Copyright 1992. All Rights Reserved

By Nicholas G. Karambelas, Esq.

[PUBLISHED IN SEPT./ OCTOBER 1992 ISSUE OF WASHINGTON LAWYER MAGAZINE Vol. 7 No. 1]

As D.C. lawyers have long recognized, the D.C. corporations law set forth at D.C. Code § 29-101 et seq. is confusing, cumbersome and antiquated. While neighboring jurisdictions have enacted corporations laws which reflect contemporary legal thought on corporate governance, the D.C. corporations law has not been substantially revised since 1954. It is not unusual for D.C. lawyers to advise clients to incorporate in the neighboring jurisdictions or in Delaware so that they can benefit from the advantages of a modern corporations law.

The purpose of the District of Columbia Corporation Law Revision Act of 1992 (Act 9-224 and referred to as "the Act"), introduced by Councilmembers John Ray and William Lightfoot as Bill 9-64, is to rectify this situation and provide for a modern and functional corporations law. The Act is the first of other anticipated legislative drafting activities by the D.C. Corporation Code Revision Project. The Project is chaired by Frank B. Goldstein of Morgan, Lewis & Bockius, and which includes representatives from the D.C. Council, the Department of Consumer and Regulatory, D.C. Bar, the D.C. Law Revision Commission and members of the Bar and intends to consult with the D.C. Council on a continuing basis to modernize and revise the D.C. corporations law.

Consistent with that age-old precept of law-making which holds that it is more prudent to amend existing law rather than to enact new law, the Act revises and modernizes selected existing provisions of the corporations law. It does not aspire to repeal the existing corporations law and replace it with a new law. The Act accomplishes the following four fundamental tasks: (1) Reconciles the two basic corporations statutes of D.C. known as the District of Columbia Business Corporation Act of 1901, (referred to as "the 1901 statute") and the District of Columbia Business Corporation Act of 1954, (referred to as "the 1954 statute), (2) Modernizes the 1954 statute by modifying certain basic corporate governance provisions and regulatory requirements, (3) Adds corporate governance provisions exclusively for closely held corporations along with regulatory requirements incident to those provisions and (4) Rationalizes the regulation of foreign corporations operating under a certificate of authority and provides a simple procedure under which a foreign corporation can become a domestic D.C. corporation.

The complete text of the Act appears in the D.C. Register, Vol. 39-No.2 7 of July 3, 1992 at pages 4863-4894 with cross references to those provisions of the D.C. Code §29-101 et seq. (1981 Edition) which are amended or to which additions have been made. Since the text of the Act, which will appear in the 1993 Cumulative Supplement to Volume 6 of the D.C. Code (1981 Edition), will not be available until July, 1993, statute references in this Article shall be to the sections of the Act as they appear in the D.C. Register. Practitioners seeking to consult the text of any of the provisions discussed in this Article should refer to the appropriate sections of the Act as they appear in the D.C. Register. The Act shall take effect after the 30-day Congressional review period has expired.

I. RECONCILING THE 1901 STATUTE AND THE 1954 STATUTE

[SECTIONS 2 AND 3]

The District of Columbia enjoys the distinction of actually having two antiquated corporations statutes in effect, the 1901 statute and the 1954 statute. One of most fundamental and laudable provisions of the Act is to finally reconcile the two corporations statutes. As many a young associate asked to draft articles of incorporation will attest, it is unclear from the texts of the two statutes which provisions, if any, of the 1901 statute are pre-empted by the 1954 statute and how or whether the two statutes relate to each other.

The Act eliminates this uncertainty by providing that the 1954 statute (including almost all of the amendments set forth in the Act) applies to all corporations formed on or after June 8, 1954. For corporations formed before June 8, 1954, the Act could have simply repealed the 1901 Act and required these corporations to comply with the 1954 Act as amended by the Act. Instead, recognizing that there is a number of corporations formed prior to the effective date of the 1954 Act, the Act allows these corporations to continue to function under the corporate governance provisions of the 1901 Act. However, the Act does impose three regulatory requirements on all corporations formed prior to June 8, 1954. These corporations shall (1) maintain a registered office in D.C., (2) appoint a registered agent and (3) file annual reports with the Mayor as do post-1954 corporations. All pre-1954 corporations must comply with these requirements within six months after the date on which the Act takes effect they will forfeit their charters, in which case, their names shall become available for use in D.C.

 

II. SELECTED AMENDMENTS TO THE 1954 STATUTES

A. Consent of Registered Agent to Act as Registered Agent [Section 4(b)]

Under current law, an individual or corporation can be appointed to act as the registered agent for a corporation without being informed of the appointment. The Act requires that the registered agent consent to the appointment and that such consent be demonstrated either by a written statement executed by the registered agent or by a written certification by the incorporator(s) that the registered agent has consented to the appointment.

B. Uncertificated Shares, [Section 4(i)]

Under current law, shares in a corporation must be evidenced by share certificates. The Act allows a corporation to provide by resolution of the board of directors that some or all classes or series of stock may be uncertificated shares, i.e. need not be evidenced by share certificates.

Unless otherwise provided by law, the rights and obligations of holders of uncertificated shares and holders of certificated shares shall be identical. Within a reasonable time after the issuance or transfer of uncertificated shares, a corporation which is authorized to issue more than one class of shares must send to the holder, without charge, a full or summary statement of the relative rights, limitation and preferences of each class of shares which the corporation is authorized to issue.

C. Minimum of One Director Instead of Three [Section 4(m)]

Under current law, the minimum number of directors is three. The Act decreases the minimum number of directors to one. All other provisions governing the election and qualification of directors remain the same.

D. Minimum Of One Officer Instead of Minimum of Two Officers [Section 4(n)]

Under current law, a corporation must elect at least a president, a vice-president, a secretary and a treasurer. More than one individual can hold more than one office except that the offices of president and secretary cannot be held by the same individual. Therefore, at least two individuals must be elected as officers. The Act requires that a corporation elect only a president and that it may elect such other officers as it chooses. Consequently, the requirement that at least two individuals be elected officers is effectively eliminated.

E. Minimum Of One Incorporator Instead Of Three [Section 4(o)]

Under current law, at least three natural persons of age eighteen or more must serve as incorporators. The Act provides that one or more such persons shall serve as incorporators. There is simply no reason to require three incorporators and many other jurisdictions require only one incorporator.

F. Less Than Two-Thirds Vote Of Shares On Extraordinary Corporate Matters, [Section 4(q)]

Under current law, there are six extraordinary events which cannot occur unless at least two-thirds of the shares entitled to vote affirmatively vote to cause them to occur. The six events are amendment of the articles of incorporation, reduction in stated capital, merger or consolidation, sale or other disposition of all or substantially all of the corporate assets, voluntary dissolution and revocation of voluntary dissolution.

The Act allows the margin of the affirmative vote on these six events to be less than two-thirds of the shares entitled to vote as long as the margin is stated in the articles of incorporation and as long as that stated margin is not less than a simple majority of the shares entitled to vote.

G. Restatement of Articles of Incorporation [Section 4(s)]

The current law does not set forth a provision under which a corporation can integrate into a single document its original articles of incorporation and any amendments to the original articles of incorporation. The Act provides a means by which a corporation which had amended its original articles of incorporation could integrate the original and all such amendments into one document. Therefore, whenever a corporation is required to produce its articles of incorporation (e.g. for an ABC application or an SBA application), it can produce a single document rather than the original document and then all documents containing any amendments.

H. Merger or Consolidation of a Corporation with a Limited Partnership, [Section 4(z)]

The current law does not empower corporations to merge or consolidate with limited partnerships although the District of Columbia Limited Partnership Act of 1987 (D.C. Code § 41-201 et seq.) empowers limited partnerships to merge or consolidate with, inter alia, corporations. The Act resolves this ambiguity by empowering corporations to merge or consolidate with limited partnerships.

The Act requires the corporation and the limited partnership to conclude a written plan of merger or consolidation setting forth the terms and conditions of the plan, the mode of effecting the plan, the manner and terms of converting the shares into partnership interests or partnership interests into shares, as the case may be and any other relevant information. Each corporation and each limited partnership shall file articles of merger and consolidation which set forth the plan of merger or consolidation and a statement that the plan was duly approved in accordance with the articles of incorporation and limited partnership agreement.

I. Other Provisions

The Act eliminates the requirement that corporate documents be verified, attested or affixed with the corporate seal in each instance in the 1954 statute where such requirement is found. The Act increases the fees for filing various documents under the 1954 statute.

III. GOVERNANCE PROVISIONS FOR CLOSELY HELD CORPORATIONS

[SECTION 4(bbb)-(qqq)]

Many jurisdictions, including Maryland and Virginia, have enacted corporate statutes which distinguish between a closely-held corporation and a public-issue corporation. These statutes recognize that in a closely-held corporation there is substantial identity between and among the shareholders, directors and officers so that the traditional formalities and principles of corporate governance are an unnecessary burden. The operative document in such corporations is the shareholder agreement rather than the by-laws or corporate resolutions.

The Act imports into the D.C. law the concept of the "close corporation" and the provisions are patterned on the Delaware Close Corporation Statute. The "close corporation" is designed to permit corporations having an identity of ownership and management to arrange their internal affairs in a manner which meets their specific needs while still maintaining the limited liability and other advantages afforded by the corporate form.

A. Definition and Formation of a Close Corporation

The legal definition of close corporation is functional rather than substantive so that as long as the following three qualifying conditions are satisfied and maintained, a corporation will be a close corporation: (1) the number of shareholders of record shall not exceed thirty-five and all issued shares shall be represented by share certificates, (2) all of the shares of all classes shall be made specifically subject to at least one of the restrictions on transfer permitted by D.C. Code §29-320 and (3) the corporation shall not offer its shares in any manner which would constitute a "public offering" as defined by the Securities Act of 1933, as amended.

A close corporation is formed in the same way as any other corporation except that, in addition to all other statements required under the 1954 statute, the articles of incorporation shall contain a heading setting forth the name of the corporation and that it is a close corporation. The articles of incorporation shall also recite the three qualifying conditions set forth in the preceding paragraph and affirmatively state that the close corporation shall comply with those conditions.

Any corporation formed under either the 1901 statute or the 1954 statute may elect to become a close corporation by filing articles of amendment which comply with the 1954 statute and which also state (1) that the corporation elects to become a close corporation, (2) the three qualifying conditions of a close corporation and (3) a heading stating the name of the corporation and that it is a close corporation. The articles of amendment shall be adopted in accordance with the Act except that the articles must be approved by a vote of the shareholders of record of at two-thirds of the outstanding shares of each class of stock of the corporation.

B. Termination of Close Corporation Status

The close corporation status may be terminated either by the voluntary act of the corporation or if one or more of the qualifying conditions is breached for any reason. A corporation may voluntarily terminate its close corporation status by filing articles of amendment which delete from the articles of incorporation the qualifying conditions and the heading stating that the corporation is a close corporation. The articles of amendment shall be adopted in accordance with the Act except that the articles must be approved by a vote of the shareholders of record of at least two-thirds of the outstanding shares of each class of stock of the corporation.

The close corporation status shall terminate as a matter of law if shares of the corporation are issued or transferred in way that breaches one or more of the qualifying conditions. Therefore, if the corporation issues shares to more than thirty-five persons or makes a public offering of its shares or a transfer of shares is made in violation of the transfer restrictions in violation of D.C. Code §29-320, then the close corporation status will terminate.

The involuntary termination is, however, not effective until thirty days after the occurrence or discovery of the event, whichever is later, which breaches a qualifying condition. If, during that thirty-day period, the corporation files a certificate executed by its president or vice-president with the Mayor and furnishes a copy to each shareholder stating the qualifying condition which has been breached and, concurrently with the filing, takes steps necessary to correct the breach, then the close corporation status shall continue in full force and effect. The Act specifically empowers the corporation or any shareholder to seek injunctive relief to prevent any threatened transfer or to set aside any transfer which would terminate close corporation status.

C. Management and Operation of the Close Corporation

The most significant practical advantage of the close corporation is that the shareholders can manage and operate the corporation with respect to all matters, both ordinary and extraordinary, as if it were a partnership and without a board of directors. Where the shareholders chose to manage the corporation without directors, they would be considered directors and subject to the same liabilities as directors but they would not be subject to the personal liability of partners.

Where the shareholders chose to manage the corporation without directors, the Act sets forth a procedure for the appointment of a custodian upon application to the court by any shareholder if the shareholders have become so divided and deadlocked that the business is suffering or is threatened with irreparable harm. Where directors manage the business of the corporation, the Act also sets forth a procedure for the appointment of a provisional director upon application to the court of at least one-half of the directors or one-third of the shareholders if the directors are so divided that the votes required for board action cannot be obtained and the business can no longer be conducted for the benefit of the shareholders.

The key document in a close corporation is the shareholder agreement. The shareholder agreement for the close corporation will be as fundamental to the corporation as the partnership agreement is to the partnership. Many of the governance concepts embodied in partnership agreements will be relevant to the close corporation agreement such as allocation of profits and losses, duties and responsibilities, disposition of shares upon transfer or death, operational matters and events in dissolution. The most significant service the practitioner will perform in the formation of a close corporation will be to draft a comprehensive and competent agreement.

The Act permits the shareholders or any single shareholder to dissolve the corporation upon any terms and conditions which the shareholders deem acceptable as long as the terms and conditions are set forth in the articles of incorporation and as long as all shareholders receive notice of the dissolution at least 30 days prior to the effective date of dissolution.

IV. FOREIGN CORPORATIONS, [SECTION 4(ii)-(tt)]

The Act clarifies those activities in which a foreign corporation authorized to invest in loans secured by real estate may engage without having to procure a certificate of authority to do business.

Under current law, a foreign corporation which has a name which is deceptively similar to the name of a D.C. corporation cannot procure a certificate of authority under any circumstances. The Act allows such a foreign corporation to procure a certificate of authority as long as the corporation files a board resolution adopting the use of a fictitious name in D.C. which is not deceptively similar to the name of a D.C. corporation.

The Act sets forth a simple procedure by which a foreign corporation which is duly qualified to do business in D.C. may in effect "re-incorporate" under the laws of D.C. Upon the filing of articles of domestication, the foreign corporation shall be deemed a domestic corporation and entitled to all rights, privileges and obligations of domestic corporations.