy of DGCL Section 262. Stockholders who elect to demand appraisal must deliver a written demand for appraisal prior to the vote.

Within ten days after the effective date of the merger, the surviving or resulting corporation must notify each dissenting stockholder of the date the merger or consolidation became effective.690 If a merger or consolidation giving rise to the appraisal remedy is approved without a stockholder vote, the corporation must notify the stockholders either before the effective date or within ten days thereafter that appraisal rights are available. Dissenters must then submit written demands as described above.691 This procedure closely mirrors the procedure to be followed under North Carolina law.

One procedural difference between the two states’ statutes concerns the surrender of stock certificates. Under the DGCL, “[t]he Court may require the stockholders who have demanded an appraisal for their shares and who hold stock represented by certificates to submit their certificates of stock to the Register in Chancery for notation thereon of the pendency of the appraisal proceedings; and if any stockholder fails to comply with such direction, the Court may dismiss the proceedings as to such stockholder.”692 By contrast, the NCBCA automatically requires the surrender of stock certificates by a dissenting shareholder demanding payment following the shareholder vote approving the underlying transaction.693

Stockholders who submit a written demand as required may commence an appraisal proceeding in the court of chancery within 120 days after the effective date of the merger or consolidation.694 The surviving or resulting corporation must receive service of the petition, and then has twenty days to file a list containing the names and addresses of all stockholders who demanded payment for their shares and with whom no agreement exists as to the value of their shares. The court then conducts a hearing to determine fair value and directs payment thereof to the dissenting stockholders.695

(4) Exclusivity of Remedy

Unlike the North Carolina statute, the Delaware statute does not explicitly state that it serves as the exclusive remedy for dissatisfied stockholders. However, the

689 Del. Code Ann. tit. 8, § 262(h). 690 Del. Code Ann. tit. 8, § 262(d)(1). 691 Del. Code Ann. tit. 8, § 262(d)(2). 692 Del. Code Ann. tit. 8, § 262(g). 693 N.C. Gen. Stat. § 55-13-23(a). Note that this aspect of the NCBCA is subject to proposed amendment, as discussed, supra, at notes 671–672 and text supported thereby. 694 Del. Code Ann. tit. 8, § 262(e). 695 Del. Code Ann. tit. 8, § 262(g) – (j).

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Delaware courts have indicated that the appraisal remedy may or may not be an exclusive remedy depending on the circumstances. In Weinberger v. UOP,696 the Delaware Supreme Court held that the appraisal remedy may be exclusive except “where fraud, misrepresentation, self-dealing, deliberate waste of corporate assets, or gross and palpable overreaching are involved.” Thus, in both states the appraisal remedy is exclusive unless the dissenting shareholder can prove fraud or illegality.

H. Dividends and Distributions

1. General

North Carolina law uses the term “distribution” to refer to any transfer of money or other property, or incurrence of indebtedness by the corporation, to or for the benefit of shareholders in respect of any of their shares.697 A distribution includes any payment of a dividend, whether in cash, stock or property, and any purchase, redemption or other acquisition of shares.

In Delaware, the term “dividend” refers to any payment to stockholders as a return upon their investment.698 The rules applicable to dividends in Delaware do not appear to apply to purchases, redemptions or other acquisitions of shares by the corporation.699

2. Surplus

a) Delaware Law

The DGCL distinguishes between “capital” and “surplus” in order to determine “the source from which dividends may be paid to [a corporation’s] stockholders on their outstanding shares.”700 Generally, in order for dividends to be lawful, they must be paid from surplus (or, in case there shall be no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year).701 The board of directors has wide discretion in determining the amounts of capital and surplus, except that “an amount equal to the par value of all shares with par value must be allocated to capital.”702 The amount of capital must be determined first, because surplus is defined as the portion of the net assets that exceeds capital.703 Under Delaware law, there is no prescribed method for calculating the surplus

696 457 A.2d 701 (Del. 1983). 697 N.C. Gen. Stat. § 55-1-40(6) (2008). 698 Penington v. Commonwealth Hotel Const. Corp., 17 Del. Ch. 394, 399, 155 A. 514, 517 (Del. 1931). For a discussion of the different kinds of payments and distributions that may or may not constitute dividends under Delaware law, see Edward P. Welch, Andrew J. Turezyn, Robert S. Saunders, supra note 320, § 171.1 et seq. 699 Sections 172 and 174 of the DGCL, however, address liability of directors for unlawful dividends and redemptions. Redemptions and stock repurchases are discussed generally in Section III.H.5. of this study. 700 Balotti & Finkelstein, supra note 552, § 5.22. 701 Del. Code Ann. tit. 8, § 170. 702 Balotti & Finkelstein, supra note 552, § 5.22. 703 Del. Code Ann. tit. 8, § 154.

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amount.704 Generally, the courts will defer to the board’s judgment, unless there is evidence of bad faith or fraud.705

b) North Carolina Law

The NCBCA “eliminat[ed] all rules relating to capital, surplus and par value that [previously] applied to North Carolina corporations.”706 Therefore, the notion of surplus no longer plays a role in determining whether a corporation can make distributions.707 The ability to make distributions is now controlled by the equity insolvency and balance sheet tests, which are discussed in Section 3(b), below.

3. Solvency Requirements

a) Delaware Law

Under Delaware law, there is no express solvency requirement that must be satisfied before dividends may be paid. However, under the DGCL “if the capital of the corporation . . . [has] been diminished by depreciation in the value of its property, or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock” with preference upon distribution of assets, then no dividends can be paid until the deficiency in the capital is “repaired.”708 Therefore, while a formal appraisal is not required, directors are “under a duty to evaluate the assets on the basis of acceptable data and by standards which they are entitled to believe reasonably reflect present ‘values’.”709 Therefore, solvency plays an indirect role in determining whether a dividend can be paid in Delaware.


The NCBCA sets forth a twofold test for solvency, both prongs of which must be satisfied. The corporation must be solvent on the basis of both the “equity insolvency” test and the “balance sheet” test.710 Under the equity insolvency test, the corporation must be able to “pay its debts as they become due in the usual course of business after giving effect to the distribution.”711 This test relies on the business judgment of the directors to determine whether the corporation is able to pay its debts.712 Under the balance sheet test, “[t]he corporation’s total assets [cannot] be less than the sum of its total liabilities.”713 In its application of the equity insolvency test and the balance sheet test, the board of directors of the corporation (i) may determine that a distribution is not prohibited on the basis of financial statements prepared in accordance with reasonable accounting practices and principles and (ii) may value assets based

704 Balotti & Finkelstein, supra note 552, § 5.22. 705 Id. 706 Robinson, II, supra note 290, § 19.01[1]. 707 Id. 708 Del. Code Ann. tit. 8, § 170(a). 709 Morris v. Standard Gas and Electric Co., 63 A.2d 577, 581 (Del. Ch. 1949). 710 Robinson, II, supra note 290, § 22.02; see also N.C. Gen. Stat. § 55-6-40(c). 711 N.C. Gen. Stat. § 55-6-40(c). 712 Robinson, II, supra note 290, § 22.02. 713 N.C. Gen. Stat. § 55-6-40(c).

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on either book values or any other fair valuation or reasonable means under the circumstances.714 The corporation must satisfy both tests before a distribution can be made.715

4. Nimble Dividends

a) Delaware Law

In the absence of a surplus, Delaware law allows dividends to be paid from the net profits of either the current or the previous fiscal year.716 These net profits are sometimes referred to as “nimble dividends.”717 Nimble dividends generally may not be paid when the capital has been impaired by depreciation, losses or otherwise.718 However, since 1955, the Delaware Supreme Court has construed the statute in such a way that nimble dividends may be paid even when the capital has been impaired, so long as there are current earnings, and the corporate charter provides for payment out of earnings.719 In contrast, if the corporate charter provides for payment out of the surplus alone, then dividends may not be paid in the absence of a surplus.720


“‘Nimble dividends’ . . . were expressly authorized under former North Carolina General Statutes Section 55-50(a)(2). That provision was not brought forward in the NCBCA as adopted in 1990.”721 Therefore, the concept of nimble dividends has become irrelevant under current North Carolina law, along with notions of capital and surplus.722

5. Share Purchases

a) Delaware Law

Under Delaware law, a corporation may “purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use, and otherwise deal in and with its own shares.”723 However, a corporation may not purchase or redeem its own shares for cash or other property when the capital of the corporation is “impaired” or when the purchase or redemption “would cause any impairment of the capital of

714 N.C. Gen. Stat. § 55-6-40(d). 715 Id. 716 Del. Code Ann. tit. 8, § 170. 717 Balotti & Finkelstein, supra note 552, § 5.26. 718 Del. Code Ann. tit. 8, § 170. 719 Weinberg v. Baltimore Brick Co., 35 Del. Ch. 225, 114 A.2d 812 (Del. 1955). In Baltimore Brick, the court justified its position by stating that “the disbursement of current earnings for dividends leaves untouched the capital assets existing before the payment. This is exactly what is contemplated by the present statute.” Id. at 239-240, 820. The court further reasoned that this construction of the statute honored the corporate framers’ intent that “the dividends should be currently paid if legally possible to do so.” Id. at 235, 817. Therefore, the payment of nimble dividends is allowed when there are current earnings, so long as it is not prohibited by the corporate charter. Del. Code Ann. tit. 8, § 170. 720 Id. 721 North Carolina Commentary to N.C. Gen. Stat. § 55-6-40; see N.C. Gen. Stat. § 55-6-40. 722 Robinson, II, supra note 290, § 19.01[1]. 723 Del. Code Ann. tit. 8, § 160(a).

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the corporation.”724 Although the statutory language does not provide guidance regarding the interpretation of capital impairment, Delaware courts have construed the impairment of capital to mean a reduction of the assets of the corporation to an amount less than the stated capital attributed to the corporation’s aggregate outstanding shares.725 Thus, a Delaware corporation may purchase its shares only to the extent that a surplus is available.726 Additionally, a Delaware corporation may not purchase any of its shares that are redeemable at the option of the corporation for a price higher than that at which they may be redeemed.727 With respect to the determination of surplus and solvency for Delaware corporations, “directors have reasonable latitude to depart from the balance sheet to calculate surplus, so long as they evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud.”728


Under North Carolina law, a distribution may take the form of a purchase, redemption or other acquisition of shares by a corporation.729 A North Carolina corporation may acquire its own shares and shares acquired thereby constitute authorized but unissued shares.730 Apart from the foregoing authority, North Carolina courts provide that a corporation has the inherent power to buy or acquire its own shares unless such power is restrained by its articles of incorporation or a particular statute.731 If the articles of incorporation prohibit the reissue of the acquired shares, the corporation must reduce the number of authorized shares by the number of shares acquired.732

With respect to the acquisition of shares, North Carolina provides that “the acquisition must be entirely free from fraud and not prejudicial to the rights of creditors, so that an insolvent corporation cannot buy its own stock.”733 Because the acquisition of shares by a corporation constitutes a distribution, the acquisition is subject to the same solvency requirements applicable to the issuance of dividends.734 Accordingly, with respect to the determination of solvency, no acquisition of shares may be made if, after giving it effect, (i) the corporation would be unable to meet the requirements of the equity insolvency test, i.e., “pay its debts as they become due in the usual course of business,” or (ii) the corporation would be unable to meet the requirements of the balance sheet test, i.e., “the total assets of the corporation would be less than the sum of its total liabilities plus the amount needed to satisfy liquidation preferences.”735 In its solvency assessment, the board of directors of the corporation may use

724 Del. Code Ann. tit. 8, § 160(a)(1). 725 In Re International Radiator Co., 92 A. 255, 256 (Del. Ch. 1914). 726 Id. 727 Del. Code Ann. tit. 8, § 160(a)(2). 728 Klang v. Smith’s Food & Drug, 702 A.2d 150, 153 (Del. Ch. 1997). 729 N.C. Gen. Stat. § 55-1-40(6). 730 N.C. Gen. Stat. § 55-6-31(a). 731 Aydlett v. Major & Loomis Co., 211 N.C. 548, 191 S.E. 31 (1937); Robinson, II, supra note 290, § 22.01. 732 N.C. Gen. Stat. § 55-6-31(b). 733 Robinson, II, supra note 290, § 22.01. 734 Id., § 22.02. 735 N.C. Gen. Stat. § 55-6-40(c).

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book values, fair valuation or any other means to value the assets that are reasonable under the circumstances.736

Thus, both North Carolina and Delaware permit a corporation to purchase its own shares provided the acquisition is free from fraud and prejudice with respect to the rights of creditors. Provided a Delaware corporation demonstrates that a sufficient surplus exists to prevent capital impairment, the Delaware corporation can acquire its shares. Likewise, provided a North Carolina corporation demonstrates that it meets the solvency requirements set forth above, the North Carolina corporation can acquire its shares.

6. Dates for Determination of Surplus and Solvency

a) Delaware Law

As discussed above, the amount of surplus (the primary basis for the payments of dividends for a Delaware corporation) can be determined only after the amount of capital is determined. In Delaware, the board of directors has wide discretion in determining the capital and surplus amounts.737 On any date when shares with par value are issued for cash, the aggregate par value of the shares is deemed to be capital.738 The board may also resolve that any amount above the aggregate par value is capital.739 If no resolution is made by the board, then the aggregate par value alone will be the capital amount.740 For shares with no par value, the board can choose an amount to be deemed as capital on the date of issue.741 If the board does not make this determination, then the total amount of consideration received by the corporation upon issuance of the shares will be deemed to be capital.742 For shares both with and without par value, if the shares are issued “for consideration other than cash,” then the board has sixty days to make a determination of the capital amount.743 If the corporation does not make a determination within 60 days of what part of the consideration received for shares issued for consideration other than cash shall be capital, the capital in respect of such shares shall be an amount equal to the aggregate par value of such shares having a par value, plus the amount of consideration received for such shares without par value.744

In addition to the initial determination of capital, the board has discretion at any time to increase or decrease the amount of capital.745 For instance, the board has “the option of increasing capital by adopting a resolution to [that] effect whenever surplus exists that can be transferred to capital, or when . . . there is a contribution of assets . . . to the corporation.”746 With respect to reductions in capital, the board is limited only by the “requirement that the assets of the corporation remaining after such reduction shall be sufficient

736 N.C. Gen. Stat. § 55-6-40(d). 737 Balotti & Finkelstein, supra note 552, § 5.22. 738 Del. Code Ann. tit. 8, § 154. 739 Id. 740 Id. 741 Id. 742 Id. 743 Id. 744 Id. 745 Balotti & Finkelstein, supra note 552, § 5.22. 746 Id.

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to pay any debts of the corporation for which payment has not otherwise been provided.”747 Once the amount of capital is determined, then the amount of surplus follows, because surplus is merely the portion of the net assets that exceed the capital.748


North Carolina corporations must use a two-part solvency test to determine whether distributions may be made, as discussed in Section III.H.3. b) of this study, above. The dates for determining solvency under the two solvency tests as set forth in the NCBCA are summarized as follows: the effect of a distribution for purposes of the applicable solvency test is measured:

(1) In the case of distribution by purchase, redemption, or other acquisition of the corporation’s shares, as of the earlier of (i) the date money or other property is transferred or debt incurred by the corporation or (ii) the date the shareholder ceases to be a shareholder with respect to the acquired shares;

(2) In the case of any other distribution of indebtedness, as of the date the indebtedness is distributed;

(3) In all other cases, as of (i) the date the distribution is authorized if the payment occurs within 120 days after the date of authorization or (ii) the date the payment is made if it occurs more than 120 days after the date of authorization.749

As the statute indicates, the dates vary based on the type of distribution that is being made.

Thus, while Delaware corporations must establish a date for determination of surplus, North Carolina corporations must establish a date for determination of solvency. This difference stems from the fact that the two states use different methods for determining when dividends can be paid and distributions can be made.

7. Director Liability for Unlawful Distributions

a) Delaware Law

Delaware law provides for the imposition of joint and several liability on directors who authorize unlawful distributions.750 Directors who dissent or who are absent during the resolution to authorize the distribution, however, “may be exonerated from such liability by causing [their dissent] to be entered on the book containing the minutes of the proceedings of the directors at the time the same was done, or immediately after such [directors have] notice of the

747 Id., § 8.15. 748 Del. Code Ann. tit. 8, § 154. 749 N.C. Gen. Stat. § 55-6-40(e). 750 Del. Code Ann. tit. 8, § 174.

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same.”751 Following the payment of an unlawful dividend, the directors of a Delaware corporation are liable for a period of up to six years.752


In North Carolina, a director may be held personally liable only to the extent that the director “votes for or assents” to the unlawful distribution.753 Additionally, North Carolina extends liability to distributions that are made in violation of a corporation’s articles of incorporation.754 Under North Carolina law, liability remains up to “three years after the date on which the effect of the distribution was measured.”755

Thus, both Delaware and North Carolina impose personal liability upon directors for distributions made in violation of their respective laws governing corporations.756 Moreover, both North Carolina and Delaware allow for contribution from other directors who either voted for or allowed the unlawful distribution.757 Likewise, both states provide directors against whom liability is imposed for unlawful distributions with a right to compensation from shareholders who knowingly accepted such distributions.758 With respect to such right to compensation, the amount the directors may seek from the shareholders is proportionate to the amounts the shareholders received while knowing the distribution to be unlawful.759

8. Right to Compel Dividends

a) Right to Demand Dividend

(1) North Carolina

Unlike Delaware law and that of many other states, North Carolina law provides shareholders of certain North Carolina corporations a statutory right to compel the payment of dividends.760 Furthermore, the North Carolina statute does not limit or otherwise impair any rights that a shareholder may have to compel payment of dividends based on general principles of equity, thus providing such shareholders two avenues of redress.761 The North Carolina statute applies to corporations with fewer than 25 shareholders (as determined as of the final day of the immediately preceding fiscal period). One shareholder is defined to include all co-owners of the same shares; or a corporation, trust, partnership, estate, or other entity; or trustees, guardians, custodians, or other fiduciaries of a single trust, estate, or account; or

751 Del. Code Ann. tit. 8, § 174(a). 752 Id. 753 N.C. Gen. Stat. § 55-8-33(a). 754 Id. 755 N.C. Gen. Stat. § 55-8-33(c). 756 Del. Code Ann. tit. 8, § 174(a); N.C. Gen. Stat. § 55-8-33(a). 757 N.C. Gen. Stat. § 55-8-33(b)(1); Del. Code Ann. tit. 8, § 174(b). 758 N.C. Gen. Stat. § 55-8-33(b)(2); Del. Code Ann. tit. 8, § 174(c). 759 Id. 760 N.C. Gen. Stat. § 55-6-40(i). 761 N.C. Gen. Stat. § 55-6-40(k). See, e.g., Gaines v. Long Manufacturing Co., 234 N.C. 331, 67 S.E.2d 355 (1951); Patterson v. Durham Hosiery Mills, 214 N.C. 806, 200 S.E. 906 (1939); Belk v. Belk Department Store, Inc., 250 N.C. 99, 108 S.E.2d 131 (1959); Steele v. Locke Cotton Mills Co., 231 N.C. 636, 58 S.E.2d 620 (1950).

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shareholdings registered in substantially similar names if it is reasonable to believe that the names represent the same person.762

(2) Delaware

Although Delaware recognizes close corporations – those having up to 30 shareholders – it does not provide preferential treatment for shareholders of close corporations in compelling the payment of dividends. Delaware follows the majority of states in providing directors wide latitude in deciding whether to declare dividends, regardless of the number of shareholders. The decision to declare is subject to solvency and capital requirements, director good faith, and restrictions or rights specified in the certificate of incorporation, such as those granted to preferred shareholders.763 Delaware courts will presume that directors are acting in good faith and will defer to their business judgment in deciding whether to declare dividends.764 A Delaware shareholder will not prevail in an action to compel dividends unless he or she can show self-dealing, fraud, gross abuse of discretion or bad faith,765 even if funds exist from which dividends can be paid.766 Absent such a showing, the directors’ actions will be measured by the intrinsic fairness test.767 Adding to the directors’ latitude is their right to set aside any funds of the corporation available for dividends as a reserve or reserves for any proper purpose, as well as the right to abolish any such reserve.768

b) Requirements for Demand

(1) North Carolina

If, as of the last day of a fiscal period, a North Carolina corporation subject to the compulsory dividend requirements has not paid to any class of shares dividends of cash or property totaling at least one-third of the “net profits” for that fiscal period allocable to that class of shares, then the holder(s) of at least 20% of the shares of that class may make written demand on the corporation for the payment of dividends for that period. However, they must make this demand in writing within four months after the close of that fiscal period.769 Once demand is made, the directors have three months from the end of the current fiscal period to (i) pay dividends in cash or property to the shareholders making demand, in an amount sufficient to make up the difference between any dividends already paid and the required one-third, or the lesser amount demanded; or (ii) give notice to the demanding shareholders that the corporation will repurchase their shares, as further outlined below. The term “net profits” is not

762 N.C. Gen. Stat. § 55-1-42. 763 North Carolina follows similar rules for corporations with more than 25 shareholders and for shareholders of any corporation who elect not to use the statutory procedure. Gaines v. Long Manufacturing Co., 234 N.C. 331, 67 S.E.2d 355 (1951). 764 Levien v. Sinclair Oil Corp., 261 A.2d 911, aff’d in part, rev’d in part, 280 A.2d 717, on remand, 300 A.2d 28, on remand, 314 A.2d 216 (Del. Ch. 1969). 765 See, e.g., Gabelli & Co. Inc. v. Liggett Group, Inc., 479 A.2d 276 (1974); Myerson v. El Paso Natural Gas Co., 246 A.2d 789 (1967); Geller v. Transamerica Corporation, 53 F.Supp. 625, aff’d 151 F.2d 534 (1943). 766 Baron v. Allied Artists Pictures Corp., 337 A.2d 653, appeal dismissed, 365 A.2d 136 (1975). 767 Gabelli & Co. Inc. v. Liggett Group, Inc., 479 A.2d 276 (1974); Harff v. Kerkorian, 324 A.2d 215, aff’d in part, rev’d in part, 347 A.2d 133 (1974). 768 Del. Code Ann. tit. 8, § 171. 769 N.C. Gen. Stat. § 55-6-40(i).

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defined under the North Carolina statute except for the solvency requirement that they be net profits that may be “lawfully paid” to a particular class of shares after making allowance for the prior claims of shares.770

A North Carolina corporation may elect to treat any dividend previously paid in the current fiscal period as having been paid in the preceding fiscal period, and if it does so, it must notify all shareholders of this treatment. If the corporation pays a dividend in satisfaction of a demand made under this statute, then the dividend shall be deemed to have been paid in the period for which it was demanded, and the corporation is required to notify all shareholders of the period to which the payment applies, such notice to be made concurrently with the payment.771

(2) Delaware

Delaware has no comparable statute mandating the payment of dividends, regardless of the number of shareholders.

c) Solvency and other Restrictions on Demand for Dividends in

North Carolina

The right to demand payment of dividends from a North Carolina corporation under this statute is not unlimited. A corporation cannot be compelled to pay dividends under this statute in four circumstances: (i) the dividend payment would exceed 50% of the corporation’s net profits for the fiscal year for which demand is made; (ii) the net profits are being retained to eliminate a deficit; (iii) payment of dividends would be a breach of a bona fide agreement between the corporation and its creditors restricting the payment of dividends; or (iv) the directors can show that the earnings are being retained to meet the reasonably anticipated needs of the business, and that such retention is not inequitable under the circumstances.772 The solvency requirement of NCBCA Section 6-40(c) would constitute a fifth restriction and is implicit in the definition of “net profits.” The statute does not address whether a shareholder can prospectively waive his or her right to compel dividends, but case law decided under prior versions of the statute may permit such waiver.773

d) Proper Parties to North Carolina Actions

(1) North Carolina

North Carolina shareholders demanding payment of a dividend under this statute may file an action against the directors, the corporation, or both.774 However, dividend suits in North Carolina historically have been individual actions.775 If the court orders payment of the dividend, then the shareholder is entitled to recover from the corporation all

770 Id.; see also N.C. Gen. Stat. § 55-6-40(c). 771 N.C. Gen. Stat. § 55-6-40(i). 772 N.C. Gen. Stat. § 55-6-40(i). 773 See Nebel v. Nebel, 241 N.C. 491, 85 S.E.2d 876 (1955) (recognizing estoppel defense under prior statute). 774 N.C. Gen. Stat. § 55-6-40(h). 775 Robinson, II, supra note 290, § 22.06.

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reasonable expenses incurred in maintaining the action, including attorney fees, and the dividends ordered to be paid are deemed to be a debt of the corporation.776

e) Mandatory Redemption of Shares

(1) North Carolina

If a North Carolina corporation elects not to pay the dividend after receiving a demand to do so pursuant to this statute, it must offer to redeem all of the shares of each shareholder making the demand.777 To pursue this option, the corporation must give written notice to each shareholder making the demand, within three months of the end of the fiscal period in question, that it elects to redeem all shares held by the demanding shareholders in lieu of payment of the dividends as required by the statute.778 The corporation must then pay each demanding shareholder the “fair value” of his or her shares as of the day preceding the mailing “or otherwise reasonably dispatching of the notice.”779 The shareholder receiving this notice then has the option to either surrender his or her shares in exchange for payment of their fair value, or to withdraw the demand by giving written notice of the withdrawal of the demand to the corporation within ten days after receiving the redemption notice.780 If the corporation’s articles of incorporation prohibit the reissue of the repurchased shares, then the number of the corporation’s authorized shares is reduced by the number of shares acquired, effective upon amendment of its articles of incorporation.781

“Fair value,” for purposes of the dividend payment statute, is either the amount agreed upon by the corporation and the shareholder, or an amount determined by a majority of three qualified and disinterested appraisers appointed by the clerk of court. If the parties agree on the amount to be paid within 30 days after the shareholder becomes entitled to payment for his or her shares (which is the date the shareholder actually receives notice from the corporation), then the corporation must pay the agreed amount within 60 days after the agreement is reached, and the shareholder must surrender his or her share certificate. At that point, the shareholder will no longer have any interest in the shares or in the corporation.782

If the parties are unable to reach agreement within 30 days after the shareholder becomes entitled to payment for his or her shares, then the shareholder may, within 60 days after the expiration of the 30-day period, petition the superior court of the county of the corporation’s registered office to request appointment by the clerk of the three appraisers. The clerk then serves a summons and a copy of the petition on the corporation at least ten days prior to the hearing. The award of a majority of the three appraisers will be confirmed by the court if neither party files an exception within ten days of the award. The award is final and conclusive when it is confirmed by the court.

776 N.C. Gen. Stat. § 55-6-40(h); see also McGladrey, Hendrickson & Pullen v. Syntek Finance Corp., 389 S.E.2d 636, 98 N.C. App. 151, aff’d 411 S.E.2d 585, 330 N.C. 602 (1990). 777 N.C. Gen. Stat. § 55-6-40(j). 778 N.C. Gen. Stat. § 55-6-40(j). 779 N.C. Gen. Stat. § 55-6-40(j). 780 N.C. Gen. Stat. § 55-6-40(j). 781 N.C. Gen. Stat. § 55-6-31(b). 782 N.C. Gen. Stat. § 55-6-40(j)(1).

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When the shareholder surrenders his or her share certificates, the shareholder is then entitled to a judgment against the corporation for the value of the shares plus interest to the date of confirmation. If either party files an exception within ten days after the award is made, the case is transferred to the civil docket of the superior court for trial, which is held in the same manner as for eminent domain proceedings under North Carolina General Statutes Chapter 40A and subject to the same right of appeal. The court may assess costs as it deems equitable. Once the judgment is paid, the shareholder no longer has an interest in the shares or in the corporation. If the shareholder fails to timely file a petition, he or she will have no right to payment for the shares and will remain a shareholder of the corporation.783

(2) Delaware

Delaware has no comparable provisions generally mandating redemption of shares, or granting shareholders a right to redemption, except for appraisal rights in appropriate circumstances.784

I. Shareholder Agreements

1. Purposes of Shareholder Agreements

A shareholder agreement is “a contract between shareholders which may apply broadly to the rights of the shareholders in conducting the business of the corporation, so long as their purposes are legal and not contrary to public policy.”785 Shareholder agreements can accomplish a number of purposes, including the documentation of voting trusts or pooling arrangements, the designation of officers and directors and the formulation of any other agreements regarding management and corporate governance (such as the provision of minority veto or consent rights), the imposition of transfer restrictions, the stipulation of the parties’ agreements regarding the payment of dividends and the establishing of mechanisms for deadlock breakage and dispute resolution. Shareholder agreements are more common in the context of close corporations (and, indeed, most of the statutory provisions enabling or validating such agreements in Delaware are limited to close corporations, as defined in the Delaware statute). In a close corporation, a shareholder agreement can enable shareholders to assume the powers of the directors and operate more like a partnership, or protect minority shareholders from the effects of majority rule in decision-making.

2. Voting Arrangements

a) Voting Trusts

NCBCA Section 7-30 permits one or more shareholders to form a voting trust, which would confer on a trustee the right to “vote or otherwise act” on behalf of such shareholders. Such an arrangement thus centralizes voting control in the hands of a single person or entity, and requires (a) a signed, written agreement that sets forth the terms of the trust and

783 N.C. Gen. Stat. § 55-6-40(j)(2). 784 Del. Code Ann. tit. 8, § 262. See Section III.G.9. of this study for a discussion of appraisal rights generally. 785 Blount v. Taft, 29 N.C. App. 626, 225 S.E.2d 583 (1976), aff’d, 295 N.C. 472, 246 S.E.2d 763 (1978).

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transfers the shares to the trustee (as well as any other terms consistent with the agreement’s purpose) and (b) that the trustee (i) prepare a list of the names and addresses of the owners of the beneficial interests under the trust and of the number and classes of shares transferred to the trust, and (ii) deliver copies of the list and the agreement to the corporation’s principal office.786 The maximum duration of any such arrangement is ten years, which term may be extended for additional periods not to exceed ten years each.787 Any such extension requires the delivery of the applicable agreements of extension (together with the list of beneficial owners) to the corporation’s principal office.788

Delaware’s statute contemplates a similar voting trust regime. The primary differences between the North Carolina and Delaware approaches are (a) the absence of any express temporal limitation under Delaware law,789 and (b) the Delaware statute’s inclusion of a number of procedural requirements. Such procedural requirements provide, for example, for (i) the surrender of stock certificates evidencing shares subject to the voting trust and the issuance of new stock certificates (bearing notice of the voting trust arrangement) in the name of the trustee(s), (ii) the entry of the voting trust transaction in the corporation’s stock ledger, and (iii) determination of the method of voting where two or more persons or trustees are designated as voting trustees, where no written agreement involving such trustees addresses such method.790 The Delaware statute also expressly requires that the voting trust agreement be available for inspection by the stockholders of the corporation as well as by the beneficiaries of the voting trusts.791

b) Pooling Arrangements

A pooling arrangement accomplishes the same objective as a voting trust, but is less formal and is typically used where it is feasible to have all parties subject to the arrangement be bound by written agreement.792 The statutory requirements for such an arrangement in North Carolina are set forth in NCBCA Section 7-31. This statute generally governs shareholder agreements for North Carolina close corporations.

This statute authorizes two or more shareholders to enter into a written agreement that will determine how their respective shares will be voted. Such agreement must be signed by all shareholders to be bound thereby, and, like voting trusts, no such arrangement may be in effect for more than ten years (subject to extension in a manner consistent with the extension of voting trusts). Unlike voting trust agreements, agreements for the simple pooling of votes are not required to be delivered to the corporation.793

786 N.C. Gen. Stat. § 55-7-30(a). 787 N.C. Gen. Stat. §§ 55-7-30(b) and (c). 788 N.C. Gen. Stat. § 55-7-30(c). 789 A ten-year limitation on the duration of such arrangements in Delaware was eliminated by statutory amendment in 1994. 790 Del. Code Ann. tit. 8, § 218. 791 Id. By contrast, NCBCA Section 7-30 does not expressly make the agreement subject to inspection by shareholders, but the Official Comment to such section makes clear that a voting trust agreement is subject to shareholder inspection pursuant to NCBCA Section 7-20 as part of the shareholder list. 792 Robinson, II, supra note 290, § 9.04[2]. 793 N.C. Gen. Stat. § 55-7-31.

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Other than through the authorization of voting trust arrangements (discussed above), the Delaware statute does not address voting agreements outside of the close corporation context.794

c) Shareholders Agreements with Respect to Other Matters

NCBCA Section 7-31(b) provides that, except with respect to public corporations, no written agreement to which all shareholders have assented “and which relates to any phase of the affairs of the corporation, whether to the management of the business or disunion of its profits or otherwise” shall be held to be invalid because such agreement treats the corporation as if it were a partnership. Consequently, a shareholder agreement of a non-public North Carolina corporation may set forth parties’ understandings with respect to the management and operation of the corporation that might deviate from the corporate formalities that might otherwise govern pursuant to Chapter 55.

NCBCA Section 7-31(c) – which applies to all North Carolina corporations (including public corporations) – provides that no written agreement between all or fewer than all of the shareholders of a corporation (and whether such agreement is between the shareholders or between one or more shareholders and a party who is not a shareholder) may not be invalidated on the grounds that such agreement “so relates to the conduct of the affairs of the corporation as to interfere with the discretion of the board of directors.” This subsection of the statute goes on to provide that the effect of any such agreement will be to “relieve the directors and impose on the shareholders who are parties to the agreement the liabilities for managerial acts or omissions . . . to the extent and so long as the discretion or powers of the board in its management of corporate affairs is controlled by such agreement.”

Again, to the extent a shareholders agreement dictates the voting of shares, such agreement is limited to a duration of ten years (and would need to be extended, as described above with respect to pooling arrangements and voting trusts, if the parties intend for such arrangement to last beyond such period).795

These statutory provisions were intended to liberalize the law, and as a consequence, the NCBCA generally does not restrict shareholders from entering into agreements among themselves with respect to the management and governance of a North Carolina corporation, so long as such agreements are on fair and reasonable terms and not inconsistent with the foregoing.796

Delaware’s statutory parallels to the foregoing North Carolina statutes are limited to the context of the Delaware close corporation. A Delaware close corporation is an entity meeting the requirements set forth in DGCL Section 342.797

794 For a discussion of close corporations, see Section III.J. of this study. 795 N.C. Gen. Stat. § 55-7-31(a). 796 Note, however, that shareholder agreements are otherwise governed by the law of contracts and are subject to challenge in that regard. 797 For a discussion of close corporations, see Section III.J. of this study.

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First, with respect to the issue of an agreement’s interference with director discretion, Delaware close corporations are governed by the same principle that applies to all North Carolina corporations under NCBCA Section 7-31(c), to the effect that (a) a written agreement among the stockholders holding a majority of the outstanding voting stock cannot be challenged on the ground that it “so relates to the conduct of the business and affairs of the corporation as to restrict or interfere with the discretion or powers of the board of directors”; and (b) “the effect of any such agreement shall be to relieve the directors and impose upon the stockholders who are parties to the agreement the liability for managerial acts or omissions which is imposed on directors to the extent and so long as the discretion or powers of the board in its management of corporate affairs is controlled by such agreement.”798 The only difference between the North Carolina and Delaware versions of the rule is Delaware’s requirement that the agreement involve holders of a majority of the outstanding shares entitled to vote.799

Second, with respect to whether the corporation is operated like a partnership, Delaware’s statute takes a different and more technical approach (though the effect of its North Carolina counterpart is similar). Under DGCL Section 351, a certificate of incorporation of a close corporation may provide for management by the stockholders rather than the board of directors, if such provision is approved by the unanimous consent of all the incorporators, subscribers and holders of outstanding stock of the close corporation.800 Therefore, the stockholders of a Delaware close corporation can simply eliminate the corporation’s board of directors. As long as any such provision is in effect, no meetings of stockholders for the election of directors need to be called, and the stockholders managing a close corporation pursuant to such provision will be subject to liabilities of directors under Delaware law.801

J. Close Corporations

1. Characteristics of a Close Corporation

A “close corporation” is generally thought of as one owned by a small number of shareholders who operate the business essentially as an “incorporated partnership.” North Carolina law does not separately define “close corporations,” but the NCBCA does contain certain provisions that accommodate corporate entities that operate in this fashion. For example and most fundamentally, a North Carolina corporation may limit the authority of its board of directors or dispense with a board altogether by specifying, either in its articles of incorporation or in a valid shareholders’ agreement, who will have the authority and responsibilities otherwise granted to the board.802 Any such limitation on the board’s authority will not be binding on anyone who does not have actual knowledge of the limitation.803 The group or individual to whom the board’s authority is transferred are deemed to be acting as the corporation’s board for

798 Del. Code Ann. tit. 8, § 350. 799 Id. 800 Note however, that only a majority vote of stockholders is necessary to remove such a provision from the certificate of incorporation. 801 Del. Code Ann. tit. 8, § 351. 802 N.C. Gen. Stat. § 55-8-01(c). 803 Id.

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all other purposes of the NCBCA and consequently will be held to all of the fiduciary obligations and duties generally assumed by directors.804

By contrast, Delaware law does provide a separate classification for “close corporations,” which are closely held entities that satisfy certain specific criteria defined in the DGCL. The primary difference between a Delaware “close corporation” and a general business corporation lies in the role of the stockholders in the governance and management of the corporation. In a typical close corporation, the same individuals will serve as the corporation’s stockholders, officers and most, if not all, of its employees. The close corporation form allows the stockholders to operate the corporation directly without the need for formal actions by a board of directors. The stockholders may choose to operate the corporation as if it were a partnership and arrange the stockholders’ relationships with one another as if they were partners, while at the same time maintaining the liability protections of the corporate form.805 In a close corporation, (a) the stockholders are not required to elect a board of directors; (b) unless the context requires otherwise, the stockholders will be deemed to be the corporation’s directors for purposes of applying the other provisions of the DGCL; and (c) the stockholders will be subject to all of the liabilities of directors.806

2. Formation

The NCBCA sets few requirements for the election of close corporation treatment. A North Carolina corporation that wishes to operate without the formal control of a board of directors must only state that intent and any alternative governance scheme in either its articles of incorporation or a shareholders’ agreement.807

Delaware law permits a corporation to elect treatment as a close corporation by providing in its certificate of incorporation that:

� All of the corporation’s shares (other than treasury shares) shall be certificated and held by no more than a specified number of stockholders, not to exceed 30;

� All of the shares of the corporation’s stock shall be subject to certain restrictions on transfer; and

� The corporation shall not make a public offering of its stock, as defined under the Securities Act of 1933.808

The certificate of incorporation may also specify the classes of persons who are entitled to hold shares of the corporation’s stock, those who are not entitled to hold such shares, or both.809 By vote of the holders of at least 2/3 of its outstanding shares of all classes, an

804 N.C. Gen. Stat. § 55-8-01(d). 805 Del. Code Ann. tit. 8, § 354. 806 Del. Code Ann. tit. 8, § 351. 807 N.C. Gen. Stat. § 55-8-01(c). 808 Del. Code Ann. tit. 8, §§ 341 and 342(a). 809 Del. Code Ann. tit. 8, § 342(b).

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existing corporation may elect to become a close corporation amending its certificate of incorporation to contain such election and the restrictions on stock ownership and transfers outlined above.810

3. Voting

Both North Carolina and Delaware law permit shareholders to act by unanimous written consent, which is a provision that may be particularly useful for closely held corporations.811 Closely held corporations organized under the laws of either state may also set supermajority quorum or voting requirements for specified matters or all matters to provide a voice for minority shareholders in the corporation’s management.812 Closely held corporations organized in each state may also use voting groups, pooling arrangements and voting trusts to consolidate corporate control in one authority in a manner that differs from the relative economic interests of the shareholders in the corporation.813

A shareholders’ agreement among all of the shareholders in a closely held corporation may be the most effective and efficient means of managing a closely held corporation organized under either Delaware or North Carolina law. Each statute expressly permits such arrangements and protects such agreements from attack on the theory that such arrangements either interfere with the authority of the board of directors or treat the corporation as if it were a partnership.814 In North Carolina, a shareholders’ agreement among all of the shareholders of a closely held corporation may be contained in the articles of incorporation, bylaws or any other side agreement signed by all of the shareholders, and the agreement will be binding on any transferees of the shares.815

4. Transfer Restrictions

NCBCA Section 6-27 expressly permits restrictions on the transfer of shares in a North Carolina corporation, which may be included in the corporation’s articles of incorporation or bylaws or in an agreement between shareholders or between shareholders and the corporation. To be valid, a transfer restriction must meet the following three criteria: (1) it must be adopted to further a purpose permitted by the statute, such as maintaining tax status or exemptions from federal or state securities laws or any other reasonable purpose; (2) it must not be unconscionable under the circumstances, including any circumstances that may have changed since its adoption; and (3) it must be noted conspicuously on the stock certificate or any information statement describing uncertificated shares.816

Transferees of shares in a Delaware close corporation, including those transferees who pay no value for their shares, are conclusively presumed to have received notice of the restrictions on transfer, eligibility requirements for stockholders and limitations on the number of

810 Del. Code Ann. tit. 8, § 344. 811 See N.C. Gen. Stat. § 55-7-04; Del. Code Ann. tit. 8, § 228. 812 See N.C. Gen. Stat. § 55-7-27(a); Del. Code Ann. tit. 8, § 216. 813 See N.C. Gen. Stat. § 55-7-31; Del. Code Ann. tit. 8, § 218. 814 N.C. Gen. Stat. § 55-7-31(b); Del. Code Ann. tit. 8, § 350. 815 N.C. Gen. Stat. § 55-7-31(b). 816 N.C. Gen. Stat. § 55-6-27.

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permitted stockholders in the corporation’s certificate of incorporation.817 If such a prohibited transfer takes place, the close corporation may refuse to register the transfer of the affected stock, unless all of the stockholders approve the transfer or the corporation amends its certificate of incorporation to allow for the transfer.818 If a restriction on the transfer of a close corporation’s stock is held to be in violation of the general regulations affecting stock transfers under DGCL Section 202, the close corporation has the option in the 30 days following such determination to acquire the restricted security at a price determined by the parties or by the court of chancery.819

5. Termination of Close Corporation Status

Because the NCBCA does not contain the formal statutory qualifications conferring close corporation status as apply under the DGCL, North Carolina law does not provide a formal mechanism for terminating close corporation status. It is reasonable to conclude that a corporation that has elected to delegate all or some of the powers of its board of directors to another person or group through a provision in its articles of incorporation or a shareholders’ agreement may terminate that delegation of authority by amending the document containing such provision.

Delaware close corporation status continues indefinitely, until the corporation amends its certificate of incorporation to delete the provisions qualifying it as a close corporation or one of those qualifying provisions has been breached and remains uncured.820 The holders of at least 2/3 of the corporation’s shares (or such higher percentage as set forth in the articles of incorporation) must vote to relinquish close corporation status.821 To cure a breach of a qualifying condition, a close corporation must, within 30 days of the occurrence or discovery of the breach, (1) file a certificate with Delaware’s secretary of state acknowledging the breach, (2) provide a copy of such certificate to each stockholder and (3) take the necessary steps to remedy the breach.822 The close corporation or any stockholder may bring a suit in the court of chancery, which has the power to enjoin or set aside any action that would cause the corporation to lose its close corporation status.823

6. Deadlock

The shareholders of a North Carolina close corporation may provide in a shareholders’ agreement the means for resolving a deadlock, including arbitration of disputes, agreement by the corporation or certain shareholders to repurchase shares held by dissenting shareholders and mandatory dissolution of the corporation upon the occurrence of a deadlock. The NCBCA establishes five grounds on which a superior court may dissolve a corporation involuntarily upon the petition of one or more shareholders:

817 Del. Code Ann. tit. 8, § 347. 818 Id. 819 Del. Code Ann. tit. 8, § 349. 820 Del. Code Ann. tit. 8, § 345. 821 Del. Code Ann. tit. 8, § 346. 822 Del. Code Ann. tit. 8, § 348(a). 823 Del. Code Ann. tit. 8, § 348(b).

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� Director Deadlock. A director deadlock occurs when (i) the directors or other persons in control of the corporation (which could include the shareholders in a close corporation) are deadlocked with respect to the corporation’s management; (ii) the shareholders are unable to break the deadlock; and (iii) the deadlock has caused or threatens irreparable injury to the corporation or has caused the corporation no longer to be able to conduct its affairs to the advantage of the shareholders generally.824

� Shareholder Deadlock. A shareholder deadlock occurs under the statute when the shareholders holding voting power cannot agree on the corporation’s management and have failed, for a period that includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired.825 The corporation need not actually hold annual meetings during the deadlock period.

� Misapplication or Waste of Assets. The North Carolina statute provides a separate ground for involuntary dissolution on the basis that “the corporate assets are being misapplied or wasted.”826

� Dissolution Agreement. All current shareholders must be parties to a dissolution agreement, and all contingencies to the complaining shareholder’s right to cause the dissolution of the corporation must have occurred, for a court to order the involuntary dissolution of the corporation based on such an agreement.827

� Shareholder Protection. A court may order dissolution upon a shareholder’s petition if “liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder.”828 In Meiselman v. Meiselman,829 the North Carolina Supreme Court established a “reasonable expectations” test for the application of this principle (with a trial court’s general equitable powers), for the protection of minority shareholders. To obtain relief, the complaining shareholder must demonstrate that (1) the shareholder had one or more reasonable expectations with respect to the corporation that were known by the other shareholders, (2) such expectations have been frustrated without the complaining shareholder’s fault and outside of his or her control and (3) under all of the circumstances, including the interests of the other shareholders, the complaining shareholder is entitled to some form of equitable relief.

824 N.C. Gen. Stat. § 55-14-30(2)(i). 825 N.C. Gen. Stat. § 55-14-30(2)(iii). 826 N.C. Gen. Stat. § 55-14-30(2)(iv). 827 N.C. Gen. Stat. § 55-14-30(2)(v). 828 N.C. Gen. Stat. § 55-14-30(2)(ii). 829 309 N.C. 279, 307 S.E.2d 551 (1983).

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In each case, the decision to dissolve the corporation involuntarily rests with the court after deliberation of the statutory requirements, all equitable considerations, and public policy.

The North Carolina statute also provides for remedies short of dissolution in an action brought by a shareholder in a deadlock situation. A court may appoint a receiver to manage the business and affairs of the corporation in the best interests of its shareholders and creditors.830 The statute does not require the receiver to wind up the corporation’s business and liquidate its assets in every instance.831 If a court determines that dissolution is appropriate in a dissolution proceeding brought for the protection of the petitioning shareholder’s rights under NCBCA Section 14-30(2)(ii), the court must give the corporation the option to purchase the dissenting shareholder’s shares at fair value in lieu of the dissolution.832

In Delaware, upon the petition of any stockholder of a close corporation, the Delaware Court of Chancery may appoint one or more custodians for the corporation (who will serve as receivers if the corporation is insolvent) when (a) the stockholders who manage the business of the corporation without a board of directors are so divided that the corporation is suffering or is threatened with irreparable injury, and all anti-deadlock measures in the certificate of incorporation, bylaws or stockholders’ agreement have failed; or (b) the petitioning stockholder has the right to dissolve the corporation under the terms of its certificate of incorporation.833

In the alternative, the court of chancery may appoint a provisional director for a close corporation in a deadlock situation.834 This option is available both for close corporations that operate without a board of directors and those that have a separate board.835 If a close corporation has a separate board, the petition for appointment of a provisional director must be filed by either (a) one half of the directors then in office, (b) the holders of at least 1/3 of the shares then entitled to elect directors or (c) by the holders of 2/3 of the shares of any class of stock entitled to elect directors, if the corporation has more than one class of shares.

A provisional director must be an impartial third party who is neither a stockholder nor a creditor of the corporation (or of any of its subsidiaries or affiliates), and, while in office, he or she receives all of the rights and powers of a duly elected director.836 The court of chancery may remove a provisional director, as may the holders of a majority of the shares entitled to elect directors or the holders of 2/3 of the shares of the class of stock that petitioned for the provisional director’s appointment.837 The provisional director and the corporation may set the provisional director’s compensation by agreement, subject to approval by the court of

830 N.C. Gen. Stat. § 55-14-32. 831 Id. 832 N.C. Gen. Stat. § 55-14-31(d). 833 Del. Code Ann. tit. 8, § 352(a). 834 Del. Code Ann. tit. 8, §§ 352(b) and 353(a). 835 Id. 836 Del. Code Ann. tit. 8, § 353(c). 837 Id.

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chancery, which also has the right to set the provisional director’s compensation if there is a disagreement between the director and the corporation.838

7. Dissolution

The shareholders of a North Carolina close corporation may agree in the corporation’s organizational documents or in a separate contract among all of the shareholders to grant one or more shareholders the right to dissolve the corporation under certain circumstances.839 Such an agreement is binding on the transferee of any shares only if the transferee has actual knowledge of it.840

A Delaware close corporation’s certificate of incorporation may grant to any stockholder or to the holders of any specified number or percentage of the corporation’s stock the right to dissolve the corporation at will or upon the occurrence of any specified event.841 The stockholders exercising such option must give the corporation’s other stockholders 30 days’ written notice of the corporation’s dissolution.842 If this provision is not included in the certificate of incorporation at the corporation’s formation, it generally must be approved unanimously by the stockholders.843 This provision will not be enforceable unless each of the corporation’s stock certificates bears a conspicuous statement on its face noting the existence of the provision.844

K. Public Corporations

Both Delaware and North Carolina recognize significant differences between close corporations and public corporations. This section summarizes the differences between Delaware and North Carolina corporate law with regard to certain takeover defense measures and governance matters applicable only to public corporations.

1. Shareholder Rights Plans

Boards of directors of public corporations often adopt defensive measures for protecting their corporations against hostile, inadequate or coercive takeovers. One of the more effective takeover defenses is a rights plan or “poison pill” (a “rights plan”). Rights plans are generally designed to deter a potential acquirer from purchasing more than a specified percentage of a target corporation’s voting securities without the prior approval of the target corporation’s board of directors.

In a standard rights plan, a corporation will distribute, in the form of a dividend to shareholders, one stock purchase right (a “right”) for each outstanding share of the corporation’s common stock. If a potential acquirer accumulates a specified percentage (typically 15% to 30%)

838 Id. 839 N.C. Gen. Stat. § 55-14-30. 840 N.C. Gen. Stat. § 55-14-30(2)(v). 841 Del. Code Ann. tit. 8, § 355(a). 842 Id. 843 Del. Code Ann. tit. 8, § 355(b). 844 Del. Code Ann. tit. 8, § 355(c).

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of the target corporation’s outstanding voting stock (a “flip-in” event), then each holder of rights, except for the potential acquirer, will be entitled to purchase additional voting securities of the target corporation at a fifty percent discount. In addition, if the target corporation is acquired after the occurrence of a flip-in event (a “flip-over” event), then each holder of rights, other than the potential acquirer, will be entitled to purchase the most senior voting securities of the acquiring entity at the same fifty percent discount.

A potential acquirer will thus suffer substantial dilution to the economic value and voting power of its securities if it crosses the flip-in ownership threshold without the approval of the target corporation’s board of directors. If the target corporation’s board of directors is in favor of a potential acquisition, then it can cause the corporation to redeem the rights before they are triggered. A rights plan does not protect a corporation from all takeovers, but it can provide the target corporation’s board with negotiating leverage or the ability to conduct an orderly auction to maximize shareholder value.

Rights plans raise a variety of issues under both Delaware and North Carolina corporate law, including issues related to (a) the authority of a board of directors to adopt a rights plan and issue rights, (b) the legality of the discriminatory feature of a rights plan (i.e., the potential acquirer being excluded from exercising its rights), (c) the directors’ fiduciary duties with regard to adopting and redeeming a rights plan, and (d) the validity of certain special provisions included in some rights plans, such as “dead hand” and “no hand” provisions.

a) Board Authority to Adopt a Rights Plan

Delaware. Delaware courts have held that a board of directors is authorized to issue rights in connection with a stockholder rights plan under Section 157 of the DGCL.845 DGCL Section 157 authorizes every Delaware corporation to “create and issue . . . rights or options entitling the holders thereof to purchase from the corporation any shares of its capital stock.” Delaware courts have also held that Section 141(a) of the DGCL authorizes a board of directors to adopt a rights plan as part of its administration of the corporation’s affairs.846 DGCL Section 141(a) provides that “the business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors.”

North Carolina. The board of directors of a North Carolina corporation is authorized to issue rights in connection with a rights plan under Section 6-24 of the NCBCA. Section 6-24(a) of the NCBCA provides that “a corporation may issue rights, options, or warrants for the purchase of shares of the corporation” and “the board of directors shall determine the terms upon which the rights, options, or warrants are issued, their form and content, and the consideration for which the shares are to be issued.” The drafters of Section 6-24 expressed the view that rights plans should not be generally prohibited.847

845 Moran v. Household Int’l, Inc., 500 A.2d 1346, 1353 (Del. 1985). 846 Id. at 1353. 847 See North Carolina Commentary to N.C. Gen. Stat. § 55-6-24.

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b) Legality of Discriminatory Rights

Most state corporate statutes provide that shares of the same class or series must have identical terms and be treated alike.848 This basic principle raises the question of whether the discriminatory feature of a rights plan (i.e., the exclusion of a potential acquirer from exercising its rights) is legal under state corporate law.849

Delaware. Unlike most states, the DGCL does not have an explicit provision requiring all securities of the same class to be treated alike. Notwithstanding this fact, the Delaware courts have determined that Delaware prohibits discrimination among the same class of shares but permits discrimination among the holders of such shares.850 Thus, the discriminatory feature of a standard rights plan is valid under Delaware law because it discriminates only against a particular shareholder (i.e., the potential acquirer) and not among the rights or shares themselves (i.e., each share of common stock affords one right and each right has identical terms).851

North Carolina. The NCBCA requires all shares of the same class of a North Carolina corporation to have identical rights, preferences, and privileges.852 Section 6-24(b) of the NCBCA, however, explicitly authorizes the board of directors of a North Carolina public corporation to issue, subject to its fiduciary duties, discriminatory rights in connection with a rights plan.853 In the case of a North Carolina public corporation, NCBCA Section 6-24(b) specifically provides that “the terms and conditions of . . . rights may include . . . restrictions or conditions that preclude or limit the exercise . . . of such rights . . . by the holder . . . of a specified number or percentage of the outstanding voting shares of a public corporation.”

c) Fiduciary Duties Related to Adoption and Redemption of Rights

Plans

Delaware. Delaware case law provides the standard of judicial review for a board’s decisions regarding the adoption of a rights plan and whether to redeem the rights in response to an actual takeover threat. In Unocal Corporation v. Mesa Petroleum Co., the Supreme Court of Delaware held that a board of directors’ decision to adopt defensive measures against a potential takeover is subject to “enhanced scrutiny” due to the “omnipresent specter” in such situations “that the board may be acting primarily in its own interests, rather than those of the corporation and its shareholders.”854 To survive judicial review under the “enhanced scrutiny” standard, a board of directors must show that (i) it had reasonable grounds for believing that a potential takeover presented a danger to the corporation’s policies and effectiveness and (ii) that the defensive measures adopted by the board were “reasonable in relation to the threat posed.”855 If the board can establish these factors, the business judgment rule will apply and the

848 Arthur Fleischer, Jr. & Alexander R. Sussman, Takeover Defense § 5.06, 5-1184 (2010). 849 Id. at 5-114. 850 Id. at 5-116; see generally Baker v. Providence & Worcester Co., 378 A.2d 121 (Del. 1977). 851 See Fleischer, Jr. & Sussman, supra note 848, at 5-116; see generally Dynamics Corp. of America v. CTS Corp., 805 F.2d 705, 718 (7th Cir. 1986). 852 N.C. Gen. Stat. § 55-6-01. 853 See North Carolina Commentary to N.C. Gen. Stat. § 55-6-24. 854 493 A.2d 946, 954 (Del. 1985). 855 Id. at 955.

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board’s actions will be invalidated only if “it is established by a preponderance of the evidence that the directors’ decisions were primarily based on perpetuating themselves in office, or some other breach of fiduciary duty such as fraud, overreaching, lack of good faith, or being uninformed.”856

The Delaware courts apply the Unocal standard of enhanced scrutiny to preemptive rights plans adopted in advance of a specific takeover threat857 as well as rights plans adopted in response to actual or perceived takeover threats.858 In addition, the Delaware courts will also apply enhanced scrutiny to a board’s decision of whether to redeem rights in response to an actual takeover threat.859

The adoption of a rights plan in advance of an actual takeover threat has been generally upheld by the Delaware courts as a reasonable and proportionate defense against future takeovers that might be coercive or otherwise against the best interests of shareholders.860 Directors have also been permitted to adopt rights plans or refuse to redeem rights in the face of an actual takeover so long as the plans are continuing to serve the best interests of shareholders, including maximizing the negotiating power of a board of directors, blocking a structurally coercive tender offer, or allowing additional time to consider transactional alternatives or complete an auction.861

North Carolina. The NCBCA explicitly authorizes a board of directors of a North Carolina corporation to issue discriminatory rights; however, it leaves the decision of whether or when to redeem rights in connection with an actual takeover threat open to judicial review.862 Section 6-24(b) of the NCBCA provides that “determinations by the board of directors whether to impose, enforce, waive or otherwise render ineffective any [restrictions or conditions that would preclude or restrict a potential acquirer from exercising rights] may be judicially reviewed in an appropriate proceeding.”

The North Carolina courts have not reviewed a decision by a board of directors regarding the adoption of a rights plan or the redemption of rights, but they would likely consider Unocal and other Delaware decisions in formulating an appropriate standard of review.863 The commentary to Section 6-24(b) of the NCBCA provides that the court “may formulate or apply appropriate standards to insure that the directors’ actions are in the best long-term interests and short-term interests of the corporation and its shareholders considering, without limitation, the prospects for potential growth, development, productivity and profitability of the corporation.”864 In addition, the NCBCA provides that, when considering a change in control situation, the duties of a director will not be any different, and the standard of care will

856 Id. at 958. 857 See Moran v. Household Int’l, Inc., 500 A.2d 1346, 1346 (Del. 1985). 858 See, e.g., Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). 859 See Moran, 500 A.2d at 1354. 860 See id. at 1354. 861 See, e.g., In re Holly Farms Corp. Shareholders Litig., 564 A.2d 342 (Del. Ch. 1989); Facet Enterprises, Inc. v.

Prospect Group, Inc., 1988 WL 36140 (Del. Ch. 1988). 862 N.C. Gen. Stat. § 55-6-24(b). 863 See generally First Union Corp. v. SunTrust Banks, Inc., No. 01-CVS-10075, 2001 WL 1885686 (N.C. Super. 2001). 864 North Carolina Commentary to N.C. Gen. Stat. § 55-6-24.

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not be any higher, than the duties or standard of care required with respect to any other decision by a director.865

d) Dead Hand and No Hand Provisions

A potential acquirer of a corporation will often couple a tender offer to purchase the outstanding voting shares of the corporation with a proxy solicitation to replace the target corporation’s board of directors. This can be an effective strategy against a rights plan because the acquirer’s nominees, if elected to the board, can redeem or amend the rights to prevent them from being triggered by the takeover. In response to this strategy, some rights plans include “dead hand” and “no hand” provisions.866

A “dead hand” provision provides that the rights may only be redeemed by the members of the board of directors who were serving on the board when the rights plan was adopted or their designated successors (the “continuing directors”). A “no hand” provision eliminates the ability of a board of directors to redeem rights once the continuing directors no longer constitute a majority of the board of directors. In each case, these provisions eliminate the ability of an acquirer’s slate of directors from voting to redeem a rights plan.

Delaware. Delaware courts have rejected dead hand and no hand provisions on the basis that they impermissibly deprive a newly elected board from discharging its full statutory duties to manage the corporation and its related fiduciary duties, including its ability to negotiate a possible sale of the corporation.867

North Carolina. North Carolina courts have not reviewed the validity of dead hand or no hand provisions. The Superior Court of North Carolina, however, did address the validity of a “numb hands” provision in First Union Corporation v. SunTrust Banks, Inc.

868 The numb hands provision was a contractual provision in a merger agreement that would have extended the life of the agreement for five months beyond a shareholder vote against the merger.869 The court cited Quickturn in rejecting the provision as being impermissibly restrictive of the board’s ability to fulfill its statutory and fiduciary duties, including its ability to negotiate a possible sale of the corporation.870 The fact that the court invalidated the numb hands provision by analogizing it to the no hand provision in Quickturn suggests that North Carolina courts would probably consider no hand and dead hand provisions to be invalid.

2. State Anti-Takeover Legislation

Public corporations may also utilize state anti-takeover statues as another defensive mechanism to resist hostile takeover attempts. Although federal law provided a regulatory framework for tender offers and proxy contests beginning in 1968 with the Williams

865 N.C. Gen. Stat. § 55-8-30(d). 866 See, e.g., Carmody v. Toll Brothers, Inc., 723 A.2d 1180, 1186 (Del. Ch. 1998). 867 See Quickturn Design Systems, Inc. v. Mentor Graphics Corporation, 721 A.2d 1281 (Del. 1988). 868 No. 01-CVS-10075, 2001 WL 1885686, 38-39 (N.C. Super. 2001). 869 Id. at 38. 870 Id.

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Act,871 many states have adopted various types of statutes with additional protections to deter hostile takeovers of companies incorporated in their jurisdictions. The importance of these various state statutes, however, has been diminished by the use of shareholder rights plans and other charter protections by many target corporations.

a) Historical Overview of State Anti-Takeover Legislation

Anti-takeover legislation was adopted by many state legislatures in response to a rash of contests for corporate control in the late 1970s and 1980s, which was fueled in part by high yield bond financing. Many of those statutes purported to impose greater constraints on takeovers than those imposed under the Williams Act. These state constraints included advance filing requirements and waiting periods before a tender offer could become effective. These so-called first generation state anti-takeover statutes were struck down by the Supreme Court as an undue burden on interstate commerce in violation of the Commerce Clause.872 Many states, in turn, developed second and third generation anti-takeover statutes. The most prevalent types of statutes include the following:

Control Share Acquisition Acts. Control share acquisition acts deny voting rights to shares purchased by an acquirer once certain ownership thresholds have been exceeded. These statutes generally require shareholder approval before the acquirer of a control block of stock can vote its control shares.873

“Fair Price” Statutes. Fair price statutes generally prohibit a large shareholder from effecting a business combination with a target corporation unless the consideration to be paid in the combination satisfies the statute’s “fair price” requirements. Such “fair price” or “best price” requirements can typically be waived by shareholder vote.

Business Combination Statutes. These statutes provide a lengthy moratorium (usually three to five years) on a business combination between an interested shareholder and the target corporation absent certain approvals, such as approval of the transaction by the target corporation’s board before the control acquisition occurs.

The overall statutory approach to hostile takeovers, as well as the specific parameters and terms within a category of anti-takeover statutes, can vary significantly from state to state. For instance, North Carolina has adopted both a control share acquisition act and a fair price statute. The control share acquisition act is similar to many other statutes of this type, but the fair price statute is unique and is substantially more onerous than other fair price statutes. Delaware, by comparison, has adopted a business combination statute, which is more flexible than the North Carolina statutes and substantially less prohibitive than the North Carolina fair

871 15 U.S.C. §§ 77m(d)-(e) and §§ 78(d)-(f) (1968). In a tender offer contest, for instance, Schedule 14D-1 requires specific disclosure about the offer, bidder’s identity, and any negotiations with the bidder, among other items. The offer also must be kept open for at least twenty business days. Additionally, the target must respond to the offer within ten business days and the offer must remain open at least five business days from the date any material change to the offer is published. 872 Edgar v. MITE, 457 U.S. 624 (1982) (striking down an Illinois statute which imposed a twenty day waiting period and giving the state secretary discretion to determine the fairness of the offering). 873 See CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69 (1987) (upholding the constitutionality of the Indiana control share acquisition statute).

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price statute. The North Carolina and Delaware anti-takeover statutes contain limited opt-out provisions. In weighing the benefits of the anti-takeover protections of particular jurisdictions when selecting the state of incorporation of a prospective public company, a practitioner will need to consider such opt-out provisions plus the value of potential non-statutory protective measures, primarily shareholder rights plans and charter and bylaw protections, such as a charter provision containing a “fair price” requirement.874

b) North Carolina Anti-Takeover Legislation

In 1987, the North Carolina legislature adopted two separate anti-takeover statutes: The North Carolina Control Share Acquisition Act875 and The North Carolina Shareholder Protection Act.876 Both statutes, as amended, remain in effect today. These acts only apply to public corporations. Additionally, these acts provide limited opt-out provisions, which generally require the corporation to opt out of the statute’s coverage before the corporation becomes public.

(1) The North Carolina Control Share Acquisition Act.

The North Carolina Control Share Acquisition Act (the “CSAA”) applies to a domestic corporation that has (i) substantial assets within North Carolina, (ii) a class of shares registered under Section 12 of the Securities Exchange Act of 1934, (iii) its principal place of business or principal office within North Carolina and (iv) either more than 10% of its shareholders resident in North Carolina or more than 10% of its shares owned by North Carolina residents.877 By its terms, the CSAA is inapplicable to foreign corporations.

A person acquiring “control shares” in a “control share acquisition” loses the right to vote those shares unless voting rights are granted to the acquirer by a majority of all outstanding voting shares in the corporation (exclusive of “interested shares”).878 A “control share acquisition” is the acquisition of voting shares that, when combined with all other shares of the corporation beneficially owned by the holder, would entitle the holder to voting power in the election of directors that is equal to or greater than any of three thresholds: one-fifth, one-third or a majority of all voting power.879 This loss of voting rights applies only to the shares that caused the acquiring person to meet or exceed the voting power threshold or shares acquired within a ninety-day period pursuant to a plan to make a “control share acquisition.”880

Certain share acquisitions, however, are expressly carved out from the definition of “control share acquisition.”881 These exemptions include, among others, acquisitions (i) pursuant to the laws of descent and distribution, (ii) in satisfaction of a security interest and (iii) effected in compliance with applicable law pursuant to an agreement to which

874 See Robinson, II, supra note 290, § 9.09; see generally Fleischer and Sussman, supra note 848. 875 N.C. Gen. Stat. §§ 55-9A-01 – 09. 876 N.C. Gen. Stat. §§ 55-9-01 – 05. 877 N.C. Gen. Stat. § 55-9A-01(b)(5). 878 N.C. Gen. Stat. § 55-9A-05. 879 N.C. Gen. Stat. §§ 55-9A-01(b)(2) and (3). 880 N.C. Gen. Stat. § 55-9A-01(b)(3); see Robinson, II, supra note 290, § 9.11[3]. 881 N.C. Gen. Stat. §§ 55-9A-01(b)(3)(a) – (i).

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the corporation is a party.882 This latter exception is especially important. By agreeing to a bidder’s proposal, or that of a “white knight,” a target corporation can remove the proposed transaction from the CSAA’s coverage and its unknowns and delay.

The potential loss of voting rights created by the CSAA provides incumbent management additional time and greater control to respond to a hostile tender offer. To avoid loss of the voting rights for the “control shares,” the prospective bidder has two choices: negotiate a satisfactory arrangement with the target corporation and effect its acquisition according to the ensuing agreement, or obtain approval of a majority of the target’s outstanding shares other than “interested shares.”883 To bolster the latter choice, the bidder could condition its tender offer on the approval of voting rights by the target’s shareholders, perhaps coupled with a proxy contest.

The CSAA gives a bidder the right to have a shareholder vote on whether to approve the voting rights for the bidder’s “control shares.” To seek shareholder approval of the grant of voting rights for “control shares,” the acquiring person, or a person who has made a bona fide written offer to make a “control share acquisition,” may request a shareholders’ meeting.884 This shareholder meeting must be held within fifty days after the corporation receives the acquiring person’s request, along with an “acquiring person statement” and an undertaking to pay the expenses of the meeting.885 As a result, the CSAA effectively serves to extend the twenty business day tender offer period (and ten business day response by the target corporation) under the Williams Act to at least fifty days. However, by giving the acquiring person the right to have a shareholders vote, the CSAA allows the bidder to have a shareholder referendum on its offer. This is one reason why a corporation may elect to opt out of the act.

Presumably as a deterrent to partial or two-tiered tender offers, the CSAA also grants shareholders a limited right to have their shares redeemed by the corporation at the fair value of those shares (as of the day prior to the shareholder vote) if the acquiring person obtains voting rights for the control shares and then holds a majority of all voting power for director elections.886

The CSAA has limited opt-out provisions for a corporation to elect not to be subject to the act. A corporation may opt out of the CSAA in its initial articles of incorporation or if the board of directors adopts an opt-out bylaw before the corporation becomes covered by the act.887 The CSAA also permitted corporations to opt out on or before September 30, 1990 and during a three-month window that ended December 31, 2000.888

882 N.C. Gen. Stat. § 55-9A-01(b)(3). 883 “Interested shares” include not only those beneficially owned by the acquiring person but also shares owned by any officer or inside director. N.C. Gen. Stat. § 55-9A-01(b)(4). 884 N.C. Gen. Stat. § 55-9A-03. 885 Id. 886 N.C. Gen. Stat. § 55-9A-06. 887 N.C. Gen. Stat. § 55-9A-09. 888 Id.

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(2) The North Carolina Shareholder Protection Act

Because of its inflexible, stringent requirements, the North Carolina Shareholder Protection Act (the “SPA”) is unique among fair price statutes. Like other fair price statutes, the SPA discourages coercive partial and two-tier tender offers in which minority shareholders who do not tender their shares in the first stage would otherwise be forced to accept lower prices in the second stage. Fair price statutes accomplish this by imposing substantial conditions on a potential suitor after it acquires a specified percentage of outstanding voting shares—20% under the SPA—in order for the second stage of the takeover to be completed unless the minority shareholders in the second stage receive a statutorily determined “fair price” for their shares. The statutes typically provide that the transaction can be approved by a vote of the shareholders, generally a supermajority, or by the disinterested directors of the target corporation. The SPA however effectively precludes its waiver by director or shareholder approval, regardless of how attractive the transaction may be. The SPA has no provision allowing waiver by director action, and approval by the shareholders is set at 95% of all voting shares, which may be impossible or extremely difficult to obtain.889

The SPA applies to a “business combination” with any other entity if that entity is the beneficial owner of more than 20% of the voting shares of the corporation.890 A 20% beneficial owner, which includes affiliated or associated parties, is denominated under the SPA as the “other entity.” There is an important exemption from the act’s coverage under clause (i) of NCBCA Section 9-05 for certain acquirers. This clause exempts an “other entity” from the SPA’s coverage if it acquired over 10% of the voting shares before the target became a public corporation.891 A “business combination” includes a merger, consolidation, or conversion of the target corporation or any sale or lease of all or a substantial part of the corporation’s assets or any exchange of its securities for assets having a fair market value of $5,000,000 or more.892

Since it is unrealistic to expect the SPA to be waived by shareholder approval, a transaction subject to the act must comply with its “fair price” requirements, which are more extensive than those contained in other state statutes. These requirements include price protections and certain procedural requirements and prohibitions to be observed by the target corporation and the “other entity.” The price protections are as follows:

� The price per share must be not less than the highest per share price ever paid by the “other entity” in acquiring any of its holdings of common stock of the target corporation.893

889 N.C. Gen. Stat. § 55-9-02. There is one limited circumstance in which a corporation may have the SPA’s provisions waived. North Carolina General Statutes Section 75E-3 permits North Carolina’s attorney general to exempt from the SPA “any business combination that is solely an internal corporate restructuring which does not effect any material change in the ultimate ownership of the corporation and does not affect the ongoing applicability of [the SPA] to the corporation or any other entity.” 890 N.C. Gen. Stat. § 55-9-04. 891 N.C. Gen. Stat. § 55-9-05. 892 N.C. Gen. Stat. § 55-9-01(b)(1). 893 N.C. Gen. Stat. § 55-9-03(2)(i).

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� The price per share must be not less than product of (a) the earnings per share of the target corporation’s common stock for the trailing four fiscal quarters and (b) the reported price/earnings multiple, if any, of the “other entity.”894

� The price per share to be paid to the target corporation’s shareholders in the business combination must at least equal the same percentage premium above the market price at the time the business combination is announced as the highest price already paid by the “other entity” for the target corporation’s shares bears to the market price of the common stock immediately prior to the commencement of the acquisition.895

In addition to the price requirements, the following prohibitions and procedural requirements apply during the period from when the “other entity” acquired its 20% interest until the consummation of the business combination:

� The “other entity” must take steps to ensure that at all times the unaffiliated shareholders have proportionate representation on the target corporation’s board.896

� Any reduction in dividends payable on the target corporation’s common stock must be approved by the unanimous vote of its directors.897

� The “other entity” must not acquire newly issued shares of the target corporation’s voting stock, except upon conversion of any convertible securities obtained prior to obtaining its 20% interest or pursuant to a stock dividend or stock split; and the “other entity” must not acquire any additional shares of voting stock except in the transaction in which it acquired the 20%.898

� The “other entity” must not receive the benefit of any loans, advances, guarantees, pledges or financial assistance from the target corporation unless the same benefits are received proportionately by other shareholders.899

894 N.C. Gen. Stat. § 55-9-03(2)(ii). 895 N.C. Gen. Stat. § 55-9-03(1). 896 N.C. Gen. Stat. § 55-9-03(3)(i). 897 N.C. Gen. Stat. § 55-9-03(3)(ii). 898 N.C. Gen. Stat. §§ 55-9-03(3)(iii) and (iv). 899 N.C. Gen. Stat. § 55-9-03(4)(i).

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� The “other entity” must not make any changes in the target corporation’s business or equity capital structure except as approved by the unanimous vote of the target corporation’s board of directors.900

In connection with the solicitation for approval of the business combination, a proxy statement consistent with the requirements of the Exchange Act must be mailed to the target’s shareholders and must contain prominently in its forepart any recommendations of the “continuing directors”901 concerning the vote on the combination and certain other specified information. If required by a majority of the continuing directors, the target corporation must have obtained a fairness opinion from a reputable investment banking firm.902

Corporations may opt out of the SPA in a manner similar to that under the CSAA. A corporation may do so by adopting a bylaw within ninety days of becoming a public corporation that states that the provisions of the act are inapplicable to it.903 A corporation may also opt out by including a similar provision in its initial articles of incorporation.904 Moreover, the SPA permitted a corporation to adopt a by-law opting out of its provisions during the period beginning September 1, 2000 and ending December 31, 2000 (or on or before September 30, 1990 if the act was not applicable to the corporation on July 1, 1990).905

Unlike the CSAA, the SPA does not expressly limit its application to only domestic corporations. Commentators have indicated, however, that the definition of “corporation” in the NCBCA renders the SPA inapplicable to foreign corporations.906

c) Delaware Anti-Takeover Legislation

In contrast to North Carolina’s two anti-takeover statutes, Delaware has one statute, a business combination statute. Delaware’s statute is more flexible and straightforward in operation than the North Carolina statutory regimen. DGCL Section 203 imposes a three-year moratorium on “interested stockholders” seeking to consummate a business combination. The moratorium begins when the stockholder becomes an “interested stockholder.”907 DGCL Section 203 was “intended to strike a balance between the benefits of an

900 N.C. Gen. Stat. § 55-9-03(4)(ii). 901 A “continuing director,” as defined by the SPA, is a member of the board elected by the public shareholders before the “other entity” acquired more than 10% of the target corporation’s voting shares or a person recommended to succeed a continuing director by a majority of the continuing directors. N.C. Gen. Stat. § 55-9-01(b)(3). 902 N.C. Gen. Stat. § 55-9-03(5). 903 N.C. Gen. Stat. § 55-9-05. 904 Id. 905 Id. 906 See Robinson, II, supra note 290, § 9.11[1] n. 8 (citing North Carolina Commentary to NCBCA Section 1-40 and explaining that the definition of “corporation” includes foreign and domestic corporations for purposes of NCBCA Section 9-01 in the event a foreign corporation is involved in a business combination with a North Carolina corporation, but the definition does not extend to the remainder of the SPA). 907 Del. Code Ann. tit. 8, § 203(a).

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unfettered market for corporate shares and the well documented and judicially recognized need to limit abusive takeover tactics.”908 It has been consistently upheld as constitutional.909

An “interested stockholder” under the statute is any stockholder who became the beneficial owner of 15% or more of a public company’s voting stock on or after December 23, 1987.910 In computing the interested shareholder’s percentage ownership, all shares beneficially owned by such person’s affiliates and associates are included. The definition of “business combination” is broadly defined and includes mergers or consolidations; sales, leases or other dispositions of 10% or more of the company’s assets; stock issuances and transactions that increase the interested stockholder’s ownership percentage and those conferring financial benefits such as loans, advances and guarantees.911

The statute has several exceptions that make it inapplicable in certain contexts, including in the following circumstances:

� Prior to the stockholder becoming an interested stockholder, the board of directors of the target corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder.912

� The interested stockholder owns at least 85% of the voting stock outstanding in the corporation at the time the business combination is commenced.913 In calculating the 85% threshold, shares owned by officers who are also directors and shares held in employee benefit plans in which the employees do not have a confidential right to tender or vote are excluded from the number of outstanding voting shares.914 Thus, under this exception a bidder making a tender offer can be assured of not being subject to the Delaware statute in the second stage of its takeover by conditioning the tender offer on its acquiring 85% of the outstanding voting shares.

� At or subsequent to the stockholder becoming an interested stockholder, the business combination is approved by the board of directors and by the affirmative vote of at least two-thirds of the outstanding voting shares of the corporation (excluding shares owned by the interested stockholder).915

908 H.B. 396, 134th Gen. Assem. 9 (Del. 1987). 909 See, e.g., BNS Inc. v. Koppers Co., 683 F. Supp. 458, 460 (D. Del. 1988); City Capital Assocs. Ltd. Partnership v.

Interco, Inc., 696 F. Supp. 1551, 1555 (D. Del. 1988). 910 Del. Code Ann. tit. 8, §§ 203(b)(4) and 203(c)(5). 911 Del. Code Ann. tit. 8, § 203(c)(3). 912 Del. Code Ann. tit. 8, § 203(a)(1). 913 Del. Code Ann. tit. 8, § 203(a)(2). 914 Id. 915 Del. Code Ann. tit. 8, § 203(a)(3).

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In addition to the foregoing transactional exceptions, the Delaware statute is slightly more flexible than the North Carolina anti-takeover statutes in how corporations may opt out of its coverage. A corporation may opt out of the statute if (1) it opts out in its original certificate of incorporation, (2) it adopted an amendment to its bylaws within 90 days of February 2, 1988 opting out of the section or (3) by majority vote of its stockholders, it adopts an amendment to its charter or bylaws expressly opting out.916

3. Majority Voting Standards in the Election of Directors

A recent movement initiated by activist shareholders has changed the standard for election of directors in many U.S. public companies. Historically, nearly all directors of U.S. public companies have been elected by a “plurality” standard, under which the director nominees with the largest number of votes are elected as directors, up to the maximum number of directors to be elected. When the plurality election standard is combined with director nomination procedures which limit the ability of shareholders to nominate directors, the result is that the board’s proposed slate of directors is almost certain to prevail absent a hostile proxy contest.917 The effect of the plurality voting standard thus assures continuity of the board, but activist shareholders have maintained that plurality voting does not give shareholders a sufficient voice in the election process.

Under the majority voting standard, director nominees must receive more votes “for” election than “against” election. The majority voting standard is often coupled with a policy requiring an incumbent director prior to the election to tender his or her resignation which is effective only if the director fails to receive more “for” votes than “against” votes, or requiring an incumbent director who fails to receive more “for” votes than “against” votes to tender his or her resignation after the election. Many of the majority voting standards adopted by U.S. public companies are only applicable in “uncontested elections,” i.e., elections where the number of nominees does not exceed the number of directors to be elected.

A study of majority voting standards by Claudia H. Allen of Neal, Gerber & Eisenberg LLP indicates that as of November 12, 2007, 66% of companies in the S&P 500 and over 57% of Fortune 500 companies have adopted some form of majority voting standard. A typical majority voting policy involves an amendment to the bylaws or articles of incorporation overriding the default plurality standard, coupled with an incumbent director resignation policy that is either incorporated into the bylaws or articles of incorporation or adopted as a separate policy by the board. Because the move to majority voting is still relatively new, it is expected that majority voting provisions will continue to evolve.

Delaware Law. The default rule for Delaware corporations is that directors are elected by a plurality of the votes of the shares present at the shareholders’ meeting and entitled to vote on the election of directors.918 Delaware corporations may specify a different standard for election of directors in the certificate of incorporation or bylaws, and any bylaw amendment

916 Del. Code Ann. tit. 8, § 203(b). 917 See CA, Inc. v. AFSCME Employees Pension Fund, No. 329, 2008, 17 (Del. July 17, 2008) (quoting Harrah’s

Entm’t v. JCC Holding Co., 802 A.2d 294, 311 (Del. Ch. 2002)). 918 Del. Code Ann. tit. 8, § 216.

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adopted by stockholders that specifies the votes that shall be necessary for the election of directors may not be further amended or repealed by the board of directors.919

DGCL Section 141(b) provides that directors may resign upon notice given to the corporation. The resignation is effective upon delivery unless the resignation specifies a later effective date or an effective date determined upon the happening of an event or events, and a resignation conditioned upon the director failing to receive a specified vote for reelection as a director may provide that it is irrevocable.

North Carolina Law. Similar to Delaware law, the default rule in North Carolina is that directors are elected by a plurality of the votes cast by the shares entitled to vote for the election of directors.920 However, the default rule in North Carolina can only be modified to provide for majority voting through a provision in the articles of incorporation or a shareholders’ agreement, whereas Delaware law permits such provision to be included in the bylaws.921 Consequently, the adoption or subsequent modification of a majority voting standard by a North Carolina corporation requires shareholder approval, while a Delaware corporation may adopt and subsequently modify a majority voting standard in its bylaws without shareholder approval.

Similar to Delaware law, a director of a North Carolina corporation may resign at any time by communicating his resignation to the board of directors, its chair, or the corporation, and the resignation is effective when it is communicated unless a later effective date or subsequent event upon which it will become effective is specified in writing.922

In addition to the flexibility of action by the board of directors via bylaw amendment, the other primary difference between Delaware and North Carolina law is that the DGCL explicitly permits a resignation to be irrevocable when it is tendered in advance of a director election and conditioned on the failure to receive a specified vote for reelection.923 Because the NCBCA does not specifically permit an advance, irrevocable resignation, it is not clear whether such a resignation would be enforceable in North Carolina.

4. 2009 DGCL Amendments

The Delaware General Assembly recently enacted several significant amendments to the DGCL with respect to, among other things, access by shareholders to a public company’s proxy solicitation materials for purposes of nominating directors for election, reimbursement of shareholder expenses in connection with proxy contests, and the establishment of separate record dates for purposes of notice and voting at shareholder meetings. The amendments took effect on August 1, 2009, but generally will not affect most companies until the 2010 proxy season.

919 See id. 920 N.C. Gen. Stat. § 55-7-28(a). 921 Id. 922 N.C. Gen. Stat. § 55-8-07. 923 See Del. Code Ann. tit. 8, § 141.

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a) Proxy Access

One amendment creates a new Section 112 of the DGCL that expressly authorizes a Delaware corporation to adopt provisions in its bylaws that grant stockholders the right to include within the corporation’s proxy solicitation materials the stockholders’ nominees for the election of directors.924 The new section also expressly permits any corporation adopting such a bylaw to impose any lawful conditions on the stockholders’ proxy access right, such as requiring: (i) a minimum record or beneficial ownership level, or duration of ownership, by the nominating stockholder; (ii) that the nominating stockholder submit specified information concerning itself and its nominees; or (iii) that the nominating stockholder indemnify the corporation with respect to any loss arising out of any false or misleading information submitted by the stockholder. The intent of this amendment is to allow corporations and stockholders to adopt procedures that will give significant stockholders an avenue for effecting changes to the composition of the board of directors while avoiding hostile proxy contests, which are often very disruptive and expensive.

Although North Carolina boards and shareholders generally have the right to adopt procedural amendments to their bylaws that are not inconsistent with law or the corporation’s articles of incorporation,925 the NCBCA does not expressly authorize “proxy access” bylaws similar to those described in new Section 112 of the DGCL.

The subject of proxy access is likely to remain under close scrutiny and debate in the months following the publication of this Comparative Study. The Securities and Exchange Commission published on June 10, 2009 a new proposed Rule 14a-11 under the Exchange Act that would require public corporations, under certain circumstances, to include shareholder nominees for director in the corporation’s proxy materials.926 If adopted, Rule 14a-11 would pre-empt, at least in part, the recent Delaware amendment, which merely provides Delaware corporations the option of adding proxy access provisions in their bylaws.

b) Reimbursement of Stockholder Proxy Contest Expenses

A second amendment aimed at reducing the burdens on stockholders engaging in proxy contests creates a new Section 113 of the DGCL that expressly authorizes a Delaware corporation to adopt a bylaw providing for reimbursement of expenses incurred by stockholders in connection with their solicitation of proxies for director elections.927 Similar to the proxy access provision, the new Section 113 also expressly permits any corporation adopting such a bylaw to impose any lawful conditions on its stockholders’ reimbursement rights, such as limiting the amount of reimbursement based on the success of the proxy contest (measured in terms of the proportion of votes cast in favor of one or more persons nominated by the stockholder seeking reimbursement). This amendment effectively codifies the Delaware

924 Del. Code Ann. tit. 8, § 112. 925 See N.C. Gen. Stat. § 55-2-06. 926 Facilitating Shareholder Director Nominations, Exchange Act Release No. 33-9046 (June 10, 2009). 927 Del. Code Ann. tit. 8, § 113.

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Supreme Court’s decision in CA, Inc. v. AFSCME Employees Pension Plan,928 which validated the concept of “short slate reimbursement” bylaw provisions.

c) Establishment of Separate Record Dates

The amendments also modify Section 213(a) (and other sections) of the DGCL with respect to the establishment of record dates in connection with stockholder meetings. The board of directors of a Delaware corporation will now have the option of selecting both (i) and initial “notice” record date for the purpose of identifying stockholders entitled to notice of a meeting, and also (ii) a later “voting” record date for the purpose of determining which stockholders would be entitled to vote at the meeting.929 The second, “voting” record date can be any date on or before the date of the meeting. This amendment is primarily meant to address the problem of “empty voting,” which can occur when there is significant stockholder turnover between a record date and a meeting date.

North Carolina, in contrast, retains a system that provides for only a single record date that is used for determining both the shareholders entitled to notice and those entitled to vote at the meeting.930

L. Derivative Lawsuits

Shareholder derivative lawsuits (which are also discussed in Section IV.C.2. of this study, below) allow one or more shareholders to enforce the rights of the corporation where the corporation itself does not file suit. The shareholder bringing the suit is a nominal plaintiff who seeks redress on behalf of the corporation for breaches of the fiduciary duties of care and loyalty.

In North Carolina, under the appropriate circumstances shareholders have a statutory right under the NCBCA to bring such an action.931 In Delaware, however, this right has been conferred by the courts and is limited by statute (as described in Section III.L.2. of this study).932

1. Derivative v. Individual or Direct Claims

a) Delaware

In Delaware, the question of whether an action is direct or derivative turns “solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing shareholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the shareholders, individually)?”933 In order to bring a direct claim, there must be an injury inflicted on stockholders or on stockholders’ individual rights. Where a claim alleges injury to a corporation or injury to the corporation’s stockholders flowing solely

928 953 A.2d 227 (Del. 2008). See supra note 159. 929 Del. Code Ann. tit. 8, § 213(a). 930 See N.C. Gen. Stat. §§ 55-7-05 and 55-7-07. 931 See N.C. Gen. Stat. § 55-7-40. 932 See Schoon v. Smith, 953 A.2d 196, 202-03 (Del. 2008). 933 Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004).

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from an injury to the corporation, the claim is derivative.934 Thus, for example, the claim that the losses caused by some act of mismanagement has reduced the value of the stockholder’s shares has been held to be derivative.935 However, the Delaware Supreme Court has recognized that an alleged wrong may give rise to both an individual and derivative claim under certain circumstances.936

b) North Carolina

In North Carolina as in Delaware, the basic distinction between a direct and derivative claim is determined by whether the right sought to be enforced belongs to the corporation or directly to the shareholder.937 A direct action is allowed where a shareholder can allege a loss peculiar to himself by reason of some special circumstance or relationship with the wrongdoers. The North Carolina rule for when a shareholder can bring a derivative claim versus an individual or direct claim is fully set out by the court in Outen v. Mical.938 The Outen Court explained:

Ordinarily stockholders have no right in their name to enforce causes of action accruing to the corporation. Thus, in a derivative action, the recovery goes to the corporation. However, a shareholder may attempt to bring a direct cause of action in addition to a derivative action and might be able to recover individual damages if the shareholder can allege a loss peculiar to himself by reason of some special circumstances or special relationship to the wrongdoers.939

In Outen, the court held that the fact that the plaintiff was a fifty percent shareholder in the closely-held corporation did not constitute a special relationship which would permit a direct action where “plaintiff did not show that he suffered a loss different from the loss to the corporation. The loss alleged [sic] resulted from the misappropriation of corporate funds.”940 As in Delaware, the North Carolina courts have held that a shareholder may not recover directly for a loss in the value of his shares caused by a wrong to the corporation, but in certain situations the same conduct can give rise to both a derivative and direct claim.

On the other hand, “the existence of a special duty may be established by facts showing that defendants owed a duty to plaintiffs that was personal to plaintiffs . . . and was

934 Id. 935 Kramer v. Western Pacific Indus., Inc., 546 A.2d 348 (Del. 1988); Bokat v. Getty Oil Co., 262 A.2d 246, 249 (Del. 1970); Colonial Securities Corp. v. Allen, CA 6778, 1983 Del. Ch. LEXIS 393 (Apr. 18, 1983); Elster v. Am.

Airlines, Inc.,100 A.2d 219, 220 (Del. Ch. 1953). Note that the Bokat and Elster cases, though not having been overruled by any Delaware court, have been stated as overruled in a California federal district court case, Ind. Elec.

Workers Pension Trust Fund v. Dunn, 2008 U.S. Dist. LEXIS 34600 (N.D. Cal. March 28, 2008). 936 Gentile v. Rossette, 906 A.2d 91 (Del. 2006); Rhodes v. Silkroad Equity, LLC, 2007 Del. Ch. LEXIS 96 (Del. Ch. July 11, 2007). 937 See N.C. Gen. Stat. § 55-7-40.1. 938 118 N.C. App. 263, 266-267, 454 S.E.2d 883, 885-886 (1995); see also Aubin v. Susi, 149 N.C. App. 320, 560 S.E.2d 875 (2002). 939 Outen v. Mical 118 N.C. App. 263, 266-267, 454 S.E.2d 883, 885-886 (1995) (internal citations omitted). 940 Id.

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separate and distinct from the duty defendants owed the corporation,” and this duty may serve as the basis for a derivative claim.941 In addition, in the context of a closely held corporation, a different analysis might apply, and a court might be inclined to treat what is essentially a derivative claim as an individual one. This, of course, would allow minority shareholders to bypass procedural requirements that are unique to derivative actions and to bring individual action seeking individual recovery.942

North Carolina recognizes a number of instances in which a shareholder may bring an individual claim:943

� to enforce the shareholder’s right to inspect the corporate books and records;944

� to recover a dividend already declared,945 or any other amount actually due the shareholder from the corporation on his shares or otherwise;946

� to compel the declaration of dividends;947

� to compel an involuntary dissolution;948

� to enjoin an ultra vires act by the corporation;949

� to enforce preemptive rights,950 to recover for damage done directly to the shareholder’s ownership interest in the corporation,951 or to preserve the rights of the shareholder’s particular class of stock against a prejudicial reorganization;952

� to recover damages from an “insider” or other party who induced him to buy or sell shares in the corporation either by actual misrepresentations953 or by failing to disclose pertinent information

941 Barger v. McCoy Hillard & Parks, 346 N.C. 650, 661, 488 S.E.2d 215, 221 (1997). 942 See Robinson, II, supra note 290, § 17.02[3]. Delaware courts, by contrast, have shown no inclination to vary the procedural requirements for derivative suits brought by minority shareholders in closed corporations. 943 See Robinson, II, supra note 290, § 17.02[2]. 944 N.C. Gen. Stat. § 55-16-04. 945 N.C. Gen. Stat. §§ 55-6-40(h) and 55-1-50(4). 946 Way v. Morehead City Sea Food Co., 184 N.C. 171, 113 S.E. 781 (1922) aff’d sub nom. Way v. Carteret Ice,

Transp. & Storage Co., 186 N.C. 224, 119 S.E. 232 (1923). 947 N.C. Gen. Stat. § 55-6-40(h) – (j); See Dowd v. Charlotte Pipe & Foundry Co., 263 N.C. 101, 139 S.E.2d 10 (1964). 948 N.C. Gen. Stat. § 55-14-30(2); See Dowd v. Charlotte Pipe & Foundry Co., 263 N.C. 101, 139 S.E.2d 10 (1964). 949 N.C. Gen. Stat. § 55-3-04(b)(1). 950 N.C. Gen. Stat. § 55-6-30. 951 See Wimberly v. Washington Furniture Stores, Inc., 216 N.C. 732, 6 S.E.2d 512 (1940). 952 Clark v. Henrietta Mills, 219 N.C. 1, 12 S.E. 2d 682 (1941). 953 Houston v. Thornton, 122 N.C. 365, 29 S.E. 827 (1898).

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about the corporate affairs in breach of a fiduciary obligation;954 and

� to enforce an agreement among the shareholders.955

2. Standing

Shareholders must have standing through contemporaneous ownership to bring a derivative lawsuit. Both North Carolina and Delaware have exceptions to the contemporaneous ownership requirement for individuals who become shareholders through a transfer by operation of law, such as an inheritance or collateral agreement.956

a) North Carolina

North Carolina requires that the plaintiff be a shareholder, legally or equitably, at the time of the transaction in question and when filing the suit, and the individual bringing the action must fairly and adequately represent the interests of the corporation in enforcing the corporation’s right.957 Unlike Delaware, North Carolina has no requirement that a shareholder maintain ownership of the shares after the action has begun.

To bring a suit for monetary damages against a director of a public corporation in North Carolina, a shareholder must follow all of the procedural rules for a derivative suit and also must hold the stock for at least one year, bring the suit within two years of the transaction underlying the suit, and agree to indemnify the corporation against fees incurred during the suit.958 Delaware does not have any corresponding requirement for public corporations.

b) Delaware

Delaware requires that an individual be a shareholder at the time of the harm and at the time of the lawsuit.959 A plaintiff must maintain ownership throughout the pendency of the suit to maintain standing and be adequately representative of the corporation’s other stockholders.960

3. Demand

Even with standing, as a prerequisite to instituting a derivative action, generally a North Carolina or Delaware shareholder must demand that the board of directors take legal action for redress.

954 See Howell v. Fisher, 49 N.C. App. 488, 272 S.E.2d 19 (1980). 955 Snyder v. Freeman, 300 N.C. 204, 266 S.E.2d 593 (1980). 956 N.C. Gen. Stat. § 55-7-41(1); Del. Code Ann. tit. 8, § 327. 957 N.C. Gen. Stat. § 55-7-41(2). 958 N.C. Gen. Stat. § 55-7-48. 959 Del. Code Ann. tit. 8, § 327. This is the only provision of the DGCL that relates to derivative actions. Otherwise, the law of derivative actions in Delaware is a matter of caselaw and the procedural rules of the Delaware Court of Chancery. 960 Delaware Chancery Court Rule 23.1. See also Lewis v. Anderson, 477 A.3d 1040, 1046 (Del. 1984).

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a) North Carolina

A shareholder of a North Carolina corporation may file a derivative lawsuit only if the corporation rejects the demand, does not act within 90 days of the demand, or if waiting 90 days after demand would cause irreparable harm to the corporation.961 North Carolina does not have a futility exception (such as Delaware’s) to the demand requirement. The demand requirement is absolute (subject to the statutory exceptions), and a complaint in a derivative action must demonstrate compliance. The degree of specificity required in the complaint, however, is not clear from the caselaw.962

b) Delaware

Prior to instituting a derivative lawsuit, a stockholder of a Delaware corporation must either make a demand on the board of directors that it bring suit on behalf of the corporation (in which case the board has a reasonable amount of time to respond),963 or otherwise establish that such a demand would be futile.964 Once a stockholder makes a demand of the board of directors, the stockholder may not later ask for demand to be excused due to futility. In addition, if a stockholder of a Delaware corporation elects to request an appraisal remedy in the demand to the board of directors, the stockholder may not later bring a derivative suit.

To excuse demand, a stockholder must plead with specificity to create a reasonable doubt that a majority of the directors are interested or not independent, and that the challenged transaction was not otherwise the product of the exercise of valid business judgment.965 This test (the “Aronson test”) does not apply in certain situations where the board of directors considering a demand did not make the business decision underlying the claim in the demand.

4. Stay of the Proceedings

a) North Carolina

Once a North Carolina corporation begins to investigate claims set forth in a demand or complaint, a court may grant the corporation a stay of the derivative proceeding to complete the investigation for a duration of time the court deems appropriate.966

b) Delaware

The rule is similar in Delaware.967 Specifically, Delaware courts have stayed derivative proceedings where the stockholder bringing the suit lost standing and time was

961 N.C. Gen. Stat. § 55-7-42. 962 See Robinson, II, supra note 290, § 17.03[1]. 963 BTZ, Inc. v. Nat’s Intergroup, CA No. 11388, slip op. at 8 (Del. Ch. Apr. 7, 1993). 964 Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 730 (Del. 1988). 965 Delaware Chancery Court Rule 23.1; Aronson v. Lewis, 473 A.2d 805 (Del. 1984). 966 N.C. Gen. Stat. § 55-7-43. 967 In re infoISA, Inc. S’holders Litig., CA No. 1956-CC, Slip op. at 2-3 (Del. Ch. Mar. 17, 2008).

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needed to find another stockholder with proper standing968 and where another derivative action was pending in a different jurisdiction and the plaintiff stockholder was adequately represented in the pending case.969

5. Dismissal

a) North Carolina

The court, upon a motion made by the corporation, shall dismiss the derivative suit if “in good faith after conducting a reasonable inquiry” it is determined that continuance of the derivative suit is not in the “best interest of the corporation.”970 Such inquiry and determination may be made by any of the following three groups: (i) a majority vote of independent directors at a directors meeting where the independent directors represent a quorum, (ii) a majority vote of a special litigation committee (appointed by a majority vote of independent directors) consisting of two or more independent directors, or (iii) a court-appointed panel of independent persons.971 A shareholder may challenge the determination that the derivative suit is not in the best interest of the corporation. The burden of proof required for such challenge is dependent on the composition of the corporation’s board of directors; if the majority of the board of directors is disinterested the burden of proof remains with the shareholder, on the other hand if the majority of the board is interested the burden of proof shifts to the corporation.972

b) Delaware

Upon demand, the board of a Delaware corporation has a duty to investigate, as courts in Delaware have required that the board must (i) determine the best method to inform itself of facts and if factual investigation is required, they must be conducted reasonably and in good faith; and (ii) weigh the alternatives available to it, including the advisability of implementing internal corrective action and commencing legal proceedings. In addition, in so doing, the board must be able to act free of personal financial interest and improper extraneous influences.973

After an objective and thorough investigation, a Delaware special litigation committee may cause the corporation to file a motion to dismiss the derivative action, provided such motion is supported by a written record of the committee’s investigation and its findings and recommendations.974

In deciding whether to approve the committee’s motion to dismiss, a Delaware court will apply the following two-step test. First, the court will inquire into the independence and good faith of the committee and confirm that the records of the investigation

968 Strategic Asset Mgmt. v. Nicholson, A.2d. (Del. Ch. Nov. 30, 2004). 969 Teachers’ Ret. Sys. of La. v. Scrushy, A.2d (Del. Ch. Mar. 2, 2004). 970 N.C. Gen. Stat. § 55-7-44(a). 971 N.C. Gen. Stat. § 55-7-44. 972 N.C. Gen. Stat. § 55-7-44(e). 973 Rales v. Blasband, 634 A.2d 927, 935 (Del. 1993). 974 In particular, if a stockholder brings a derivative suit without having first made a demand for corrective action, the board may establish a special litigation committee to evaluate the suit and determine whether it is in the best interests of the corporation that the suit be continued. Grimes v. Donald, 673 A.2d 1207, 1217 (Del. 1996).

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support the committee’s recommendations.975 The corporation will have the burden of proving independence, good faith, and a reasonable investigation. Second, if the first step is satisfied, the court may apply its “own business judgment” to the issue of whether or not the case is to be dismissed.976 In making this determination, the court may consider such things as the corporation’s interest in having the suit dismissed and matters of public policy. The second step is wholly within the discretion of the court, thus a court may decline to impose its own independent business judgment.977

A Delaware court will dismiss the action (i) if there has been no demand and the plaintiff cannot prove that demand was futile; (ii) if demand was made and rejected, the plaintiff claims that rejection was wrongful, and the court rules that the business judgment rule applies to board’s refusal of the demand; or (iii) a special litigation committee files a pre-trial motion to dismiss, supported by a written record and court rules that (A) the committee is independent and worked in good faith and that its conclusions are supported with reasonable bases, and (B) in the court’s own independent judgment, it determines that action should be dismissed.978

6. Director Independence

Delaware and North Carolina take slightly different approaches with respect to determining whether a director is independent for these purposes. In North Carolina, the issue normally arises when determining whether an action should be dismissed after corporate inquiry. The NCBCA provides that none of the following factors shall cause a director not to be independent: (i) nomination or election by the defendants in the proceeding; (ii) the naming of the director as a defendant; or (iii) the approval by the director of act being challenged if the act resulted in no personal benefit to the director.979

In Delaware, the inquiry arises when determining if a demand is futile and if the special litigation committee was independent. Under Delaware law, none of the following factors shall cause a director not to be independent: (i) simply that the director acquiesced in or approved the challenged act980 (unless there is a substantial likelihood of liability);981 (ii) a director’s membership on a committee;982 or (iii) receipt of directors’ fees and other board perquisites.983 The following factors, however, will generally cause a director to be considered interested: (i) a direct financial interest in challenged transaction;984 or (ii) close family, business or other social relationships.985

975 Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981). 976 Id. 977 Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1985). 978 Zapata Corp. v. Maldonado, 430 A.2d 779, 784 (Del. 1981). 979 N.C. Gen. Stat. § 55-7-44. 980 Aronson v. Lewis, 473 A.2d 805, 814, 817 (Del. 1984). 981 In re Baxter Int’l, Inc. Shareholders Litigation, 654 A.2d 1268, 1270 (Del. Ch. 1995). 982

See, e.g., Desimone v. Barrows, 924 A.2d 908, 943 (Del. Ch. 2007). 983 See, e.g., Growbow v. Perot, 539 A.2d 180, 188 (Del. Ch. 1988). 984 See Edward P. Welch, Andrew J. Turezyn, Robert S. Saunders, supra note 320, § 327.4.2.4.3. 985 See id. § 327.4.2.4.5.

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7. Attorney-Client Privilege.

As provided in NCBCA, a shareholder does not have right to the corporation’s privileged communications that could not be obtained by or would not be accessible to a party in an action other than a derivative action.986 Delaware, however, leaves open the possibility that the privilege might be set aside, as Delaware courts have established that the plaintiff has the burden of establishing good cause to lay aside the privilege, based on certain factors that include the nature of the claim and whether it is colorable, the apparent necessity or desirability of the stockholders having the information and the availability of the information from other sources, and the extent to which the communication is identified versus the extent to which the stockholders are on a “fishing expedition.”987

8. Discontinuance or Settlement

Derivative proceedings in North Carolina and Delaware may not be settled or discontinued without the court’s approval.988 In North Carolina, the court will notify shareholders if a settlement or discontinuance will substantially affect their interests.989 Delaware courts must also notify stockholders of dismissal or settlement.990 Delaware courts have discretion to determine if the settlement terms are fair, reasonable, and adequate, which can include the long-term benefit to all stockholders at the expense of immediate tangible benefits.

9. Expenses

A court in North Carolina or Delaware may award attorneys’ fees and costs to either party in a derivative action, regardless of when the suit is terminated or which side is the prevailing party.991 North Carolina courts may award attorney’s fees to the plaintiff where the proceeding brings substantial benefit to the corporation, to the defendant where the case was brought without reasonable cause or for an improper purpose, and to either party for a lack of good faith or improper purpose by the opposing side.992 Delaware courts also may award attorneys’ fees to the plaintiff where the result of the case brings a benefit to the corporation or a class of stockholders. Director indemnification is mandatory in Delaware when a director wins a derivative suit on the merits.993 Director indemnification is permissive where a director acts in good faith and shows either that he or she reasonably believed he or she was acting in the best interest of the corporation, or that he or she at least did not act against the interest of the corporation.994

986 N.C. Gen. Stat. § 55-7-49. 987 Lee v. Engle, CA No. 12649, slip op. at 3 (De. Ch. July 1, 1993). 988 N.C. Gen. Stat. § 55-7-45, Delaware Chancery Court Rule 23.1(c). 989 N.C. Gen. Stat. § 55-7-45. 990 Delaware Chancery Court Rule 23.1(c). If dismissal is without prejudice or with prejudice to plaintiff only, however, then no notice is required if no compensation has passed from defendant to plaintiff or plaintiff’s attorney and no promise to give any such compensation has been made. 991 N.C. Gen. Stat. § 55-7-46; Baron v. Allied Artists Pictures Corp., 395 A.2d 375 (Del Ch. 1978), affirmed 413 A.2d 876 (Del. 1980). 992 N.C. Gen. Stat. § 55-7-46. 993 Del. Code Ann. tit. 8, § 145(c). 994 Del. Code Ann. tit. 8, § 145(a).

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M. Dissolutions

1. Voluntary Dissolution

Both North Carolina and Delaware allow the directors of a corporation to recommend a plan of dissolution to the shareholders (a simple majority of which must approve such plan, in order that it become effective).995 Shareholder liability in both states, provided the corporation has taken advantage of the statutory dissolution and disposal of claims provisions, is limited to the lesser of the assets the shareholder received upon dissolution or the shareholder’s pro-rata share of a claim against the corporation.996

a) North Carolina

Under North Carolina law, a corporation’s board of directors may recommend dissolution of the corporation to the corporation’s shareholders.997 Unless the board of director’s plan of dissolution, the corporation’s bylaws or the corporation’s articles of incorporation require otherwise, dissolution must be approved by a simple majority of shareholders entitled to vote on dissolution.998 After dissolution is authorized, articles of dissolution must be filed with North Carolina’s secretary of state.999 These articles may be revoked for a period of 120 days after filing by following the same approval and procedure that was used to dissolve the corporation.1000

A dissolved corporation continues its corporate existence but may not carry on any business except business appropriate to wind up and liquidate its business and affairs, including:

� Collecting its assets;

� Disposing of its properties that will not be distributed in kind to its shareholders;

� Discharging or making provision for discharging its liabilities;

� Distributing its remaining property among its shareholders according to their interests; and

995 N.C. Gen. Stat. § 55-14-02; Del. Code Ann. tit. 8, § 275. 996 N.C. Gen. Stat. § 55-14-08(a)(2); Del. Code Ann. tit. 8, § 282. 997 In addition, the NCBCA authorizes dissolution by the incorporators or by the directors if shares have not yet been issued. N.C. Gen. Stat. § 55-14-01. The DGCL has a similar provision that is somewhat more liberal, in that it permits dissolution by a majority of the incorporators (or, if the directors have been named in the certificate of incorporation, the directors) after the issuance of shares but before the corporation’s business has commenced. See

Del. Code Ann. tit. 8, § 274. 998 N.C. Gen. Stat. § 55-14-02. 999 Articles of dissolution must set forth (i) the name of the corporation; (ii) the names and addresses of its officers and directors; (iii) the date dissolution was authorized; and (iv) a statement that shareholder approval was obtained as required by Chapter 55. N.C. Gen. Stat. § 55-14-03. 1000 N.C. Gen. Stat. § 55-14-04. Delaware does not have a corresponding procedure for revocation.

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� Taking every other act necessary to wind up and liquidate its business and affairs.1001

The NCBCA provides no statutory wind-up period.1002

North Carolina provides a procedure for expedited handling of claims against a dissolved corporation. To dispose of known claims against the corporation, the corporation must notify known claimants in writing of the dissolution and require that all claims against the corporation be made within a certain period.1003 The claims period must be at least 120 days from the date of the notice. Claims not received within the claims period will be barred. If the corporation rejects a claim, the claimant must file an action to enforce the claim within 90 days of the rejection notice or the claim is barred.1004

To dispose of unknown claims, the corporation must publish a one-time notice in a general circulation newspaper in the county in which the corporation’s registered office was located. Anyone having a claim against the corporation has five years from the publication date in which to file a proceeding to enforce that claim, or the claim is barred.1005

The corporation may dispose of unknown or contingent claims more quickly by filing an application with the superior court of the county where the dissolved corporation’s principal office or, if there is no principal office in the state, its registered office, is located. In response to this application, the court will determine the amount and form of security to be provided for payments of claims that are contingent, unknown or that are based on an event occurring after the effective date of dissolution but that, based on the facts known to the dissolved corporation, are reasonably estimated to arise after the effective date of dissolution. Provisions need not be made for any claim that is or is reasonably anticipated to be barred under NCBCA Section 14-07(c) (for example, claims that are based on events occurring after the effective date of dissolution). Within 10 days after the filing of the application, notice of the proceeding shall be given by the dissolved corporation to each claimant holding a contingent claim whose contingent claim is shown on the records of the dissolved corporation. The court may appoint a guardian ad litem to represent all claimants whose identities are unknown, the costs of which shall be paid by the dissolved corporation. Once a determination has been made, the dissolved corporation shall pay any claims or post any security required by the court. This

1001 N.C. Gen. Stat. § 55-14-05. 1002 This differs from the Delaware statute, as discussed below. 1003 NCBCA Section 14-06 sets forth the required contents of such notice. Such notice must (i) describe information that must be included in a claim; (ii) provide a mailing address where a claim may be sent; (iii) state the deadline, which may not be fewer than 120 days from the effective date of the written notice, by which the dissolved corporation must receive the claim; and (iv) state that the claim will be barred if not received by the deadline. N.C. Gen. Stat. § 55-14-06. 1004 N.C. Gen. Stat. § 55-14-06. 1005 N.C. Gen. Stat. § 55-15-07. In addition, if the dissolved corporation publishes a newspaper notice in accordance with subsection (b), the claim of each of the following claimants will be barred unless the claimant commences a proceeding to enforce the claim against the dissolved corporation within five years after the publication date of the newspaper notice: (i) a claimant who did not receive written notice under NCBCA Section 14-06; (ii) a claimant whose claim was timely sent to the dissolved corporation but not acted on; and (iii) a claimant whose claim is contingent or based on an event occurring after the effective date of dissolution. N.C. Gen. Stat. § 55-15-07(c).

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payment or security discharges all liability to the claimant, and claims shall not be enforced against a shareholder who received assets in liquidation.1006

Claims properly brought pursuant to NCBCA Sections 14-06 or 14-07 may be enforced against any undistributed assets of the corporation. If the assets have been distributed in liquidation, claims may be enforced against a shareholder of the dissolved corporation to the extent of the lesser of the shareholder’s pro rata share of the claim or the corporate assets distributed to the shareholder in liquidation. A shareholder’s total liability for all claims, after pursuing the procedures in NCBCA Sections 14-06 or 14-07, may not exceed the total amount of assets distributed to the shareholder.1007 Claims brought under the court proceeding described in NCBCA Section 14-09 are satisfied by the dissolved corporation complying with the court’s order, and such claims may not be enforced against a shareholder.

b) Delaware

The court of chancery has jurisdiction with respect to dissolution proceedings in Delaware.1008 In Delaware, a majority of a corporation’s board of directors must adopt a plan of dissolution, which must be approved by a majority of the stockholders entitled to vote on the dissolution. Dissolution may also be approved without the decision of the board of directors if approved by all of the stockholders entitled to vote thereon. Thereafter, a certificate of dissolution is filed (in accordance with DGCL Section 103) with the secretary of state.1009 The corporation then has three years to settle and close the business of the corporation.1010

During the three year continuation period, corporations may not continue the business for which the corporation was organized. The purposes for which a corporation may continue as a corporate entity are to: (i) bring and defend lawsuits; (ii) gradually settle its business; (iii) dispose of its property; (iv) discharge its liabilities; and (v) distribute to its stockholders any remaining assets.1011

Delaware law, like North Carolina law, provides an expedited procedure for resolving claims against the corporation during the dissolution process. The corporation may give notice of the dissolution and require all persons having a claim against the corporation to present their claims in accordance with the notice.1012 The claims period may be as short as 60

1006 N.C. Gen. Stat. § 55-15-09. 1007 N.C. Gen. Stat. § 55-14-08. 1008 Del. Code Ann. tit. 8, § 283. 1009 Del. Code Ann. tit. 8, § 275. The certificate of dissolution must set forth: (i) the name of the corporation ; (ii) the date dissolution was authorized; (iii) that the dissolution has been authorized by the board of directors and stockholders of the corporation, in accordance with subsections (a) and (b) of DGCL Section 275, or that the dissolution has been authorized by all of the stockholders of the corporation entitled to vote on a dissolution, in accordance with subsection (c) of Section 275; and (iv) the names and addresses of the directors and officers of the corporation. Del. Code Ann. tit. 8, § 275. These requirements are essentially the same as the North Carolina counterpart. See supra note 999. 1010 Del. Code Ann. tit. 8, § 278. Thus the DGCL differs somewhat from the NCBCA, which establishes no statutory period for the wind-up. 1011 Del. Code Ann. tit. 8, § 278. 1012 Such notice shall state: (i) that all such claims must be presented in writing and must contain sufficient information reasonably to inform the corporation or successor entity of the identity of the claimant and the substance of the claim; (ii) the mailing address to which such a claim must be sent; (iii) the date by which such a claim must be

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days. Notice to claimants must be given by both certified mail, return-receipt requested,1013 and publication for two consecutive weeks in a newspaper of general circulation in the county in which the corporation’s registered agent is located and in the corporation’s principal place of business, and in the case of a corporation having $10,000,000 or more in total assets, at least once in all editions of a daily newspaper with a national circulation.1014 Claims not brought within the notice period are barred. If the corporation rejects a claim,1015 the claimant must bring an action to enforce the claim within 120 days of the rejection notice, or the claim is barred.1016

A corporation may also dispose of conditional or contingent claims by following the same procedure applicable to non-conditional or non-contingent claims,1017 and offering sufficient security to the claimant to compensate the claimant if the claim matures.1018 Such notice and offer must be sent via certified mail, return-receipt requested, within 90 days of the receipt of such claim or no later than 150 days before the 3-year winding up period runs.1019 Additional provisions apply where a receiver or trustee has been appointed by the court of chancery.1020

If a dissolving Delaware corporation follows the foregoing procedures, then the claims against it are handled pursuant to DGCL Section 281, which stipulates that (i) first, payment shall be made as to claims made but not rejected; (ii) second, any required security (but that is not rejected) shall be posted; (iii) third, any required security in respect of an action already pending against the corporation, as required by the court, shall be posted; and (iv) finally, all other claims that are mature, known and uncontested or that have been finally determined to be owing by the corporation or such successor entity shall then be paid.1021 In this regard, in North Carolina where a claim has been prosecuted as the statute requires, the NCBCA (in a much less detailed fashion) simply provides (as discussed above) that such claim will be enforced against the dissolved corporation to the extent of its undistributed assets, including coverage under applicable insurance policies, or if assets have been distributed in liquidation,

received by the corporation or successor entity, which date shall be no earlier than 60 days from the date thereof; (iv) that such claim will be barred if not received by such date; (v) that the corporation or a successor entity may make distributions to other claimants and the corporation's stockholders or persons interested as having been such without further notice to the claimant; and (vi) the aggregate amount, on an annual basis, of all distributions made by the corporation to its stockholders for each of the 3 years prior to the date the corporation dissolved. Del. Code Ann. tit. 8, § 280(a)(1). Thus Delaware requires more information than North Carolina requires for its counterpart notice. See supra note 1003. 1013 Note that North Carolina’s statute requires only written notice, and does not specify the required medium of delivery. N.C. Gen. Stat. § 55-14-07. 1014 Del. Code Ann. tit. 8, § 280(a)(1). 1015 The Delaware statute (unlike the NCBCA) sets forth a detailed procedure by which the corporation may reject a claim. See Del. Code Ann. tit. 8, § 280(a)(3). 1016 Del. Code Ann. tit. 8, § 280(a)(4). 1017 That is, by providing notice of dissolution to claimants via registered mail, return receipt requested. Del. Code Ann. tit. 8, § 280(b)(1). 1018 Del. Code Ann. tit. 8, § 280(b)(2). As in North Carolina, the amount of security is determined by the court, in response to a petition of the corporation. See Del. Code Ann. tit. 8, § 280(c)(1). 1019 Del. Code Ann. tit. 8, § 280(b)(2). 1020 See Del. Code Ann. tit. 8, § 279. 1021 Del. Code Ann. tit. 8, § 281(a). DGCL Section 281(a) then goes on to address situations in which there are insufficient assets to cover claims, as well as payment of any residual amounts to stockholders. Id.

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against a shareholder to the extent of the shareholder's pro rata share of the claim or the corporate assets distributed to the shareholder in liquidation, whichever is less.1022

Corporations not availing themselves of the dissolution procedure in DGCL Section 280, (i) shall pay or make reasonable provision to pay all claims and obligations, including all contingent, conditional or unmatured contractual claims known to the corporation or such successor entity; (ii) shall make such provision as will be reasonably likely to be sufficient to provide compensation for any claim against the corporation which is the subject of a pending action, suit or proceeding to which the corporation is a party; and (iii) shall make such provision as will be reasonably likely to be sufficient to provide compensation for claims that have not been made known to the corporation or that have not arisen but that, based on facts known to the corporation or successor entity, are likely to arise or to become known to the corporation or successor entity within 10 years after the date of dissolution.1023

The DGCL (unlike the NCBCA) specifically exempts directors of dissolving Delaware corporations (as well as governing persons of a successor entity) from liability for claims against the corporation, so long as the corporation or successor entity has complied with subsections (a) and 9b) of DGCL Section 281.1024

As is the case with shareholders of a dissolving North Carolina corporation, claims may be enforced against a stockholder of a dissolved corporation that disposed of its assets in accordance with DGCL Section 281 only to the extent of the lesser of the stockholder’s pro-rata share of any claim brought or the amount distributed to the stockholder in liquidation. Stockholders of a dissolved corporation, the assets of which were distributed pursuant to DGCL Section 281(a), shall not be liable for any claim that is not brought prior to the expiration of the 3 year continuation period set forth in DGCL Section 278.1025

Note also that the DGCL makes special provision for the dissolution of a joint venture having two stockholders, each holding fifty percent of the shares. The effect of this provision is to permit one of the stockholders to force a dissolution of the entity, where such stockholders are unable to agree upon the desirability of discontinuing the joint venture and disposing of its assets.1026 The NCBCA has no such provision.

1022 N.C. Gen. Stat. § 55-14-08. Note, again, that a shareholder's total liability for all claims may not exceed the total amount of assets distributed to the shareholder. Id. 1023 Del. Code Ann. tit. 8, § 281 (b). The plan of distribution shall provide that such claims shall be paid in full and any such provision for payment made shall be made in full if there are sufficient assets. If there are insufficient assets, such plan shall provide that such claims and obligations shall be paid or provided for according to their priority and, among claims of equal priority, ratably to the extent of assets legally available therefor. Any remaining assets shall be distributed to the stockholders of the dissolved corporation. Id. In this respect as well, the North Carolina statute is less detailed, as it does not specifically address situations in which the assets are insufficient to cover claims. 1024 Del. Code Ann. tit. 8, § 281(c). 1025 Del. Code Ann. tit. 8, § 282. 1026 See Del. Code Ann. tit. 8, § 273.

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2. Involuntary Dissolution

a) Delaware

The Delaware statute governing revocation or forfeiture of charter provides that:

� The Court of Chancery has the jurisdiction to revoke the charter of any corporation for abuse, misuse or nonuse of its corporate powers, privileges or franchises, and the Attorney General may proceed for this purpose by complaint in the county in which the registered office of the corporation is located;

� The Court of Chancery has the power to administer and wind up the affairs of any corporation whose charter shall be so revoked by any court . . . , and to make such orders and decrees with respect thereto as are just and equitable; and

� No such proceeding shall be so instituted for nonuse of any corporation’s powers, privileges or franchises during the first 2 years after its incorporation.1027

Under these provisions, the Delaware Court of Chancery has held that the “Court may order the dissolution of a solvent company and the appointment of a custodian or receiver only upon a showing of gross mismanagement, positive misconduct by corporate officers, breach of trust, or extreme circumstances showing imminent danger of great loss to the corporation which, otherwise, cannot be prevented. The Court exercises this power to dissolve a solvent corporation with great restraint and only upon a strong showing. Mere dissension among corporate stockholders seldom, if ever, justifies the appointment of a receiver for a solvent corporation. The minority’s remedy is withdrawal from the corporate enterprise by the sale of its stock.”1028

b) North Carolina

The NCBCA provides two means by which a North Carolina corporation may be subject to involuntary dissolution.

First, a North Carolina corporation may be administratively dissolved under NCBCA Section 14-20. Pursuant thereto, the secretary of state may commence a dissolution proceeding if (i) the corporation is 60 days delinquent in payment of any penalties, fees, or other payments due under Chapter 55; (ii) the corporation is delinquent in delivering its annual report; (iii) the corporation is without a registered agent or registered office in North Carolina for 60 days or more; (iv) the corporation does not notify the secretary of state within 60 days that its registered agent or registered office has been changed, that its registered agent has resigned, or that its registered office has been discontinued; (v) the corporation's period of

1027 Del. Code Ann. tit. 8, § 284. 1028 Carlson v. Hallinan, 925 A.2d 506, 543 (Del. Ch. 2006) (internal citations omitted).

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duration stated in its articles of incorporation expires; or (vi) the corporation knowingly fails or refuses to answer truthfully and fully within the time prescribed in Chapter 55 any interrogatories propounded by the secretary of state in accordance with such chapter.1029 NCBCA Section 14-21 sets forth the procedure applicable to such a proceeding,1030 and Section 14-22 provides the means by which the corporation may be reinstated.1031 If the secretary of state denies the application for reinstatement, the administratively dissolved corporation may appeal the decision pursuant to NCBCA Section 14-23.

Second, the NCBCA provides for the judicial dissolution of a North Carolina corporation based on an action brought by a shareholder. The DGCL lacks any corresponding provision.

Specifically, NCBCA Section 14-30 provides in part as follows:

The superior court may dissolve a corporation:

(2) In a proceeding by a shareholder if it is established that (i) the directors or those in control of the corporation are deadlocked in the management of the corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened or being suffered, or the business and affairs of the corporation can no longer be conducted to the advantage of the shareholders generally, because of the deadlock; (ii) liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder; (iii) the shareholders are deadlocked in voting power and have failed, for a period that includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired; (iv) the corporate assets are being misapplied or wasted; or (v) a written agreement, whether embodied in the articles of incorporation or separate therefrom, entitles the complaining shareholder to liquidation or dissolution of the corporation at will or upon the occurrence of some event which has subsequently occurred, and all present shareholders, and all subscribers and transferees of shares, either are parties to such agreement or became a shareholder, subscriber or transferee with actual notice thereof; . . .1032

However, the final decision to grant dissolution “is within the trial court’s discretion even though grounds for dissolution are found to exist under the statute.”1033 Thus, a

1029 N.C. Gen. Stat. § 55-14-20. 1030 N.C. Gen. Stat. § 55-14-21. 1031 N.C. Gen. Stat. § 55-14-22. If the corporation applies for reinstatement and pays any fees or other amounts owed, it may be reinstated, effective as of the date of dissolution (as though dissolution had never occurred). Note, however, that if between the date of dissolution and the date of the application for reinstatement another corporation is formed under the name of the administratively dissolved corporation, the latter must change its name to one that is distinguishable from that of the newly formed entity. Id. 1032 N.C. Gen. Stat. § 55-14-30. 1033 Foster v. Foster Farms, Inc., 112 N.C. App. 700, 706, 436 S.E.2d 843, 847 (1993).

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court will decree dissolution only if the plaintiff has established the statutory standards allowing it and has also established that equity favors dissolution.1034

Clause (ii) in NCBCA Section 14-30 as quoted above provides a potential remedy for minority shareholders in a closely held company whose reasonable expectations regarding their participation in the company have been frustrated. The North Carolina Supreme Court, in Meiselman v. Meiselman, laid out the test for determining what those reasonable expectations are and whether they have been sufficiently frustrated so as to require dissolution.1035 The standard articulated by the court requires an examination of the complainant’s relationship with the company to assess his reasonable expectations both at the beginning of his relationship with the company and as it evolved over time. In order to obtain relief under this analysis, a complaining shareholder must prove that “(1) he had one or more substantial reasonable expectations known or assumed by the other participants; (2) the expectation has been frustrated; (3) the frustration was without fault of plaintiff and was in large part beyond his control; and (4) under all of the circumstances of the case, plaintiff is entitled to some form of equitable relief.”1036

In the event that the court determines that dissolution is “reasonably necessary,” the corporation may elect to buy-out the complaining shareholder at the fair value of the shares as determined by the court. If the corporation elects to do so, the court will not order dissolution.1037 Note, however, that the buy-out provisions of NCBCA Section 14-31(d) apply only to dissolutions granted under NCBCA Section 14-30(2)(ii) on grounds that liquidation is reasonably necessary for protection of a complaining shareholder’s rights or interests.1038

After a decree of dissolution is entered by the court, the court must then direct the winding up and liquidation of the corporation’s business and affairs in accordance with NCBCA Sections 14-05, 14-06, and 14-07.

Judicial dissolution is also discussed below in Section IV.C.3. of this study.

1034 “When a shareholder brings suit seeking [judicial dissolution], he has the burden of proving that his “rights or interests” as a shareholder are being contravened. However, once the shareholder has established this, the trial court, in deciding whether to grant relief, must exercise its equitable discretion, and consider the actual benefit and injury to all of the shareholders resulting from dissolution or other possible relief. The question is essentially one for resolution through the familiar balancing process and flexible remedial resources of courts of equity.” Meiselman v.

Meiselman, 309 N.C. 279, 297, 307 S.E.2d 551, 562 (1983) (decided under prior version of statute). 1035 309 N.C. 279, 307 S.E.2d 551 (1983). 1036 Id. N.C. 279 at 301, 307 S.E.2d at 564. 1037 “In any proceeding brought by a shareholder under G.S. 55-14-30(2)(ii) in which the court determines that dissolution would be appropriate, the court shall not order dissolution if, after such determination, the corporation elects to purchase the shares of the complaining shareholder at their fair value, as determined in accordance with such procedures as the court may provide.” N.C. Gen. Stat. § 55-14-31(d). 1038 Foster v. Foster Farms, Inc., 112 N.C. App. 700, 712, 436 S.E.2d 843, 851 (1993).

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IV. FIDUCIARY DUTIES GENERALLY

A. Fiduciary Duties of Directors

1. General Principles

Both North Carolina and Delaware recognize three primary fiduciary duties of directors – the duties of good faith, due care, and loyalty. While North Carolina explicitly sets forth these duties by statute, Delaware courts have developed these duties over time.1039 Delaware courts also recognize a duty of oversight, which may be considered part of the duty of due care in North Carolina. Both states have statutes permitting directors to rely on specified information and advice when exercising their duties. Additionally, both states have statutes providing a safe harbor for business decisions involving an interested director that are approved as provided by the statute or are fair to the corporation. For change of control situations, North Carolina has adopted a statute explicitly prohibiting the application of a higher standard of care, while Delaware has developed a complex set of heightened standards and an additional duty known as the “Revlon duty.”

2. Choice of Law

The internal affairs doctrine is a conflicts of law principle that recognizes that only one state should have authority to regulate the internal affairs of a corporation.1040 Generally, a court will apply the laws and standards of care of the state of incorporation. The NCBCA codifies this principle, providing that “[i]n any derivative proceeding in the right of a foreign corporation, the matters covered by this Part shall be governed by the laws of the jurisdiction of incorporation of the foreign corporation . . . .”1041 Delaware follows the internal affairs doctrine, but also permits parties to agree that internal matters ordinarily governed by the law of the state of incorporation will be resolved under Delaware law.1042

3. Director Fiduciary Duties Under North Carolina Law

The NCBCA provides:

A director shall discharge his duties as a director, including his duties as a member of a committee:

(1) In good faith;

(2) With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and

1039 Consequently, Delaware law of fiduciary duty is much more a function of case law, and from a court of equity, and therefore tends to depend more heavily on the facts and context of a given case. 1040 Bluebird Corp. v. Aubin,188 N.C. App. 671, 680, 657 S.E.2d 55, 63 (2008) (quoting Edgar v. MITE Corp., 457 U.S. 624, 645 (1982)). 1041 N.C. Gen. Stat. § 55-7-47. 1042 Del. Code Ann. tit. 6, § 2708.

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(3) In a manner he reasonably believes to be in the best interests of the corporation.1043

These duties are generally referred to as the duties of good faith, due care, and loyalty. The NCBCA also provides that if a director performs his or her duties in compliance with the standards set forth in the statute, then any action taken by the director, or any failure to act, will not result in personal liability to the director.1044

a) Duty of Good Faith

A director’s primary obligation to the corporation is to discharge his or her duties in good faith. This duty requires a director to manage the corporation in the best interest of all shareholders and not a particular group of shareholders to the exclusion of another, and to discharge his or her responsibilities “honestly, conscientiously, fairly, and with undivided loyalty to the corporation.”1045 Although cited separately in NCBCA Section 8-30(a), the duty of good faith arguably operates more as a component of the duties of due care and loyalty.1046 North Carolina courts have yet to define whether and to what extent a director can be held liable solely for breach of the duty of good faith.1047

b) Duty of Due Care

The NCBCA provides that a director must discharge his or her duties with the care an ordinarily prudent person in a like position would exercise under similar circumstances.1048 This duty is often referred to as the “duty of care.” It requires a director to exercise diligence and care in directing and supervising the affairs of the corporation.1049 Additionally, the obligation of due care imposes upon a director a “duty of reasonable inquiry,” requiring a director to become informed about the general condition and affairs of the corporation and about the facts and circumstances relevant to a particular matter prior to taking action on that matter.1050

In discharging his or her duties a director is entitled by statute to:

rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by:

(1) One or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented;

1043 N.C. Gen. Stat. § 55-8-30(a)(2). 1044 Id. § 55-8-30(d). 1045 Robinson, II, supra note 290, § 14.02. 1046 See id. 1047 Id. 1048 N.C. Gen. Stat. § 55-8-30(a). 1049 Anthony v. Jeffress, 172 N.C. 378, 380, 90 S.E. 414, 415 (1916). 1050 Robinson, II, supra note 290, § 14.03[2]; see N.C. Gen. Stat. § 55-8-30, Official Comment 1.

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(2) Legal counsel, public accountants, or other persons as to matters the director reasonably believes are within their professional or expert competence; or

(3) A committee of the board of directors of which he is not a member if the director reasonably believes the committee merits confidence.1051

The statute also explicitly states that a director is not entitled to rely upon such information if the director has actual knowledge concerning the matter in question that makes the reliance unwarranted.1052 The director’s right of reliance may be asserted as a defense against a claim that the director breached his or her duty of care.1053 It has been posited that directors actually have a “duty of reliance,” requiring them to seek advice and information to properly inform themselves when a complex corporate matter is beyond their capabilities.1054

Case law discussing the duty of care in North Carolina is sparse, but a few cases provide some guidance as to what is expected of directors. In Houston v. Thornton, the North Carolina Supreme Court indicated that directors have an affirmative duty to inform themselves about the condition and affairs of the corporation, stating: “It is no answer to this to say that the [directors] themselves were misled as to the condition of the bank . . . . They had opportunity to know the true condition of the bank. They ought to have known. It was their duty to have known.”1055 The North Carolina Business Court found in First Union Corp. v. SunTrust

Banks, Inc. that it would not go beyond the duty of an “ordinarily prudent person . . . under like circumstances” to require that directors understand every word of a complex merger agreement.1056 Thus, it seems appropriate for directors to rely on advisors to obtain adequate knowledge and understanding in such a complex situation. Generally, to be adequately informed, directors should (1) regularly hold and attend board meetings, (2) receive and review in a timely manner all documentation necessary to consider a matter, (3) seek assistance and advice for complex transactions, (4) devote sufficient time to corporate matters so that they stay informed about the corporation’s affairs, (5) engage in adequate discussion and deliberation before deciding a matter, and (6) keep accurate board minutes.1057

c) Duty of Loyalty

The requirement under the NCBCA that a director discharge his or her duties in a manner he or she reasonably believes to be in the best interests of the corporation is often referred to as the “duty of loyalty.” The duty of loyalty precludes a director from engaging in self-dealing that is detrimental to the corporation. Of course, not every transaction in which a director is interested is prohibited. Certain “conflict of interest” transactions, such as a loan from

1051 N.C. Gen. Stat. § 55-8-30(b). 1052 Id. §55-8-30(c). 1053 Robinson, II, supra note 290, § 14.05. 1054 Id. 1055 Houston v. Thornton, 122 N.C. 272, 279, 29 S.E. 827, 830 (1898). 1056 First Union Corp. v. SunTrust Banks, Inc., 2001 NCBC 9A, 130 (N.C. Super. Ct. 2001). 1057 “How Informed Must a Director Be?”, Notes Bearing Interest (NCBA Vol. 27, No. 2, Dec. 2006).

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a director to the corporation, may be desirable and beneficial to the corporation.1058 Therefore, NCBCA Section 8-31 provides that:

A conflict of interest transaction is a transaction with the corporation in which a director of the corporation has a direct or indirect interest. A conflict of interest transaction is not voidable by the corporation solely because of the director’s interest in the transaction if any one of the following is true:

(1) The material facts of the transaction and the director’s interest were disclosed or known to the board of directors or a committee of the board of directors and the board of directors or committee authorized, approved, or ratified the transaction;

(2) The material facts of the transaction and the director’s interest were disclosed or known to the shareholders entitled to vote and they authorized, approved, or ratified the transaction; or

(3) The transaction was fair to the corporation.1059

Approval, authorization, or ratification of a conflict of interest transaction by the board of directors requires the affirmative vote of a majority of the directors on the board or committee who have no direct or indirect interest in the transaction.1060

NCBCA Section 8-31 rejects the common law view that conflict of interest transactions are automatically voidable at the option of the corporation without regard to the fairness of the transaction.1061 To determine the fairness of a transaction, the facts and circumstances surrounding the transaction as they were known, or should have been known, at the time of the transaction should be evaluated. The terms of the transaction should be deemed fair if they resemble the terms that might have been entered into in an arm’s-length transaction between disinterested persons.1062 Section 8-31 sets forth three tests to determine whether a conflict of interest transaction “is not voidable solely because of the director’s interest,” thus recognizing that the transaction may be voidable for other reasons.1063 Even if the transaction meets the test of fairness, it does not necessarily mean that the transaction is valid.1064 The transaction could still be voidable, for example, because it constituted waste, was not duly authorized, or violated other sections of the NCBCA.1065

1058 Robinson, II, supra note 290, § 14.04. 1059 N.C. Gen. Stat. § 55-8-31(a). 1060 Id. § 55-8-31(c). 1061 Id. § 55-8-31, Official Comment 1. 1062 Id. § 55-8-31, Official Comment 4. 1063 Id. § 55-8-31, North Carolina Commentary. 1064 Id. § 55-8-31, Official Comment 1. 1065 Id.

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A conflict of interest transaction can result from either a direct or indirect interest of a director. The NCBCA does not define a “direct” interest. The North Carolina Business Court in Battleground Veterinary Hospital v. McGeough explained that whether an interest is direct is left to common sense. The court did note, however, that a direct interest exists where either the director or his or her immediate family member has a financial interest in the transaction.1066 An indirect interest, on the other hand, is clearly defined in the NCBCA:

[A] director of the corporation has an indirect interest in a transaction if:

(1) Another entity in which he has a material financial interest or in which he is a general partner is a party to the transaction; or

(2) Another entity of which he is a director, officer, or trustee is a party to the transaction and the transaction is or should be considered by the board of directors of the corporation.1067

Another facet of the duty of loyalty is the corporate opportunity doctrine, which recognizes that a director cannot compete with the corporation and cannot usurp an opportunity of the corporation.1068 To defeat a claim that he or she has usurped a corporate opportunity, a director must show that the challenged transaction was “just and reasonable” to the corporation because it did not involve an opportunity the corporation would have desired.1069 In applying this standard, North Carolina courts will “examine not only whether the disputed opportunity is functionally related to the corporation’s business, but also whether the corporation has an interest or expectancy in the opportunity.”1070 The following circumstances should be considered in the examination: (1) the ability of the corporation to take advantage of the opportunity, (2) whether the corporation engaged in prior negotiations for the opportunity, (3) whether the corporate director was aware of the opportunity by virtue of his or her fiduciary position, (4) whether the existence of the opportunity was disclosed to the corporation, (5) whether the corporation rejected the opportunity, and (6) whether corporate facilities were used to acquire the opportunity.1071

1066 Battleground Veterinary Hosp. v. McGeough, 2007 NCBC 33, ¶ 94 (N.C. Super. Ct. 2007) (citing Robinson, II, supra note 290, § 15.01(1)). 1067 N.C. Gen. Stat. § 55-8-31(b). 1068 Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983). The corporate opportunity doctrine is discussed further in Section IV.B.4. of this study, below. 1069 Id. at 309, 307 S.E.2d at 568. The Meiselman court indicated the “just and reasonable” test was prescribed by N.C. Gen. Stat. § 55-30(b)(3), but that provision has since been replaced by N.C. Gen. Stat. § 55-8-31(a)(3), which sets forth a “fair to the corporation” test. See Boyd v. Howard, 147 N.C. App. 491, 556 S.E.2d 337 (2001). 1070 Id. at 311, 307 S.E.2d at 569. 1071 Id. at 310, 307 S.E.2d at 569.

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d) Duty to Creditors

The general rule in North Carolina is that directors of a corporation do not owe a duty, fiduciary or otherwise, to third parties, including creditors of the corporation.1072 There are two exceptions to this general rule. First, “a director or other corporate agent can . . . be held directly liable to an injured third party for a tort personally committed by the director or one in which he participated.”1073 Second, directors have fiduciary obligations to the corporation’s creditors when the corporation is “winding up” or dissolving.1074 Once the fiduciary duty to creditors arises, “a director must treat all creditors of the same class equally by making any payments to such creditors on a pro rata basis.”1075 Thus, directors and officers of an insolvent North Carolina corporation in liquidation may be directly liable to a creditor of the corporation if they use their power and control of corporate assets to pay more than their pro rata share of corporate debts owed to or guaranteed by them to the injury of other creditors.1076

In determining whether there exist circumstances amounting to winding up or dissolution, “balance sheet insolvency” is a factor, but alone is insufficient to trigger a fiduciary duty to creditors.1077 North Carolina courts will consider the following factors in determining whether circumstances amount to winding up or dissolution of a corporation: (1) whether the corporation was insolvent or nearly insolvent based on its balance sheet; (2) whether the corporation was cash flow insolvent; (3) whether the corporation was planning to cease doing business; (4) whether the corporation was liquidating assets with a view to going out of business; and (5) whether the corporation was still prosecuting its business in good faith and with the ongoing expectation of continuing to do so.1078

e) Change of Control

NCBCA Section 8-30(d) provides that “[t]he duties of a director weighing a change of control situation shall not be any different, nor the standard of care any higher, than otherwise provided in this section.”1079 Directors must continue to discharge their duties of good

1072 Oberlin Capital, L.P. v. Slavin, 147 N.C. App. 52, 57, 554 S.E.2d 840, 845 (2001) (quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 14.08 (6th ed. 2000)); see also North Carolina Commentary to N.C. Gen. Stat. § 55-8-30 (“The drafters considered adding a new section 55-8-34 expressly stating that the directors do not have any such duty to creditors; but, because of the complexities and novelty of such a provision, they finally decided not to add the new section but instead to express in this Comment their opinion that in general no such duty exists.”). 1073 Id. 1074 Phillips and Jordan, Inc. v. Bostic, 2009 NCBC 13, ¶ 42 (N.C. Super. Ct. June 2, 2009) (citing Keener Lumber

Co. v. Perry, 149 N.C. App. 19, 31, 560 S.E. 2d 817, 825 (2002) (quoting Whitley v. Carolina Clinic, Inc., 118 N.C. App. 523, 528, 455 S.E.2d 896, 900 (1995))). As discussed below in Section IV.A.4.e) of this study, Delaware imposes the duty to creditors at a different stage – at the point of insolvency of the corporation. See also Thomas A. Allen and Anthony L. Williams, “Director Duties in Times of Financial Crisis,” Notes Bearing Interest (NCBA Vol. 30, No. 4, June 2009). 1075 Id. at ¶ 44 (quoting Keener at 33, 560 S.E. 2d at 827). 1076 See Bassett v. Pamlico Cooperage Co., 188 N.C. 511, 125 S.E. 14 (1924); Graham v. Carr, 130 N.C. 271, 41 S.E. 379 (1902). 1077 Keener at 31, 560 S.E.2d at 825. 1078 Id. 1079 N.C. Gen. Stat. § 55-8-30(d).

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faith, due care, and loyalty to the best of their abilities in a change of control situation.1080 The practical effect of this section, which was added to the NCBCA in 1993, is unclear.1081 The complexity of a change of control transaction and the inherent conflicts of interest may lead a court to examine more carefully the directors’ adherence to their duties, in effect raising the requisite level of care.1082 This is especially true in North Carolina, where courts have traditionally been protective of shareholder rights.1083

In First Union Corp v. SunTrust Banks, Inc., the North Carolina Business Court held that the 1993 amendment was implemented to preclude the court from applying a heightened standard of conduct to board action in a change of control case, not to prevent the court from applying a heightened standard of judicial review.1084 Faced with the difficult task of determining the validity of deal protection measures, the court devised a new case-specific and fact-specific standard of review, designed to protect both the shareholders’ voting rights and the board’s ongoing ability to perform its statutory duties.1085 This standard of review is separate from the business judgment rule, discussed below, and allows for efficiency and reasonable risk taking.1086

In this case-specific and fact-specific standard of review, the shareholder bears the initial burden of proving that the directors breached their duty of care. If this burden is not met, directors’ actions are presumed to be reasonable and valid. The presumption can be overcome only by clear and convincing evidence that the deal protection measures adopted by the board either “(a) actionably coerce[d] the shareholders in the exercise of their right to vote on the [transaction] or (b) prevent[ed] the directors from performing their statutory duties.”1087 This review process in change of control cases focuses on shareholder rights rather than on director performance. It permits recourse to shareholders for directors’ actions that infringe upon shareholder rights even though those actions might otherwise be protected under the business judgment rule.1088

f) Exculpation

N.C. Gen. Stat. § 55-2-02(b)(3) provides that a corporation may include a provision in its articles of incorporation “limiting or eliminating the personal liability of any director arising out of an action whether by or in the right of the corporation or otherwise for monetary damages for breach of any duty as a director.”1089 However, a director cannot avoid liability for:

1080 Robinson, II, supra note 290, § 9.08[3]. 1081 Id. 1082 Id. 1083 Id. 1084 First Union Corp. v. SunTrust Banks, Inc., 2001 NCBC 9A, ¶ 69 (N.C. Super. Ct. 2001). 1085 Id.; see also Robinson, II, supra note 290, § 9.08[3]. 1086 Robinson, II, supra note 290, § 9.08[3]. 1087 Id. 1088 Id. 1089 N.C. Gen. Stat. § 55-2-02(b)(3); cf. Del. Code Ann. tit. 8, § 102(b)(7) (permitting limiting directors’ liability for breach of fiduciary duty other than duty of loyalty).

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(i) acts or omissions that the director at the time of such breach knew or believed were clearly in conflict with the best interests of the corporation, (ii) any liability under G.S. 55-8-33 [regarding unlawful distributions], (iii) any transaction from which the director derived an improper personal benefit, or (iv) acts or omissions occurring prior to the date the provisions became effective.1090

This exculpation provision applies to direct or derivative actions brought by shareholders as well as to third-party actions. While the statute allows a corporation to limit or eliminate liability for monetary damages, it does not permit the elimination or limitation of injunctive relief against the directors.1091

4. Director Fiduciary Duties Under Delaware Law

Traditionally Delaware courts have recognized the existence of fiduciary duties corporate directors must follow. As in North Carolina, these include the duties of care, good faith and loyalty. Although the duty of good faith was once considered a separate duty with its own cause of action, recent case law seems to subsume the duty of good faith into the duty of loyalty. Good faith is still required in all acts by corporate directors, but allegations of a breach of the duty of good faith alone do not state a cause of action. A separate cause of action does exist under the duty of oversight, often referred to as a Caremark claim. Directors are also required to disclose full and accurate information when communicating with stockholders. This “duty of disclosure” is not an independent duty, but arises out of the duties of loyalty, care and good faith.1092

a) Duty of Care

Generally, the duty of care requires directors to inform themselves “of all material information reasonably available” before making a business decision.1093 Delaware law provides by statute that a director may be

fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation’s officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person’s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.1094

1090 N.C. Gen. Stat. § 55-2-02(b)(3). 1091 For a general discussion of this topic, see Section III.E.1. of this study, above. 1092 Malone v. Brincat, 722 A.2d 5, 11-12 (Del. 1998). 1093 Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985) (quoting Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984)), overruled on other grounds, Gantler v. Stephens, 965 A.2d 695 (Del. 2009). 1094 Del. Code Ann. tit. 8, § 141(e).

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Even though directors are not required to know every detail of the workings of the corporation, the statute will offer no protection if the directors rely blindly on the reports of experts without making a reasonable inquiry into the information available to them.1095 The business judgment rule, discussed below, also provides directors protection from duty of care claims by creating a presumption that, in the absence of bad faith, the action was taken in the best interest of the company.

b) Duty of Oversight

While the typical duty of care case results from an alleged negligent or ill-advised decision, a duty of oversight case would result from “unconsidered inaction.” In In re

Caremark Int’l, Inc. Derivative Litig., shareholders filed five derivative actions alleging that the Caremark International, Inc. directors breached their fiduciary duty of care.1096 The alleged breach was based on the board’s failure both to monitor the company’s employees and to implement a reporting and oversight mechanism that would keep the board informed.1097 The Caremark court held:

Where a claim of directorial liability for corporate loss is predicated upon ignorance of liability-creating activities within the corporation . . . only a sustained or systematic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.1098

Stone v. Ritter, discussed below, confirmed the standard set forth in Caremark for director oversight liability, explained the interplay between the duty of oversight and the duty of good faith and concluded that a breach of those duties is ultimately a breach of the duty of loyalty.1099

c) Duty of Good Faith

In In re Walt Disney Co. Derivative Litig., the Delaware Supreme Court defined a breach of the duty of good faith as an “intentional dereliction of duty, a conscious disregard for one’s responsibilities . . . .”1100 The court gave three examples of when a failure to act in good faith may be shown:

A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to

1095 Smith, 488 A.2d at 875. 1096 In re Caremark Int’l, Inc. Derivative Litig., 698 A.2d 959, 968 (Del. Ch. 1996). 1097 Id. 1098 Id. at 971. 1099 Stone v. Ritter, 911 A.2d 362 (Del. 2006); see also Bradley W. Voss, Brian C. Ralston & Roxanne L. Houtman, Recent Developments in Corporate Law, 9 Del. L. Rev. 153 (2007). 1100 In re Walt Disney Co. Derivative Litig., 906 A. 2d 27, 62 (Del. 2006) (quoting chancery court decision).

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act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.1101

Good faith was once considered one of the three primary fiduciary duties under Delaware law. Stone v. Ritter clarified the question of whether the duty of good faith is separate from the duties of care and loyalty – concluding it is not – and at the same time moved the duty of oversight, traditionally a duty of care claim, under the duty of loyalty.1102

In Stone, the shareholders initiated a derivative action, alleging the directors failed to properly oversee the company’s activities. AmSouth, a wholly owned subsidiary, paid over $50 million in fines and penalties for its employees’ failure to file required “Suspicious Activity Reports.”1103 The chancery court recognized the claim as a “classic Caremark claim.”1104 On appeal, the Delaware Supreme Court held:

Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.1105

Stone further confirmed Caremark by its adoption of the notion that the lack of good faith is a “necessary condition to liability.”1106 The court explained the role good faith plays in a finding of liability by stating: “The failure to act in good faith may result in liability because the requirement to act in good faith ‘is a subsidiary element[,]’ i.e., a condition, ‘of the fundamental duty of loyalty.’ It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.”1107 The court went further and explained the consequences of interpreting good faith as a subsidiary element of the duty of loyalty:

This view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a “triad” of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability,

1101 Id. at 67. 1102 Stone v. Ritter, 911 A.2d 362 (Del. 2006). 1103 Id. at 365. 1104 Id. at 364. 1105 Id. at 370. 1106 Id. at 369. 1107 Id. at 369, 370 (quoting in part Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003)).

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whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest.”1108

While the analysis of what constitutes good faith and the duty of oversight has not changed drastically, the effect of moving these duties under the umbrella of duty of loyalty results in a major change in a director’s potential liability, as discussed below.

d) Duty of Loyalty

Generally, the traditional duty of loyalty requires “that there be no conflict between duty and self-interest” and an undivided loyalty by directors to the corporation.1109 In Solash v. Telex Corp., the Delaware chancery court explained:

The duty of loyalty is transgressed when a corporate fiduciary, whether director, officer or controlling shareholder, uses his or her corporate office or, in the case of a controlling shareholder, control over corporate machinery, to promote, advance or effectuate a transaction between the corporation and such person (or an entity in which the fiduciary has a substantial economic interest, directly or indirectly) and that transaction is not substantively fair to the corporation. That is, breach of loyalty cases inevitably involve conflicting economic or other interests, even if only in the somewhat diluted form present in every “entrenchment” case.1110

As discussed above, because the duties of good faith and oversight are now under the umbrella of the duty of loyalty, a breach of the duty of loyalty no longer “inevitably involve[s] conflicting economic or other interests.”1111

When evaluating a breach of loyalty claim, the director’s independence or interest in the transaction will be taken into account when determining liability. A director is independent when “he is in a position to base his decision on the merits of the issue rather than being governed by extraneous considerations or influences.”1112 “A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not

1108 Id. at 370. 1109 Guth v. Loft, 5 A.2d 503, 510 (Del. 1939). 1110 Solash v. Telex Corp., 1988 Del. Ch. LEXIS 7, 19 (Del. Ch. 1988). 1111 Id. 1112 Kaplan v. Wyatt, 499 A.2d 1184, 1189 (Del. 1985).

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equally shared by the stockholders.”1113 This possible benefit or detriment can also arise indirectly such as through a family member or close friend.

Because all business decisions that benefit a director are not inherently unfair to the corporation, DGCL Section 144 provides a safe harbor for business decisions that involve an interested director. Similar to NCBCA Section 8-31, DGCL Section 144 provides that a contract or transaction is not void or voidable solely because of a director’s interest in the transaction if: (1) the material facts as to the director’s or officer’s relationship are disclosed to the board and the board authorizes such transaction; (2) the material facts as to the director’s or officer’s relationship are disclosed to the stockholders who approve or authorize the transaction; or (3) the contract or transaction is fair to the company at the time it is authorized or approved by the board, a committee or the stockholders.1114

Recently, the duty of loyalty has been expanded to include the duties of good faith and oversight.1115 This expansion of the duty of loyalty profoundly affects a director’s exposure to liability. DGCL Section 102(b)(7) allows a company’s certificate of incorporation to limit a director’s liability for monetary damages for a breach of fiduciary duty.1116 Such a provision may not, however, eliminate or limit a director’s liability.

(i) for any breach of the director’s duty of loyalty to the corporation or its shareholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title [regarding director liability for unlawful payment of dividends or unlawful stock purchase or redemption]; or (iv) for any transaction from which the director derived an improper personal benefit.1117

Because DGCL Section 102(b)(7) does not allow a corporation to eliminate or limit liability for breaches of the duty of loyalty, directors may not be insulated from oversight, or Caremark, claims.

e) Duty to Creditors

In Delaware, the general rule is that directors do not owe fiduciary duties to creditors absent “special circumstances,” which Delaware courts have identified as “fraud, insolvency or a violation of a statute,”1118 and in at least one case, the institution of dissolution proceedings.1119 In the context of insolvency, it is clear that director fiduciary duties to creditors arise when a corporation is insolvent.1120 Delaware courts define insolvency as occurring when the corporation “is unable to pay its debts as they fall due in the usual course of business . . . or

1113 Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993). 1114 Del. Code Ann. tit. 8, § 144. 1115 See supra notes 1097to 1103 and accompanying text. 1116 For a general discussion of this topic, see Section III.E.1. of this study, above. 1117 Del. Code Ann. tit. 8, § 102(b)(7). 1118 Harff v. Kerkorian, 324 A.2d 215, 222 (Del. Ch. 1974). 1119 Kidde Indus., Inc. v. Weaver Corp., 593 A.2d 563, 564 (Del. Ch. 1991). 1120 Geyer v. Ingersoll Publications Co., 621 A.2d 784, 787 (Del. Ch. 1992).

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when it has liabilities in excess of a reasonable market value of assets held.”1121 Once such fiduciary duties have arisen, creditors have standing to assert derivative claims, but not direct claims, against corporate directors for breach of those fiduciary duties.1122 Thus, while creditors of an insolvent corporation may assert derivative breach of fiduciary duty claims on behalf of the corporation or direct nonfiduciary claims against the corporation or its directors, creditors of an insolvent Delaware corporation do not have standing to assert direct claims against the corporation’s directors for breach of fiduciary duty.

f) Change of Control – Standards of Review

Delaware courts employ four different standards of review under which directors’ actions will be scrutinized in connection with change of control cases. Where there is no evidence that the directors failed to satisfy their duties of good faith, due care and loyalty, the standard of review will be under the business judgment rule, which is discussed below.1123

The courts will employ “enhanced scrutiny” when the directors, without stockholder approval, adopt defensive measures to combat a possible change in control.1124 This heightened level of review is used because of “the omnipresent specter that a board may be acting in its own interests, rather than those of the corporation and its shareholders.”1125 The “enhanced scrutiny” standard requires directors to show that they had a reasonable basis to believe that the prospective takeover posed a threat to “corporate policy and effectiveness” and that their defensive action was “reasonable in relation to the threat posed.”1126

Under the third standard of review, if it appears a director’s action is affected by self-interest, all aspects of the director’s action will be reviewed by the court for its “entire fairness” to the corporation.1127 This standard requires a director or the board of directors to establish to the court’s satisfaction that the transaction was the product of both fair dealing and fair price.1128

The fourth standard of review requires the directors who take a defensive action against a change of control to show a “compelling justification” for their action, when the purpose of the action is to impede the exercise of stockholder voting rights.1129 “Compelling justification” requires the court to balance the reasons for the directors’ action with the need for complete protection of the stockholders’ right to vote.1130 Importantly, the heightened scrutiny of “compelling justification” is often used in conjunction with other standards of review where

1121 Id. at 789; see also N.A. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007) (indicating that creditors may not be owed fiduciary duties until the corporation is actually insolvent and not while the corporation is operating in the zone of insolvency). 1122 N. A. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101, 103 (Del. 2007). 1123 Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1283-84 (Del. 1989). 1124 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). 1125 Id. at 954. 1126 Id. 1127 Cinerama, Inc., v. Technicolor, Inc., 663 A.2d 1156 (Del. 1995). 1128 Id. at 1163. 1129 Blasius Indus., Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988). 1130 MM Companies, Inc. v. Liquid Audio, Inc., 813 A.2d 1118, 1131-32 (Del. 2003).

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director action could infringe a stockholder’s right to vote in addition to other consequences of such action.1131 The standards are not mutually exclusive.1132

g) Change of Control – Revlon Duty

While Delaware courts do not impose a duty to propose or approve a sale of the corporation, they do require the directors to obtain the best value for the stockholders when they decide to sell the company or when the sale of the company is inevitable.1133 The duty to achieve the highest shareholder value under such circumstances is frequently referred to as the board’s “Revlon duty.”

Revlon duties are triggered only when there is a sale of control or a breakup of the corporation; transactions in which the stockholders receive shares in the surviving or acquiring company do not necessarily require Revlon duties because control is often unaffected.1134 Once Revlon duties have been triggered, the board has wide latitude in determining what action to take to maximize value for stockholders. “Lockups,” “termination fees,” “no shop” and “fiduciary out” provisions are normally allowed as long as they are used in good faith and aid in the achievement of stockholder value.1135

5. Business Judgment Rule

The business judgment rule (the “BJR”), which exists in both North Carolina and Delaware, has evolved out of the principle that disinterested and independent business decisions made in good faith by corporate directors should be protected from judicial second-guessing when the directors exercise reasonable care and business judgment. The BJR creates an evidentiary presumption that directors of a corporation in making a business decision acted on an informed basis and in good faith in the honest belief that their action was in the best interests of the corporation. If the presumption is not rebutted, the decision will not be disturbed by a court if it can be attributed to any rational business purpose.1136 Protecting directors’ informed decision making avoids judicial interference where judges lack expertise and keeps judges from substituting their hindsight perspective when directors have used reasonable care and business judgment.1137 Thus, absent evidence of self-dealing or improper motive, corporate directors are not legally responsible to the corporation for losses that may be suffered as a result of a decision made in good faith and with due care.1138

North Carolina. North Carolina has codified the principles of the BJR at NCBCA 8-30(d), which provides: “A director is not liable for any action taken as a director, or any failure

1131 Id. 1132 Stroud v. Grace, 606 A.2d 75, 92 n.3 (Del. 1992). 1133 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). 1134 Paramount Commun., Inc. v. QVC Network, Inc., 637 A.2d 34 (Del. 1994). 1135 Paramount Commun., Inc. v. Time, Inc., 571 A.2d 1140 (Del. 1989); Mills Acquisition Co. v. Macmillan, 559 A.2d 1261, 1287 (Del. 1989); Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986). 1136 See State ex rel. Long v. ILA Corp., 132 N.C. App. 587, 602, 513 S.E.2d 812, 822, (1999) (quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 14.6 (5th ed. 1995)). 1137 See Hammonds v. Lumbee River Elec. Membership Corp., 178 N.C. App. 1, 631 S.E.2d 1 (2006). 1138 See Gagliardi v. Triffods Int’l, Inc., 683 A.2d 1049 (Del. 1996).

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to take any action, if he performed the duties of the office in compliance with this section.”1139 In other words, directors of North Carolina corporations will not be liable for a business decision if they satisfy the duties of good faith, due care and loyalty. The NCBCA does not impose varying standards of care based on the relative importance of board action.1140

However, the statutory BJR does not abrogate the common law, and either the statute or the common law or both may insulate the director from potential liability.1141 The common law business judgment rule holds that “a court will not invalidate or hold directors liable for: (1) an advertent business decision (2) made by disinterested directors (3) within the scope of their authority (4) in good faith (5) with reasonable care and (6) not for their own self-interests.”1142 While the common law rule is in large part a summary of the same standards found in the statute, the codification of the rule leaves open the possibility that a director who has not met the requisite standards of NCBCA Section 8-30 might still be able to invoke the protection of the common law rule to avoid liability.1143

Delaware. In Delaware, as in North Carolina, the “protection” afforded to directors under the business judgment rule in practice stands for the proposition that if directors perform their management functions in accordance with the requisite standards, they will not be held liable for losses caused by their decisions or failures to act and courts will not later second guess their decisions.1144 The rule, in turn, leads to an initial presumption that directors have comported with their duties. Delaware courts, however, have developed a series of judicial standards of review for the presumption that vary depending on the relative importance of the board action being challenged. In other words, certain major decisions like the sale of the business or a change of control may be the subject of a has greater degree of scrutiny than minor corporate activities. “Accordingly, Delaware courts have used ‘enhanced judicial scrutiny’ in sale of ownership or control cases, a ‘compelling justification’ inquiry in cases involving interference with the shareholder right to vote, and an ‘entire fairness’ review upon a showing of self-dealing or other default of duty.”1145

B. Fiduciary Duties of Corporate Officers

1. Introduction

Corporate officers in North Carolina and Delaware are required to adhere to the same standards of conduct as directors. In North Carolina, officers with discretionary authority must, by statute, act in good faith, with due care, and with loyalty to the corporation. However, the duties of good faith, due care and loyalty may not be fiduciary in nature unless the officer wields domination and control over the corporation. The discussion of the fiduciary duties of directors of North Carolina corporations, above, is generally applicable to officers who wield

1139 N.C. Gen. Stat. § 55-8-30(d). 1140 For a discussion of a heightened standard of judicial review as compared to heightened standards of care, see supra notes 1080–1089 and accompanying text. 1141 State ex rel. Long v. ILA Corp., 132 N.C. App. 587, 601-2, 513 S.E.2d 812, 821 (1999). 1142 Robinson, II, supra note 290, § 14.06. 1143 Id. 1144 See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984); Balotti & Finkelstein, supra note 552, § 4.19[A]. 1145 Robinson, II, supra note 290, § 14.06.

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such influence over the corporation. Delaware, in contrast, has no statutory provision setting forth the fiduciary duties of corporate officers. Case law in Delaware established that officers have fiduciary duties to the corporations they manage. Those fiduciary duties had largely been left undefined by Delaware courts until January 27, 2009, when the Delaware Supreme Court explicitly held that officers of Delaware corporations owe the same fiduciary duties as directors.1146 Thus, the discussion of the fiduciary duties of directors of Delaware corporations, above, is generally applicable to officers of Delaware corporations. The statutory codification of officer fiduciary duties in North Carolina and the judge-made standards for officers in Delaware follow generally the same framework, with some differences noted below.

2. Fiduciary Duties of Officers Generally

North Carolina. NCBCA Section 8-42 sets forth standards of conduct for officers of corporations. It states in part:

(a) An officer with discretionary authority shall discharge his duties under that authority:

(1) In good faith;

(2) With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and

(3) In a manner he reasonably believes to be in the best interests of the corporation.1147

The North Carolina statutory requirements of good faith and the care of an ordinarily prudent person were enacted in 1957. The North Carolina Supreme Court in Fulton v.

Talbert noted that those statutory provisions, which applied to both officers and directors, codified common law principles as applied in North Carolina.1148 The court went on to say that if “an officer . . . so utilizes his authority as to benefit himself to the detriment of the corporation, a right of action accrues to the corporation.”1149

However, the obligations of a corporate officer to act in good faith and with due regard to the corporation’s interests are not fiduciary in nature absent evidence of the officer’s “domination and influence” over the corporation.1150 Thus, in Dalton v. Camp, the North Carolina Supreme Court held that where an officer’s responsibilities as a production manager did not position him to exercise dominion over the corporation, the corporation could not maintain an action for breach of a fiduciary duty of loyalty.1151 This limitation reflects the statutory requirement that the officer have “discretionary authority.” Once that threshold is met, the requirements of good faith and conduct believed to be in the best interests of the corporation are

1146 See Gantler v. Stephens, 965 A.2d 695, 708-09 (Del. 2009). 1147 N.C. Gen. Stat. § 55-8-42. 1148 Fulton v. Talbert, 255 N.C. 183, 120 S.E.2d 410 (1961). 1149 Id. at 185, 120 S.E.2d at 412. 1150 Dalton v. Camp, 353 N.C. 647, 651, 548 S.E.2d 704, 708 (2001). 1151 Id.

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defined by the officer’s particular degree of discretionary authority.1152 While shareholders do not normally have a right of action in their own names with regard to breaches of fiduciary duties by officers, minority shareholders do have a right to bring such an action, and make the corporation a party, where the corporation is dominated and controlled by the wrongdoer.1153

Delaware. In 1939 the Delaware Supreme Court set forth the broad principle, based on public policy, that both directors and officers have a fiduciary duty to the corporation.1154 The court stated, “corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. While technically not trustees, they stand in a fiduciary relation to the corporation and its stockholders.”1155 The chancery court applied the duty of loyalty to an officer when it held that the president of a corporation breached his fiduciary duty to the corporation (in which he was also a small stockholder) where, prior to the termination of his employment with the corporation, he helped found a competing corporation in which he owned a 50% stock interest, and the two corporations had a limited number of potential customers confined to a particular area.1156 In a decision issued January 27, 2009, the Delaware Supreme Court finally confirmed what other Delaware courts had implied – that officers, “like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors.”1157

3. Duty to Inquire

North Carolina. The officers’ duty to inquire in North Carolina is incorporated into the second of the statutory standards of conduct in NCBCA Section 8-42, which charges an officer with exercising the care of an ordinarily prudent person in a like position under similar circumstances. Like directors, therefore, officers with discretionary authority have a duty to inquire to inform themselves about the financial condition of the corporation and the conduct of its affairs.1158 In Anthony v. Jeffress, the president and the directors of an insolvent corporation had left the management of the corporation to the general manager and never exercised oversight over its affairs. The president of the corporation represented to the plaintiff that the corporation was solvent, and the plaintiff sold goods to the corporation on that representation. The court held that the president, as well as the directors, had a duty to know the financial condition of the corporation.1159

Delaware. While Delaware has not addressed the duty of officers to inquire into significant corporate matters, it does impose such a duty on directors.1160 After the Delaware Supreme Court’s decision in Gantler v. Stephens,1161 providing that officers of Delaware

1152 Robinson, II, supra note 290, § 16.07. 1153 Fulton v. Talbert, 255 N.C. 183, 185, 120 S.E.2d 410, 412 (1961). 1154 Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939). 1155 Id. at 510. 1156 Craig v. Graphic Arts Studio, Inc., 166 A.2d 444 (Del. Ch. 1960). 1157 Gantler v. Stephens, 965 A.2d 695, 708-09 (Del. 2009). 1158 Anthony v. Jeffress et al., 172 N.C. 378, 90 S.E. 414 (1916). 1159 Id. 1160 See, e.g., Mills Acquisition Co. v. MacMillan, Inc., 559 A. 2d 1261 (Del. 1988). 1161 965 A.2d 695, 708-09 (Del. 2009).

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corporations owe the same fiduciary duties as directors, the duty to inquire and to act on a fully informed basis may exist under the duty of care for officers as it does for directors.

4. Corporate Opportunities

North Carolina. The third common law principle codified in the standards of NCBCA Section 8-42 requires an officer to act in a manner that he reasonably believes to be in the best interests of the corporation – the duty of loyalty. This principle has come before the courts most often in the context of usurping of corporate opportunities.1162 In Meiselman v.

Meiselman, the North Carolina Supreme Court held that in determining whether a corporate fiduciary has wrongfully taken a corporate opportunity, the trial court must consider “not only whether the disputed opportunity is functionally related to the corporation’s business, but also whether the corporation has an interest or expectancy in the opportunity.”1163 The court cited a series of recurring circumstances that courts in various jurisdictions have found germane, including those in the Delaware case of Guth v. Loft, Inc. case discussed below.

Delaware. In Guth v. Loft, Inc., the chancery court provided guidance on the test for an officer’s misappropriation of a corporate opportunity: an officer cannot avail himself of a business opportunity that is one that “the corporation is financially able to undertake, is . . . in the line of the corporation’s business and is of practical advantage to it, is one in which the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the officer or director” would then conflict with the corporation’s interest.1164

The chancery court in Gottlieb v. McKee cited the standard set forth in Guth v.

Loft, Inc. when it denied defendant’s motion for summary judgment and remanded the case for further findings.1165 In that case, some of the directors and officers of the corporation helped organize another corporation for the transport of natural gas and then arranged for the first corporation to buy stock in the natural gas corporation on less favorable terms than they received as organizers.1166 In remanding, the court stated that the question to be answered by the trial court was “whether the opportunity of defendants was so closely associated with the existing business activities of [the corporation] and so essential thereto as to bring the transaction within that class of cases where the acquisition of the property would throw the corporate officer purchasing it into competition with his company.”1167

5. Reliance on Others

North Carolina. Having set forth the fiduciary standard for officers in NCBCA Section 8-42, the same statutory provision provides corporate officers some protections. Similar to directors, corporate officers are allowed

1162 See, e.g., Brite v. Penny, 157 N.C. 110, 72 S.E. 964 (1911). 1163 Meiselman v. Meiselman, 309 N.C. 279, 311, 307 S.E.2d 551, 570 (1983). 1164 Guth v. Loft, Inc., 5 A.2d 503, 511 (Del. 1939). 1165 Gottlieb v. McKee, 107 A.2d 240 (Del. Ch. 1954). 1166 Id. at 241. 1167 Id. at 243.

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to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by:

(1) one or more officers or employees of the corporation whom the officer reasonably believes to be reliable and competent in the matters presented; or

(2) legal counsel, public accountants, or other persons as to matters the officer reasonably believes are within their professional or expert competence.1168

An officer may not, however, rely on such information, opinions, reports or statements if he has actual knowledge that would make reliance unwarranted.1169 If an officer complies with the duties set forth in NCBCA Section 8-42, he will not be liable for actions taken or inaction in his official capacity.1170

Delaware. Delaware does not have a statutory provision allowing officers to rely on information from other officers or expert third parties. DGCL Section 141(e) provides only directors with liability protection for reliance upon corporate records, officers or experts.1171

6. Business Judgment Rule

As discussed above in Section IV.A.5. of this study, the common law business judgment rule, adhered to in both Delaware and North Carolina, provides directors an important defense against claims of breach of fiduciary duty. Under the rule the courts will not invalidate a board of directors’ decision made in good faith with reasonable care and in the best interest of the corporation. While North Carolina cases have not squarely extended the business judgment rule to the actions of officers, North Carolina courts have indicated generally that the business judgment rule is available to officers as well as directors.1172 Similarly, in Delaware, courts have suggested in dicta that decisions of executive officers may be protected by the business judgment rule,1173 but the issue is not definitively settled by the Delaware courts.

7. Exculpation

Both the North Carolina1174 and Delaware1175 statutes authorize corporations to include provisions in their articles or certificates of incorporation to limit directors’ liability for monetary damages for breaches of their duties as directors. However, neither state provides for similar exculpation for officers. Hence, as noted by the Delaware Supreme Court in Gantler v.

1168 N.C. Gen. Stat. § 55-8-42(b). 1169 Id. § 55-8-42(c). 1170 Id. § 55-8-42(d). 1171 Del. Code Ann. tit. 8, § 141(e). 1172 See, e.g., Alford v. Shaw, 320 N.C. 465, 466-67, 358 S.E.2d 323, 324 (1987) (describing the rule in dictum). 1173 See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993) (“the business judgment rule attaches to protect corporate officers and directors”). 1174 See N.C. Gen. Stat. § 55-2-02(b)(3); supra notes 1090–1092 and accompanying text. 1175 See Del. Code Ann. tit. 8, § 102(b)(7); supra note 1113 and accompanying text.

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Stephens, the consequences of breach of fiduciary duties of officers and directors may not be the same.1176

C. Fiduciary Duties of Shareholders

1. Generally

North Carolina. While the general rule in North Carolina is that shareholders, unlike officers and directors, do not normally owe fiduciary duties to each other or to the corporation, a shareholder or group of shareholders that has control over the corporation is restricted by certain equitable limitations on their conduct with respect to minority owners. North Carolina courts have held that majority shareholders owe a fiduciary duty and an obligation of good faith to minority shareholders, as well as to the corporation.1177 The fiduciary duty to act in good faith and with due regard to the interests of the minority shareholders is imposed by virtue of the majority’s controlling position in the corporation.1178 These duties are especially applicable to controlling shareholders in the context of fundamental changes to the corporation that might disadvantage minority shareholders,1179 and to close corporations, where the relationship among shareholders may resemble that between partners.1180 Consequently, a special confidence is reposed in the majority shareholders by the minority shareholders to act in good faith and with due regard to the interests of the minority shareholders and the corporation.1181 Included in the fiduciary duty is a responsibility by the majority shareholders to not misuse their power to promote their personal interests at the expense of the corporation and minority shareholders.1182

In addition to actual control by virtue of ownership of shares in the corporation, when a shareholder or other individual wields the power normally allocated to directors, such shareholder or individual will be subject to the same fiduciary duties as a director. NCBCA Section 8-01(d) provides that to the extent the articles of incorporation or another control agreement vests the power normally allocated to the board of directors to one or more individuals, such individuals will be subject to the same liability as would otherwise be imposed on directors of the corporation.1183

In the event that a minority shareholder challenges an action by the majority shareholder, claiming breach of the fiduciary duties described above, the burden rests upon the majority or controlling shareholder to establish that its actions were in all respects inherently fair to the minority and undertaken in good faith.1184

1176 Gantler v. Stephens, 965 A.2d 695, 709 n.37 (Del. 2009). 1177 Freese v. Smith, 110 N.C. App. 28, 428 S.E.2d 841 (1993). 1178 Hill v. Erwin Mills, Inc., 239 N.C. 437, 80 S.E.2d 358 (1954); Gaines v. Long Mfg. Co., 234 N.C. 340, 67 S.E.2d 350 (1951). 1179 Robinson, II, supra note 290, § 11.04[1]. 1180 Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983). 1181 Hill v. Erwin Mills, Inc., 239 N.C. 437, 80 S.E.2d 358 (1954). 1182 Farndale Co., LLC v. Gibellini, 176 N.C. App. 60, 67, 628 S.E.2d 15, 19 (2006) (citing United States v. Byrum, 408 U.S. 125, 137 (1972)). 1183 N.C. Gen. Stat. § 55-8-01(d). 1184 Farndale Co., LLC v. Gibellini, 176 N.C. App. 60, 628 S.E.2d 15 (2006).

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Delaware. In Delaware, a stockholder owes a fiduciary duty to minority stockholders if it owns a majority interest in or exercises control over the business affairs of the corporation.1185 In the absence of controlling stock ownership, where a stockholder exercises actual control of the corporation, the controlling stockholder owes fiduciary duties to the other stockholders.1186 Delaware requires of majority stockholders complete candor to minority stockholders in the context of certain corporate transactions.1187 This is a restatement of the principle of Delaware law requiring a director to uphold a duty of uncompromising loyalty to minority stockholders and to act fairly.1188

Similar to NCBCA Section 8-01(d), the DGCL provides that where stockholders manage the business of a close corporation (by agreement1189 or as indicated in the certificate of incorporation1190), the “stockholders of the corporation shall be deemed to be directors for purposes of applying the provisions” of the Delaware General Corporation Law.1191 Therefore, when stockholders manage the affairs of a close corporation as directors, they will be held to the same fiduciary duties as directors.

The presumption in Delaware is that absent any conflicting interests, decisions of the majority of stockholders or the board of directors or both are presumed to be made in good faith and for bona fide purposes.1192 However, when the fairness of the majority’s actions are challenged or interests conflict, such a presumption no longer exists.1193 If a majority stockholder, by virtue of being the dominant party, causes a corporation to act in such a way that it receives something of value to the exclusion of, and detriment to, the minority stockholder, an act of self-dealing has occurred.1194 When there is evidence of self-dealing, the majority’s actions are evaluated under the entire fairness test and the burden is upon the majority stockholder to show the intrinsic fairness of the entire transaction.1195 Alternately, if there is no proof of self-dealing, the actions are given the benefit of the business judgment rule.1196 Under the business judgment rule, unless there is a showing of fraud or gross abuse of discretion, the court will not interfere.1197

1185 Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1344 (Del. 1987). 1186 Kahn v. Lynch Commun. Sys., Inc., 638 A.2d 1110, 1114 (Del. 1994) (quoting Citron v. Fairchild Camera &

Instrument Corp., 569 A.2d 53, 70 (Del. 1989)). 1187 Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) (citing Lynch v. Vickers Energy Corp., 383 A.2d 278, 281 (Del. 1977)). 1188 Id. 1189 Del. Code Ann. tit. 8, § 350. 1190 Del. Code Ann. tit. 8, § 351. 1191 Id. 1192 David J. Greene & Co. v. Dunhill International Inc., 249 A.2d 427, 430 (Del. Ch. 1968). 1193 Id. 1194 Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971); Gabelli & Co., Inc. Profit Sharing Plan, 444 A.2d 261, 265 (Del. Ch. 1982). 1195 Gabelli, 444 A.2d at 264. 1196 Id. at 265. 1197 Sinclair, 280 A.2d at 720.

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2. Derivative v. Individual/Direct Claims

North Carolina. In North Carolina, the basic distinction between a direct and derivative claim is determined by whether the right sought to be enforced belongs to the corporation or directly to the shareholder. A direct action is allowed where a shareholder can allege a loss peculiar to himself by reason of some special circumstance or relationship with the wrongdoers.1198 While the general rule is that an action against directors, officers or controlling shareholders of a corporation claiming a breach of their duty to the corporation is derivative, a North Carolina court of appeals case has carved out an exception to the rule, holding that in the context of close corporations, a minority shareholder can assert claims that are traditionally derivative in nature in an individual action against majority shareholders.1199

Delaware. In Delaware, the question of whether an action is direct or derivative turns “solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?”1200 To bring a direct claim, there must be an injury inflicted on stockholders or on stockholders’ individual rights. Where a claim alleges injury to a corporation or injury to the corporation’s stockholders flowing solely from an injury to the corporation, the claim is derivative.1201 Thus, for example, the claim that the losses caused by some act of mismanagement has reduced the value of a stockholder’s shares has been held to be derivative.1202 The Delaware Supreme Court has recognized, however, that an alleged wrong may give rise to both individual and derivative claims where a minority stockholder’s claim challenges a controlling stockholder’s expropriation of economic and voting power at the expense of the minority.1203

3. Standards for Judicial Dissolution

North Carolina. NCBCA Section 14-30(2) lays out the circumstances under which a court may dissolve a corporation based on an action brought by a shareholder. Among other circumstances, the statute sets forth in part that “[t]he superior court may dissolve a corporation . . . [i]n a proceeding by a shareholder if it is established that . . . (ii) liquidation is

1198 A further discussion of derivative and direct claims may be found in Section III.L. of this study, above. 1199 Norman v. Nash Johnson & Sons’ Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000), appeal w’drawn, 354 N.C. 219, 553 S.E.2d 684 (2001). But see generally Robinson, II, supra note 290, § 17.02[3] (examining whether the case establishes a categorical rule that will be followed in other cases and noting that the case resulted in a split decision by the court of appeals, with the dissent positing that the majority opinion did not adequately distinguish the general rule laid out by the North Carolina Supreme Court in Barger v. McCoy Hillard & Parks, 346 N.C. 650, 488 S.E.2d 215 (1997) (holding that “shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation”)). 1200 Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004). 1201 Id. 1202 See, e.g., Kramer v. Western Pacific Indus., Inc., 546 A.2d 348 (Del. 1988); Bokat v. Getty Oil Co., 262 A.2d 246, 249 (Del. 1970) ; Elster v. Am. Airlines, Inc., 100 A.2d 219, 220 (Del. Ch. 1953). Note that the Elster case, though not having been overruled by any Delaware court, has been stated as overruled in a California federal district court case, Ind. Elec. Workers Pension Trust Fund v. Dunn, 2008 U.S. Dist. LEXIS 34600 (N.D. Cal. March 28, 2008). 1203 See Gatz v. Ponsoldt, 925 A.2d 1265 (Del. 2007); Gentile v. Rossette, 906 A.2d 91 (Del. 2006).

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reasonably necessary for the protection of the rights or interests of the complaining shareholder.”1204

In the context of close corporations, NCBCA Section 14-30(2)(ii) provides a potential remedy for minority shareholders in a closely held corporation whose reasonable expectations have been frustrated in the operation of the business. The North Carolina Supreme Court’s opinion in Meiselman v. Meiselman lays out the test for determining what those reasonable expectations are and whether they have been sufficiently frustrated so as to require dissolution.1205 The standard articulated by the court requires an examination of the complainant’s relationship with the corporation to assess their reasonable expectations both at the beginning of the relationship with the corporation and how those expectations evolved over time.1206 To obtain relief under the expectations analysis, a complaining shareholder must prove that:

(1) he had one or more substantial reasonable expectations known or assumed by the other participants; (2) the expectation has been frustrated; (3) the frustration was without fault of plaintiff and was in large part beyond his control; and (4) under all of the circumstances of the case, plaintiff is entitled to some form of equitable relief.1207

The final decision whether to grant dissolution “is within the trial court’s discretion even though grounds for dissolution are found to exist under the statute.”1208 Thus, a court will decree dissolution only if the plaintiff has established the standards allowing it and the court concludes that equity favors dissolution.

In the event that the court determines that dissolution is “reasonably necessary” to protect the rights or interests of a complaining shareholder, the corporation may avoid dissolution by electing to buy out the complaining shareholder at the fair value of the shares as determined by the court.1209

Delaware. The Delaware statute governing revocation or forfeiture of a corporation’s charter provides that “The Court of Chancery shall have jurisdiction to revoke or forfeit the charter of any corporation for abuse, misuse or nonuse of its corporate powers, privileges or franchises.”1210 Delaware courts have set a high standard for dissolution in applying this statutory provision, explaining that the

Court may order the dissolution of a solvent company and the appointment of a custodian or receiver only upon a showing of gross mismanagement, positive misconduct by corporate officers, breach of trust, or extreme circumstances showing imminent danger of great loss to the corporation

1204 N.C. Gen. Stat. § 55-14-30. 1205 Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983). 1206 Id. at 301. 1207 Id. 1208 Foster v. Foster Farms, Inc., 112 N.C. App. 700, 706, 436 S.E.2d 843, 847 (1993). 1209 N.C. Gen. Stat. § 55-14-31(d). This buy-out option applies only in the context of dissolutions sought under N.C. Gen. Stat. § 55-14-30(2)(ii). Foster v. Foster Farms, Inc., 112 N.C. App. 700, 712, 436 S.E.2d 843, 851 (1993). 1210 Del. Code Ann. tit. 8, § 284.

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which, otherwise, cannot be prevented. The Court exercises this power to dissolve a solvent corporation with great restraint and only upon a strong showing. Mere dissension among corporate stockholders seldom, if ever, justifies the appointment of a receiver for a solvent corporation. The minority’s remedy is withdrawal from the corporate enterprise by the sale of its stock.1211

Judicial dissolution is also generally addressed above in Section III.M. of this study.

1211 Carlson v. Hallinan, 925 A.2d 506, 543 (Del. Ch. 2006) (internal citations omitted).

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V. LIMITED LIABILITY COMPANIES

A. Formation and Organizational Matters

1. Filing Requirements

a) Articles of Organization/Certificate of Formation

To form an LLC in North Carolina, one or more persons must file executed articles of organization (the “Articles”) with the secretary of state’s office.1212 A person may execute the Articles in either the capacity of member or organizer of the LLC being formed.1213 An organizer is defined as “a person who executes the [Articles] of [an LLC] in the capacity of an organizer.”1214 The Articles are effective at the time of filing by the secretary of state on the date filed, as evidenced by the secretary of state’s date and time endorsement on the filed document, at the time specified as the effective time on the date of filing, or at a delayed effective date and time specified in the document.1215

The NCLLCA distinguishes between the “formation” and the “organization” of an LLC. Filing of the Articles is conclusive evidence of the “formation” of an LLC.1216 “Organization,” however, requires one or more initial members. If initial members are not identified in the Articles of an LLC, the organizers must hold one or more meetings at the call of a majority of the organizers to identify the initial members. At such meetings, all decisions made by the organizers require the agreement of a majority of the organizers, unless otherwise provided in the Articles. In lieu of a meeting, the organizers may take action by written consent signed by all of the organizers, unless otherwise provided in the Articles, and such written consent may be incorporated in the initial written operating agreement of the LLC.1217 The practical significance of the organization of an LLC is that if the entity is not organized in compliance with the statute, the ostensible “members” may not in fact be members, and their actions may not be the acts of the LLC.

In order to form an LLC in Delaware, one or more “authorized persons” must execute a certificate of formation (the “Certificate”), which shall be filed in the office of the secretary of state.1218 The members must authorize an “authorized person” to execute the Certificate. Such authorization need not occur before the filing of the Certificate.1219 In Delaware, an LLC is formed at the time of the filing of the initial Certificate in the office of the secretary of state, or at any later date or time specified in the Certificate, if, in either case, there has been substantial compliance with the requirements of DLLCA Section 18-201.

1212 N.C. Gen. Stat. § 57C-2-20(a). 1213 N.C. Gen. Stat. § 57C-2-21(a)(3). 1214 N.C. Gen. Stat. § 57C-1-03(16a). 1215 N.C. Gen. Stat. § 57D-13. 1216 N.C. Gen. Stat. § 57C-2-20(b)(2). 1217 N.C. Gen. Stat. § 57C-2-20(c). 1218 Del. Code Ann. tit. 6, § 18-201(a). 1219 Del. Code Ann. tit. 6, § 18-204(a).

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In Delaware there is no distinction between organization and formation, nor is there the related distinction between the filing by organizer versus member. The concept of the “authorized person” under the DLLCA, however, is analogous to North Carolina’s “organizer” in that in both cases the statute attempts to draw a connection between the person submitting the publicly filed document and the people who are the principals of the entity.

North Carolina prescribes more mandatory elements for Articles than Delaware does for Certificates. In North Carolina, Articles must set forth (1) a name for the LLC, which must contain the words “limited liability company,” the abbreviation “L.L.C.” or “LLC,” or the combination “ltd. liability co.,” “limited liability co.” or “ltd. liability company,” and must otherwise satisfy the provisions of North Carolina General Statutes Sections 55D-20 and 55D-21; (2) the latest date on which the LLC is to dissolve, if the LLC is to dissolve by a specific date; (3) the name and address of each person executing the Articles and whether the person is executing the Articles in their capacity as a member or an organizer of the LLC; (4) the street address, and the mailing address if different from the street address, of the LLC’s initial registered office and principal office, the county in which each is located, and the name of the LLC’s initial registered agent at the initial registered office address; and (5) unless all of the members by virtue of their status as members shall be managers of the LLC, a statement that the members shall not be managers, except as provided in Section 3-20(a) of the North Carolina Limited Liability Company Act (“NCLLCA”). Also, if the purposes and powers of the LLC are to be limited, such limitations must be set forth in the Articles.1220

In Delaware, the Certificate must set forth (1) the name of the LLC, which must contain the words “Limited Liability Company” or the abbreviation “L.L.C.” or the designation “LLC”;1221 and (2) the address of the registered office and the name and address of the registered agent for service of process, required to be maintained by Section 18-104 of the Delaware Limited Liability Company Act (“DLLCA”).1222 The existence of the LLC shall continue until cancellation of the LLC’s Certificate, pursuant to Section 18-203.1223

In addition, the Articles and Certificate may set forth any other optional provisions the members (and/or organizers) wish to include.1224

In North Carolina, Articles may be filed with the secretary of state (1) via mail to N.C. Department of the Secretary of State, P.O. Box 29622, Raleigh, NC 27626-0622; or (2) in person at 2 Salisbury Street, Raleigh, NC 27601-2903, along with the filing fee.1225 Any signature on the document may be a facsimile or an electronic signature in a form acceptable to the secretary of state, and may, but need not, contain a seal, attestation, acknowledgment,

1220 N.C. Gen. Stat. § 57C-2-01(a). 1221 Del. Code Ann. tit. 6, § 18-102(1). 1222 Del. Code Ann. tit. 6, § 18-201(a). See In re Grupo Dos Chiles, LLC, C.A. No. 1447-N, slip op. at 10 (Del. Ch. Mar. 10, 2006) (court of chancery held that because the certificate of formation did not require the members of the LLC to be set out in the certificate, there was no continuing obligation to amend the certificate any time that the members changed.). 1223 Del. Code Ann. tit. 6, § 18-201(b); Poore v. Fox Hollow Enterprises, C.A. No. 93A-09-005 (Del. Super. Ct. Mar. 29, 1994). 1224 Del. Code Ann. tit. 6, § 18-201(a); N.C. Gen. Stat. § 57C-2-21(b). 1225 North Carolina Department of the Secretary of State, Corporations Division, Organizing your Limited Liability

Company in North Carolina, http://www.secretary.state.nc.us/corporations/.

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verification or proof.1226 In Delaware, the Certificate shall be delivered for filing (1) via mail to Division of Corporations, John G. Townsend Building, 401 Federal Street, Suite 4, Dover Delaware 19901; or (2) via facsimile to (302) 739-3812.1227 Any signature on the Certificate may be a facsimile, a conformed signature or an electronically transmitted signature.1228

The web sites for both the North Carolina Secretary of state (http://www.secretary.state.nc/corporations/) and the Delaware Department of State, Division of Corporations (http://corp.delaware.gov/corpformsllc.shtml) have forms that provide useful guidance as to the required information for the Articles and Certificate, respectively.

An LLC in either Delaware or North Carolina may also be formed through the conversion of another business entity, as discussed below.1229

b) Annual Reports

Each North Carolina LLC must file an annual report with the secretary of state that sets forth (1) the name of the LLC; (2) the street address and the mailing address, if different, of the registered office located in North Carolina and the name of its registered agent at that office, the county in which the registered office is located, and a statement of any change of the registered office or registered agent, or both; (3) the address and telephone number of its principal office; (4) the names and business addresses of its managers or, if the LLC has never had members, its organizers; and (5) a brief description of the nature of its business.1230

The secretary of state must notify each LLC of the annual report filing requirement and each LLC must deliver its annual report to the secretary of state by April 15th of each year,1231 along with a fee that is currently $200.1232 If an annual report does not contain the above information, the secretary of state shall promptly notify the LLC in writing and return the report for correction. If the report is corrected and delivered to the secretary of state within 30 days after the effective date of notice, it is deemed to be timely filed.1233 Amendments to any previously filed annual report may be filed with the secretary of state at any time for the purpose of correcting, updating, or augmenting the information contained in the annual report.1234

The secretary of state may administratively dissolve an LLC if the secretary of state determines that the LLC did not deliver its annual report to the secretary of state on or before the date it was due, subject to prior notice by the secretary of state and a 60-day opportunity to cure by the LLC.1235

1226 N.C. Gen. Stat. § 55D-10(6). 1227 http://corp.delaware.gov/howtoform.shtml (updated February 6, 2009). 1228 Del. Code Ann. tit. 6, § 18-206(a). 1229 Del. Code Ann. tit. 6, § 18-214; N.C. Gen. Stat. § 57C-9A-01. 1230 N.C. Gen. Stat. § 57C-2-23(a). 1231 N.C. Gen. Stat. § 57C-2-23(c). 1232 N.C. Gen. Stat. § 57C-1-22(a)(25). 1233 N.C. Gen. Stat. § 57C-2-23(d). 1234 N.C. Gen. Stat. § 57C-2-23(e). 1235 N.C. Gen. Stat. § 57C-6-03(a)(2)(b).

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There is no statutory requirement in Delaware that an LLC file an annual report.

c) Fees and Taxes

The standard filing fee for Articles in North Carolina is $125; however, the secretary of state also has two levels of expedited service. For an additional $100, the secretary of state will file Articles within 24 hours, excluding weekends and holidays. For an additional $200, the secretary of state provides same-day service for documents that are received by 12:00 noon eastern time. A schedule of North Carolina administrative fees is set forth in NCLLCA Section 1-22, which was last amended effective November 1, 2002.

In Delaware, the standard fee for the filing of a Certificate is $90, though expedited service is also available in Delaware. Service within 24 hours is an additional $50 and same day service is an additional $100. Delaware also provides priority two-hour service for $500 per document and priority one-hour service for $1000 per document.1236 A schedule of Delaware administrative fees is set forth in DLLCA Section 18-1105.

In addition, each Delaware LLC must pay the annual franchise tax of $250 in order to remain in good standing with the State of Delaware.1237 The annual franchise tax is due and payable for a particular calendar year on the first day of June following the close of such calendar year, or upon the cancellation of the LLC’s Certificate. If the annual tax remains unpaid after the due date, the tax bears interest at the rate of 1.5% for each month or portion thereof until fully paid.1238 The secretary of state is required, at least 60 days prior to the first day of June of each year, to cause to be mailed to each LLC, in care of its registered agent in the State of Delaware, an annual statement for the tax to be paid.1239 There is a penalty of $100 for failure to pay the franchise tax when due.1240 This $100 penalty is added to the principal amount due and will incur interest as stated above.1241

North Carolina does not require LLCs to pay a franchise tax.1242

If an LLC is classified for federal income tax purposes as a C-corporation or an S-corporation, the company and its members are subject to tax in North Carolina, under Article 4 of Chapter 105 of the General Statutes, to the same extent as a C-corporation or an S-corporation, as the case may be, and its shareholders. Similarly, if an LLC is classified for federal income tax purposes as a partnership, the company and its members are subject to tax in North Carolina, under Article 4 of Chapter 105 of the General Statutes, to the same extent as a partnership and its members.1243

1236 http://corp.delaware.gov/newfee.pdf. 1237 See Section II.A.4. of this Study; see also http://corp.delaware.gov/howtoform.shtml (effective July 1, 2008). 1238 Del. Code Ann. tit. 6, § 18-1107(c). 1239 Del. Code Ann. tit. 6, § 18-1107(d). 1240 Del. Code Ann. tit. 6, § 18-1107(e). 1241 Id. 1242 N.C. Gen. Stat. § 105-114(b)(2). 1243 N.C. Gen. Stat. § 57C-10-06.

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For purposes of any tax imposed by the State of Delaware or any instrumentality, agency or political subdivision of the State of Delaware, an LLC is classified as a partnership unless classified otherwise for federal income tax purposes, in which case the LLC is classified in the same manner as it is classified for federal income tax purposes.1244

d) Registered Office and Agent

Each North Carolina LLC must maintain a registered office in North Carolina and a registered agent.1245 The registered office may be the same as any of its places of business or any place where the LLC conducts its affairs.1246 A registered agent can be an individual who resides in North Carolina and whose business office is identical with the registered office. A registered agent can also be a domestic corporation, nonprofit corporation, an LLC, or a company that provides, as a commercial service, registered offices and registered agents.1247 The registered office may not have a post office box in lieu of a street address because the primary purpose of designating a registered office is to provide a physical address where a notice or service of process can be served. The requirements for changing a registered office or agent are provided in North Carolina General Statutes Section 55D-31. The registered agent may resign by signing and filing a statement of resignation with the secretary of state.1248

If an LLC fails to appoint or maintain a registered agent in the state, or if its registered agent cannot with due diligence be found at the registered office, then North Carolina’s secretary of state is deemed to be an agent of the LLC upon whom any process, notice, or demand may be served.1249 The secretary of state may administratively dissolve an LLC if it determines that the LLC has been without a registered agent or registered office for 60 days or more, subject to prior notice by the secretary of state and a 60-day opportunity to cure by the LLC.1250

The laws for maintaining a registered office and having a registered agent are similar in Delaware.1251

2. Operating Agreements and Limited Liability Company Agreements

a) Overview

Neither Delaware nor North Carolina expressly requires that its members enter an operating agreement.1252 In North Carolina, an operating agreement is defined as any

1244 Del. Code Ann. tit. 6, § 18-1107(a). 1245 N.C. Gen. Stat. § 57C-2-40; N.C. Gen. Stat. § 55D-30; see Smith ex rel. Strickland v. Jones, 183 N.C. App. 643 (2007). 1246 N.C. Gen. Stat. § 55D-30(a)(1). 1247 N.C. Gen. Stat. § 55D-30; see Former Official Comment to N.C. Gen. Stat. § 55-5-01. 1248 N.C. Gen. Stat. § 55D-32. 1249 N.C. Gen. Stat. § 57C-2-43(b); see Advanced Wall Systems, Inc. v. Highlande Builders, LLC, 167 N.C. App. 630 (2004) (holding that service on the secretary of state was proper where the company’s registered agent had left North Carolina for an extended period and the company had failed to designate a new or replacement registered agent). 1250 N.C. Gen. Stat. § 57C-6-03(3). 1251 Del. Code Ann. tit. 6, § 18-104.

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agreement, written or oral, of the members with respect to the affairs of an LLC and the conduct of its business that is binding on all the members.1253 The Delaware statute uses the term “LLC agreement” and defines an LLC agreement as any agreement (whether referred to as a limited liability company agreement, operating agreement or otherwise), written, oral or implied, of the member or members as to the affairs of an LLC and the conduct of its business.1254

With regard to single-member LLCs, North Carolina provides that an operating agreement shall include any writing signed by the member, without regard to whether the writing constitutes an agreement, that relates to the affairs of the LLC and the conduct of its business;1255 similarly Delaware provides that an LLC agreement of an LLC having only one member shall not be unenforceable by reason of there being only one person who is a party to the agreement.1256

In North Carolina, a member is bound by any operating agreement, including any amendment thereto, (i) to which the member has expressly assented, or (ii) which was in effect at the time the member became a member and either was in writing or the terms of which were actually known to the member, or (iii) with respect to any amendment, if the member was bound by the operating agreement in effect immediately prior to such amendment and such amendment was adopted in accordance with the terms of such operating agreement.1257 In Delaware, a member or manager of an LLC is bound by the LLC agreement whether or not the member or manager executes the operating agreement.1258

In both North Carolina and Delaware, the LLC itself is not required to execute the operating agreement, but it will be bound by the agreement even if it does not sign.1259 The NCLLCA allows the operating agreement to limit the extent to which the LLC will be bound by the operating agreement.

The NCLLCA provides that the Articles or a written operating agreement may require that all agreements of the members constituting the operating agreement be in writing.1260 This provision negates the application of some North Carolina case law calling into question the enforceability of “no oral modification” clauses in contracts.1261 The DLLCA has a similar provision.1262

1252 The NCLLCA refers to this document as an operating agreement while the DLLCA refers to it as a limited liability company agreement. For purposes of this Study, “operating agreement” will be used to refer to either. 1253 N.C. Gen. Stat. § 57C-1-03 (16). 1254 Del. Code Ann. tit. 6, § 18-101(7). This study generally refers to “operating agreements” in the context of North Carolina LLCs, and “LLC agreements” in the contect of Delaware LLCs, and when referring to such agreements in the abstract or in relation to both jurisdictions, the study refers to “operating agreements.” 1255 N.C. Gen. Stat. § 57C-1-03 (16). 1256 Del. Code Ann. tit. 6, § 18-101(7). 1257 N.C. Gen. Stat. § 57C-3-05. 1258 Del. Code Ann. tit. 6, § 18-101(7). This is not to say that the operating agreement may be adopted or modified unilaterally, but that execution, or lack of execution, is not conclusive proof of whether or not there is an agreement. 1259 N.C. Gen. Stat. § 57C-3-05; Del. Code Ann. tit. 6, § 18-101(7) (2008). 1260 N.C. Gen. Stat. § 57C-3-05. 1261 See, e.g., Son-Shine Grading, Inc. v. ADC Construction Co., 68 N.C. App. 417, 422, 315 S.E.2d 346, 349, disc.

Rev. denied 312 N.C. 85, 321 S.E.2d 900 (1984). 1262 Del. Code Ann. tit. 6, § 18-302(e).

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It should be noted that some of the NCLLCA default rules may only be modified by a written operating agreement, but not an oral operating agreement.1263 That approach is unique to the NCLLCA.

b) Amendment

In both Delaware and North Carolina, members may agree to alter or amend the operating agreement in any manner not inconsistent with the LLC’s Articles or Certificate, as the case may be, and the laws of the applicable state. In North Carolina, the consent of all members is required to amend the operating agreement unless the Articles or written operating agreement provides otherwise.1264

Delaware does not have a rule providing the requirements for amendment of the LLC agreement if the LLC agreement itself does not address amendments. In that case, consent of all members would be required as a matter of contract law.1265 If an LLC agreement provides for the manner in which it may be amended, including a requirement for the approval of a person who is not a party to the operating agreement or the satisfaction of certain conditions, it may be amended only in that manner or as otherwise permitted by law (provided that the approval of any person may be waived by such person and that any such conditions may be waived by all persons for whose benefit such conditions were intended).1266

c) Interpretation by the Courts

(1) North Carolina

There is limited case law addressing the interpretation and enforcement of provisions of the operating agreement in North Carolina. The superior courts of North Carolina have jurisdiction to enforce the provisions of the NCLLCA.1267 In addition, issues under the NCLLCA may be decided by the North Carolina Business Court, which is discussed at length in Section I of this study.

(2) Delaware

The DLLCA provides that any action to interpret, apply or enforce the provisions of an operating agreement, or the duties, obligations or liabilities of an LLC to the members or managers of the LLC, or the duties, obligations or liabilities among members or managers and of members or managers to the LLC, or the rights or powers of, or restrictions on, the LLC, members or managers, may be brought in the court of chancery.1268

1263 See, e.g., N.C. Gen. Stat. §§ 57C-2-22(b) (requiring unanimous vote of members to amend or restate the articles of organization absent a provision in the Articles or operating agreement to the contrary) and 57C-2-22.1(b). 1264 N.C. Gen. Stat. § 57C-3-03. 1265 R. Symonds, Jr. & J. O’Toole, Symonds & O’Toole on Delaware Limited Liability Companies § 4.06[A][3] (2009 Supp.). 1266 Del. Code Ann. tit. 6, § 18-302(e). 1267 N.C. Gen. Stat. § 57C-10-04. 1268 Del. Code Ann. tit. 6, § 18-111. See Elf Atochem N. Am., Inc. v. Jaffari, 727 A.2d 286 (Del. 1999) (the Delaware Supreme Court explained the purposes for vesting the court of chancery with jurisdiction of disputes involving

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3. Purposes and Powers

In North Carolina, an LLC has the purpose of engaging in any lawful business, whether or not for profit, unless a more limited lawful purpose is set forth in its Articles.1269 Unless the Articles provide otherwise, each LLC has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs.1270

Delaware LLCs have similarly broad purposes and powers.1271

4. Admission of Members/Managers

a) Members

In North Carolina, unless the Articles provide otherwise, each person executing the Articles in the capacity of a member, and each person who is otherwise named in the Articles as a member of the LLC, becomes a member at the time that the filing with the secretary of state of the Articles becomes effective.1272 In the case of a person acquiring a membership interest directly from the LLC, a person may be admitted as a member of an LLC (a) upon being so identified by the organizers of the LLC or (b) upon compliance with the Articles or operating agreement or, if the Articles or operating agreement do not so provide, upon the unanimous consent of the members.

In Delaware, in connection with the formation of an LLC, a person is admitted as a member upon the later to occur of (a) the formation of the LLC; or (b) the time provided in the LLC agreement, or if the LLC agreement does not so provide, when the person’s admission has been duly approved and is reflected in the records of the LLC.1273

In both North Carolina and Delaware, a person may be a member of an LLC even if that person is not required to make contributions to the LLC or does not have any economic interest in the LLC.1274

See Sections V.B.1. and 2. of this study, below, for a discussion of members’ obtaining their interests through assignment.

limited liability companies: “In vesting the Court of Chancery with jurisdiction, the Delaware Limited Liability Company Act accomplished at least three purposes: (1) it assured that the Court of Chancery has jurisdiction it might not otherwise have because it is a court of limited jurisdiction that requires traditional equitable relief or specific legislation to act; (2) it established the Court of Chancery as the default forum in the event the members did not provide another choice of forum or dispute resolution mechanism; and (3) it tends to center interpretative litigation in Delaware courts with the expectation of uniformity.”). 1269 N.C. Gen. Stat. § 57C-2-01(a); see also § 57C-1.03(3). 1270 N.C. Gen. Stat. § 57C-2-02. An LLC may render professional services only as allowed under the North Carolina Professional Corporations Act, contained in Chapter 55B. Any LLC engaged in rendering professional services shall contain the word “Professional” or the abbreviation “P.L.L.C.” or “PLLC,” N.C. Gen. Stat. § 57C-2-01(c). See also

Mitchell, Brewer, Richardson, Adams, Burge & Boughman, PLLC v. Brewer, 2007 WL 2570749 (N.C. Super. Ct. May 8, 2007) (“The relevant statutes treat a professional LLC and an LLC identically.”). 1271 Del. Code Ann. tit. 6, § 18-106. 1272 N.C. Gen. Stat. § 57C-3-01(a). 1273 Del. Code Ann. tit. 6, § 18-301(a). 1274 N.C. Gen. Stat. § 57C-3-01(c); Del. Code Ann. tit. 6, § 18-301(d).

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b) Managers

The NCLLCA states that unless the Articles provide otherwise, all members of an LLC by virtue of their status as members shall be managers of such LLC. If the Articles provide that all members of an LLC are not necessarily managers by virtue of their status as members, then those persons designated as managers in, or in accordance with, the Articles or a written operating agreement shall be managers, but for any period during which no such designation has been made or is in effect, all members shall be managers.1275 Except to the extent otherwise provided in the Articles or a written operating agreement, management of the affairs of the LLC shall be vested in the managers.1276 Managers also have the authority to bind the LLC, unless the manager has no such authority and the party dealing with the manager is aware of that fact.1277

In Delaware, unless the LLC agreement provides otherwise, the management of an LLC shall be vested in its members in proportion to the then current percentage or other interest of members in the profits of the LLC owned by all of the members.1278 An LLC may have more than one manager. Unless otherwise provided in an LLC agreement, each member and manager has the authority to bind the LLC.

A significant difference between North Carolina and Delaware is that unless the Articles or a written operating agreement provide otherwise, the managers of a North Carolina LLC all have equal rights in the management of the LLC.1279 This means that, in the absence of provisions to the contrary, in a member-managed LLC, all the members will have equal powers, regardless of any differences in their ownership percentages. In Delaware, by contrast, the members in a member-managed LLC have management powers in proportion to their ownership percentages.1280

B. Member Withdrawal / Resignation

Although North Carolina uses the term “withdrawal” and Delaware uses the term “resignation,” the two states treat an LLC member’s right to unilaterally end his or her member status in a similar manner, with some minor differences. The NCLLCA provides that a member may withdraw only at the time or upon events specified in the Articles or a written operating agreement.1281 The DLLCA similarly provides that a member may resign only at the time or upon events specified in the LLC agreement. The DLLCA also includes an express provision

1275 N.C. Gen. Stat. § 57C-3-20(a). 1276 N.C. Gen. Stat. § 57C-3-20(b). 1277 N.C. Gen. Stat. § 57C-3-23. 1278 Del. Code Ann. tit. 6, § 18-402; see Hamby v. Profile Products, L.L.C., 361 N.C. 630, 637, 652 S.E.2d 231, 235 (2007). (holding that the DLLCA is similar to the NCLLCA in that both vest management of an LLC in its managers). 1279 N.C. Gen. Stat. § 57C-3-20(b). 1280 Del. Code Ann. tit. 6, § 18-402. 1281 N.C. Gen. Stat § 57C-5-06. See also Mitchell, Brewer, Richardson, Adams, Burge & Boughman, PLLC v.

Brewer, 2007 NCBC 18, 2007 WL 2570749 (N.C. Super. Ct. 2007) (dispute arising whether acts constituted withdrawal when no written operating agreement was executed).

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overriding any other applicable law with respect to resignation prior to the dissolution and winding up of the LLC.1282

The NCLLCA and the DLLCA provisions share similar language and a similar approach regarding the final distribution to be made to a withdrawing or resigning member. In both states, the withdrawing or resigning member will have the right to receive the fair value of the member’s interest unless the articles or operating agreement provide otherwise.1283

1. Assignment or Pledge of Member’s Interest

Both North Carolina and Delaware define a membership interest as being personal property in nature and provide that a member has no interest in specific LLC property.1284 Likewise, both jurisdictions have adopted a similar approach in reference to the assignment of membership interests and, unless otherwise provided in the Articles, Certificate or operating agreement, membership interests may be assigned in whole or in part.1285 This assignment entitles the assignee to receive only the distributions and allocations to which the assignor would have been entitled.1286 Furthermore, NCLLCA and DLLCA contemplate that, except as otherwise provided in the Articles, Certificate or operating agreement, a member continues to be a member with all of his or her rights and powers when the member has pledged or granted a security interest, lien or any other encumbrance against his or her LLC interest.1287

2. Rights of Assignee

An assignee of an LLC is entitled in both jurisdictions to receive only the distributions and allocations which the assignor would have been entitled to receive.1288 As to such an assignee becoming a member, the primary difference between the NCLLCA and

1282 Del. Code Ann. tit. 6, § 18-603. 1283 N.C. Gen. Stat. § 57C-5-07; Del. Code Ann. tit. 6, § 18-604. A small difference in wording raises some uncertainty about the intent of the NCLLCA provision. The NCLLCA provides that a withdrawing member is to receive, upon withdrawal, any distribution to which he is entitled under the Articles or the operation agreement, or, “if not otherwise provided in the articles of incorporation and operating agreement, upon a reasonable time after withdrawal, the fair value of the member’s interest” as of the date of withdrawal. This language appears to give a withdrawing member the option of a withdrawal date recovery of due and owing distributions or a type of “put” right based on a fair value determination paid at a later date. The DLLCA allows a resigning member to receive any distribution to which he is entitled under the LLC agreement, and, if not otherwise provided in the operating agreement, upon reasonable time after withdrawal, the fair market value of the member’s interest as of the withdrawal date. Accordingly, the DLLCA appears to grant the same type of fair market value “put” rights to a withdrawing member but does so in a manner that appears cumulative to the right of receiving a withdrawal date distribution, although any outstanding distribution rights would be rolled into the “fair value” determination. It is possible, however, that the “or” in the NCLLCA is inadvertent, as the statute is based on the DLLCA and there is no sensible reason for such difference. 1284 N.C. Gen. Stat. § 57C-5-01; Del. Code Ann. tit. 6, § 18-701. 1285 N.C. Gen. Stat. § 57C-5-02; Del. Code Ann. tit. 6, § 18-702. 1286 N.C. Gen. Stat. § 57C-5-02; Del. Code Ann. tit. 6, § 18-702. 1287 N.C. Gen. Stat. § 57C-05-02; Del. Code Ann. tit. 6, § 18-702-(b)(3). 1288 N.C. Gen. Stat. § 57C-05-02; Del. Code Ann. tit. 6, § 18-702(b)(2).

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DLLCA is that the DLLCA does not expressly require the assignee’s consent to attain member status while the NCLLCA mandates such consent.1289

NCLLCA and DLLCA have similar provisions with respect to the rights and obligations of an assignee who becomes a member. For example, in both states, the assignee is liable for the obligations of the assignor to make contributions, but is not liable for the assignor’s liabilities for wrongful distributions.1290 It should be noted also that both provide that an assignee is not obligated for liabilities unknown to the assignee at the time the assignee became a member, which liabilities could not be ascertained from the Articles or operating agreement in North Carolina or the LLC agreement in Delaware.

Delaware specifically addresses the issue of an assignee’s participation in the LLC’s management by providing that an assignee of a member’s LLC interest shall have no right to participate in the management and affairs of the business, except as provided in an operating agreement and upon the approval of all the members and compliance with any procedure provided for in the LLC agreement.1291 North Carolina does not have a similar provision, although by providing that an assignee of an LLC membership interest gets “only the distributions allocation to which the assignor would be entitled but for the assignment,” the NCLLCA implicitly provides that the assignee gets no voting or management rights.1292

3. Residual Liability of Assignor

The NCLLCA and DLLCA share the concept that, independent of whether or not an assignee becomes a member, the assignor remains liable and is not released from its liability to the LLC for contributions or wrongful distribution.1293

4. Dissolution, Generally

Both the DLLCA and the NCLLCA list the following as events that will trigger the dissolution of an LLC: the time specified in the operating agreement;1294 the happening of an event specified in the operating agreement (and/or the Articles, under the NCLLCA);1295 and the entry of a decree of judicial dissolution.1296 Both statutes also state that members may choose to dissolve an LLC, although the requirements for doing so differ. Under the NCLLCA, in order for the members to dissolve the LLC, all members must consent in writing.1297 Under the DLLCA, if the LLC has only one class of members, a majority of members may vote to dissolve the LLC; if the LLC has more than one class of members, two-thirds of the members of each class must vote

1289 N.C. Gen. Stat. § 57C-05-04(a); Del. Code Ann. tit. 6, § 18-704. 1290 N.C. Gen. Stat. § 57C-5-04(b); Del. Code Ann. tit. 6, § 18-704(b). 1291 Del. Code Ann. tit. 6, § 18-702(a). 1292 N.C. Gen. Stat. § 57-5-02. 1293 N.C. Gen. Stat. § 57C-5-04(c); Del. Code Ann. tit. 6, § 18-704(c). 1294 Del. Code Ann. tit. 6, § 18-801(a)(1); N.C. Gen. Stat. § 57C-6-01(1). 1295 Del. Code Ann. tit. 6, § 18-801(a)(2); N.C. Gen. Stat. § 57C-6-01(2). 1296 Del. Code Ann. tit. 6, § 18-801(a)(5); N.C. Gen. Stat. § 57C-6-01(5). 1297 N.C. Gen. Stat. § 57C-6-01(3).

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to dissolve the LLC.1298 This difference could afford owners holding a minor interest in a North Carolina LLC a stronger hand in preventing an undesired dissolution.

Furthermore, under both statutes, an LLC will be dissolved at any time that there are no more members, subject to certain exceptions, including contrary provisions in the operating agreement. In North Carolina, an LLC will be dissolved for want of a member unless the assignee or fiduciary of the estate of the last remaining member agrees in writing within 90 days of the event of withdrawal that the LLC may continue until the assignee or fiduciary (or its designee) is admitted as a member, effective as of the occurrence of the withdrawal event.1299 Delaware has a similar 90-day provision.

The NCLLCA also states that an LLC will be dissolved upon the filing by the secretary of state of a certificate of dissolution.1300 The DLLCA also permits involuntary dissolution of an LLC by cancellation of the Certificate, as a matter of law, where the LLC has not paid taxes in 3 years or the LLC is without a registered agent (due to the registered agent’s resignation or an injunction order prohibiting the registered agent from continuing to serve as such) and doesn’t replace the registered agent within specified period.1301 Furthermore, the DLLCA expressly states that the death, retirement, resignation, expulsion, bankruptcy or dissolution of a member will not cause the dissolution of an LLC,1302 subject to contrary provisions in the LLC agreement, while the NCLLCA does not expressly deal with these issues and instead leaves these issues open for the person drafting the operating agreement.

If the LLC is to be dissolved upon agreement of the members or pursuant to the occurrence of some event in the operating agreement the managers must file articles of dissolution with the secretary of state, setting forth (1) the name of the LLC, (2) the dates of the filing of the Articles and any amendments thereto, (3) reason for dissolution, (4) date of dissolution and (5) other information as determined by the managers.1303 Articles of dissolution may be cancelled if filed in connection with withdrawal of last member and, within 90 days of event of withdrawal, members decide to continue the LLC and file articles of cancellation in accordance with NCLLCA Section 6-06.1.

5. Judicial Dissolution

The judicial dissolution provisions of the NCLLCA and the DLLCA differ markedly. Both the DLLCA and the NCLLCA allow a court (superior court in North Carolina; court of chancery in Delaware) to order the dissolution of an LLC. Unlike the NCLLCA, however, which enumerates in great detail both the grounds and the procedure for judicial dissolution,1304 the DLLCA provides for judicial dissolution by simply stating: “On application

1298 Del. Code Ann. tit. 6, § 18-801(a)(3). 1299 N.C. Gen. Stat. § 57C-6-01(4). 1300 N.C. Gen. Stat. § 57C-6-01(5); see also § 57C-6-03. 1301 Del. Code Ann. tit. 6, §§ 18-203 and 18-101(d)(i)(4). 1302 Del. Code Ann. tit. 6, § 5-18-203, 18-1108(a). 1303 N.C. Gen. Stat. § 57C-6-06. 1304 N.C. Gen. Stat. § 57C-6-02 – 02.1. Grounds for Dissolution (NCLLCA Section 6-02): The superior court may dissolve a limited liability company in a proceeding by the following:

1. The attorney general if it is established that (i) the limited liability company obtained its articles of organization through fraud; or (ii) the limited liability company has, after written notice by the attorney

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by or for a member or manager the court of chancery may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.”1305 The effect of this approach is to leave to case law the development of more specific standards.

One area of law to which the court of chancery has looked for guidance in interpreting the dissolution provision of the statute is Delaware’s limited partnership law. The Delaware Revised Uniform Limited Partnership Act (“DRULPA”) contains a dissolution provision for limited partnerships that is essentially identical to the DLLCA dissolution provision for LLCs: the DRULPA allows the court of chancery to dissolve a limited partnership when “it is not reasonably practicable to carry on the business in conformity with the partnership agreement.”1306 Because of the similarity between the two provisions, courts interpreting the dissolution provision of the DLLCA frequently analogize to cases that have interpreted the DRULPA dissolution provision.1307

The court of chancery has made clear that, under the DRULPA, the determination of the reasonable practicability of carrying on a limited partnership in conformity with the partnership agreement involves a fact-specific inquiry in which the court of chancery evaluates the business and stated purpose of the limited partnership and the general partners’ ability to

general given at least 120 days prior thereto, continued to exceed or abuse the authority conferred upon it by law;

2. A member if it is established that (i) the managers, directors, or any other persons in control of the limited liability company are deadlocked in the management of the affairs of the limited liability company, the members are unable to break the deadlock, and irreparable injury to the limited liability company is threatened or being suffered, or the business and affairs of the limited liability company can no longer be conducted to the advantage of the members generally, because of the deadlock; (ii) liquidation is reasonably necessary for the protection of the rights or interests of the complaining member, (iii) the assets of the limited liability company are being misapplied or wasted; or (iv) the articles of organization or a written operating agreement entitles the complaining member to dissolution of the limited liability company; or

3. The limited liability company to have its voluntary dissolution continued under court supervision.

Procedure for Judicial Dissolution (NCLLCA Section 6-02.1): (a) Venue for a proceeding to dissolve a limited liability company lies in the county where the limited liability

company’s principal office (or, if none in this State, its registered office) is or was last located. (b) It is not necessary to join members as parties to a proceeding to dissolve a limited liability company unless

relief is sought against them individually, however the court shall order that appropriate notice of the dissolution proceeding be given to all members by the party initiating the proceeding.

(c) A court in a proceeding brought to dissolve a limited liability company may issue injunctions, appoint a receiver with all powers and duties the court directs, take other action required to preserve the assets of the limited liability company, wherever located, and carry on the business of the limited liability company.

(d) In any proceeding brought by a member under NCLLCA Section 6-02(2)(ii) in which the court determines that dissolution would be appropriate, the court shall not order dissolution if, after the court’s determination, the limited liability company elects to purchase the membership interest of the complaining member at its fair value, as determined in accordance with any procedures the court may provide.

1305 Del. Code Ann. tit. 6, § 18-802. 1306 DRULPA § 17-802. 1307 But see Haley v. Talcott, 864 A.2d 86 (Del. Ch. 2004) (Two deadlocked members of an LLC each owned 50% of the company; the court granted dissolution, analogizing to the DGCL, which provides that when the stockholders of a joint venture corporation with only two 50% stockholders are absolutely unable to agree upon whether to discontinue the business or how to dispose of the assets, the joint venture should be dissolved.).

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achieve that purpose while operating in conformity with the partnership agreement.1308 The court of chancery has stated that the standard to be applied in these determinations is one of reasonable impracticability rather than impossibility1309 and has liberally interpreted the dissolution provision of the DLLCA to permit judicial dissolution of unprofitable LLCs.1310

6. Comparing the DLLCA and the NCLLCA

While some Delaware precedent (analogizing to the DGCL rather than the DRULPA and permitting dissolution in the case of member deadlock) hints at a trend towards a more flexible interpretation of the DLLCA dissolution standard,1311 most Delaware case law indicates that a Delaware LLC will be judicially dissolved only if the LLC is no longer carrying out its business in conformity with the explicit purposes of the LLC agreement. The NCLLCA, on the other hand, clearly states that a member may petition the court for judicial dissolution when the managers are in a deadlock, the rights of the petitioning member are being threatened, assets are being wasted, or the operating agreement so provides.1312 Furthermore, the NCLLCA allows a proceeding for judicial dissolution by the attorney general and by the LLC itself.1313 Accordingly, the NCLLCA appears to provide more specific and a broader range of grounds for granting judicial dissolution than does the DLLCA.

7. Administrative Dissolution

The process of administrative dissolution is largely the same under the DLLCA and the NCLLCA. While the DLLCA contains no section devoted solely to administrative dissolution, provisions of the DLLCA do state than an LLC’s Certificate will be cancelled for (1)

1308 In re Silver Leaf, L.L.C., No. 20611, 2005 Del. Ch. LEXIS 119 (Aug. 18, 2005); Red Sail Easter Ltd. Partners v.

Radio City Music Hall Prod., Inc., No. 12036, 1993 Del. Ch. LEXIS 154 (July 28, 1993); Cincinnati Bell Cellular

Sys. Co. v. Ameritech Mobile Phone Serv. of Cincinnati, Inc., No. 13389, 1996 Del. Ch. LEXIS 116 (Sept. 3, 1996). 1309 See Cincinnati Bell v. Ameritech Mobile, 1996 Del. Ch. LEXIS 116 (Del. Ch. Sept. 3, 1996) (Limited partnership whose purpose was providing cellular mobile services sought dissolution due to reduced profits because of competition from companies owned by its partners; dissolution denied and court held that in the absence of an express provision enumerating profit as a purpose of the partnership, a disappointing investment did not render impracticable the parties’ ability to carry on the partnership in conformity with the partnership agreement); Red Sail

Easter Ltd. Partners v. Radio City Music Hall Prod., Inc., 1993 Del. Ch. LEXIS 154 (Del. Ch. July 28, 1993) (Limited partners file for dissolution arguing that general partner failed to effectuate limited partnership’s purpose of producing an annual Easter Show at Radio City and developing a series of road shows; dissolution denied because an average of 25 shows per year were presented and the road show concept was sufficiently explored, considering its impracticality). 1310 See Silver Leaf (The three members of an LLC formed to market and sell french-fry vending machines became deadlocked as a result of a disagreement about a sales and marketing agreement and two members sought judicial dissolution; the court, analogizing from DRULPA and following the standard of reasonable impracticability, not impossibility, awarded dissolution, finding that the members’ deadlock made it impracticable to carry on the business.); PC Tower Ctr., Inc. v. Tower Ctr. Dev. Assocs. Ltd. P’ship, 10788, 1989 Del. Ch. LEXIS 72 (June 8, 1989). (Partnership formed expressly for the purpose of developing real estate “for profit and as an investment”; judicial dissolution granted because it was no longer reasonably practicable to carry on the business for profit in conformity with the partnership agreement because of the heavily leveraged purchase of the property, the depressed real estate market, and the debt owed on the property that greatly exceeded the value of the property.). 1311 See Haley v. Talcott, 864 A.2d 86 (Del. Ch. 2004), cited supra note 1308. 1312 N.C. Gen. Stat. § 57C-6-02(2). 1313 N.C. Gen. Stat. § 57C-6-02(1) and (3).

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failure to pay required taxes for three years from the date on which they are due1314 or (2) failure to designate a registered agent to replace a registered agent who has resigned1315 or whom the secretary of state has enjoined from being a registered agent.1316

The NCLLCA, on the other hand, contains a separate provision on administrative dissolution, stating that the secretary of state may administratively dissolve an LLC if: (1) the LLC has not paid within 60 days after they are due any penalties, fees, or other payments due under the NCLLCA; (2) the LLC does not deliver its annual report to the secretary of state on or before the date it is due; (3) the LLC has been without a registered agent or registered office in North Carolina for 60 days or more; (4) the LLC has not notified the secretary of state within 60 days that its registered agent or registered office has been changed, that its registered agent has resigned, or that its registered office has been discontinued; or (5) the LLC’s period of duration stated in its Articles has expired.1317

The NCLLCA thus contains more grounds on which an LLC may be administratively dissolved than does the DLLCA, which lists neither failure to deliver an annual report nor expiration of the LLC’s duration as a reason for administrative dissolution.

The NCLLCA provides that an LLC has 60 days to correct any of the five grounds for administrative dissolution and may thereafter apply for reinstatement within two years of the date of dissolution.1318 Any automatic cancellation of the Certificate of a Delaware LLC may be undone by filing a certificate of revival pursuant to DLLCA Section 18-1109 and paying all fines, taxes and penalties due.1319 The DLLCA prescribes no limitation on the time an LLC has in which to file a certificate of revival.1320

8. Winding Up

Under both the NCLLCA and DLLCA, initially the managers are responsible for winding up an LLC’s affairs (although in Delaware, the manager must be one who has not previously wrongfully dissolved an LLC).1321 Also in both states, a member (or, in Delaware, a creditor, manager, or any other person who shows good cause1322) may apply to the court to appoint a receiver or trustee to do the winding up.1323 Under North Carolina law, the court may grant this request and may require the receiver to post bond,1324 or it may do the winding up itself.1325

1314 Del. Code Ann. tit. 6, § 18-11089(a). 1315 Del. Code Ann. tit. 6, § 18-104(d). 1316 Del. Code Ann. tit. 6, § 18-104(i)(4). 1317 N.C. Gen. Stat. § 57C-6-03(a). 1318 N.C. Gen. Stat. § 57C-6-03. 1319 Del. Code Ann. tit. 6, § 18-1109; see also § 18-1105(a)(3). 1320 See Del. Code Ann. tit. 6, § 18-1109. 1321 Del. Code Ann. tit. 6, § 18-803(a); N.C. Gen. Stat. § 57C-6-04(a). 1322 Del. Code Ann. tit. 6, § 18-805. 1323 Del. Code Ann. tit. 6, § 18-803(a); N.C. Gen. Stat. § 57C-6-04(a). 1324 N.C. Gen. Stat. § 57C-6-02.2(b). 1325 N.C. Gen. Stat. § 57C-6-04(a).

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Both statutes grant a receiver the authority to sue and defend: in Delaware, the receiver does so in the name of the LLC; in North Carolina, the receiver does so in the receiver’s own name.1326 In Delaware, the liquidating trustee may also settle and close the LLC’s business; in North Carolina, he or she may manage the affairs of the LLC in the best interests of its members and creditors.1327

The statutes differ as to the treatment of situations in which there are no managers to perform the duty of winding up and no member applies to the court to appoint someone to do so. In North Carolina, the legal representative of or successor to the last remaining member does the winding up.1328 In Delaware, however, if there is no qualifying manager, the members who own more than 50% of the profits interest in the LLC (or members of each class owing more than 50% of the profits interest owned by the members of the group) may wind up the LLC.1329 Under the NCLLCA, an LLC’s business may be carried on during wind up, but only to the extent necessary to wind up and liquidate the business and its affairs.1330 The DLLCA has more general statutory language on this point, referencing the gradual settling and closing out of the LLC business.1331

The winding up process commences upon dissolution of the LLC and continues until the LLC’s liabilities have been satisfied and any remaining assets have been distributed pursuant to the operating agreement.1332

In Delaware, the filing of the certificate of cancellation marks the end of the winding up process.1333 The following events terminate the existence of the LLC without requiring the LLC to wind up its affairs: (i) administrative cancellation, (ii) termination, in connection with merger or consolidation, (iii) conversion, and (iv) transfer or domestication or continuance of an LLC outside of Delaware.1334

9. Miscellaneous

The NCLLCA, unlike the DLLCA, expressly states that dissolution of an LLC does not: (1) transfer title to assets, (2) prevent assignment of interests, (3) subject managers to different standards, (4) change provisions of the operating agreement, (5) abate, suspend, or prevent commencement of a proceeding by or against the LLC, or (6) terminate the authority of the registered agent.1335

1326 Del. Code Ann. tit. 6, § 18-805; N.C. Gen. Stat. § 57C-6-02.2(c)(2). 1327 Del. Code Ann. tit. 6, § 18-803(b); N.C. Gen. Stat. § 57C-6-02.2(c)(3). 1328 Del. Code Ann. tit. 6, § 57C-6-04(a). 1329 Del. Code Ann. tit. 6, § 18-803(a). 1330 N.C. Gen. Stat. § 57C-6-04(b). 1331 Section 18-803(b) of DLLCA states that wind up and the delegation of wind up responsibilities does not affect the liability of members and managers, and no liability is imposed on the liquidity trustee. Del. Code Ann. tit. 6, § 18-803(b). 1332 Del. Code Ann. tit. 6, §§ 18-803 and 18-804; N.C. Gen. Stat. § 57C-6-04. 1333 Del. Code Ann. tit. 6, § 18-203. 1334 Del. Code Ann. tit. 6, §§ 18-209(g), 18-213(d) and 18-216(c). 1335 N.C. Gen. Stat. § 57C-6-04(c).

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10. Distribution of Assets

Subject to the exception noted below, the Delaware and North Carolina provisions on distributing assets after dissolution are essentially identical. Both provide that, upon winding up, an LLC’s assets are to be distributed: (1) first to creditors (including members and, in Delaware, managers) in satisfaction of liabilities other than liabilities for distribution to members,1336 (2) then to members or former members in satisfaction of liabilities or distributions, unless otherwise provided,1337 and finally (3) to members, first for the return of their contributions, and second in the proportions in which they share in distributions.1338

One key difference between the two provisions is that under Delaware law, the dissolved LLC’s members are generally not liable to the dissolved LLC’s claimants.1339 This difference is discussed in greater detail in Section V.C. below.

C. Claims against a Dissolved LLC and Residual Liability of the Dissolved LLC

Under the DLLCA, a dissolved Delaware LLC must pay all claims and obligations known to it1340 and make provision sufficient to compensate for any claim that is the subject of a pending action to which the LLC is a party.1341 The LLC must also make provision sufficient to compensate for any claims that it knows are likely to arise within ten years of the date of dissolution.1342 If there are sufficient assets to meet these claims, the claims must be paid in full; if assets are insufficient, the claims must be paid according to priority or ratably if equal in priority.1343

According to the NCLLCA, a dissolved North Carolina LLC may opt to dispose of known claims1344 by notifying its claimants in writing of the dissolution at any time after it has filed its articles of dissolution. This notice must: (1) describe information that must be included in a claim, (2) provide a mailing address where claims can be sent, (3) state the deadline, (not fewer than 120 days from the date of the written notice) by which the dissolved LLC must receive the claim, and (4) state that the claim will be barred if not received by the deadline.1345 A claim against a dissolved LLC is barred: (1) if not received by the deadline or (2) if a claimant whose claim was rejected by written notice from the dissolved LLC fails to commence a proceeding to enforce the claim within 90 days from the date of receipt of the rejection notice.1346

1336 Del. Code Ann. tit. 6, § 18-804(a)(1); N.C. Gen. Stat. § 57C-6-05(1). 1337 Del. Code Ann. tit. 6, § 18-804(a)(2); N.C. Gen. Stat. § 57C-6-05(2). 1338 Del. Code Ann. tit. 6, § 18-804(a)(3); N.C. Gen. Stat. § 57C-6-05(3). 1339 Del. Code Ann. tit. 6, § 18-804(b)(3). 1340 Del. Code Ann. tit. 6, § 18-804(b)(1). 1341 Del. Code Ann. tit. 6, § 18-804(b)(2). 1342 The DLLCA defines “knowledge” as actual knowledge, rather than constructive knowledge. Del. Code Ann. tit. 6, § 18-101(5). 1343 Del. Code Ann. tit. 6, § 18-804(b)(3). 1344 Neither the NCLLCA, nor the NCBCA (on which these notice provisions are based), defines the term “knowledge.” 1345 N.C. Gen. Stat. § 57C-6-07(b). 1346 N.C. Gen. Stat. § 57C-6-07(c).

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Alternatively, a dissolved North Carolina LLC may publish notice of its dissolution and request that persons with claims present them in the manner described in the notice.1347 This notice must: (1) be published one time in a newspaper of general circulation in the county where the dissolved LLC’s principal office (or registered office, if there is no principal office) is or was located; (2) describe the information that must be included in a claim and provide a mailing address where the claim may be sent; and (3) state that a claim will be barred unless a proceeding to enforce it is commenced within five years after the publication of the notice.1348 If the dissolved LLC publishes such a notice, the claim of each of the following claimants is barred unless the claimant commences a proceeding to enforce the claim within five years after the publication date of the newspaper notice: (1) a claimant who was known but did not receive written notice; (2) a claimant whose claim was timely sent to the LLC but not acted on; and (3) a claimant whose claim is contingent or based on an event occurring after the filing of the articles of dissolution.1349

Any claim sent to the LLC (or person charged with winding up the LLC’s affairs) pursuant to NCLLCA Section 6-07 or 6-08 may be enforced against the dissolved LLC to the extent of its undistributed assets, including coverage under any applicable insurance policy,1350 or against a member if the LLC’s assets are distributed in winding up. A claimant may pursue his claim against a member of the dissolved LLC to the extent of that member’s pro rata share of the claim or the LLC’s assets distributed to him in winding up, whichever is less. A member’s total liability cannot be greater than the total amount of assets distributed to him.1351

Under Delaware law, the dissolved LLC’s members are not liable to the dissolved LLC’s claimants.1352 However, the member may be liable to the LLC for any improper distributions not in accord with Section 18-804(a) of the DLLCA. A member who knowingly receives a distribution in violation of the provisions for distributing assets will be liable to the LLC for the amount of the distribution. But, a member who receives a distribution in violation of the provisions for distributing assets and does not know of the violation will not be liable to the LLC for the amount of that distribution.1353 Likewise, the liquidating trustee, provided that he has followed the provisions for distributing assets, will not be personally liable to the LLC’s claimants.1354 And finally, the DLLCA sets a final 3 year time period for claims on a member’s liquidating distribution.1355

Thus, North Carolina law is less forgiving to dissolved LLC members who receive distributed assets (since imposition of liability does not require a finding that such members received the assets wrongfully, as required under he DLLCA). In addition, given that an unknown claimant has five years to bring its claim,1356 a member of a North Carolina LLC may

1347 N.C. Gen. Stat. § 57C-6-08(a). 1348 N.C. Gen. Stat. § 57C-6-08(b). 1349 N.C. Gen. Stat. § 57C-6-08(c). 1350 N.C. Gen. Stat. § 57C-6-09(a)(1). 1351 N.C. Gen. Stat. § 57C-6-09(a)(2). 1352 Del. Code Ann. tit. 6, § 18-804(b). 1353 Del. Code Ann. tit. 6, § 18-804(c). 1354 Del. Code Ann. tit. 6, § 18-804(b)(3). 1355 Del. Code Ann. tit. 6, § 18-804(a). 1356 N.C. Gen. Stat. § 57C-6-08(b).

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not know for such time period whether he or she will be required to retain or reserve for all, or some portion, of his or her distribution proceeds.

D. Rights of Members

1. Voting Rights of Members and Managers

The DLLCA expressly provides that a Delaware LLC may have classes of members with the voting rights of each set forth in the operating agreement.1357 The NCLLCA does not explicitly state that an LLC may have classes with different voting rights, but provides that members shall be bound by the terms of the written operating agreement.1358

The DLLCA provides that, unless otherwise provided in the LLC agreement, the management of the LLC is vested in its members in proportion to their interest in the profits of the LLC, with the decision of more than 50% of the interests in the profits of the LLC prevailing.1359 The NCLLCA provides that each manager shall have all rights and authority to participate in the management of the LLC, and management decisions shall require the approval of a majority of managers, without reference to their respective interests.1360

The NCLLCA provides for a unanimous vote of all members, except as otherwise provided in the operating agreement, to (1) adopt or amend an operating agreement; (2) admit any person as a member; (3) sell, transfer, or otherwise dispose of all or substantially all of the assets of the LLC prior to the dissolution of the LLC;1361 (4) amend the Articles;1362 (5) convert the LLC to another type of business entity;1363 (6) dissolve the LLC;1364 or (7) compromise a member’s obligation to contribute capital to the LLC.1365

2. Series of Interests

The rights of a member of an LLC (including voting or approval rights, rights to receive payments in respect of profits, etc.) may be defined by reference to the series of membership interests held by such member. DLLCA Section 18-215 contemplates the creation of series of membership interests. By contrast, the NCLLCA does not expressly allow for the creation of separate series of interests.

1357 Del. Code Ann. tit. 6, § 18-302. 1358 N.C. Gen. Stat. § 57C-3-05. See N.C. Gen. Stat. § 57C-4-03 (providing for different classes of LLC membership with different rights to income, tax, distribution and other economic allocations). 1359 Del. Code Ann. tit. 6, § 18-402. 1360 N.C. Gen. Stat. § 57C-3-20(b). 1361 N.C. Gen. Stat. § 57C-3-03. 1362 N.C. Gen. Stat. § 57C-2-22(b). 1363 N.C. Gen. Stat. § 57C-9A-11(b). 1364 N.C. Gen. Stat. § 57C-6-01(3). 1365 N.C. Gen. Stat. § 57C-4-02(c).

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3. Access to Records of LLC

Both the NCLLCA and DLLCA set out six types of basic information to which a member of an LLC is entitled upon request, subject to reasonable restrictions contained in the operating agreement: (1) status and financial condition of the business; (2) a copy of the most recent federal, state, and local income tax returns; (3) the name and address of each current member (and manager in Delaware); (4) a copy of any operating agreement, Articles or Certificate, any written powers of attorney, and any amendment to each; (5) the amount of cash and a description and statement of the agreed value of any other property or services contributed by each member and the property and services that each member has agreed to contribute in the future and the date on which each became a member;1366 and (6) such other information regarding the LLC’s affairs as is just and reasonable.1367

Under both the DLLCA and the NCLLCA, demands for information by a member are required to be in writing and must state the purpose of the demand.1368 The NCLLCA adds that the demand must be in good faith and for a proper purpose and that the demand must state with reasonable particularity the records or information desired.1369

Both the NCLLCA and the DLLCA provide that the managers have the right to keep certain information of the LLC confidential from its members, such as trade secrets or other information the disclosure of which is not in the best interest of the LLC. The NCLLCA specifies, however, that this provision does not permit such information to be withheld from a member that is a manager.1370 The DLLCA further provides that the managers may keep information confidential from a member if the disclosure of the information could damage the LLC or its business or if the LLC is required by law or by agreement with a third party to keep such information confidential.1371

The DLLCA provides a detailed procedure to follow in order to enforce the rights of a member to information regarding the LLC.1372 The NCLLCA does not provide for any specific enforcement procedures.

4. Restrictions on Distributions

Both the DLLCA and NCLLCA prohibit an LLC from making a distribution if after the distribution the LLC would be insolvent. Both statutes use a “balance sheet” insolvency test (i.e., a test that determines whether the total assets of the LLC would be less than its total

1366 The DLLCA says that “true and full” information shall be provided for parts (1) and (5); the NCLLCA does not. 1367 N.C. Gen. Stat. § 57C-3-04(a); Del. Code Ann. tit. 6, § 18-305(a). 1368 Del. Code Ann. tit. 6, § 18-305(e); N.C. Gen. Stat. § 57C-3-04(c). 1369 N.C. Gen. Stat. § 57C-3-04(c). 1370 Del. Code Ann. tit. 6, § 18-305(c); N.C. Gen. Stat. § 57C-3-04(e). 1371 Del. Code Ann. tit. 6, § 18-305(c). 1372 Del. Code Ann. tit. 6, § 18-305(f).

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liabilities),1373 but North Carolina also uses a liquidity test (determining whether the LLC would not be able to pay its debts as they become due in the usual course of business).1374

5. Liability for Wrongful Distributions

a) Managers’ and Members’ Liability under North Carolina Law

Under the NCLLCA, a manager or director who votes for or assents to a distribution in violation of NCLLCA Section 4-06 or a written operating agreement is personally liable to the LLC for the amount of the distribution that exceeds the amount that could have been distributed without such violation if in assenting to the distribution the manager or director did not act in compliance with NCLLCA Section 3-22, which outlines obligations of a manager or director to act in good faith.1375

Each manager or director held liable under NCLLCA Section 4-07 is entitled to contribution from other managers and directors who voted for or assented to the wrongful distribution, and reimbursement from each member for the amount the member received knowing that the distribution was made in violation of NCLLCA Section 4-06 or the operating agreement.1376

b) Members’ Liability under Delaware Law

The DLLCA has no comparable law making managers personally liable for approval of wrongful distributions.

Under the DLLCA, a member who receives a distribution in violation of DLLCA Section 18-607(a), and who knew at the time of the distribution that the distribution was in violation of the DLLCA, is liable to the LLC for the amount of the distribution.1377

Note that actions for wrongful distribution under both the DLLCA and NCLLCA are barred if not brought within three years of the wrongful distribution. 1378

E. Management/Agency

1. Fiduciary Duties of Managers

The NCLLCA enumerates the duties of LLC managers in Section 3-22: “a manager shall discharge his duties as manager in good faith, with the care an ordinary prudent person in a like position would exercise under similar circumstances, and in the manner the manager reasonably believes to be in the best interests of the limited liability company.”1379

1373 Del. Code Ann. tit. 6, § 18-607(a); N.C. Gen. Stat. § 57C-4-06(a)(2). 1374 N.C. Gen. Stat. § 57C-4-06(a)(1). 1375 N.C. Gen. Stat. § 57C-4-07. 1376 N.C. Gen. Stat. § 57C-4-07(b). 1377 Del. Code Ann. tit. 6, § 18-607(b). 1378 Del. Code Ann. tit. 6, § 18-607(c); N.C. Gen. Stat. § 57C-4-07(c). 1379 N.C. Gen. Stat. § 57C-3-22(b).

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Thus, managers are subject to the fiduciary duties of good faith, due care and loyalty. The NCLLCA provides an additional duty to account – a manager must “account to the LLC and hold as trustee for it any profit or benefit derived without the informed consent of the members by the manager from any transaction connected with the formation, conduct, or liquidation of the LLC or from any personal use by the manager of its property.”1380 The duties of good faith, due care and loyalty may not be eliminated or restricted by agreement of the members, but the Articles or a written operating agreement may eliminate or modify a manager’s duty to account as a trustee.

While the DLLCA does not list the duties of managers, the common law duties of due care and loyalty do apply, in the absence of a contrary provision in the LLC agreement,1381 and the implied covenants of good faith and fair dealing apply to every Delaware contract.1382

The NCLLCA does not permit the LLC to contract around the duties of good faith, due care and loyalty; however, the operating agreement may provide for exculpation and/or indemnification of managers for breaching fiduciary duties.1383 Thus, while managers may under certain circumstances be exonerated due to an exculpation provision, a court could still issue an injunction to halt the offending conduct. The NCLLCA is more stringent than the DLLCA in this respect, and the NCLLCA rule requiring a manager to account to the LLC and hold any improper profit as a trustee for the benefit of the LLC imposes a higher fiduciary standard on LLC managers than the general corporate duty of loyalty.

2. Authority of Members and Managers

Under the NCLLCA, a member is deemed to be a manager of the LLC, unless the Articles provide otherwise.1384 Under DLLCA, the member(s) holding more than 50% of the profit interest in the LLC have the power to manage the LLC unless the LLC agreement provides otherwise.1385 Although stated differently, the practical result is the same under both statutes: an LLC is managed by its members unless provided otherwise. In North Carolina, such non-member management may be provided for in the Articles, while in Delaware it may be in the LLC agreement.

Unless otherwise provided in the LLC agreement, under the DLLCA, both members and managers have the authority to bind the LLC.1386 In North Carolina, only a manager may bind the LLC, but an act of a manager that is not apparently done in the usual course of the business of the LLC does not bind the LLC unless authorized in fact or ratified by the LLC.1387

1380 N.C. Gen. Stat. § 57C-3-22(e). 1381 Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, 2009 WL 1124451 (Del. Ch. April 20, 2009). 1382 Chamison v. Health Trust Inc., 735 A.2d, 912, 9220 (Del. Ct. 1999). 1383 For a discussion of indemnification, see Section V.I. of this study, below. 1384 N.C. Gen. Stat. § 57C-3-20. 1385 Del. Code Ann. tit. 6, § 18-402. 1386 Del. Code Ann. tit. 6, § 18-402. 1387 N.C. Gen. Stat. § 57C-3-23.

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3. Delegation of Authority

Under the NCLLCA, the authority of a manager or a member may be delegated only if and to the extent permitted in a written operating agreement.1388 The DLLCA reverses the presumption, providing that members and managers have the right to delegate their authority to others, except to the extent provided in the LLC agreement1389 (whether or not written).

4. Apparent Authority

The NCLLCA provides that any person dealing with an LLC may rely conclusively upon its most recent annual report and any amendments to it filed with the secretary of state as to the identity of managers, except to the extent that person has actual knowledge that a person is not a manager.1390 The DLLCA has no analogous provision.

5. Removal/Resignation of Managers

Managers of a North Carolina LLC may be removed in accordance with procedures set forth in the Articles or a written operating agreement.1391 In the absence of such removal procedures, NCLLCA provides that removal of a manager may occur upon (1) a person’s resignation; (2) the occurrence of an event described in NCLLCA Section 3-02 whereby a person ceases to be a member; (3) an event specified in the Articles or the operating agreement; or (4) an amendment of the operating agreement removing the person as a manager.1392

The DLLCA does not provide for the removal of a manager, other than as may be provided in the LLC agreement. A manager may resign as manager as provided in an LLC agreement.1393 The LLC agreement may prohibit a manager from resigning but the manager may nevertheless resign by giving written notice of resignation to the members and any other managers.1394

F. Merger

The statutory schemes governing the mechanics of merger transactions are similar in the two states. Each state allows a domestic LLC to merge with other domestic LLCs, other domestic business entities, and foreign business entities.1395 Both statutes also provide that mergers are effectuated by having the LLC’s members approve a plan or agreement of merger1396

1388 N.C. Gen. Stat. § 57C-3-24(a). 1389 Del. Code Ann. tit. 6, § 18-407. 1390 N.C. Gen. Stat. § 57C-3-25(a). 1391 N.C. Gen. Stat. § 57C-3-21. 1392 N.C. Gen. Stat. § 57C-3-21(3). 1393 Del. Code Ann. tit. 6, § 18-602. 1394 Del. Code Ann. tit. 6, § 18-602. 1395 Del. Code Ann. tit. 6, § 18-209(a); N.C. Gen. Stat. § 57C-9A-20. It is worth noting, however, a unique provision in the DLLCA which provides that an LLC agreement may prohibit mergers of domestic LLCs. Del. Code Ann. tit. 6, § 18-209(h). 1396 Del. Code Ann. tit. 6, § 18-209(b); N.C. Gen. Stat. § 57C-9A-21(a),(b).

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and, subsequently, having the surviving entity file with the secretary of state1397 a written certificate or articles of merger.1398

However, despite the similarities of the merger mechanics, there are a number of notable differences between the two statutory schemes.

1. Approval

To approve a merger involving a Delaware LLC, the DLLCA requires a vote of the LLC’s members who own more than 50% of the interests in the profits of the operating agreement (the same vote is required for each class of members, if there are multiple classes), unless otherwise provided in the LLC agreement.1399 The NCLLCA, on the other hand, requires the unanimous consent of the members, in the absence of a provision to the contrary in a written operating agreement or in the Articles.1400

The NCLLCA also provides that the plan of merger must be approved by any member of a merging domestic LLC that has or will have personal liability for any existing or future obligation of the surviving entity solely as a result of holding an interest in the surviving entity.1401 Unlike the default rule requiring unanimous member approval of the merger, this provision of the NCLLCA is not subject to modification under the operating agreement. In this way, the NCLLCA assures that each member who will suffer a change in the fundamental nature of its interest (from limited personal liability to broader personal liability) will have agreed to such change before it takes effect, even if such member’s consent would not otherwise be required under the operating agreement.

2. Termination

In Delaware, once an agreement of merger is approved, the ability to amend or terminate the agreement is governed by the agreement of merger.1402 In North Carolina, the NCLLCA provides that the LLC may amend the plan of merger before the articles of merger become effective if so permitted by the terms of the plan of merger.1403 The LLC may abandon the merger entirely before the articles of merger become effective in accordance with the plan, the Articles, or the written operating agreement, and if abandonment is not addressed in any such document, the managers may vote to abandon the plan by majority vote.

1397 The NCLLCA incorporates by reference a section of the North Carolina General Statutes which requires that, in addition to requiring articles of merger to be filed with the secretary of state, “if title to real property in this State is vested by operation of law in another entity upon the merger . . . such vesting is effective against lien creditors or purchasers for a valuable consideration from the entity formerly owning the property, only from the time of registration of a certificate thereof [with the register of deeds], in the county where the land lies.” N.C. Gen. Stat. § 47-18.1. 1398 Del. Code Ann. tit. 6, § 18-209(c); N.C. Gen. Stat. § 57C-9A-22. 1399 Del. Code Ann. tit. 6, § 18-209(b). 1400 N.C. Gen. Stat. § 57C-9A-21(b). 1401 Id. 1402 Del. Code Ann. tit. 6, § 18-209(b). 1403 N.C. Gen. Stat. § 57C-9A-21(c).

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3. Appraisal Rights

Neither the NCLLCA nor the DLLCA provide appraisal rights to members of a merging domestic LLC. The NCLLCA, however, does expressly provide that dissenting shareholders of any merging domestic corporation are entitled to appraisal rights under Article 13, Chapter 55 of the North Carolina General Statutes.1404 The DLLCA provides that an LLC may include contractual appraisal rights in the operating agreement.1405

4. Contents of Merger Plan or Agreement

The NCLLCA requires a written plan of merger to be approved by both the LLC and the other merging entity. The plan of merger must include (1) for each merging entity, the name, entity classification, and state or country whose laws govern its organization and internal affairs; (2) the name of the surviving entity; (3) the terms and conditions of the merger; (4) the manner and basis of converting interests in the merging entities into interests in the surviving entity, or into cash or other property in whole or in part; (5) if the surviving entity is a domestic LLC, any amendments to its Articles that are to be made in connection with the merger; and (6) any other provisions relating to the merger.1406 The DLLCA merely requires that the agreement contain the name of the entity that will survive the merger. Once again, the difference between the two statutory schemes reflects Delaware’s reluctance to impose mandatory rules or conditions on parties to an agreement.

While in both states interests in each merging entity may be exchanged for or converted into cash, property, or securities of or interests in the surviving entity, only the DLLCA expressly provides that interests in the merging entity may be exchanged for securities of or interest in a domestic business entity other than the surviving entity or cancelled rather than exchanged.1407

5. Certificate or Articles of Merger

The DLLCA requires that the certificate of merger (1) state the name and jurisdiction of each merging entity; (2) assert that the agreement of merger has been approved by each entity merging; (3) state the name of the surviving entity; (4) if a domestic LLC is the surviving entity, state any amendments to the Certificate necessitated by the merger; (5) the future effective date or time of the merger, if the merger will not be effective upon filing; (6) state the address of the principal place of business of the surviving entity and assert that the agreement of merger is filed there; (7) assert that the surviving entity will provide a copy of the agreement of merger on request and without charge to any person holding an interest in any merging entity; and (8) if the surviving entity is a foreign business entity, state that surviving entity agrees to receive service of process in Delaware and appoints the secretary of state as

1404 N.C. Gen. Stat. § 57C-9A-23(a)(7). See Section III.G.9. of this study, above, for a discussion of dissenters’ rights under the NCBCA. 1405 Del. Code Ann. tit. 6, § 18-210. 1406 N.C. Gen. Stat. § 57C-9A-21(a) and (a1). 1407 Del. Code Ann. tit. 6, § 18-209(b); N.C. Gen. Stat. § 57C-9A-23(a)(6).

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agent to accept service of process.1408 The agreement of merger may be filed in lieu of a separate certificate of merger if all of the information required of a certificate is contained therein.1409

The articles of merger for a North Carolina LLC must include (a) the name, entity type and governing law of the merging entity, (b) the name of the surviving entity and, if that entity is not authorized to transact business in North Carolina, a designation of a mailing address and a commitment to keep the address up-to-date, (c) if the surviving entity is a North Carolina entity, any amendments to the articles necessitated by the merger, and (d) a statement confirming that the plan of merger was duly approved.1410

G. Conversion

In response to more limited earlier iterations of the entity conversion concept, many states – including North Carolina and Delaware – enacted entity conversion statutes in the late 1990’s to permit conversion by an LLC to any other type of business entity and vice versa.1411 In both North Carolina and Delaware, slightly different rules and processes apply to conversions to, and conversions from, domestic LLCs.1412 While both statutory structures are consistent in that they draw a distinction between conversions to and from domestic LLCs, the statutory structures are dissimilar in terms of how those conversions are accomplished.

1. Conversion to a Domestic LLC

The DLLCA and NCLLCA provisions relating to conversions to domestic LLCs achieve similar results; however, the NCLLCA accomplishes in one filing what the DLLCA does in two filings. The DLLCA provides that a certificate of conversion containing certain prescribed elements1413 and a Delaware certificate of formation each must be filed with the secretary of state.1414 The NCLLCA requires that the converting entity deliver Articles to the secretary of state for filing, which, in addition to the typical requirements for Articles, must contain articles of conversion stating (1) that the domestic LLC is being formed pursuant to a conversion of another business entity; (2) the name of the converting business entity, its type of business entity, and the state or country whose laws govern its organization and internal affairs; and (3) that a plan of conversion has been approved by the converting business entity as required by law.1415 In North Carolina, certificates of conversion must also be recorded in the county where real

1408 Del. Code Ann. tit. 6, § 18-209(c). 1409 Del. Code Ann. tit. 6, § 18-209(e). 1410 N.C. Gen. Stat. § 57C-9A-22(a). 1411 Robert R. Keatinge, Plumbing and Other Transitional Issues, 58 Bus. Law 1051 (2003). 1412 See Section III.G.8. of this study, above, for a discussion of entity conversions generally. 1413 DLLCA Section 18-214(c) requires (1) the date on which and jurisdiction where the converting entity was first formed, and, if it has changed, its jurisdiction immediately prior to its conversion to a domestic LLC; (2) the name of the converting entity immediately prior to the fling of the certificate of conversion; (3) the name of the resulting LLC; and (4) the future effective date or time of the conversion if it is not to be effective upon the filing of the certificate of conversion and the certificate of formation. Del. Code Ann. tit. 6, § 18-214(c). 1414 Del. Code Ann. tit. 6, § 18-214(c). 1415 N.C. Gen. Stat. § 57C-9A-03(a).

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property lies, if, by operation of law, the vesting of title to such real in the resulting entity is to be effective against lien creditors or bona fide purchasers of the real property.1416

While both statutes require that a conversion to a domestic LLC be approved in the manner required by the organization documents and laws of the converting entity,1417 only North Carolina requires that a written plan of conversion be adopted.1418 Even though Delaware does not require a written plan of conversion to be adopted, it does require that the converting entity approve the form of LLC agreement that will govern the LLC once the conversion is complete.1419 In both states, interests in the converting entity may be exchanged for or converted into cash, property, or securities of or interests in the domestic LLC or another entity; however, under the DLLCA, interests of the converting entity may also be cancelled rather than exchanged.1420

2. Conversion from a Domestic LLC

The DLLCA requires that conversion of a Delaware LLC into another business entity be approved as provided in the LLC agreement; if the LLC agreement is silent with respect to conversions, the approval method in the operating agreement for mergers will govern. If the LLC agreement is silent on both conversion and merger the conversion must be approved by members who own more than 50% of the profits interest in the LLC, or by the members in each class or group, as appropriate.1421

The approval process under the NCLLCA includes other requirements that do not have counterparts in Delaware. The converting domestic LLC must provide a copy of the plan of conversion to each member at the time provided in its Articles or a written operating agreement or, if there is no such provision, prior to its approval of the plan of conversion.1422 As with mergers, if any member of the converting domestic LLC has or will have personal liability for any existing or future obligation of the resulting business entity solely as a result of holding an interest in the resulting business entity, then approval of the plan of conversion requires the consent of each such member.1423

3. Termination of Conversion

The NCLLCA provides that the LLC may amend the plan of conversion if so permitted by the terms of the plan of conversion. Moreover, the LLC may abandon the

1416 N.C. Gen. Stat. § 47-18.1; N.C. Gen. Stat. § 57C-9A-03(d). 1417 Del. Code Ann. tit. 6, § 18-214(h); N.C. Gen. Stat. § 57C-9A-02(c). 1418 The plan of conversion must include (1) the name of the domestic LLC resulting from the conversion; (2) the name of the converting entity, its entity classification, and the state or country whose laws govern its organization and internal affairs; (3) the terms and conditions of the conversion; (4) the manner of converting interests in the converting entities into interests in the resulting entity or other property; and (5) any other provisions relating to the conversion. N.C. Gen. Stat. § 57C-9A-02. 1419 Del. Code Ann. tit. 6, § 18-214(h). 1420 Del. Code Ann. tit. 6, § 18-214(i); N.C. Gen. Stat. § 57C-9A-04(5). 1421 Del. Code Ann. tit. 6, § 18-216(b). 1422 Id. 1423 Id. Unlike the default rule regarding 100% member approval of the conversion, this provision of the NCLLCA is not subject to modification by the operating agreement.

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conversion entirely in accordance with the plan, the articles of organization, or a written operating agreement, and if abandonment is not expressly permitted or prohibited in any such documents, the managers may vote to abandon the plan by majority vote.1424 Amendment or abandonment of the plan must be done before the articles of conversion, filed pursuant to NCLLCA Section 9A-12, become effective.

Some unique aspects to the DLLCA are worth noting. While in both states, interests in the converting entity may be exchanged for or converted into cash, property, or securities of or interests in the domestic LLC or another entity,1425 only the DLLCA provides that interests in the converting entity may be cancelled rather than exchanged.1426 Also, under the DLLCA, an LLC agreement may provide that a domestic LLC shall not have the power to convert.1427

H. Piercing the Veil and Alter Ego

The history of the LLC form of business organization is relatively short in the United States. Because of a lack of LLC case law, there is much uncertainty regarding how the courts will deal with issues of limited liability and veil-piercing. Neither Delaware nor North Carolina has established a definitive analysis for member and manager liability comparable to the corporate concept of piercing the veil. As shown below, the DLLCA and NCLLCA set the stage for potential liability of members and managers, but there are uncertainties.

Under DLLCA Section 18-303, no member or manager of an LLC “shall be obligated personally for any such debt, obligation or liability of the LLC [arising in contract, tort, or otherwise] solely by reason of being a member or acting as a manager of the LLC.”1428 DLLCA Section 18-1101 states, “The rule that statutes in derogation of the common law are to be strictly construed shall have no application to this chapter.”1429 Thus, Delaware courts should generally adhere to the relevant statutory language in assessing veil-piercing issues.1430

One of the first applicable decisions in Delaware involved plaintiffs who alleged that two Delaware LLCs were “alter egos” for one another.1431 The plaintiffs asserted that because the LLCs had a common principal, “there is a strong indication that [one of the LLCs] may have been acting as the mere instrumentality or alter ego of [the other LLC].”1432 In response, the court applied reasoning derived from opinions addressing piercing a corporate veil, stating “a court can pierce the corporate veil of an entity where there is fraud or where a subsidiary is in

1424 N.C. Gen. Stat. § 57C-9A-11(c) 1425 Del. Code Ann. tit. 6, § 18-216(d); N.C. Gen. Stat. § 57C-9A-13(a)(5). 1426 Del. Code Ann. tit. 6, § 18-216(d). 1427 Del. Code Ann. tit. 6, § 18-216(i). 1428 Del. Code Ann. tit. 6, § 18-303(a) (emphasis added). 1429 Del. Code Ann. tit. 6, § 18-1101. 1430 David L. Cohen, Theories of the Corporation and the Limited Liability Company: How Should Courts and

Legislatures Articulate Rules for Piercing the Veil, Fiduciary Responsibility and Securities Regulation for the

Limited Liability Company?, 51 Okla. L. Rev. 427, 477 (1998). 1431 Trustees of the Village of Arden v. Unity Const. Co., 2000 WL 130627 (Del. Ch. Jan. 26, 2000) (unpublished decision). 1432 Id. at 3.

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fact a mere instrumentality or alter ego of the owner.”1433 Along those lines, the court acknowledged one applicable factor is common management as claimed by the plaintiffs.1434 However, the court did not find any additional allegations which, if true, might warrant disregarding the business forms of the two LLCs.1435 Thus, while the court did not actually pierce the LLC’s veil, it suggested that an LLC’s veil might be pierced on the appropriate facts.1436

North Carolina appellate courts have considered the issue of piercing the veil of an LLC in connection with NCLLCA Section 3-30.1437 The first notable case involving this issue suggested that there might be member liability if there are allegations of acts on the part of the member individually which are not related to his status as a member of a North Carolina LLC, which acts would justify the naming of the member as an individual party defendant.1438 A number of subsequent cases have similarly hinted at the possibility of veil-piercing, but none has ultimately imposed liability on an LLC member.1439

1433 Id. 1434 Id. 1435 Id. at 4. 1436 See Somersville S Trust v. USV Partners, LLC, 2002 WL 1832830 (Del. Ch. Aug. 2, 2002) (unpublished decision) (plaintiff sought to compel access to the books and records of a Delaware LLC to investigate claims that defendant both failed to observe corporate formalities and utilized the LLC as his alter ego; the court agreed with the plaintiff’s alter ego claim, however, it did so in light of the overall issue – inspection of the LLC books and records – falling short of making an actual finding of personal liability on that basis.); Pepsi-Cola Bottling Co. of Salisbury,

Maryland v. Handy, C.A. 2000 WL 364199 (Del. Ch. March 15, 2000) (unpublished decision) (The court reasoned that the language of the statute, specifically the word “solely,” implied that there were “situations where LLC members and managers would not be shielded from liability; the court opined that someone could not run afoul of the law, form an LLC, and then claim that his status as an LLC member protects him from liability.); Weber v. U.S.

Sterling Securities, Inc., 282 Conn. 722 (2007) (Connecticut court interpreting Delaware law concluded that although § 18-303(a) of the Delaware Code shields the defendants from personal liability based solely on their affiliation with the LLC, it does not shield them from personal liability for their own tortious conduct.). 1437 NCLLCA Section 3-30 provides in relevant part: (a) A person who is a member, manager, director, executive, or any combination thereof of an LLC is not liable for the obligations of an LLC solely by reason of being a member, manager, director, or executive and does not become so by participating, in whatever capacity, in the management or control of the business. A member, manager, director, or executive may, however, become personally liable by reason of that person’s own acts or conduct. (b) A member of an LLC is not a proper party to proceedings by or against an LLC, except where the object of the proceeding is to enforce a member’s right against or liability to the LLC. N.C. Gen. Stat. § 57C-3-30. 1438 Page v. Roscoe, LLC, 128 N.C. App. 678 (1998). This case, however, involved no such allegations. 1439 See, State ex rel. Cooper v. NCCS Loans, Inc., 174 N.C. App. 630, 624 S.E.2d 371 (2005) (holding that where an individual repeatedly set up business entities to evade state usury laws, the trial court correctly looked beyond the LLC form to restrain the individuals behind the conduct, noting that NCLLCA Section 3-30(a) clearly anticipates that a member who is also a manager, director, executive, or any combination thereof might be made a defendant and become personally liable by reason of his own acts or conduct); Bear Hollow, L.L.C. v. Moberk, L.L.C., 2006 WL 1642126 (W.D.N.C., June 05, 2006) (unpublished decision) (plaintiff alleged the right to pierce the corporate veil because the LLC was inadequately capitalized, failed to comply with corporate formalities, and was completely dominated and controlled by individual defendants such that the LLC had no separate mind, will or existence of its own and was a mere instrumentality of the individual members.; the court, analyzing the issue as if it involved corporations as opposed to LLCs, held the plaintiffs sufficiently alleged facts to sustain their claim for piercing the corporate veil past the motion to dismiss stage); Spaulding v. Honeywell Int’l, Inc., 184 N.C. App. 317 (2007) (holding that absent an independent duty, mere participation in the business affairs of an LLC by a member is insufficient, standing alone and without a showing of some additional affirmative conduct, to hold the member independently liable for harm caused by the LLC); Hamby v. Profile Products, L.L.C., 361 N.C. 630 (2007) (stating

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A review of DLLCA Section 18-303 and NCLLCA Section 3-30 indicates numerous similarities1440 The most significant similarity is the shared principle that neither a member nor manager of an LLC in either jurisdiction may become personally liable for the obligations of the LLC “solely” by reason of being a member or manager. Most of the decisions from both jurisdictions are careful to dismiss claims for member or manager liability due to a plaintiff’s failure to proffer evidence supporting the claim that extends beyond the mere status of being a member or manager. Interestingly, NCLLCA Section 3-30(a) specifically states, “a member, manager, director, or executive may, however, become personally liable by reason of that person’s own acts or conduct.” As yet, no North Carolina decision suggests more of a tendency on the part of North Carolina courts than Delaware courts to impose liability on members or managers.

Thus, the cases indicate that there does not appear to be a discernible difference between the two jurisdictions in their respective approaches to piercing the veil of an LLC.

I. Indemnification and Exculpation

DLLCA Section 18-108 states, “subject to such standards and restrictions, if any, as are set forth in its limited liability company agreement, a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.” This statute gives an LLC broad authority to adopt an indemnification provision in the LLC agreement with a scope as broad or limited as it desires.1441 Upon judicial review, the court will look exclusively to the applicable provisions of the LLC agreement to determine the scope.1442

In addition, DLLCA Section 18-1101(e) provides that an LLC agreement may provide for the limitation or elimination of any and all liabilities for breach of contract or duties (including fiduciary duties) of a member, manager or other person to an LLC or another member or manager or to another person bound by the LLC agreement. The only limitation is that the agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing.

The NCLLCA provides for two different aspects of indemnification. The first, Section 3-31 sets forth what the section heading calls “mandatory” indemnification of managers, directors and executives, though this provision is more of a default provision that will apply unless the

that, absent an agreement to the contrary, member-managers are specifically shielded from liability when acting as LLC managers.; since the plaintiffs neither averred anything in their complaint nor proffered any evidence beyond that showing the member-manager managed the employer LLC, such does not break the shield of limited liability). 1440 Del. Code Ann. tit. 6, § 18-303(a); N.C. Gen. Stat. § 57C-3-30(a); see Hamby v. Profile Products, L.L.C., 361 N.C. 630, 652 S.E.2d 231 (2007) (The North Carolina Supreme Court noted that Del. Code Ann. tit. 6, § 18-303 and N.C. Gen. Stat. § 57C-3-30 are “substantially similar.”). 1441 See Senior Tour Players 207 Mgmt. Co. LLC v. Golftown 207 Holding Co. LLC, 853 A.2d 124, 127-8 (Del. 2004) (“Section 18-108 of the [DLLCA] gives broad authority to members of LLCs to set the terms for indemnification in their operating agreements.”); see also Del. Code Ann. tit. 6, § 18-1101(b) (The policy of the DLLCA is “to give the maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements.”). 1442 See id., 853 A.2d at 127-8 (“Both parties concede that the operating agreement governs the issue of whether to award advancement [in light of the indemnification provision] in this action.”).

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Articles or written operating agreement provide otherwise.1443 This so-called mandatory indemnification provides for indemnification of managers, directors and executives for amounts “reasonably incurred . . . in the authorized conduct” of the LLC’s business or for the preservation of the LLC’s business or property. In addition, mandatory indemnification provides for indemnification of a member, manager, director or executive who is wholly successful, on the merits or otherwise, in the defense of a proceeding in which the person was involved because of such status.

The second type of indemnification permitted under the NCLLCA, applicable only if the Articles or written operating agreement provide for it, imposes standards for the indemnitee that in most circumstances will be less onerous than the standards that apply to mandatory indemnification. This indemnification option does not cover liability of a manager, director, or executive for: (i) acts or omissions they knew at that time were clearly in conflict with the interests of the LLC; (ii) any transaction from which the manager, director, or executive derived an improper personal benefit; or (iii) acts or omissions occurring prior to the date the provision became effective (except that indemnification pursuant to Section 3-32(a)(2) may be provided if approved by all the members).1444

The standards applicable to indemnification in the preceding paragraph also apply to exculpation of managers, directors or executives of a North Carolina LLC.1445

In theory, the only limits to indemnification in Delaware, including who may be indemnified, are those set forth in the LLC agreement subject to the obvious common law and judicially-recognized restrictions.1446 Thus, the members enjoy broad freedom to define these rights and obligations under general contract principles. There are no statutory limits.

By contrast, the default rule in North Carolina is that there will be mandatory indemnification for a limited scope of persons in certain situations, unless the Articles or written operating agreement provide otherwise.1447 The optional indemnification provisions set forth in NCLLCA Section 3-32(a) allow for supplemental coverage for a manager, member, director, or executive. But, subsection (b) of the statute limits the LLC’s ability to indemnify its managers,

1443 N.C. Gen. Stat. § 57C-3-31 (emphasis added). The statute reads:

(a) Unless otherwise provided in the Articles or a written operating agreement, an LLC must indemnify every manager, director, and executive in respect of payments made and personal liabilities reasonably incurred by the manager, director, and executive in the authorized conduct of its business or for the preservation of its business or property.

(b) Unless otherwise provided in the Articles or a written operating agreement, an LLC shall indemnify a member, manager, director, or executive who is wholly successful, on the merits or otherwise, in the defense of any proceeding to which the person was a party because the person is or was a member, manager, director, or executive of the LLC against reasonable expenses incurred by the person in connection with the proceeding.

See also Morris v. Hennon & Brown Properties, LLC, 2008 WL 2704292 at 2 (M.D.N.C. July 3, 2008). 1444 N.C. Gen. Stat. § 57C-3-32(b). 1445 N.C. Gen. Stat. § 57C-3-32. 1446 See Del. Code Ann. tit. 6, § 18-108 (indemnification may insulate “any member or manager or other person from and against any and all claims and demands whatsoever.”) (emphasis added). 1447 N.C. Gen. Stat. § 57C-3-31.

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members, executives, and officers.1448 The result is that indemnification provisions are relatively constrained under the NCLLCA.

J. Derivative Actions

The nature of derivative claims, as opposed to direct ones, is discussed in Sections III.L. and IV.C.2. of this study, above. The same principles that apply to corporations are no less applicable to LLCs.

In Delaware, “a member or an assignee of limited liability company interest may bring an action in the court of chancery in the right of a limited liability company to recover a judgment in its favor if managers or members with authority to do so have refused to bring the action or if an effort to cause those managers or members to bring the action is not likely to succeed.”1449 A plaintiff may proceed in bringing its action without making a demand if such would be futile due to existence of a reasonable doubt as to whether (a) the managers were disinterested or independent, or (b) the challenged transaction was the product of a valid exercise of business judgment.1450 The plaintiff must be a member or an assignee of an LLC interest at the time of bringing the action, and either (1) have been a member at the time of the transaction of which the plaintiff complains, or (2) the plaintiff’s status as a member or assignee had devolved upon the plaintiff by operation of law or the LLC agreement at the time of the transaction.1451 The complaint must allege with particularity the effort, if any, of the plaintiff to secure initiation of the action by a manager or member or the reasons for not making the effort.1452 “If a derivative action is successful, in whole or in part, as a result of a judgment, compromise or settlement of any such action, the court may award the plaintiff reasonable expenses, including reasonable attorney’s fees, from any recovery in any such action or from a limited liability company.”1453

In North Carolina, derivative actions involving an LLC are governed by NCLLCA Section 8-01. A member may bring an action in superior court in the right of any domestic or foreign an LLC to recover a judgment in its favor if (1) the plaintiff does not have the authority to cause the LLC to sue in its own right; and (2) the plaintiff is a member when bringing the

1448 Specifically, no provision indemnifying such person or limiting his or her liability shall “limit, eliminate, or indemnify against the liability of a manager, director, or executive for (i) acts or omissions that the manager, director, or executive knew at the time of the acts or omissions were clearly in conflict with the interests of the limited liability company, (ii) any transaction from which the manager, director, or executive derived an improper personal benefit, or (iii) acts or omissions occurring prior to the date the provision became effective, except that indemnification [consistent with NCLLCA Section 3-32 (a)(2)] may be provided if approved by all the members. As used in this subsection, ‘improper personal benefit’ does not include reasonable compensation or other reasonable incidental benefit for or on account of service as a manager, director, executive, officer, employee, independent contractor, attorney, or consultant of the limited liability company. ” N.C. Gen. Stat. § 57C-3-32. 1449 Del. Code Ann. tit. 6, § 18-1001; VGS, Inc. v. Castiel, 2003 WL 723285 at 11 (Del. Ch., Feb 28, 2003) (“This provision originates from the well-developed body of Delaware law governing derivative suits by stockholders of a corporation. Accordingly, case law governing corporate derivative suits is equally applicable to suits on behalf of an LLC.”) (unpublished decision); but see Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286, 292 (Del. Supr., 1999) (an LLC may select a foreign jurisdiction as its forum for dispute resolution in its written operating agreement). 1450 VGS, Inc. v. Castiel, 2003 WL 723285 (Del. Ch., Feb 28, 2003). 1451 Del. Code Ann. tit. 6, § 18-1002. 1452 Del. Code Ann. tit. 6, § 18-1003. 1453 Del. Code Ann. tit. 6, § 18-1004.

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action and was a member at the time of the underlying transaction.1454 The plaintiff may also bring the action if his or her status as a member devolved to plaintiff under the terms of the operating agreement.1455 Thus the plaintiff must have been admitted as a member of the LLC in order to have standing to bring an action. The complaint must specifically allege the plaintiff’s efforts to obtain the action from the managers, directors, or other applicable authority, and must include the reasons for the plaintiff’s failure to obtain the action, or for not making the effort.1456 If the LLC is conducting an investigation of the charges, the court may stay the proceedings until such investigation is completed.1457 The LLC may move the court to appoint a committee of two or more disinterested managers, directors, or other disinterested persons to determine whether it is in the best interest of the LLC to pursue a particular legal right or remedy.1458

Once the suit is initiated, the court must approve any settlement, discontinuance, compromise, or the like.1459 It will take into consideration the interests of members and creditors and determine, among other things, whether to provide them notice of the resolution.1460 The court may also charge those costs resulting from the notices to one or more of the parties.1461 If the action is successful, whether by compromise or judgment, reasonable expenses including attorneys’ fees may be awarded to the plaintiff.1462 If there are excess proceeds, the plaintiff will account for them with the LLC.1463 However, if it is determined that the action was brought without reasonable cause, the court may require the plaintiff to pay the defendant’s reasonable expenses in defending the action, including attorneys’ fees.1464

A review of the statutes and relevant case law governing derivative claims indicates several important differences between Delaware and North Carolina. One such distinction concerns who may bring the claim and where the claim may be brought. In Delaware, “a member or an assignee” of an LLC interest may initiate the action.1465 The proper forum may be set forth in the LLC agreement, despite the statute providing the court of chancery jurisdiction over such

1454 N.C. Gen. Stat. § 57C-8-01(a). 1455 Id. 1456 N.C. Gen. Stat. § 57C-8-01(b). 1457 Id. 1458 N.C. Gen. Stat. § 57C-8-01(c). 1459 N.C. Gen. Stat. § 57C-8-01(d). 1460 Id. 1461 Id. 1462 N.C. Gen. Stat. § 57C-8-01(e). 1463 Id. 1464 N.C. Gen. Stat. § 57C-8-01(e); see Crouse v. Mineo, 189 N.C. Ct. App. 232, 658 S.E.2d 33 (2008) (Member-manager of an LLC and the LLC itself alleged the co-member-manager misappropriated funds. The initial issue concerned whether an LLC manager has inherent authority to authorize lawsuits to protect the LLC’s interests. The court determined in that situation where two managers shared responsibility and the NCLLCA applied by default, initiation of a lawsuit was not “carrying on in the usual way the business of the LLC.” Thus, such action required authorization or ratification by the other member-manager. The second issue regarded whether the plaintiff enjoyed standing by properly proceeding to initiate the derivative action under NCLLCA Section 8-01. The fact that the plaintiff lacked the authority to bring the action on his own, satisfied the first requirement under NCLLCA Section 8-01(a). Despite having filed for dissolution of the LLC before filing the complaint, the plaintiff remained a member of the LLC. Finally, the plaintiff sufficiently alleged in the complaint his previous efforts to obtain the action now demanded of the defendant. Based upon these factors, the court held the trial court improperly dismissed the plaintiffs’ actions and remanded the matter for the derivative proceedings.). 1465 Del. Code Ann. tit. 6, § 18-1001.

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claims.1466 In North Carolina, an assignee of an LLC interest does not enjoy the right to bring a derivative claim unless the assignee has been admitted as a member of the LLC, pursuant to the operating agreement.1467 To date, North Carolina courts have not directly addressed the forum selection issue. However, operating agreements frequently include alternative dispute resolution provisions.

Delaware has expressly recognized the “futility doctrine” (which exempts a plaintiff from being required to make demand upon the appropriate members or managers).1468 The North Carolina Court of Appeals hinted at the doctrine in Crouse v. Mineo, but eventually held that the plaintiff sufficiently alleged demand efforts upon the member-manager.1469 Thus, the issue remains uncertain in North Carolina.1470

Another significant difference between the two jurisdictions concerns judicial oversight of derivative claims. North Carolina courts must approve essentially any resolution of such matters, but this is not the case in Delaware.1471 This judicial oversight includes the power to charge related notice and publication costs to some or all of the parties.1472 In addition, the courts of North Carolina may award reasonable expenses, including attorneys’ fees, to the prevailing party whether the plaintiff or the defendant.1473 Delaware limits such potential recovery to the plaintiff(s) alone.1474

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1466 See Elf Atochem North America, Inc., 727 A.2d at 292. 1467 N.C. Gen. Stat. § 57C-8-01(a). 1468 VGS, Inc. v. Castiel, 2003 WL 723285 at 11 (Del. Ch., Feb 28, 2003). 1469 Crouse v. Mineo, 658 S.E.2d 33 (N.C. Ct. App., March 18, 2008). 1470 For s discussion of the demand requirement, see Section III.L.3. of this study, above. 1471 N.C. Gen. Stat. § 57C-8-01(d). 1472 Id. 1473 N.C. Gen. Stat. § 57C-8-01(e). 1474 Del. Code Ann. tit. 6, § 18-1004.

A COMPARATIVE STUDY OF THE CORPORATE AND … · A COMPARATIVE STUDY OF THE CORPORATE AND LLC LAWS...

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