On May 12, 2022, Governor Hogan signed several bills into law that will affect the formation, ownership and operation of business entities under Maryland law. Below is a summary of the new laws. Most noteworthy is the creation of a statutory process for the ratification of defective corporate acts. All of the changes will become effective on October 1, 2022.
1. Ratification of Defective Corporate Acts
During legal due diligence, it is not unusual to discover that a corporation has issued more stock than it had legally authorized through its charter or has made other governance missteps. Early-stage corporations, often without the resources to engage sophisticated financial or legal professionals, may be preoccupied with growth plans or simple survival and neglect basic corporate housekeeping. This species of legal flaw, and others like it, are commonly known as “defective corporate acts,” and can exist undetected for years in corporations, coming to light at the worst possible time. Examples include:
- The unauthorized issuance of shares of stock;
- Failure of the board of directors to adopt bylaws;
- Failure of a board of directors to properly elect officers of the corporation;
- Corporate action taken in the absence of board resolutions authorizing the action;
- Failure to obtain the requisite stockholder approval of a corporate action;
- Failure to file with the State Department of Assessments and Taxation of the State of Maryland (the “SDAT”) a required charter document; and
- Failure to retain evidence that consideration was paid to the corporation for shares of stock.
Defective corporate acts may be remedied under common law, through a variety of approaches, but not with the certainty that third party acquirers, investors or lenders often prefer.
House Bill 996 / Senate Bill 879 (Chs. 289/ 290) adds a formal process and safe harbor to the Maryland General Corporation Law (the “MGCL”) that allows a Maryland corporation to ratify defective corporate acts and, where a defective act is so ratified, prevent the act from being void or voidable solely by virtue of the defective nature of the act. This change in the law creates a process to eliminate uncertainty and, in turn, can be a useful tool where Maryland corporations are the target of an acquisition, investment, or financing transaction.
The process set forth in the legislation specifies certain information that must be included in a ratifying resolution, as well as certain approvals that may be required for ratification. In certain instances, filing articles of validation with the SDAT may also be required. The requirements outlined in the legislation depend on the nature of authorization or corporate action that would have initially been required for the act in question to be a valid corporate act. The periods for when the ratification becomes effective and binding on the corporation are likewise variable based on certain enumerated conditions.
The legislation also provides that compliance with the new process is not the exclusive means for ratifying a defective corporate act and that failure to ratify through such process does not, itself, create a presumption that such act is indeed void or voidable. Thus, the existing common law approaches to ratification are still available. As a counterbalance to the formal ratification process created for the benefit of corporations, the legislation also provides a process for adversely affected parties to challenge ratification upon application to the courts.
2. Operating Agreements and Partnership Agreements Providing for Transfer of an Equity Interest Upon Certain Events
House Bill 342 / Senate Bill 261 (Chs. 294/ 295) responds to a recent ruling by the Maryland Court of Special Appeals in the case of Potter v. Potter, 250 Md. App. 569 (2021). In Potter, the Court ruled that when a person is subject to Maryland’s statute on wills, and holds an equity interest in an LLC or partnership, a transfer of that equity interest upon the person’s death is subject to Maryland’s testamentary and probate laws. In effect, the ruling would invalidate a provision often seen in operating agreements and partnership agreements that provides for the transfer of a deceased’s interest in the company to a non-equity holder, unless drafted and implemented in compliance with the formalities required by Maryland’s statute on wills (e.g. attestation by two credible witnesses). The General Assembly’s legislation avoids that result by expressly permitting the inclusion of transfer on death provisions in an operating agreement or partnership agreement. The new law specifies that, in the case of a transfer upon death, such provisions are not testamentary (and thus not subject to probate scrutiny), thereby preserving an important tool for business succession planning.
3. Miscellaneous Amendments
As it does in many years, the General Assembly, through House Bill 999 / Senate Bill 431 (Chs. 292/ 293), amended certain sections of the MGCL to enhance the statute or to reflect advancements in corporate governance. Some highlights of the bill are:
- A corporation’s term of existence may now be limited to a specific period, and/or conditioned on the occurrence of a particular event or action (as opposed to a fixed, specific period). This will aid asset managers, who have long preferred to utilize Maryland corporations to form certain registered and unregistered funds, by allowing for the maximum flexibility in the duration of the existence of the fund.
- A director wishing to dissent to a corporate action proposed at any board meeting, at which the director is present, may now, along with other requirements needing to be satisfied, submit their written dissent by electronic submission following the adjournment of the meeting (this requirement previously had to be satisfied by certified mail).
- The effective time for the dissolution of a corporation is the later of the time the SDAT accepts articles of dissolution for record or a time set forth in the articles of dissolution not to exceed 30 days after the acceptance of the articles of dissolution (previously the effective time ran solely based on the acceptance by SDAT).
- Various provisions of the MGCL, where existing language applied only to a specific entity, were expanded to apply to entities, generically, or to incorporate a specific entity not otherwise captured by the existing language, such as:
- the treatment of a corporation’s own stock as being indirectly owned by the corporation if held by another corporation in which that corporation owns the majority of voting shares, was expanded to apply to other (non-corporate) entities in which that corporation owns a majority of the voting interests.
- the required majority approval for abandonment of a proposed consolidation, merger, or share exchange before the effective date, is revised to include approval by the governing body of any entity party to the articles of merger (as opposed to previously listing only a board of directors or board of trustees).
- the list of entity types, for which a corporation is permitted to obtain insurance for a person serving at such entity upon the request of the corporation, is expanded to include limited liability companies.
4. Use or Maintenance of Improper or Outdated Addresses in Recorded Documents
In filings submitted to the SDAT, business entities are required to include addresses for various purposes (e.g., a business’ principal office and resident agent address). Existing law prohibits a governing document or charter document to be recorded with SDAT using an address that the entity is not authorized to use for such purpose or that does not otherwise conform with Maryland law. Despite those requirements, SDAT has limited basis to investigate outdated or improper addresses or to enforce compliance. Similarly, in cases where a business sells its property, moves or closes, a new property owner has little recourse to separate the property from the prior business entity, in SDAT’s records.House Bill 390 / Senate Bill 447 (Chs. 287/ 288), sponsored by the SDAT, will change that by permitting a property owner to submit an affidavit to SDAT, when it suspects its address is being used in a business entity filing in violation of Maryland law. Upon receipt of the affidavit, the SDAT will notify the affected business of the alleged violation. Businesses receiving such notices will have a period of 45 days to refute the claim and if not refuted, SDAT may void the governing document or charter document at issue. In addition to this 45 day response period, the legislation includes procedures for a business to correct the claimed violation. The legislation was designed to relieve the administrative burden, as well as the inconvenience to property owners when, for example, service of process is repeatedly made at an outdated address. This relief places the burden back on business entities to monitor the status of addresses in all SDAT filings and promptly update them where necessary, or risk jeopardizing the validity of the filing, or potentially the business’ good standing with the State of Maryland.
For many years, Miles & Stockbridge lawyers have held leadership positions in the Corporate Laws Committee of the Business Law Section of the Maryland State Bar Association. That committee monitors legislation that effects the Maryland General Corporation Law, as well as laws governing other business entities in Maryland. If you have questions about the above summarized laws, or how they may affect your business, please contact our corporate, securities and tax practice group for further assistance.
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