For Privately Held Companies, Missouri Corporate Law May Prove More Favorable Than Delaware Law
Seth Chertok1Delaware is the most common jurisdiction of incorporation for publicly traded corporations.
2 While Delaware’s anti-takeover rules provide significant advantages for public companies, the General and Business Corporation Law of Missouri (MBCL) has features that generally make it more attractive for private companies than the Delaware General Corporation Law (“DGCL”). This article compares the most important features of Delaware and Missouri corporate law in order to guide practitioners when choosing a jurisdiction of incorporation for privately held companies.
I. Board of Directors Considerations
A. Business Judgment Rule
Missouri’s business judgment rule provides greater protections to a board of directors than the Delaware business judgment rule. As one treatise notes, “When compared to a jurisdiction such as Delaware, case law in Missouri is relatively sparse and the law is therefore not as well developed. However, particularly in recent years, a pattern has emerged which shows that the Missouri business judgment rule has unique features providing distinct advantages over the law of other states.”3 Missouri’s business judgment rule, unlike Delaware’s, does not have a well defined procedural due care element, which would require directors and officers to become properly informed prior to making a decision.4 As a result, under Missouri’s business judgment rule, decisions of directors of Missouri corporations will generally be upheld absent fraud, illegality, ultra vires or similar conduct, such as oppression.5
In the decision making context, Missouri courts have determined that oppression by a majority shareholder generally means “harsh, dishonest or wrongful conduct and a visible departure from the standards of fair dealing” which inure to the benefit of the majority and to the detriment of the minority.6 A recent Missouri court has even suggested that, absent one of the above bases, even a subjectively dishonest decision would meet the standard of the business judgment rule, if it were objectively rational.7 Absent one of the above bases, Missouri courts have rejected the proposition that majority shareholders have a duty to act fairly.
The Delaware business judgment rule is more stringent and provides that the substantive result of business judgments of directors will not be questioned by Delaware courts if the directors satisfy a number of elements.8 First, directors must be disinterested and independent. Second, directors must meet appropriate standards of procedural due care. Third, directors must act in good faith.
Procedural due care requires ascertaining relevant facts and law before making the decision and reasonable deliberation leading up to the decision.9 Procedural due care is measured against standards of gross negligence.10 Good faith requires that the directors acted in the honest belief that a decision was in the best interest of the corporation.11 Disinterestedness requires that the decision maker have no pecuniary interest in the transaction.12 Independence requires that the directors consider the merits of the situation and be not beholden to a controlling person or majority shareholder.13
In the decision making context, if the business judgment rule is inapplicable for one of the above reasons, then the defendant must show that the transaction in question was entirely fair,14 which means fairness of price and fair dealing. As a consequence, Missouri’s business judgment rule is considerably more favorable to directors, as it lacks the requirement of procedural due process, and potentially does not even require subjective good faith.
B. Demand in Derivative Suits
The MBCL requires that a shareholder seeking to bring a derivative suit make demand upon the board of directors.15 If demand upon the board of directors would be futile, then the shareholder bringing a derivative action must make demand upon the shareholders.16 Demand upon directors is futile when the shareholder alleges with particularity that a majority of the directors participated in wrongdoing. If demand upon directors is excused, Missouri case law17 holds that demand upon the shareholders is not required:
• when officers or directors of the corporation have committed “ultra vires, illegal, or fraudulent acts”; 18
• “where a majority of the [shareholders] participated in the acts”19 of which the plaintiff complains; or
• “where the defendants sued” hold “a majority of the [outstanding] shares.”20
The DGCL requires that a shareholder seeking to bring a derivative suit make demand upon the board of directors.21 Demand is generally not required when the shareholder seeking to make demand can show that demand would be futile.22 The standard for “demand futility [under Delaware case law] is inextricably bound to issues of business judgment” since directors, rather than shareholders, manage the corporation.23 This creates two hurdles for the shareholder,24 who must:
• show that directors are not disinterested or otherwise are not capable of exercising independent business judgment; or
• plead facts creating a reasonable doubt as to the soundness of the challenged transaction sufficient to rebut the business judgment rule presumption that attaches to the transactions.
Unlike the MBCL, the DGCL does not require demand upon the shareholders. Consequently, the MBCL requires the shareholder seeking to bring a derivative suit to exhaust more avenues, thereby increasing the difficulty of bringing such suits. The MBCL therefore favors owners of privately held companies.
C. Indemnification of Directors and Officers
The MBCL permits a corporation to indemnify its directors, officers, employees and agents against expenses, settlements, and judgments, and requires a corporation to indemnify such persons if they are successful on the merits of the claim.25 The only major exception to permitted indemnification under Missouri case law is for misconduct that is “finally adjudged to have been knowingly fraudulent, deliberately dishonest or willful.”26 Indemnification is also not permitted for violations of the Securities Act of 1933. A Missouri corporation, however, may purchase insurance on behalf of its directors, officers, employees and agents, regardless of whether the corporation would be permitted to indemnify such person pursuant to the statute or under the Securities Act.27
The DGCL is generally similar to the MBCL on this subject in all material respects. One notable difference is that, in actions brought by or in the right of the corporation, the DGCL only permits indemnification against expenses, whereas the MBCL allows indemnification against expenses and settlements. Overall, the MBCL’s indemnification provisions are slightly better for privately held companies than the DGCL’s provisions.
D. Limitation on Liability of Directors
The DGCL permits a corporation to eliminate or limit “the personal liability of a director to the corporation or its [shareholders] for monetary damages for breach of fiduciary duty as a director, provided that” liability for the following actions cannot be limited or eliminated:28 (i) “breach of the … duty of loyalty;”29 (ii) “acts or omissions not in good faith;”30 (iii) “intentional misconduct”;31 (iv) “knowing violation[s] of law;”32 (v) unlawful distributions; or (vi) receipt of “improper personal benefit.”33
The MBCL was patterned after the DGCL, with two important exceptions. First, the MBCL revises the “not in good faith” exception to read “not in subjective good faith,” which arguably has the effect of providing exculpation for actions that might be deemed to be taken in “constructive bad faith.”34 Second, Delaware case law requires that if a plaintiff asserts only a duty of care claim, an exculpation provision must be analyzed at trial and cannot be disposed of in a motion to dismiss.35 In contrast, the MBCL permits such an issue to be resolved in a motion to dismiss prior to discovery.
Missouri’s limitation of liability provisions are more favorable for privately held companies and make for a particularly potent protection package for directors when viewed together with Missouri’s indemnification provisions.36
II. Shareholder Matters
A. Shareholder Action Without a Meeting
Under the MBCL, written action of shareholders in lieu of a meeting is permitted only if the consent is “signed by all of the shareholders entitled to vote with respect to the subject matter.”37 The DGCL permits shareholder action “without a meeting … if a consent … [is] signed by the holders of outstanding stock having … the minimum number of votes that would be necessary to authorize … such action at a meeting at which all shares entitled to vote” were represented.38 A Delaware corporation may opt out of this provision by an amendment to its certificate of incorporation or by-laws.39
B. Shareholder Class Voting Rights
Under both the MBCL and the DGCL, shareholders must approve an amendment to the corporation’s charter by a vote of the holders of “a majority of outstanding shares” “entitled to vote thereon.”40
The MBCL permits holders of a particular class of shares to vote as a separate class, along with the voting shares, if the rights of that class are affected adversely in various respects by an amendment to the articles of incorporation.41 The MBCL does not treat mergers and consolidations as amendments to the articles of incorporation.42 The MBCL also does not require class voting for a sale of all or substantially all assets or for dissolution. If the amendment affects only a part of a class, the affected part is entitled to vote as a class.43
Similar to the MBCL, the DGCL permits holders of a particular class of shares to vote as a separate class if an amendment to the certificate of incorporation:
• alters or changes the powers, preferences or special rights of that class; or
• would increase or decrease the authorized shares or par value of that class.44
“In the [first] instance, if the amendment would not affect the entire class, then only the shares of the series so affected would be considered the separate class.”45 With regard to the first instance, Delaware courts have concluded that the powers, preferences or special rights of the class must be changed in a way that is different from all the other classes of stock in order to trigger class voting. Delaware courts have also held that the creation of a new class with preferences prior to the existing class does not trigger a class vote.46 A certificate of incorporation often is amended in a merger, but under the DGCL, such an amendment in itself will not trigger class voting.47 Overall, the DGCL grants broader class voting rights than the MBCL.
C. Amendments to By-laws
The MBCL vests the power to amend the by-laws in the shareholders “unless and to the extent that [this] power is vested in the board of directors by the articles of incorporation.”48
The DGCL provides that a corporation’s stockholders may “adopt, amend or repeal [the corporation’s] by-laws.”49 This power may be non-exclusively conferred upon the directors of the corporation by a corporation’s certificate of in-corporation.50
D. Shareholders’ Agreements
The MBCL contemplates that the terms of capital stock of Missouri corporations may involve the imposition of restrictions. Shareholders’ agreements that impose restrictions are upheld by Missouri courts, provided that such restrictions are reasonable51 and are supported by proper consideration.52 Rights of first refusal and restrictions that provide for the corporation’s right to purchase stock upon the occurrence of a specified event such as death are usually reasonable. The test for unreasonableness is whether the restraint in the shareholder agreement is sufficiently needed to justify overriding the general policy against restraints on alienation.
As with Missouri case law, Delaware case law also requires that restrictions in shareholders’ agreements satisfy the reasonableness standard.53 Restrictions that are necessary to maintain “a tax advantage” or that are required to maintain “statutory or regulatory advantage[s]” or requirements are “conclusively presumed to be for a reasonable purpose.”54 Restrictions must be in writing.55 In addition, the DGCL has enacted § 202 dealing with the subject matter. The effectiveness of restrictions in shareholders’ agreements depends on whether there was conspicuous notation of the restriction on the encumbered security, statutory notice in the case of an uncertificated security, or actual knowledge of the restriction.56 The holders of the securities outstanding at the time a restriction is imposed must also assent thereto.57
E. Voting Trusts
The MBCL provides that one or more shareholders of a corporation may transfer all or part of their shares to any person for the purpose of vesting in the transferee voting or other rights pertaining to the shares upon terms and conditions and for the period stated in the agreement. The MBCL provides no guidance for how voting trusts are established, so Missouri courts have looked to the common law concerning the creation of inter vivos trusts to determine whether or not a valid voting trust has been established.58 Missouri courts require the following:59
• Present intent to create the trust, but no “form of declaration of intent” is necessary;
• “Enforceable duties must be imposed [up]on the trustee” (the duty “to vote the stock which is the subject of the trust” usually suffices);
• “The object of the trust must be in existence” (the existence of the stock suffices); and
• “The trustee must be vested with legal title or possession of the trust res,” which requires that “[r]ecord ownership of the stock … be vested [with] the trustee.”
In addition to “these requirements, a voting trust must have a valid purpose.”60 “[C]reating a solidly united and enduring majority, ensuring continuity and stability of policy in management, and preventing rival concerns or compete[tion] from gaining control” are all valid purposes under Missouri case law.61
A voting trustee has a fiduciary duty of loyalty to act in the best interest of the beneficiaries and cannot “favor one class at the expense of another.”62 The MBCL does not limit the duration of a voting trust.
The DGCL provides that stockholders may validly enter voting trusts designed to control the voting of shares as well as other lawful purposes not inconsistent therewith.63 The DGCL requirements for a voting trust are:64
• a written agreement by one or more stockholders that vests in a designated voting trustee (or trustees) the right to vote the shares;
• the agreement and all amendments thereto must be filed with the registered office of the corporation in Delaware to ensure that all stockholders have the right to inspect the agreement; and
• certificates representing shares deposited in the voting trust must be canceled and new certificates must be issued to the voting trustee, which certificates must state that they are issued pursuant to a particular voting trust agreement.
A voting trust may be invalidated if it serves fraudulent or otherwise illegal purposes,65 but, as under Missouri case law, more is required than merely perpetuating incumbent management in office.66 Trustee fiduciary duties apply to the voting trustee. The DGCL, like the MBCL, does not limit the duration of voting trusts.67 Agreements that fail to meet the DGCL requirements for voting trusts may still qualify as voting agreements, which may determine the voting of shares or specify a method for determining the manner in which shares are to be voted.
III. Corporate Transactions
A. Shareholder Vote Required for Mergers and Corporate Sale Transactions
The MBCL requires that a merger, consolidation or sale of substantially all of the corporation’s assets be approved by “the affirmative vote of holders of at least two-thirds of the outstanding shares entitled to vote” thereon.68 The articles of incorporation may further increase the required vote, or may require class voting.69
The DGCL requires that a merger, consolidation or sale of substantially all of the corporation’s assets be approved by the affirmative vote of holders of a majority of the outstanding shares entitled to vote thereon,70 but the certificate of incorporation may require a higher percentage.71
In a merger under the DGCL, approval by the surviving corporation’s shareholders is not required if the following conditions are met:72
• the certificate of incorporation of the surviving corporation is not amended;
• shares of the surviving corporation outstanding before the merger continue to exist as such; and
• new shares to be issued in the merger do not exceed 20% of the shares outstanding before the merger.
Mergers and corporate sale transactions are more easily approved under the DGCL than under the MBCL.
B. Dissenters’ Appraisal Rights
Under the MBCL, a shareholder of any “corporation which is a party to a merger or consolidation,” or which sells “all or substantially all” of its assets, has the right to dissent from this corporate action and to demand payment “of the fair value of his shares.”73 Factors that Missouri courts may consider in making a determination of fair value include the corporation’s net “asset value, earnings, dividends, management and every relevant fact and circumstance which enters into the value of the corporate property and which reflects itself in the worth of corporate stock.”74
The DGCL provides that a shareholder who is a party to a merger or consolidation has the right to demand the fair value of his shares.75 Delaware courts determine fair value based on all relevant factors and based upon any expert’s methodology.76
Unlike the MBCL, the DGCL only provides appraisal rights in mergers and consolidations effected pursuant to enumerated sections of the DGCL (e.g., §§ 251, 252, 254, 257, 258, 263 and 264).77 The DGCL “does not extend appraisal rights to … sales of all or substantially all of the [corporation’s] assets.”78 Under the Delaware courts’ doctrine of “independent legal significance,”79 the de facto merger doctrine does not apply, unlike in Missouri, and, as a consequence, a transaction effectuated outside of the applicable statutory merger and consolidation provisions will not trigger appraisal rights. For example, a sale of assets by a corporation in exchange for stock is not a de facto merger, whether or not the selling corporation thereafter dissolves and distributes the stock it receives to its shareholders, and whether or not the plaintiff is a stockholder of the purchasing or the selling corporation. Delaware case law also does not consider an exchange of stock a merger, even though a change in control may thereby result.
No appraisal rights are available under the DGCL for holders of any shares of stock of the surviving corporation if the holders were not required to vote to approve the merger, as might be the case in a reverse triangular merger.
The DGCL generally grants more limited rights to dissenting shareholders in corporate sale transactions and permits corporations to structure their sale transactions to entirely avoid appraisal rights. In this respect, the DGCL is generally more favorable for privately held companies than the MBCL.
C. Dividends
A Missouri corporation “may pay dividends on its [outstanding] shares in cash, property,” or other shares of its stock.80 Under the MBCL, a Missouri corporation may not pay a dividend “at a time when the net assets of the corporation are less than its stated capital or when the payment [of the dividend] would reduce the net assets . . . below its stated capital.”81 A Missouri corporation can minimize the effect of this requirement by choosing a low par value.
The MBCL makes it more onerous to pay dividends from “paid-in surplus,” as opposed to retained earnings, by requiring the following, effectively placing shareholders on notice that the retained earnings of the corporation have been exhausted:82
• “all cumulative dividends . . . on preferred or special classes” of stock must have been paid;83
• net assets may not be less than stated capital and the dividend may not reduce net assets below stated capital; and
• such a dividend must “be identified as a liquidating dividend and the amount per share [must] be disclosed to the shareholders.”84
With regard to dividends that are payable in shares of the corporation’s stock, the MBCL prescribes special rules of accounting for transferring paid-in surplus to stated capital.85 Under the MBCL, both the articles of incorporation and agreements entered into by the corporation or shareholders may place greater restrictions on the payment of dividends.
Like the MBCL, the DGCL permits dividends to “be paid in cash, in property, or [other] shares” of its stock.86 The DGCL provides that a corporation may pay dividends out of the corporation’s surplus or, if the corporation has no available surplus, “out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.”87 “Dividends paid from the second source may not be paid unless the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets at current market value is intact.”88 As is the case for Missouri law, a board of directors may choose a low par value, thereby leaving the board with only a nominal hurdle when it pays dividends from its surplus. Under the DGCL, as under the MBCL, both the corporate charter and agreements entered into by the corporation or shareholders may place greater restrictions on the payment of dividends.
The DGCL is more favorable to the shareholders of a corporation than the MBCL since the DGCL allows, in the event that surplus is unavailable for the payment of dividends, the payment of nimble dividends out of the net profits for the fiscal year in which the dividend is declared, as well as the preceding fiscal year.
Footnotes
1 Seth Chertok received his undergraduate degree, with honors, from the University of Chicago and his J.D. from the University of Pennsylvania where he was a senior editor of the University of Pennsylvania Journal of International Economic Law and the recipient of the Lefever Prize for the best paper in law and economics. Mr. Chertok is a frequent commentator on various corporate and securities laws issues and is most recently the author of Jurisdictional Competition in the European Community, which appeared in the University of Pennsylvania Journal of International Economic Law. Mr. Chertok practices in the area of corporate and securities law at Lathrop & Gage, L.C.
2 See Lucian Arye Bebchuk & Assaf Hamdani, Vigorous Race or Leisurely Walk: Reconsidering the Competition Over Corporate Charters, 112 Yale L.J. 553, 554-54 (2002).
3 Charles Hansen & Don G. Lents, Missouri Corporation Law & Practice §4.5(b) (5th ed. 2005).
4 See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
5 See, e.g., Broski v. Jones, 614 S.W.2d 300, 304 (Mo. App. W.D. 1981).
6 See Struckhoff v. Echo Ridge Farm, Inc., 833 S.W.2d 463, 466 (Mo. App. E.D. 1992).
7 Ironite Products Co. v. Samuels, 17 S.W.3d 566, 573 (Mo. App. E.D. 2000).
8 R. Franklin Balotti & Jesse A. Finkelstein, 1 Delaware Law of Corporations & Business Organizations, §4.33[B] (2002)
9 See id.
10 See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
11 See R. Franklin Balotti & Jesse A. Finkelstein, 1 Delaware Law of Corporations & Business Organizations, §4.33[B] (2002).
12 See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 363 (Del. 1993), modified 636 A.2d 956 (Del. 1994).
13 See Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1375 (Del. 1995).
14 See Orman v. Cullman, 794 A.2d 5 (Del. Ch. 2002).
15 See Charles Hansen & Don G. Lents, Missouri Corporation Law & Practice, §5.5(a) (5th ed. 2005).
16 See Punch v. Hipolite Co., 100 S.W.2d 878, 884 (Mo. 1936).
17 See Saigh v. Busch, 396 S.W.2d 9, 17-18 (Mo. App. E.D. 1965).
18 Id.
19 Id.
20 Id.
21 See Del. Ch. Ct. R. 23.1
22 See Rodman Ward, Jr. et al., Folk on the Delaware General Corporation Law, § 327.4.2.1 (2001)
23 See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
24 See id.
25 Section § 351.355, RSMo. 2006.
26 Id.
27 Id.
28 Del. Code Ann. tit. 8, § 102(b)(7) (2007).
29 Id.
30 Id.
31 Id.
32 Id.
33 Id.
34 See Charles Hansen & Don Lents, Missouri Corporation Law and Practice, § 4.8 (5th ed. 2005).
35 See id.
36 See id.
37 Section 351.273, RSMo 2006.
38 Del. Code Ann. tit. 8, § 228.
39 Id.
40 Del. Code Ann. tit. 8, § 242; § 351.090, RSMo 2006.
41 Section 351.093, RSMo 2006.
42 Id.
43 Id.
44 Del. Code Ann. tit. 8, § 242.
45 See R. Franklin Balotti & Jesse A. Finkelstein, 1 Delaware Law of Corporations & Business Organizations, §8.11 (2002).
46 See Hartford Accident & Indem. Co. v. W.S. Dickey Clay Mfg. Co., 24 A.2d 315 (Del. 1942).
47 See R. Franklin Balotti & Jesse A. Finkelstein, 1 Delaware Law of Corporations & Business Organizations, § 9.15 (2002).
48 Section 351.290, RSMo 2006.
49 Del. Code Ann. tit. 8, § 109.
50 Id.
51 See Black and White Cabs v. Smith, 370 S.W.2d 669, 674-75 (Mo. App. E.D.1963).
52 See Sumners v. Service Vending Company, Inc., 102 S.W.3d 37 (Mo. App. S.D. 2003).
53 See Grynberg v. Burke, 378 A.2d 139 (Del. Ch. 1977).
54 Del. Code Ann. tit. 8, § 202(d).
55 See Lakeshore Deli, Inc. v. Landis Wilson, 1978 WL 2508, No. 715 (Del. Ch. April 13, 1978).
56 Del. Code Ann. tit. 8, § 202(a).
57 Del. Code Ann. tit. 8, § 202(b).
58 See Schultz v. Schultz, Nos. 40681, 40682, 40683, 40684, 1981 Mo. App. LEXIS 3291, (Mo. App. E.D. 1981).
59 See Charles Hansen & Don G. Lents, Missouri Corporation Law and Practice, §3.11 (5th ed. 2005).
60 See id.
61 See id.
62 Jesser v. Mayfair Hotel, 316 S.W.2d 465, 471 (Mo. 1958).
63 Del. Code Ann. tit. 8, § 218.
64 Id.
65 Chandler v. Bellanca Aircraft Corp., 162 A.63 (Del. Ch. 1932).
66 Adams v. Clearance Corp., 116 A.2d 893 (Del. Ch. 1955), aff’d, 121 A.2d 302 (Del. 1956).
67 Del. Code Ann. tit. 8, § 218 (2007). See the 1994 amendment to § 218 and commentary thereto.
68 Section 351.425, RSMo 2006; § 351.400(3), RSMo 2006.
69 Section 351.270, RSMo 2006.
70 Del. Code Ann. tit. 8, § 251(c); Del. Code Ann. tit. 8, § 271.
71 See Glazer v. Pasternak, 693 A.2d 319 (Del. 1997).
72 Del. Code Ann. tit. 8, § 251(f).
73 Section 351.455, RSMo 2006; § 351.405, RSMo 2006.
74 See Dreisezun v. FLM Indus., Inc., 577 S.W.2d 902 (Mo. App. 1979) (citing Phelps v. Watson-Stillman Co., 293 S.W.2d 429 (Mo. 1956)).
75 Del. Code Ann. tit. 8, § 262(b).
76 See Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983).
77 See Del. Code Ann. tit. 8, § 262(b).
78 See R. Franklin Balotti & Jesse A. Finkelstein, 1 Delaware Law of Corporations & Business Organizations, § 9.43 (2002)).
79 See Hariton v. Arco Elecs., Inc., 182 A.2d 22, 25 (Del. Ch. 1962).
80 Section 315.220, RSMo. 2006.
81 Id.
82 Section 351.210, RSMo 2006.
83 Id.
84 Id.
85 Section 351.220(3), RSMo. 2006.
86 Del. Code Ann. tit. 8, § 173.
87 Del. Code Ann. tit. 8, § 170(a).
88 See R. Franklin Balotti & Jesse A. Finkelstein, 1 Delaware Law of Corporations & Business Organizations, § 5.26 (2002).