“Mother, should I trust the government?”
– Pink Floyd
That question answers itself, does it not?
I’m pretty sure Pink Floyd did not have form documents promulgated by
the Texas Secretary of State’s office in mind when those lyrics were
written. Nonetheless, it’s a helpful
reminder that you often get what you pay for when it comes to free legal forms. Or perhaps the economic maxim of TANSTAAFL (“There
ain't no such thing as a free lunch”) would be a more suitable reference.
Regardless, for those looking to incorporate a Texas for-profit
corporation, I do not recommend using the Texas Secretary of State’s form of
Certificate of Formation (Form 201), which is available on the Secretary of
State’s website here.
What’s so bad about Form 201?
Well, nothing is horrible about it – you could certainly file it (and
pay the related filing fee) and have yourself a functioning Texas for-profit corporation. But an experienced Texas corporate lawyer is
likely to suggest a using a form of Certificate of Formation that includes
other helpful provisions in addition to the minimum required provisions
dictated by the Texas Business Organizations Code (TBOC).
For example, Form 201 does not include any of the following provisions
which are common for Texas for-profit corporations:
Director
Exculpation. As a rule,
directors do not like to be subject to potential personal liability in
connection with their service as a director of a corporation. So Texas
corporations often elect to take advantage of Section 7.001 of the TBOC, which
permits a Texas corporation to exculpate (relieve from liability) its directors
from liability to the corporation or its shareholders. They may achieve director exculpation by adopting
a director exculpation provision as part of the corporation’s Certificate of
Formation. The basic Form 201 does not
include a director exculpation provision, though one could elect to supplement
the basic Form 201 by adding such a provision (or any of the other provisions
discussed below). Our clients typically elect to include a director exculpation
provision in their Certificate of Formation when forming a new Texas
corporation.
Mandatory
Indemnification of Directors and Advancement of Expenses. Likewise,
directors typically think it’s a good idea to have corporations on which they
serve indemnify (cover the costs of) directors from potential liability arising
from their service as a director. While exculpation relieves directors of
liability to the corporation and its shareholders, indemnification protects
directors from claims made by third parties. Section 8.101(a) of the TBOC
permits Texas corporations to indemnify its directors who gets sued by a third
party because of their service as a director so long as the director (1) acted
in good faith, (2) reasonably believed that his or her actions taken in an
official capacity were in the corporation’s best interest, (3) reasonably
believed that his or her actions in all other cases were not opposed to the
corporation’s best interests, and (4) in the case of criminal proceedings, did
not have reasonable cause to believe his or her conduct was unlawful.
Section 8.103(c) of the TBOC permits a
Texas corporation to adopt a provision as part of its Certificate of Formation
which makes permissive indemnification mandatory. That means that once it has been determined
that a director has met the 4-part standard described in the previous paragraph
for a corporation to be permitted to indemnify a director, then the corporation
would be required to provide such indemnification for the benefit of the
director.
Of course, sometimes it is unclear at
the outset of a suit against a director whether or not the director has met the
standard for permissive indemnification. Meanwhile, the director may be
incurring substantial expenses in defending himself or herself against third
party claims. In cases where it has not yet been determined if the director has
met the standard for permissive indemnification, Section 8.104(a) of the TBOC
permits Texas corporations to advance expenses to directors in connection with
their defense of a claim, so long as the director provides a written statement confirming
that (1) the director believes he or she has met the standard for permissive
indemnification, and (2) the director will repay any expenses advanced if it is
ultimately determined that he or she has failed to meet the standard for
permissive indemnification.
Section 8.104(b) of the TBOC permits
corporation to adopt a provision in part as part of its Certificate of Formation
requiring the corporation to advance expenses to directors who have provided
the written confirmation described in the previous paragraph. As one might
expect, directors of Texas corporations typically think it is a good idea to
include such an advancement of expenses provision in the corporation’s
Certificate of Formation.
Action
by Written Consent of less than all Shareholders. Let’s say you want to amend the
corporation’s Certificate of Formation to change the name of the
corporation. As with any other amendment
to the Certificate of Formation, that change requires the approval of the corporation’s
shareholders. If all shareholders are willing and able to sign a written consent approving the name change, then shareholder approval is fairly simple. But let’s further assume that all shareholders fully support the name
change, but one of the shareholders, holding only 1% of the corporation’s
outstanding shares of stock, is on vacation and is unable to sign a written
consent approving the name change. What
then? Well, if the name change is
important and the corporation does not have a provision in its Certificate of
Formation authorizing shareholder action by less than unanimous consent, the
only way the corporation may change its name is to call a meeting of the
shareholders to approve the name change. Such a meeting must be done in
compliance with applicable notice, quorum, proxy, and other provisions of the
corporation’s bylaws and relevant provisions of the TBOC. Finding a time and
place convenient for an adequate number of shareholders to attend in person or
by proxy may be difficult. On the other
hand, a corporation with a Certificate of Formation that includes a provision
permitting shareholder action by less than unanimous written consent of its
shareholders (as permitted by Section 6.202 of the TBOC) can very easily
circulate a written consent to its shareholders requesting approval of the name
change. Once signed by a sufficient
number of shareholders, the name change may proceed.
Section 6.204 of the TBOC provides that
a corporation need not provide advance notice to shareholders of shareholder
action taken by written consent, so depending upon the advance notice of a
shareholder meeting required in the corporation’s bylaws, the right of
shareholders to take action by written consent can be important when timing is
critical for a matter requiring shareholder approval.
Of course, that’s just of few of the possible
Certificate of Formation provisions ignored by the Secretary of State’s Form
201. A Texas corporation might elect to include all sorts of other provisions
in its Certificate of Formation, including provisions authorizing preferred
stock, providing for preemptive rights, providing for cumulative voting rights,
electing status as a “close corporation,” or adopting other provisions which
may be appropriate for some Texas corporations.
Bottom line, careful consideration should be given
to the options available to a new corporation before just grabbing Form 201 and
filing away.
