Senate Bill 218: California’s proposal to remedy defective corporate acts

This article originally appeared in Westlaw Today powered by Reuters on September 8, 2022. It is republished here with permission. 

Since its enactment in 2014, Section 204 of the Delaware General Corporation Law (DGCL) has provided direct mechanisms for a corporation’s board of directors and stockholders to ratify defective corporate acts. Other states, including California, are aiming to adopt analogous provisions.

On August 17, 2022, the California legislature presented to Governor Newsom Senate Bill 218 (SB 218), which would ratify or validate corporate acts not in compliance, or purportedly not in compliance, with the California General Corporation Law (Corporations Code) or the corporation’s articles of incorporation, bylaws, plan or agreement to which the corporation is a party in effect at the time of such defective corporate act.¹

Once the defective corporate act is properly ratified, the corporate act is considered retroactively valid as of the date the corporate act was purportedly taken. The corporation is then required to keep all records related to the ratification and validation.

Importance of SB 218 for California corporations

Unlike its Delaware counterpart, the Corporations Code currently does not provide corporations with a means to correct defective corporate acts on a retroactive basis, even for unintended corporate acts. As such, certain corporate acts taken by California corporations, like the over issuance of shares, are considered void and deemed invalid by California courts. The inability to retroactively correct these mistakes may amount to severe legal and financial consequences for a corporation and its stockholders.

For example, if a California corporation issues shares of its stock in excess of what is authorized for issuance under the corporation’s governing documents, the shares are considered invalid. Any stockholder that was issued the unauthorized shares would not have any valid votes in the corporation because he or she is not considered an actual owner of stock in the corporation.

The mechanisms for ratifying a defective corporate act under SB 218

SB 218 provides clear mechanisms for how a California corporation’s board of directors and stockholders, if applicable, can ratify corporate acts otherwise deemed voidable or void. The corporation must first seek approval from the board of directors.

With the exception of a ratification relating to the election of the corporation’s initial directors, the board of directors must adopt resolutions that specify:

(1) Each corporate act to be ratified;

(2) The date the corporate act was purportedly taken;

(3) In the event the corporate act involves the purported issuance of shares, the number and type of shares, as well as the date(s) upon which such shares were purported to have been issued;

(4) The nature of the noncompliance or purported noncompliance of the corporate act; and

(5) A statement approving the ratification of the corporate act.

If the ratification relates to the election of the initial directors, a majority of the corporation’s existing directors must approve of the ratification by adopting resolutions that specify the name of initial directors, the date such directors were elected in their capacities, and a statement that the ratification is approved.

Once the corporation obtains approval from the board of directors, the corporation must give prompt notice of the ratification to each stockholder regardless of whether stockholder approval is required for ratification.

If at the time of the consummation of the defective corporate act, the corporation would have been required to file an instrument with the Secretary of State (or if the ratification would cause a previously filed instrument to be materially inaccurate or incomplete), the corporation must file a certificate of ratification to implement or amend the instrument in question by providing the name and file number of the corporation, the date and title of any existing instrument that is being amended, and a statement declaring the effect of the ratification on the validity of the instrument and the corporation’s approval of the ratification, along with a copy of the instrument and adopted resolutions approving the ratification.

Key differences between SB 218 and Section 204 of DGCL

The key differences between SB 218 and Section 204 of the DGCL can be summarized into three main categories: 1) notice to stockholders, 2) challenges to ratification, and 3) pending legal proceedings.

Notice of ratification to stockholders

Pursuant to Section 204(g) of the DGCL, notice of ratification must be promptly given to stockholders or within sixty days after the board of director’s adoption of the resolutions approving the ratification of the defective corporate act. Additionally, if approval of the stockholders is required, then the corporation must give the stockholders notice of the stockholders’ meeting at least twenty days prior to such meeting. SB 218, on the other hand, only provides that notice to stockholders must be given promptly.

Petition of ratification

Timeframe to challenge ratification

Section 204(g) of the DGCL provides that any petition that challenges the ratification of a defective corporate act must be filed one hundred and twenty days after the later of the effective time of the court’s validation of the corporate act and the time of notice of the ratification. SB 218 lengthens this period of time to one hundred and eighty days after notice of the ratification is given.

Proper venue to petition the ratification

While Delaware prescribes the proper venue as the Court of Chancery, the California legislature seeks to cast a wide net of potential counties in which a petitioner may challenge the ratification of a defective corporation act.

Under SB 218, an authorized person may file a petition in the county where the corporation’s principal office is located. In the event that the corporation’s principal office is located outside of California, the petitioner may file in the county with the corporation’s agent for service of process is located.

In either case, the superior court shall have jurisdiction in equity to determine the validity of any corporate act and declare the effective date of any such corporate act.

Pending legal proceeding

Unlike Section 204 of the DGCL, SB 218 contemplates the possibility that a corporation may become a party to a pending legal proceeding in which the validity of a corporate act is a central issue to the proceeding. The California legislature proposes to require the corporation to notify the judge or arbitrator of the pending proceeding at least ten court days prior to adopting any resolutions that would ratify a defective corporate act or filing a petition with respect to a ratified corporate act.

The legislature also provides that a petitioner has ten days to move for leave to amend a petition to identify any pending legal proceeding of which the petitioner is aware (including any readily identifiable information, such as a case number, names of the parties, and the date the proceeding was filed) and in which the validation of the corporate act would result in the dismissal of the proceeding in whole or in part.

Notes

¹ California State Senate. Senate Bill 218, Introduced 13 Jan. 2021.