ABA's M&A Deal Points Study

The Mergers & Acquisitions Market Trends Subcommittee of the Mergers and Acquisitions Committee of the American Bar Association Business Law Section (I dare you to say that name five times fast!) has released its 2011 Private Target Mergers & Acquisitions Deal Points Study (For Transactions Completed in 2010).  It's available to members of the ABA's M&A Committee here: http://apps.americanbar.org/dch/committee.cfm?com=CL560003.  Dallas's own Wilson Chu co-chairs this project.

The annual Deal Points Study contains a tremendous amount of valuable information for M&A participants regarding deal terms actually negotiated in transactions which are publicly disclosed.  This year's survey looked at 100 acquisitions of private companies by publicly traded buyers with transaction values between $25 million and $960 million which were completed in 2010.

The beauty of the Deal Points Study is that it gives the deal lawyer something tangible to point to when arguing that a particular deal point is (or is not) "market."  For example, let's say the buyer in an M&A transaction is demanding a "full-disclosure" representation and warranty from the seller, which would provide that, in addition to the reps and warranties specifically set forth in the acquisition agreement, the seller must also promise that the seller is not aware of any other material fact about the business that has not been disclosed to the buyer.  The buyer and its counsel will likely argue that such a full-disclosure rep is one they "always" get from sellers and what is typical in the "market."  The seller and its counsel will probably take the opposite position.  A seller armed with the Deal Points Study could point out that 63% of the deals closed in 2010 excluded such a full-disclosure rep.  While that won't end the debate, it's certainly more persuasive than a general comment such as: "That's not what we've been seeing in the market."
   

Southlake Carroll Dragons 2011 Texas State Football Champions

I must take a detour from my usual discussion of corporate and securities law topics to congratulate the Southlake Carroll High School football team.  The Dragons just finished off an undefeated season with a record-tying 8th Texas state football championship.  The Dragons showed tremendous heart and determination in coming from behind to win five of their six playoff games.  Thier playoff run included the "Miracle on Mockingbird," in which Carroll scored two touchdowns and recovered an onside kick in the final two minutes to erase a 10-point lead by Dallas Skyline High School.  That state semi-final game also featured a wild fox running out on to the field on the same play the go-ahead touchdown was scored.  What an amazing run for this team which inspired so many of us!  

I am pleased to report that this blog recorded its 10,000th pageview this week.  I look forward to sharing much more with you in 2012.  Merry Christmas and Happy New Year!

New Texas Securities Commissioner

Yesterday, the Texas Securities Board announced that it has named John Morgan as the new Texas Securities Commissioner.  He replaces Benette L. Zivley, who resigned in November.  Further details are available in the Texas State Securities Board's press release here:  http://www.ssb.state.tx.us/News/Press_Release/12-14-11_press.php.

Annual UT-CLE Securities Regulation Conference Approaching

In the heart of the Christmas season, I thought it would be a great time to mention that the gift every securities attorney in Texas has on their wish list is a ticket to the UT-CLE 34th Annual Conference on Securities Regulation and Business Law.  Okay, I can't confirm that, but I can tell you that this conference is always one of the best around for those of us interested in securities law.  The 2012 conference will be February 9 and 10 at the Belo Mansion in Dallas.  The conference includes 13.25 hours of programming over two days, including the latest on fracking and other hot topics in energy, issues facing microcap public companies, and the new investment advisors rules.  And Yours Truly will be serving as a Presiding Officer.  You can learn more about the conference here: http://www.utcle.org/conference_overview.php?conferenceid=1007.  Hopefully, I'll see you there.

Is Going Public a viable Exit Strategy?

When I began practicing securities law in the late 1990's, it was the golden era of public offerings.  It seemed anybody with a hot idea and a Silicon Valley address was taking their company public.  That's no longer the case.  The Great Recession has really put a damper on the number of public offerings generally, and initial public offerings in particular.  According to the September issue of Inc. magazine, only 67 companies have gone public so far this year in the United States, 109 went public in 2010, and only 48 went public in 2009.  Accordingly, shareholders of private companies seeking a near-term exit strategy should generally be thinking of a sale in a privately negotiated M&A transaction rather than tapping into the public equity markets. 

Fort Worth Public Company Shareholders Speak on Say-On-Pay Frequency

Among the many new rules introduced by the Dodd-Frank Act of 2010, are the so-called "say-on-pay" provisions, which give shareholders of public companies the right to a non-binding advisory vote approving or disapproving of the company's executive compensation.  In connection with the say-on-pay rules, public companies are required to give their shareholders a say on the how frequently the say-on-pay votes will be held: annually, every other year, or every third year.  The say-on-pay and say-on-frequency rules have been codified by the SEC as Exchage Act Rule 14a-21(a) and Rule 14a-21(b), respectively.

We were curious how companies have reacted to the new SEC rules, so we conducted a survey of the proxy statements of the 20 largest publicly traded companies based in the Fort Worth area as reported by the Fort Worth Business Press.  Of those 20 companies, 15 have conducted say-on-frequency votes.  Of those 15 publicly traded companies, the board recommended annual say-on-pay votes in 10 cases (67%), but the shareholders voted for annual say-on-pay votes in 14 cases (93%).  In fact, only one Fort Worth-based publicy traded company in our survey had shareholders who voted for a say-on-pay vote every 3 years.  Below are graphs showing our results:

       

Piercing the Veil of a Texas LLC

Good news for members of Texas limited liability companies ("LLCs"):

As a general rule, a member or a manager of a Texas LLC may not be held liable for the debts or obligations of the LLC unless the LLC's company agreement provides otherwise.  In fact, the Texas Business Organizations Code ("TBOC") makes that point explicitly in Section 101.114. 

On the other hand, Texas corporate law has long recognized the concept of "veil-piercing" in which a corporation's shareholder may be held liable for obligations of the corporation in extraordinary circumstances, such as when the shareholder has used the corporation as an instrument of fraud.  Texas corporate law statutes provide strict limits on such corporate veil piercing, however.  See Sections 21.223 through 21.226 of the TBOC. 

So are members of a Texas LLC entitled to enjoy the same limits of veil piercing as those enjoyed by shareholders of a Texas corporation under Texas corporate law statutes? 

Although logic would dictate that the answer should be "yes," at least two out-of-state courts interpreting the TBOC have concluded that the Texas corporate law anti-veil piercing statutes by their own terms apply only to Texas corporations and thus have no application to Texas LLCs. 

The Texas legislature recently corrected the potential for unequal treatment for members of Texas LLCs by adopting a new Section 101.002 to the TBOC.  The new provision explicitly provides that the anti-veil piercing provisions enjoyed by shareholders of Texas corporations under Sections 21.233-21.236 of the TBOC will apply to members of Texas LLCs as well.  The new provision took effect September 1, 2011.

Private Placements outside of Safe Harbors

Is it possible to conduct a lawful private placement of securities under federal securities laws without relying upon Regulation D or other so-called "safe harbor" exemptions from registration under the Securities Act of 1933, as amended (the "Securities Act")? 

Absolutely.  By definition, a legal safe harbor means that compliance with the safe harbor is not required, but failure to comply is done at one's own peril.  Accordingly, an issuer of securities who fails to comply with each and every term and condition of Regulation D or other safe harbor exemption from registration may still be exempt from registration under federal securities laws.  An issuer who chooses to sail outside of those safe harbors, however, takes the risk that the Securities and Exchange Commission ("SEC") or a judge may conclude that the issuer has conducted a public offering rather than a private placement of securities in violation of the Securities Act.  Failure to comply with the registration requirement under the Securities Act has serious consequences, so most issuers conducting a private placement play it safe by relying or attempting to rely on Regulation D as a safe harbor exemption from the registration requirements.

The November 2010 issue of The Business Lawyer, a legal journal published by the Business Law section of the American Bar Association ("ABA"), has a terrific report summarizing the history and current state of the law of private placements outside of safe harbors.  Its title, appropriately enough, is "Law of Private Placements (Non-Public Offerings) Not Entitled to Benefits of Safe Harbors - A Report."  It was written by the Committee on Federal Regulation of Securities of the ABA Section of Business Law.

The report notes that whether an offering of securities will be considered a public offering or a private placement which is therefore exempt from registration under Section 4(2) of the Securities Act depends upon the facts and circumstances of the offering.  The report says that the concepts that underlie the Regulation D safe harbor are the same factors that should be considered in evaluating whether or not an offering should be deemed a private placement for the purposes of Section 4(2) of the Securities Act.  Specifically, the four critical factors in determining whether of not an offering is a private placement are:

(1) Manner of offering.  The issuer may not use "general solicitation" or "general advertising."
(2) Sophisticated Purchasers.  The issuer must reasonably believe that all purchasers in the offering are knowledgeable and sophisticated.
(3) Access to Information.  The purchasers must have access to information about the issuer and the offering to make an informed decision.
(4) Resale Limitations.  The issuer must take reasonable steps to prevent the purchasers from reselling the securities.

Importantly, the report noted a few factors which should not be considered to be relevant factors independently, except to the extent that such factors inform one of the factors listed above, such as manner of offering.  Items which are sometimes cited as relevant, but which should not be considered independently relevant include:

(1) Number of purchasers.  As long as the purchasers are capable of evaluating the investment, the number of purchasers should not matter.
(2) Preexisting relationship with purchaser.  The purchaser need not have a preexisting relationship with the issuer.       
(3) Eligibility of Offerees and Purchasers.  It should not matter whether or not an offeree who does not ultimately become a purchaser is knowledgeable or sophisticated.  Also, the ability of a purchaser to bear the economic risk of an investment should not be relevant, except to the extent that concept is baked into the definition of "accredited investor," who are persons assumed to be financially sophisticated.
(4) Size of the Offering. 
(5) Number of Units. 
(6) Manner of Offering.  The existence of an investment banker (whether the broker-dealer is acting as principal or agent of the issuer) should not be a relevant factor.  Also, dissemination of information about the offering by parties other than the issuer or someone acting on its behalf should not be deemed a "general solicitation" which would destroy the issuer's exemption from registration.
(7) Information.  It should not matter whether or not a non-purchasing offeree received full access to information.  Generally, purchasers will be deemed to have adequate information about any issuer that is publicly traded and therefore subject to the reporting requirements of the Securities Exchange Act of 1934, as amended.
(8) Resales.  If the issuer takes reasonable steps to prevent resales of the securities, it shouldn't matter if one or more purchasers nonetheless resells the securities in violation of the issuer's resale restrictions.

New Director Appointed to SEC's Fort Worth Regional Office

On August 12, 2011, the Securities and Exchange Commission (SEC) announced that David Woodcock would be replacing Rose Romero as the Regional Director of the SEC’s Fort Worth Regional Office.  The SEC's Fort Worth Regional Office has jurisdiction over SEC enforcement matters in Texas, Oklahoma, Arkansas, and Kansas.  The SEC's press release announcing the appointment is available here: http://www.sec.gov/news/press/2011/2011-168.htm

Texas Adopts Assignment of Rents Act

On June 17, 2011, Texas Governor Rick Perry signed into law the Texas Assignment of Rents Act (TARA).  Dubbed the "most significant finance-related bill" of the 82nd Texas Legislature's last session in the Texas Bar Journal's Legislative Update, the TARA clarifies some ambiguous case law regarding the status of assignment of rents. 

The TARA should benefit both creditors and borrowers in Texas by making assignments of rents in Texas much simpler and more straightforward.  Under the new law, every deed of trust, mortgage, or other instrument evidencing a lien against real property in Texas (with certain exceptions) includes a collateral assignment of rents to such real property unless otherwise stated in the instrument itself.  Such assignment of rents creates a presently effective security interest in all accrued and unaccrued rents arising from the real property, which security interest is separate and distinct from any security interest in the real property itself.  The security interest in the rents is perfected upon filing in the county in which the real property is located.

The TARA, codified as a new Chapter 64 of the Texas Property Code, was inspired by the Uniform Assignment of Rents Act (UARA), which was written by the National Conference of Commissioners of Uniform State Laws.  The TARA is much shorter than the UARA and more tailored to Texas property law concepts generally, however.

I won't get into the history of assignment of rent case law, which involves, among other things, a 1981 Texas Supreme Court case, absolute vs. collateral assignment of rents, bankruptcy law, and the pro tanto reduction concept.  A good capsule summary of these issues was provided in the TARA's Sponsor's Statement of Intent, which is available here: http://www.legis.state.tx.us/tlodocs/82R/analysis/pdf/SB00889F.pdf#navpanes=0
Luckily, thanks to the TARA, Texas lenders no longer need to worry about many of these issues that once complicated assignments of rents in Texas.
 

Texas Entrepreneurship Progams Rank Highly

The October issue of Entrepreneur magazine has some good news for the future of the Texas economy.  Texas based universities made an impressive showing in the Princeton Review's top 25 entrepreneurship programs in the country as reported by the magazine.  According to this blogger's count, 3 of the top 25 undergraduate programs (Houston (1), Baylor (3) and TCU (21)) and 3 of the top 25 graduate programs (Texas (8), Rice (9) and Acton (13)) are based in Texas.

Since entrepreneurship is the engine of economic growth, it is encouraging to know that some of the top young talent is graduating from programs right here in the Lone Star State.

More Caddy Shack Quotes

As noted in a prior blog post: (See http://www.northtexasseclawyer.com/2011/08/caddy-shack-m-article-publiched-in.html),
my article identifying M&A guidance from Caddy Shack's Judge Smails has been pretty popular, so I thought my readers might enjoy a few more quotes from everyone's favorite golfing judge.  These quotes were edited out of the article published in the Dallas Business Journal to meet its word count limits, but that doesn't make these quotes any less entertaining. Here they are:

“Well, we're waiting!”

Just as every golfer has felt the frustration of waiting for another golfer to swing their club, every veteran of merger and acquisition transactions has felt the frustration of waiting for the all of the parts of the transaction to come together for a closing.  Typically, many parties are involved in an M&A transaction, including buyers and sellers, lawyers, bankers, accountants, appraisers, title companies, and potentially many others.  The deal may need to be approved by boards of directors, shareholders, creditors, landlords, regulatory authorities, or others.  Thus, you may find yourself waiting on any number of deal participants.  An experienced M&A lawyer prepares a detailed closing checklist, anticipates and addresses potential bottlenecks that might delay closing, politely but persistently reminds other deal participants of their responsibilities, keeps the deal moving forward, and keeps the client informed on the status of the transaction.     

“Oh, Porterhouse, look at the wax build up on these shoes.  I want that wax stripped off there, then I want them creamed and buffed with a fine chamois, and I want them now.  Chop, chop.”

A seller in an M&A transaction should scrub up its business records with the same zeal that Judge Smails expects Porterhouse to apply to shining shoes.  A well represented buyer is going to conduct detailed due diligence review during which the seller’s problems are likely to come to light.  It is much better for the seller, and the seller’s reputation, if any bad news comes from the seller rather than as a result of an audit by the buyer’s accountants or other representatives of the buyer.  The seller will want to put the seller’s best foot forward.  That means business records should be as complete, accurate, and organized as possible.  And of course, the seller can make Judge Smails happy by assuring that its business records are free of wax build up.

“I've sentenced boys younger than you to the gas chamber.  Didn't want to do it.  I felt I owed it to them.”

When things go badly for the target of an acquisition after the closing, the buyer may share Judge Smails’s sense of moral obligation with respect to the seller.  For example, the buyer may refuse to pay the seller the earn-out portion of the purchase price if profits fall short of expectations.  As the buyer learns more about the target company and its operations after the closing, the buyer often becomes aware of breaches of the seller’s representations and warranties.  Like Judge Smails, the buyer may feel it owes it to the seller to sue and seek indemnification from the seller under the purchase agreement.

Judge Smails: “Do you mind, sir. I'm trying to tee off.”

Al Czervik: “I'll bet you a hundred bucks you slice it into the woods.”

Judge Smails: “Gambling is illegal at Bushwood sir, and I never slice.”

Too often, sellers take too little time reviewing the representations and warranties in an M&A purchase agreement because they think their company is “clean” or the target company has “never had a problem.”  Like Judge Smails, sellers think they will never slice.  But guess what?  There is a first time for everything.  And with new management of the target company after the sale, sometimes new problems emerge or old problems are uncovered.  When that happens, the seller will be glad if the seller carefully reviewed the representations and warranties and reasonably limited the representations and warranties with qualifications as to the seller’s knowledge and materiality.  Failure to carefully review the representations and warranties and related disclosure schedules in a purchase agreement can truly be a gamble for the buyer or the seller.    

Fraud Vitiates Everything It Touches

On July 29, the Fort Worth Business Press published an article I wrote titled "Texas Supreme Court Ruling May Surprise Landlords," which is available here.

The article discusses a very interesting recent Texas Supreme Court case in which a tenant sued a landlord for failure to disclose the existence of "ungodly" sewer gasses at the space the tenant had planned to use as a restaurant.  In fact, the landlord's representative said that the location was "perfect" for a restaurant.  The lease was silent as to the existence of smells at the property, and the lease provided that the landlord made no representation or warranties outside of the lease.  Nonetheless, the court ruled that the landlord's misrepresentations prior to the execution of the lease amounted to fraud and that "fraud vitiates everything it touches" - including contrary provisions in the lease itself.

This is an important cases for parties conducting business in Texas because it reminds us that Texas courts may not enforce contracts tainted by fraud or other misrepresentation even if the misrepresentation occurs outside of the contract itself.

Thanks to the Fort Worth Business Press for publishing the article.

DFW Venture Capital Investments

I just stumbled upon a statistic that will be discouraging to those of us in the Dallas-Fort Worth venture capital community.  The Dallas Business Journal recently reported that DFW companies raised only $714 million in 38 venture capital tranactions in 2010. That's down from $2.8 billion in 137 transactions in 2000.  Hopefully, that means the venture arrow can only point up from here!

Caddy Shack M&A Article published in Dallas Business Journal

I have received a lot of positive feedback for an article I wrote which was published in the July 22 issue of the Dallas Business Journal.  It was titled "Acquiring Knowledge: Don't let your M&A deal end up in the rough." Based on the premise that everybody loves quotes from the movie Caddy Shack, the article takes several quotes from Judge Elihue Smails and explains how they apply to merger or acquisition transactions.  In case you missed it, here is a link to the article: http://www.canteyhanger.com/content.php?page=news&newsid=165

Special thanks to the Dallas Business Journal for publishing my work.

Limits on Distributions by Texas Corporation

Are there limits on the ability of a Texas corporation to distribute cash or other property to its shareholders?  As former Alaska Governor Sarah Palin might say, “You betcha.”

It’s important that the board of directors of a Texas corporation correctly determine the amount of corporate funds available for distributions because directors may be held jointly and severally personally liable for distributions in excess of the amount permitted by law (Section 21.316 of the Texas Business Organizations Code (TBOC)).

Generally, a Texas corporation may make distributions in an amount by which the value of its net assets exceeds the aggregate par value of the corporation’s outstanding stock. 

That’s the answer, but the TBOC does not make it particularly easy to get there.  Let’s walk through the daisy chain of definitions in the portion of the TBOC which provides rules for distributions from a Texas corporation, Title 2 (Corporations), Chapter 21 (For-Profit Corporations), Subchapter G (Distributions and Share Dividends)(a/k/a Section 21.301-318 of the TBOC).  

A Texas corporation may not make distributions that would make the corporation insolvent or that would exceed the corporation’s distribution limit, except upon winding up and termination of the corporation (Section 21.303 of the TBOC). 

A corporation’s “distribution limit” is generally equal to the corporation’s surplus, with certain exceptions (Section 21.301 of the TBOC). 

A corporation’s “surplus” is the amount by which the net assets of the corporation exceed the stated capital of the corporation (Section 21.002(12) of the TBOC). 

A corporation’s “net assets” is the amount by which the total assets of the corporation exceed the total debts of the corporation (Section 21.002(9) of the TBOC). 

A corporation’s “stated capital” is the sum of (a) par value of all shares issued by the corporation, plus (b) the aggregate consideration received by the corporation for the issuance of shares without par value, reduced by any portion of such consideration that the board properly allocates to surplus, plus (c) any additional amounts added to the corporation’s stated capital by share dividends or board resolution (Section 21.002(11) of the TBOC).    

Lessons from Dallas Mavericks Championship Season

As part of the North Texas business community, I must congratulate the World Champion Dallas Mavericks on their first ever NBA championship!  In a sense, the success of the Dallas Mavericks reflects what's going on across our region and around the global economy.  Here are the top 5 lessons from the Mavs championship season:

1)  Globalization.  It's become a bit of a business cliche that today's competition doesn't come from the guy down the block so much as the from around the globe.  Never was that more true than in the NBA than in 2011, when Dirk Nowitzki, the "Big German," led the Mavs to the championship and proved to be one of the best, if not the best, player in the world.  The Mavs roster also boasts a Serbian (Paja Stojakovic), two Frenchmen (Ian Mahinmi and Rodrigue Beaubois), a Puerto Rican (J.J. Barea).  Successful businesses must be able to mold the best talent from around the world to compete on a global stage.

2)  Don't Mess With Texas.  Just as the Larry O'Brien Trophy is headed to Texas, so is much of the growth of the U.S. economy.  In the twelve months ending this April, the Texas economy has created 254,400 new non-farm jobs, representing almost 20% of all jobs created in the U.S. during that time.  See http://www.texasahead.org/economy/outlook.html.  The absence of a state income tax, the right-to-work laws discouraging unionization, and a generally friendly regulatory environment makes Texas a great place to do business, whether you are an NBA team or any other business.

3)  German Efficiency.  Just as the Mavs were rewarded by trusting in their Big German and his hard work, responsibility, and precision shooting, the U.S. political and business leaders would do well to look to the model of the German economy, the world's fourth largest, when it comes to smaller budget deficits, higher savings rate, and high quality products built with attention to detail.  Dirk's tireless work ethic to continually refine and improve his game should be an inspiration to all of us.    

4)  Teamwork Matters.  Few question that the Miami Heat's roster boasted two of the top ten players in the world, and many thought that superior talent would be decisive in the NBA Finals.  It wasn't.  The Mavs played together as a team with small egos and role players knowing their role.  You can't have success without talent, but talent alone is not enough.  Successful business leaders get buy-in from their team members and get everyone rowing in the same direction.  Teamwork matters and chemistry matters.  The 2011 Mavs proved that.

5)  "The Main Thing is to keeping the Main Thing the Main Thing."  That quote from business guru, Stephen Covey, came to mind as I watched the Mavericks tear through the 2011 NBA playoffs.  The Trailblazers were more athletic, the Lakers were more experienced, the Thunder were younger and faster, and the Heat were more talented, but the Mavs did one thing better than any team I've ever watched.  In basketball, the Main Thing is putting the basketball through the hoop.  Throughout the NBA Finals, the Mavs shot 41% from 3-point range, including 5 players who shot 36% or better from 3-point range (Nowitzki 37%, Terry 39%, Kidd 43%, Stevenson 57%, and Cardinal 67%).  Dirk shot an out-of-this-world 97.8% from the free throw line.  When you can put the ball in the basket that efficiently, you are very difficult to beat.  The Mavs did the Main Thing.              

EDGAR Electronic Signatures

Nowadays, virtually all SEC filings are made electronically via the SEC's EDGAR database.  Such filings are generally required to be signed by one or more representatives of the filer.  But how does one sign an electronically filed document?

The signer signs a paper copy of the document manually, and the signature itself is typed into the signature block of the filed version of the document.  The filer is required to keep a copy of the manually signed version of the filed document for five years for possible inspection by the SEC.  This is all covered in the SEC's Rule 302 under Regulation S-T.     

Was the SEC's position on the treatment of electronic signatures impacted by the federal E-Sign Act?  No, the E-Sign Act, which generally recognizes electronic signatures in commerce, specifically exempts most government filing format requirements from the E-Sign Act.  In the SEC's 2001 Interpretive Release No. 33-7985, the SEC explained that the E-Sign Act would not apply to EDGAR filings because SEC filings are generated principally for governmental purposes.   

You can read more about the E-Sign Act in my paper on E-Corporate Law which is available here: http://www.canteyhanger.com/content/Clayton_SR11_paper_revised_02_10_11.pdf

TECH Fort Worth Impact Awards

I recently attended the Impact Awards luncheon presented by TECH Fort Worth, a business incubator and accelerator serving the Fort Worth business community.  Each year, the Impact Awards are given to three North Texas companies who the judges believe will have an impact on people's lives in the areas of Environmental, Community, or Health.  As usual, TECH Fort Worth put on a terrific event that highlighted North Texas companies doing amazing things. 

My firm, Cantey Hanger LLP, was one of the sponsors of the event.  I was lucky enough to be seated with the management team of Image Vision Labs, the winner of the Community category.  Image Vision Labs is a pioneer in the field of visual recognition products which help businesses and parents identify and filter inappropriate images from computers and other communication devices.  It is inspiring to see all of the great work being done by Image Vision Labs and the other Impact Award finalists.  Congratulations to all of them - and thanks for making an impact!    

Leadership Southlake Graduation

The graduation luncheon for the Leadership Southlake Class of 2011 was held on Thursday.  Leadership Southlake is an 8-month program sponsored by the Southlake Chamber of Commerce in which participants learn about our community, network with business and civic leaders, and develop leadership skills.  I am a proud member of the Class of 2011.

In the class, a learned a tremendous amount about the way our city, region, and state operate.  More importantly, I met some amazing and talented classmates who will be friends long after the class is complete.  I encourage readers of this blog to participate in a leadership program in your community.  You won't regeret it. 

I am especially proud of our class project, a website with information for Southlake families in need called SouthlakeCommunityResource.com.  The website provides names and contact information for organizations that assist in meeting the emotional, financial, legal, health, spiritual, and other needs of our community.     

Little Known Facts: The Zero Percent General Partner

One often sees general partnerships in which the general partner owns 1% or even 0.1% of the limited partnership.  But may the general partner of a Texas limited partnership own 0% of the limited partnership?

Yes.  Section 153.151(d) of the Texas Business Organizations Code, adopted effective 2006, provides that:  “A written partnership agreement may provide that a person may be admitted as a general partner in a limited partnership, including as the sole general partner, without acquiring a partnership interest in the limited partnership.” 

Every general partnership must have at least one general partner.  The general partner is generally responsible for managing the limited partnership and faces unlimited liability for the debts of the limited partnership if the limited partnership is unable to pay its debts.

So why would a person agree to serve as a 0% general partner – getting all of the downside but none of the upside of the limited partnership?  Typically a 0% general partner is also an affiliate of one or more of the limited partners who do enjoy part or all of the upside of the partnership. 

Foreign Entities Transacting Business in Texas

Foreign entities transacting business in Texas must register with the Texas Secretary of State's office.  For purposes of the Texas Business Organizations Code (TBOC), a "foreign" entity is any entity formed under the laws of another jurisdiction, such as a Delaware limited liability company or a Nevada corporation.

But what does it mean to "transact business" in Texas?  Unfortunately, the TBOC does not define that term.  Section 9.251 of the TBOC offers some assistance by providing the following non-exclusive list of activities which do NOT, by themselves, constitute transacting business in Texas:

(1)  maintaining or defending an action or suit or an administrative or arbitration proceeding, or effecting the settlement of: (A)  such an action, suit, or proceeding; or (B)  a claim or dispute to which the entity is a party;
(2)  holding a meeting of the entity's managerial officials, owners, or members or carrying on another activity concerning the entity's internal affairs;
(3)  maintaining a bank account;
(4)  maintaining an office or agency for: (A)  transferring, exchanging, or registering securities the entity issues; or (B)  appointing or maintaining a trustee or depositary related to the entity's securities;
(5)  voting the interest of an entity the foreign entity has acquired;
(6)  effecting a sale through an independent contractor;
(7)  creating, as borrower or lender, or acquiring indebtedness or a mortgage or other security interest in real or personal property;
(8)  securing or collecting a debt due the entity or enforcing a right in property that secures a debt due the entity;
(9)  transacting business in interstate commerce;
(10)  conducting an isolated transaction that: (A)  is completed within a period of 30 days; and (B)  is not in the course of a number of repeated, similar transactions;
(11)  in a case that does not involve an activity that would constitute the transaction of business in this state if the activity were one of a foreign entity acting in its own right: (A) exercising a power of executor or administrator of the estate of a nonresident decedent under ancillary letters issued by a court of this state; or (B) exercising a power of a trustee under the will of a nonresident decedent, or under a trust created by one or more nonresidents of this state, or by one or more foreign entities;
(12)  regarding a debt secured by a mortgage or lien on real or personal property in this state: (A) acquiring the debt in a transaction outside this state or in interstate commerce; (B) collecting or adjusting a principal or interest payment on the debt; (C) enforcing or adjusting a right or property securing the debt; (D) taking an action necessary to preserve and protect the interest of the mortgagee in the security; or (E) engaging in any combination of transactions described by this subdivision;
(13)  investing in or acquiring, in a transaction outside of this state, a royalty or other nonoperating mineral interest;
(14)  executing a division order, contract of sale, or other instrument incidental to ownership of a nonoperating mineral interest; or
(15)  owning, without more, real or personal property in this state.

The Texas Secretary of State's website provides further information on this topic here: http://www.sos.state.tx.us/corp/foreign_outofstate.shtml

Drafting Tip: Indemnified Affiliates or Third Party Beneficiairies?

Can a party be an indemnified affiliate of a contracting party but not a third party beneficiary of that contract?  A recent New York case (Diamond Castle Partners IV PRC, L.P. v. IAC/InterActiveCorp, 2011 N.Y. App. Div. LEXIS 1542 (2011)) highlights an interesting legal drafting issue that comes up often in deal documents. 

Diamond Castle is a private equity fund that formed an acquisition vehicle, Panther, to acquire the equity of another company, PRC, for $286.5 million.  Immediately after the closing, Panther was merged into PRC.  The purchase agreement included two arguably contradictory statements:

(1) The seller, IAC, would indemnify Panther and all of its affiliates for any breaches of the purchase agreement; and

(2) There are no third party beneficiaries of the purchase agreement. 

So when Diamond Castle, an affiliate of Panther, sought indemnification for an alleged breach under the purchase agreement, IAC argued that statement (2) above controlled.  Obviously, Diamond Castle argued that statement (1) controlled.

The New York court agreed with Diamond Castle, reasoning that the only logical reading of the agreement was that affiliates of Panther were intended to be indemnified and that such indemnified parties were therefore not "third parties" for the purposes of statement (2).

Regardless of the results in this particular case, drafters of purchase agreements can remove any ambiguity on this point by more careful drafting.  When drafting agreements, consider including a carve-out to the "no third party beneficiary" provision to specifically except third parties indemnified under other provisions of the agreement.

Special thanks to Jonathan P. Gill, Michael C. Hefter, and Kelly Koscuiszka of Bracewell & Giuliani LLP who brought the Diamond Castle case to my attention.

Little Known Facts: Ownership Certificate in Bearer Form

May a Texas entity issue stock or other ownership interest in bearer form? 

No.  Section 3.202(f), which prohibits ownership certificates in bearer form, was added to the Texas Business Organization Code (TBOC) September 2009.  "Bearer form" means that the certificates have no registered owners - they are owned by any party who "bears" the certificate.  This provision to the TBOC was added in part because law enforcement officials objected to parties being able to disguise the actual ownership of business entities through the use of bearer ownership.  Bearer certificates might also make theft of certificates easier.  For example, although it involved debt rather than equity, it was the theft of bearer bonds that was at the heart of the plot of the movie Die Hard.  Had the bonds been issued in registered form rather than bearer form, Bruce Willis's character might have had a much less eventful Christmas holiday.

Securities Sales by Affiliates under Texas Securities Act

Let's say you are an officer or director of a privately held company in Texas.  Can you sell shares of the Company to another officer or director without registering the sale or otherwise making a filing with the Texas State Securities Board?  Probably so, but the answer is not nearly as obvious as you might think. 

As a reminder, all sales of securities must be registered or exempt from registration.  Even if a sale is exempt from registration under federal securities laws, one must also register or find an exemption from registration under applicable state securities laws, such as the Texas Securities Act.

The Texas Securities Act provides a number of exemptions from registration, but most of the exemptions are not available for affiliates (such as officers and directors) of privately held companies.  Let's walk through some of them. 

Most of the exemptions are available only to the issuer of the securities, so those won't help you. Rule 139.13 provides an exemption for sales of securities that comply with the SEC's Rule 144, but affiliates of the issuer cannot rely on Rule 144 unless "current public information" regarding the issuer of the securities is available - that's virtually never the case for a privately held company.  Rule 139.14 provides an exemption for a limited number of sales of securities by non-issuers, but affiliates of the issuer who wish to rely on this exemption must file a Form 133.34 with the Texas State Securities Board.

Fortunately, we have Section 5.C(1) of the Texas Securities Act, which exempts "[s]ales of securities made by or in behalf of a vendor, whether by dealer or other agent, in the ordinary course of bona fide personal investment of the personal holdings of such vendor, or change in such investment, if such vendor is not engaged in the business of selling securities and the sale or sales are isolated transactions not made in the course of repeated and successive transactions of a like character; provided, that in no event shall such sales or offerings be exempt from the provisions of this Act when made or intended by the vendor or his agent, for the benefit, either directly or indirectly, of any company or corporation except the individual vendor (other than a usual commission to said agent), and provided further, that any person acting as agent for said vendor shall be registered pursuant to this Act;"

The Texas Securities Board has issued several opinions interpreting Section 5.C(1).  Basically, a "vendor" under Section 5.C(1) appears to mean anyone who sells securities held for personal investment.  Unfortunately, the statutory language quoted above is simply not very clear.

Mythbuster: the "Limited Liability Corporation"

Occasionally I'll hear someone describe a company as a "limited liability corporation," and I'll cringe like an English teacher who has just heard a student split an infinitive.  Or like anyone who hears the sound of fingernails on a chalkboard.

An entity can be a limited liability COMPANY (LLC) or a corporation, but not both.  Countless legal treatises have been written comparing and contrasting the LLC, the corporation, and other business entities, so I will not attempt to summarize all of the difference in this blog post, but here are two big differences:

1. Taxes.  Although an LLC can elect to be taxed as a corporation, LLC's typically choose to be taxed as a partnership (if the LLC has more than one member) or as a disregarded entity (if the LLC has a single member) for federal tax purposes.  Generally, that means income generated by the LLC is taxed just once - each member pays tax on the portion of the LLC's income attributable to such member's percentage ownership of the LLC.  Conversely, earnings of a corporation are taxed twice - once to the corporation when it earns the income, and second to the shareholder of the corporation when the shareholder receives dividends from the corporation.

2. Governance Flexibility.  The rules for operating and managing a corporation are very strict and set out in length in the corporate statutes of the corporation's state of incorporation.  Those rules typically can be modified by contract among the shareholder's of the corporation only in limited circumstances.  On the other hand, LLC statutes are typically very flexible and generally permit the members to enter into company agreements which provide for all sorts of operating and management arrangements.  For example, corporations are virtually always managed by the corporation's directors, while an LLC may choose to be mananged by its members or by managers.

Accordingly, an LLC is often the business entity of choice.  Just don't call it a limited liability corporation!         

Is Your Fate "Sealed" in Delaware?

Have you ever seen the word "Seal" on a signature page to a contract?  Have you ever wondered what that word means?  It turns out it means quite a bit under Delaware law.

Stamping a contract with a corpoate seal means that the contract or instrument is extra official.  Contracts "under seal" can subject to a 20-year common law statute of limitations rather than the typical 3-year statutory limitations period in Delaware.  In the case of an individual, merely writing the word "Seal" next to that person's signature is enough to create a sealed contract under Delware law.  That result came as a bit of a surprise to legal practitioners when the Delaware Supreme Court made that decision in the 2009 case of Whittington v. Dragon Group, L.L.C.

The 3-year statute of limitations, which includes a carve out for records or instruments "under seal," can be found in Title 10 (Court and Judicial Procedures), Section 8106 of the Delaware Code.

Parties to contracts governed by Delaware law would be wise to look for the word "Seal" on the signature page of the contract and understand its far-reaching implications.

Mythbuster: Dilution is not a 4-letter word

Dilution is not something to be feared.  It is something to be respected.  Let me explain.

Dilution is a much talked-about topic among company founders, angel investors, and venture capitalists.  Founders are understandably fearful of any dilution of their stake in the company.  A company's founder always starts off owning 100% of the company.  Then, the founder may sell off pieces of the company to key executives and employees, strategic partners, sources of equity capital, and others.  Each time a new party gets new shares of stock from the company, all of the existing shareholders get diluted and own less of the company.

At first glance this seems bad - the founder used to own 100% of the company and now he owns less, often much less.  But what did he get in return?  Hopefully, by issuing stock to key executives and employees the founder was able to recruit and retain a highly motivated management team.  By issuing stock to strategic partners the company got access to exciting new markets.  By issuing stock in exchange for equity capital, the company got the funds it needed to complete its prototype, or to build its new factory, or to compensate its sales team. 

Any time a company issues new stock the company's board of directors must evaluate whether or not the issuance will expand the size of the pie (the equity value of the company) enough to justify diluting the amount of the pie held by existing shareholders (their repsective percenatge ownership of the company).  Of course, no company has a crystal ball, and stock issuances do not always benefit the company.  If the board does its job correctly, however, dilution (along with the issuance that caused the dilution) will actually benefit the existing shareholders.

Bill Gates no longer owns 100% of Microsoft, but I imagine that he is quite pleased with the value of the 7% of Microsoft that he owns as of the company's most recent proxy statement!

Seed Investing as a Team Sport

I was both a speaker and a participant yesterday at the "Seed Investing as a Team Sport" seminar, which was part of the three-day World's Best Technology Innovative Showcase in Arlington, Texas.  My presentation, "Structuring the Deal" reviewed key terms of seed investment and venture capital transactions.  Our training director and moderator, Jim Troxel, did an outstanding job facilitating a lively and informative discussion with a ton of audience participation.  Special thanks to Development Capital Networks for inviting me to participate in this event. 

As our economy starts to turn around, it is easy to get excited about the many opportunities for start-up ventures and their investors to work together to develop the Next Big Thing! 

Little Known Facts: Shareholder Rights to Financial Information

In honor of Cliff Clavin, the postman from television's "Cheers," I am starting a new feature on this blog called "Little Known Facts."  We'll explore nuances of corporate and securities law that may be somewhat obscure but (hopefully) pretty interesting.

Today we'll explore the following question: Can shareholders of a Texas corporation demand to see the corporation's financial statements?  Yes they can. 

Section 21.219 of the Texas Business Organizations Code (TBOC) provides: "On written request of a shareholder of the corporation, a corporation shall mail to the shareholder: (1) the annual statements of the corporation for the last fiscal year that contain in reasonable detail the corporation's assets and liabilities and the results of the corporation's operations; and (2) the most recent interim statements, if any, that have been filed in a public record or other publication." 

In addition, a person who has been a shareholder for at least six months or who holds at least 5% of the outstanding shares of the company may examine and copy the corporation's books, records, minutes, and share transfer records for any proper purpose, subject to any contrary provision of the corporation's governing documents.  That provision is set forth in Section 21.218 of the TBOC.

Mythbuster: "Freely Tradable Shares"

The purpose of this post is to expose the myth that a person may own "freely tradable" shares of stock.  In truth, the term "freely tradable" is not used anywhere in state or federal securities laws for a simple reason - that concept does not exist under the law!

Every sale of stock in the United States is either (1) registered, (2) exempt from registration, or (3) illegal.  Generally, sales of stock may be registered, but not the shares of stock themselves.  Therefore, even if a person acquires stock in a registered offering, that person cannot "freely trade" those shares.  Each transaction in shares of stock must be individually evaluated to determine whether or not the shares can be further traded without registration.

Most open market sales of stock (such as buying or selling shares of stock traded on the New York Stock Exchange) are exempt from registration by virtue of Section 4(1) of the Securities Act of 1933, as amended, which exempts "transactions by any person other than an issuer, underwriter, or a dealer." 

The term "freely tradable" is often used to describe restricted securities which may be sold in accordance with Rule 144.  An explanation of Rule 144 is beyond the scope of this blog post, but it should be noted that compliance with Rule 144 can depend upon a number of factors, such as whether or not the seller is an affiliate of the issuer, the volume of recent sales made by the seller, whether or not the sales are made through a broker, whether or not current public information about the issuer exists, the length of time the seller has held the shares, etc.  Accordingly, it is very difficult to declare that any shares are "freely tradable."   One may be able to say that a particular sale may be made in compliance with Rule 144, however.

E-Corporate Law Paper

Have you ever wondered if clicking "I accept" on a website was legally binding?  Or when can you "sign" a document by fax or e-mail?

I presented a paper to the UT-CLE Securites Regulation Conference earlier this month on E-Corporate Law.  The paper analyzes Texas, Delaware, and U.S. federal law regarding electronic contracting and electronic corporate formalities (such as directors taking action by unanimous written consent in lieu of a meeting).  It includes an analysis of the Electronic Signature In Global and National Commerce Act (E-Sign) and the Uniform Electronic Transactions Act (UETA).   

A copy of the paper is available on Cantey Hanger's website here:  http://www.canteyhanger.com/content/Clayton_SR11_paper_revised_02_10_11.pdf

  

Texas State Securities Board Commissioner Retires

Denise Voigt Crawford has been the Texas State Securities Board Commissioner since 1993.  She will be stepping down this month after 17 years of service in that roll.  I have had the pleasure of serving with Ms. Crawford on the Planning Committee for the University of Texas's Annual Conference on Securities Regulation and Business Law for several years, including serving on a panel with her discussing unregistered private offerings or securities and unregistered broker dealers at the 2010 conference.  Ms. Crawford is a true professional and a national leader in securities regulation and investor protection.  She will be missed. 

SEC Proposes Changes to Accredited Investor Definition

On January 25, 2011, the SEC proposed amendments to the definition of "accrdited investor" for the purposes of private placements under Regulation D and Section 4(5) (f/k/a Section 4(6)) of the Securities Act of 1933. 

As readers of this blog surely know, accredited investors are those more affluent investors who are deemed by the SEC to be sophisticated enough able to make investment decisions in private placements without the benefit of many of the issuer disclosure and registration requirments otherwise required by the Securities Act. 

For many years, among the parties who could claim accredited investor status was an investor who was a natural person with an invidual net worth, or joint net worth with that investor's spouse, in excess of $1,000,000.  Until the adioption of the Dodd-Frank Act in July of 2010, an investor could include the value of his or her home in determining whether or not the $1,000,000 threshold had been met.

As required by the Dodd-Frank Act, the definition of accredited investor now excludes the value of the primary residence of a natural person.  The SEC's proposed rules go on to clarify that the statutorily required phrase "excluding the value of the primary residence of such natural person" should be interpreted to mean that the natural person's net worth should be "calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property."

The purpose of the proposed rule changes are to (1) implement the definition change otherwise required by the Dodd-Frank Act, and (2) clarify that the investor's net worth will be calculated by excluding only the investor's net equity in the primary residence (not the entire value of the investor's home).

Intersection of Law and Business

Why do I have a picture of Wall Street as the wallpaper for this blog? 

Well, for one thing, it comes free with Google's Blogger application.  For another, it really captures the essence of corporate and securities law - the place where money, people, ideas, plans, and dreams come together to build businesses and the whole U.S. economy.

To practice corporate and securities law is to operate at the intersection of law and business.  That was the mantra of Ron Frappier, one of the finest securities lawyers around and the former head of the corporate and securities law section of Jenkens & Gilchrist, P.C.   He even wrote an excellent article elaborating on that topic which is available here: http://roadaccidentlawyer.com/the-intersection-of-law-and-business. 

What Ron understood better than most attorneys is that knowing the law is great, but knowing how the law impacts a client's business is much more important.  Clients generally want real world, practical business advice in light of legal risks ("What should I do now?") - not a 25 page memorandum exhaustively analyzing every nuance of a legal question without reaching an actual conclusion. 

That's the intersection of law and business - and it's something try to keep in mind every day.        

Raising Capital for the Future of Your Business

NET Business Resource magazine has published an article I wrote on Raising Capital for the Future of Your Business in its Jan/Feb 2011 issue.  Here is a link to the article:

http://www.branchsmith.com/eBook/GREN/27800_GREN/27800_GREN/flash.html#/40/

Texas Two-Step Trap for Secured Lenders

When is a secured lender not a secured lender?  When a loan guarantor steps into the secured lenders shoes through subrogation following foreclosure of the borrower's equity.  Suddenly, the lender owns the equity of the borrower, but the guarantor has a lien on the borrower's assets!  It's what I call the Texas Two-Step Trap. 

Allow me to back up and explain.  Let's say a Bank lends $20,000,000 to Borrower, which loan is secured by (1) all of Borrower assets, (2) a guaranty of the loan by Guarantor, the 100% owner of Borrower, and (3) a pledge of all of the stock of Borrower by Guarantor.  Now let's say Borrower defaults on the loan and Bank acquires all of Borrower's stock pledged by Guarantor at a foreclosure sale with a credit bid equal to all amounts owed to Bank by Borrower under the loan.  So now Bank owns all of the stock of Borrower and the debt has been extinguished.

But wait.  Bank has exercised its right to enforce the guaranty against Guarantor, thereby giving Guarantor the right to seek reimbursement from Borrower.  Guarantor probably also has a right of subrogation to step into Bank's shoes as a secured creditor of Borrower.  Hence, now the Guarantor is structurally ahead of Bank with regard to claims against the assets of Borrower! 

One possible way for Bank to avoid this Texas Two-Step Trap is to make sure its credit bid is for an amount less than 100% of the oustanding balance of Borrower's loan.  Guarantees typically provide that the Guarantor waives its right of subrogation until the lender has been paid in full. 

Thanks to Lynn Soukup and Steven Weise who explored this hypothetical in their CLE presentation earlier today.