The High-touch Legal Services® Blog • For Startup Companies

Corporate Business Filings Joins Hall of Shame

Dana — Fri, 10 May 2013 01:27:48 +0000

A couple of weeks ago a client emailed me with great concern. He received a letter that looked like a government demand for $225, lest a penalty of $250 be imposed by the state. It turns out that the letter was not from the state, but from Corporate Business Filings, the latest addition to my Hall of Shame.

Most of the way down the second page, the letter does have an oddly-worded disclaimer that there is no obligation to pay the amount requested. However, even though the disclaimer is upper-case, it is not nearly so prominent as the fear-inducing language in the rest of the letter – and it does not comply with a disclaimer that has been required by law since January 1, 2012.

My client is not the only one who was misled. Scambook has dozens of complaints, many of which clustered in mid-April.

Perhaps most disheartening, a search of the Secretary of State database shows that the agent for service of process address is the same as a law firm in Beverly Hills. In other words, it appears that one or more of my legal colleagues has enabled this corporation’s misleading activities!

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Corporate Directors in California Can Inspect (Almost) Anything

Dana — Wed, 08 May 2013 00:09:44 +0000

I have written about shareholders’ rights to inspect corporate financial records and shareholder lists. This post discusses directors’ far greater inspection rights.

California Corporations Code Section 1602 states:

Every director shall have the absolute right at any reasonable time to inspect and copy all books, records and documents of every kind and to inspect the physical properties of the corporation of which such person is a director and also of its subsidiary corporations, domestic or foreign. Such inspection by a director may be made in person or by agent or attorney and the right of inspection includes the right to copy and make extracts. This section applies to a director of any foreign corporation having its principal executive office in this state or customarily holding meetings of its board in this state.

This statute is quite broad, in that it permits inspection of physical properties in addition to books and records; applies to domestic and foreign (out-of-state) subsidiaries; and applies to foreign corporations having a principal office, or customarily holding board meetings, in California.

Delaware General Corporation Law Section 220(d) states, in relevant part:

Any director shall have the right to examine the corporation’s stock ledger, a list of its stockholders and its other books and records for a purpose reasonably related to the director’s position as a director…. The burden of proof shall be upon the corporation to establish that the inspection such director seeks is for an improper purpose.

The Delaware statute is noticeably narrower, in that it applies only to books and records (not physical properties) and it requires that the inspection be “for a purpose reasonably related to the director’s position as a director.” Nevertheless, in Delaware directors’ inspection rights are substantially greater than those of shareholders.

Photo credit: iStockphoto

Who Gets to See the Shareholder List?

Dana — Sat, 04 May 2013 01:12:16 +0000

The founder of a closely-held corporate client, knowing that some employees soon would be shareholders, recently asked whether those employee-shareholders would have the right to find out how many shares he owns. Here is the information I provided.

Because the client is a California corporation, Corporations Code Section 1600(a) governs. That Section states, in relevant part (emphasis added):

A shareholder or shareholders holding at least 5 percent in the aggregate of the outstanding voting shares of a corporation…shall have an absolute right to…inspect and copy the record of shareholders’ names and addresses and shareholdings during usual business hours upon five business days’ prior written demand upon the corporation….

For Delaware corporations, the applicable provision is in Delaware General Corporation Law Section 220(b), which states, in relevant part (emphasis added):

Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from [t]he corporation’s stock ledger [and] a list of its stockholders….

The most notable differences between the two states are that:

Delaware provides the inspection right to all stockholders, whereas California provides it to owners of , in the aggregate, at least five percent of the shares; and
Delaware requires that the inspection be for a “proper purpose,” though that term is not defined, leaving it for courts to determine its meaning on a case-by-case basis.

Photo credit: Klaus Post via stock.xchng

“Director” and “Director” May not Mean the Same Thing

Dana — Thu, 02 May 2013 01:30:30 +0000

While working with one of my international clients several months ago, I re-learned a lesson that I already knew: The same word can mean different things under different countries’ legal systems.

The client is located in Vietnam and wanted to open a branch office in the Bay Area. It would be “doing business” in California, so it needed to qualify as a foreign corporation.

I duly prepared a Statement and Designation by Foreign Corporation and had it signed by the client’s most senior officer. That officer’s title, translated as “Director,” was entered onto the form.

The Secretary of State rejected the form. The reason: In the U.S., “Director” is not the title of an officer – in the legal context it refers, typically, to a member of the board of directors.

I didn’t have time to argue with the Secretary of State’s Document Examiner. I changed “Director” to “President” and resubmitted the form successfully.

Moral: Be careful when taking terms from one legal system to another. Sometimes, straightforward translation may not be enough.

Corporations are Incorporated, but LLCs are Formed

Dana — Wed, 10 Apr 2013 00:50:19 +0000

This post, which discusses legal terminology, is adapted from a Quora answer that I provided almost two years ago. Q. Why do you “incorporate” corporations but “form” LLCs? Why the differing terminology?

A. Corporations have existed for much longer than LLCs. “Incorporate” was chosen as the single word that denotes “forming a corporation” (the latter also a legitimate way of describing the process). The obvious tie between the words “corporation” and “Incorporate” is why “incorporate” applies only to corporations and is easily understood.

Many years later, LLCs – more fully, limited liability companies – come along. Right away, we see this three-word phrase is awkward to work with. I suppose that one could have made up a related term to designate formation, such as “inlimit” or “inLLC”, but, to say the least, those do not roll off the tongue. Maybe someone will devise such a term; for now, we must be satisfied with “forming” LLCs.

You should not feel that LLCs are being discriminated against. Neither does one incorporate trusts (revocable or irrevocable), partnerships (general or limited), etc.

Which is Best – “Inc.”, “Corp.” or Something Else?

Dana — Fri, 05 Apr 2013 23:55:34 +0000

This post is based on and expands an answer I provided on Quora. Q. Which company suffix to choose: Inc, Corp, etc? What are the criteria?

Many states – notably including Delaware (General Corporation Law Section 102(a)(1)) but, under most circumstances, excluding California – require that the name of a corporation include a word or abbreviation designating corporate status. Those that are used commonly include Corporation (Corp.), Incorporated (Inc.) and Limited (Ltd.).

The choice is totally a matter of style – more a marketing issue than a legal issue.

In my experience, “Inc.” is most popular – typically without a preceding comma, nowadays, for a cleaner look. Indeed, most of my foreign clients say “an Inc.” when they mean “a corporation”!

Tech Contracts: Confidentiality Provisions and Unlimited Liability

Dana — Fri, 29 Mar 2013 01:51:04 +0000

This post is based on a question I answered on Quora.

Q. Why do technology contracts often carve breach of confidentiality out of the limitation of liability?

A. I’m going to start by broadening the discussion, a bit.

First, the carve-outs typically modify both limitations of liability and limitations of damages. So, whereas an agreement might include provisions both limiting the total (dollar) amount of liability and liability for consequential damages, such limitations will not apply to the carved-out subject matter.

Second, the subject matter of the carve-outs typically includes not only breaches of confidentiality, but also indemnification obligations.

Here is why the carve-outs exist:

The subject matter (confidentiality and indemnification) inherently have significant consequential damages components (outside the subject matter of the agreement, for which damages would be direct), thus consequential damages must be recoverable.
Breach of confidentiality and indemnification obligations are very important, thus there is a consensus that injured parties should have the broadest remedies available in these areas.

When a Handshake Isn’t a Handshake

Dana — Mon, 18 Mar 2013 00:29:06 +0000

Last week Y Combinator announced The Handshake Deal Protocol. A “handshake deal” is an oral commitment to a funding transaction between a startup’s founders and an investor. Handshake deals are necessary in Silicon Valley because, in the world of startups, one must move quickly.

As Y Combinator notes, however, handshake deals can create problems:

Unfortunately, things don’t work as smoothly in Silicon Valley as among diamond dealers. This is not a closed community of pros who deal with one another day after day. Many participants in the funding market are noobs, and some are dishonest.

To avoid these problems, Y Combinator developed the following protocol, which must be followed for a handshake deal to exist:

The investor says “I’m in for .” [The must specify an amount to be invested, plus a valuation or valuation cap (or no cap), plus an optional discount.]
The startup says “Ok, you’re in for .”
The startup sends the investor an email or text message saying “This is to confirm you’re in for .”
The investor replies yes.

The protocol makes a lot of sense. The irony, however, is that once the protocol has been satisfied, the terms have been agreed upon in writing (email or text) – i.e., the parties no longer have merely a handshake (oral) deal!

Chubby Checker Files Ridiculous Trademark Infringement Lawsuit

Dana — Tue, 05 Mar 2013 18:57:28 +0000

Singer Chubby Checker (real name Ernest Evans) – famous for The Twist dance craze in the 1960s – and certain corporations that he controls have filed a lawsuit against Hewlett-Packard Company and Palm, Inc. concerning a no-longer-available app named “The Chubby Checker”.

The app purported to allow women to calculate the size of a man’s penis based on his shoe size. According to webOS Nation, the app was downloaded only 84 times before it was removed in September 2012 – yet press reports state that the plaintiffs are seeking damages of $500 million for trademark infringement and unfair competition!

This blog’s Ridiculous category used to be limited to ridiculous contract provisions. In light of the Chubby Checker suit, I now am expanding that category to include ridiculous litigation, as well.

Photo credit: Wikipedia

Are Class F Shares a Good Idea?

Dana — Fri, 15 Feb 2013 02:31:18 +0000

A client told me that she wants to include Class F shares in her Certificate of Incorporation for the Delaware corporation we were forming. This post describes how we concluded that – for this client, at any rate – Class F shares were not a good idea.

Class F shares were invented by the Founder Institute several years ago to protect founders (largely against investors, especially VCs – see If You Accept Venture Capital, You will Lose Control of Your Company). Class F shares provide 2:1 board votes per founder versus normal board members, and 10:1 share votes as compared to normal common shares.

Sounds great – shouldn’t every founder want these protections? The main problem is that Class F shares are likely to discourage many prospective investors, because they suggest that the founder is too interested in exercising power. This is especially likely to be true for institutional investors, such as VCs, who are investing large amounts and, understandably, want to have certain protections in place.

Furthermore, even if the prospective investor is not turned off, it may make elimination of the Class F provisions a condition of making the investment – in which case, the incremental effort and expense of the Class F shares will have been wasted.

In light of the foregoing, my client concluded that Class F shares would not be helpful, and we formed the corporation accordingly.