Some registrants may find that they nonetheless have an obligation to file or furnish a Form 8-K as a result of the new tax law.  As pointed out by Gibson Dunn & Crutcher and noted by Broc, issuers need to be mindful of the possibility that their public announcements will trigger an obligation to furnish a Form 8-K pursuant to Item 2.02.

My own addition to the list of possible Form 8-K triggers is Item 2.04 (Triggering Events That Accelerate or Increase a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Agreement).  It seems to me that it is at least conceivable that some financial covenants may be triggered by a re-measurement of deferred tax assets.  Of course, this will depend on the nature of the covenant and the magnitude of the re-measurement.

The no-name tax law

Section 11000(a) of the Senate engrossed amendment of H.R. 1 on December 14, 2017 read as follows: “(a) Short title.—This title may be cited as the ‘Tax Cuts and Jobs Act'”.  The enrolled version of the bill omits this language although numerous provisions of the bill explicitly refer to the “Tax Cuts and Jobs Act”.  See, e.g., Section 12002.

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How it began . . .

The case started with the plaintiff’s decision to retire and sell three of his businesses.  He hired an investment banker who duly found a buyer.  The plaintiff wanted cash.  Ultimately, the parties agreed on a mostly cash deal with some preferred stock.  This preferred stock became a problem for the parties because the plaintiff’s insistence on a guaranteed redemption in three years would create an immediate taxable event.  After some discussions, the plaintiff extracted an oral agreement to repurchase the stock.

Three agreements

According to the Court of Appeal, there were three key written transaction agreements: (1) a contribution and purchase agreement, (2) a stock subscription agreement, and (3) a stockholder agreement.  The parties were represented by large law firms in their negotiation of these agreements.  All three agreements included an integration clause.  When the oral promise to redeem was not honored, the plaintiff sued.

Choice of law and the parol evidence rule

The first issue for the Court of Appeal was the question of applicable law.  The contribution and purchase agreement included a California choice-of-law provision while the stock subscription and stockholder agreements had a Delaware choice of law provision.  The Court of Appeal applied California law to the contribution and purchase agreement and Delaware law to the other two agreements.  As an initial matter, one might question whether a contractual choice of law provision would dictate the application of the parol evidence rule on the basis that the rule is procedural and not substantive.  However, California courts consider the parol evidence rule to be a rule of substantive law and not of evidence.  See
Hutchinson v. Hutchinson, 48 Cal. App. 2d 12, 19, 119 P.2d 214, 217 (1941).

For more on the parol evidence rule, see this post from two years ago.

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The Nevada Supreme Court refused to grant extraordinary writ relief, explaining:

Mandamus is an important escape hatch from the final judgment rule, but such relief must be issued sparingly and thoughtfully due to its disruptive nature.  Advisory mandamus, like any form of interlocutory review, carries the significant negative risks of delaying the ultimate resolution of the dispute and undermining the “mutual respect that generally and necessarily marks the relationship between . . . trial and appellate courts”.   Bauman v. U.S. Dist. Court, 557 F.2d 650, 653 (9th Cir. 1977).

This is not the end of the road for the defendants.  As the Supreme Court pointed out, they will have further opportunities to present their arguments at summary judgment, or to the Supreme Court on appeal or, even, in another writ petition depending upon discovery and the eventual substantive motion practice that may ensue.

Giving a hand to mandamus

For the etymology of “mandamus” and California’s two forms of mandamus, see this post from August, 2016.

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The following description summarizes important terms of our capital stock. For a complete description, you should refer to our certificate of incorporation and bylaws, as well as the relevant portions of the Nevada General Corporation Law chapter 78, or the NRS (Nevada Revised Statutes).

After deregistration of our shares, our stockholders will have access to our corporate books and records to the extent provided by the Nevada General Corporation Law, and to any additional disclosures required by our directors’ and officers’ fiduciary duties to the Company and our stockholders.

Furthermore, the Company may maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of the Company or another company against any expense, liability or loss, whether or not the Company would have the power to indemnify such person against such expense, liability or loss under the Nevada General Corporation Law.

The problem with these statements is that they refer to a non-existent law.  Nevada does have a general law providing for the organization of corporations, but it does not carry the name “Nevada General Corporation Law”.  It is simply Chapter 78 of Nevada Revised Statutes.  (Note that the definite article “the” should not precede Nevada Revised Statutes.  See, NRS 0.010.)

Chapter 78 is fairly characterized as a general corporation law because it provides for the formation of corporations generally, as opposed to the formation of a specific corporation.  Until 1860, state legislatures created corporations by special acts.  Eventually, the practice of special charters gave way to general laws.  Nevada’s constitution, which dates to 1864, actually prohibits, with certain exceptions, the creation of corporations by special legislative act:

The Legislature shall pass no Special Act in any manner relating to corporate powers except for Municipal purposes; but corporations may be formed under general laws; and all such laws may from time to time, be altered or repealed.

Art. 8, Section 1.  None other than the United States Supreme Court has explained the impetus for banning incorporation by special act:

The desire for equality and the dread of special privilege were largely responsible for the general incorporation laws as indicated by the fact that many states included in their constitutions a prohibition on the grant of special charters.

Louis K. Ligget Co. v. Lee, 288 U.S. 517, 549, n.4 (1933) (citing Nevada’s constitution).

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City of Birmingham Ret. & Relief Sys. v. Good, 2017 Del. LEXIS 522 (Dec. 15, 2017) involved a derivative suit against certain directors and officers of Duke Energy Corporation after the company had pled guilty to nine misdemeanor criminal violations of the Federal Clean Water Act and paid a fine of over $100 million.  After the directors moved to dismiss for failure to make a pre-suit demand, the plaintiffs argued that “demand was futile because the board’s mismanagement of the Company’s environmental concerns rose to the level of a Caremark” [In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996)].  Under Caremark, the plaintiffs must allege that the directors intentionally disregarded their oversight responsibilities such that their dereliction of fiduciary duty rose to the level of bad faith.  The plaintiffs conceded that they were required to plead sufficient facts showing that Duke Energy’s board knew that its state regulator was a “captive regulator” with whom the company was “colluding”.

The Delaware Supreme Court agreed with the Court of Chancery’s description of the plaintiffs’ pleading target:

As the Court of Chancery found, it is not enough to allege cooperation with what plaintiffs describe as a too-friendly regulator. Instead, the plaintiffs must allege in sufficient detail that Duke Energy illegally colluded with a corrupt regulator.  And then, plaintiffs must tie the improper conduct to an intentional oversight failure by the board.  The complaint falls short of these pleading requirements.

(Footnotes omitted).  The Supreme Court affirmed the Court of Chancery’s conclusion that the plaintiffs’ had missed their mark.

If Robert Mueller is looking for collusion, he need not go any further than the following footnote to the Supreme Court’s opinion:

In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975, 2005 WL 5756357, at *31 n.50 (Del. Ch. 2005) (quoting Merriam-Webster’s Online Dictionary (10th ed. 1993)) (defining collusion as “a secret agreement or cooperation, especially for an illegal or deceitful purpose”); see also Dickerman v. N. Tr. Co., 176 U.S. 181, 190, 20 S. Ct. 311, 44 L. Ed. 423 (1900) (“Collusion is defined by Bouvier as ‘an agreement between two or more persons to defraud a person of his rights by the forms of law, or to obtain an object forbidden by law,’ and in similar terms by other legal dictionarians.”); Sidman v. Travelers Cas. & Sur., 841 F.3d 1197, 1206 (11th Cir. 2016) (quoting Collusion, Webster’S 3d New Int’l Dictionary 446 (2002)) “Dictionary definitions of collusion include a ‘secret agreement,’ ‘secret cooperation for a fraudulent or deceitful purpose,’ ‘a secret agreement between two or more persons to defraud a person of his rights often by the forms of law,’ an ‘agreement between parties considered adversaries at the law,’ and ‘a secret agreement considered illegal for any reason.'”).

If we trace the etymologic roots of the word, it is derived from a Latin word, collusio, which means a secret agreement.  The Latin word itself is derived from two words (cum and ludere) meaning to play together.

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• the median of the annual total compensation of all employees of a registrant (excluding the chief executive officer),
• the annual total compensation of that registrant’s chief executive officer, and
• the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

The SEC duly responded to Congress’s mandate and issuers are required to make these disclosures for their first fiscal year beginning on or after January 1, 2017.

The SEC’s approach in Item 402(u) of Regulation S-K assumes the existence of a “median employee”.  For example, Instruction #1 begins “Registrants may use reasonable estimates both in the methodology used to identify the median employee . . .”.  But what if there is no “median employee”?  Is that even possible?

As discussed in the adopting release, a median is not the same thing as an average.  The median is the middle number in a sequence of numbers.  For example, the median in the a sequence of 10, 20 and 30 is 20 (the average of the sequence is also 20 (10+20+30/3)).  Some sequences, however, contain an even number; for example 10, 20, 30 and 40.  In this sequence there is no middle, but there is a median.  It is 25, or the average of the two middle numbers in the sequence.  The average of the sequence is also 25 (100/4).

The SEC knows what a median is and even explains the concept in footnote 314 of the adopting release.  The SEC, moreover, knows the problem with even numbered sequences:

Another commenter suggested that, where a registrant has an even number of employees and, therefore, is unable to select one median employee, the registrant should be permitted to select and disclose an average of the compensation of the two employees nearest the median.

Knowing that in some cases there will be no middle person, the SEC nonetheless persists in the fiction that the median employee is an actual person and not sometimes an average.  For example, the adopting release states:

For example, if the median employee identified in year one is no longer employed by the registrant in years two or three . . . the registrant is permitted to identify its median employee in each of the following two years from among employees that had similar compensation to the median employee in year one.

At least one issuer has recognized that there will not always be a real, live median employee: “since we have an even number of employees when not including the CEO, determining the average of the annual total compensation of the two employees ranked sixth and seventh on the list (“Median Employee”).”  Novagold Resources Inc. (filed 3/23/2017).

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A sheriff’s sale of shares pursuant to a writ of execution is a nonissuer transaction, i.e., a transaction not directly or indirectly for the benefit of the issuer.  See Cal. Corp. Code § 25011.  A sheriff won’t have to worry about qualifying sales because Corporations code Section 25014(f) provides that the qualification requirements of Section 25130 do not apply to the following:

Any transaction by an executor, administrator, sheriff, marshal, receiver, trustee in bankruptcy, guardian, or conservator.

The word “sheriff” is derived from “shire” and “reeve”.  A “shire” was a name a county in England and a “reeve” was an official appointed by the King.  The word appears multiple times in the Magna Carta. For example, Section 30 states: “Nullus vicecomes, vel ballivus noster, vel aliquis alius, capiat equos vel carettas allcujus liberi hominis pro cariagio faciendo, nisi de voluntate ipsius liberi hominis (“Let no sheriff, bailiff or anyone else, seize the horses or carts of any free man for making transport, except by the consent of the freeman himself”).

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In Duke v. Superior Court, Cal. Ct. Appeal Case No. F073712 (filed 11/21/2017; certified for publication 12/13/2017) involved three guarantors of a commercial lease. All three guarantors were shareholders in the corporate lessee.  After the lessor had obtained a judgment against the corporation and its three guarantors, two of the guarantors settled with the lessor and took an assignment of the judgment.   The two guarantors then levied on the third guarantor’s shares.  They then purchased the shares at the ensuing sheriff’s sale.

The third guarantor then sued the other two; alleging, among other things, conversion.  Now defendants themselves, the two guarantors successfully demurred to the conversion claim.  The Fifth District Court of Appeal held that the two guarantors had acted improperly because they had enforced the full amount of the judgment against the third guarantor rather than a proportionate share of the judgment.  It then turned to the question of whether the sale supported a conversion claim.

Not surprisingly, the two guarantors argued that even if the writ of execution was improper, it is not conversion if they had acted in accordance with judicial process.  The Court of Appeal disagreed:

Our conclusion is guided by common sense and a practical application of the elements of conversion.  Here real parties used a writ of execution, subscribed by a clerk rather than a judge, to levy all of Duke’s shares of stock in Skinsation. . . . Accepting Duke’s allegations as true, it appears that the parties intentionally over-enforced the judgment to divest Duke of all control and ownership in Skinsation.

The procedural posture of the case is important.  Neither the trial court nor the Court of Appeal held that the defendants were liable for conversion.  In fact, the Court of Appeal noted that “nothing shall prevent real parties from challenging Duke’s conversion claim pursuant to a motion for summary judgment, or challenging this cause of action by a subsequent appeal”.  Or, as Yogi Berra famously quipped, “It ain’t over ’til it’s over.”

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[A]ny cannnabis cooperative that is organized pursuant to this chapter [Chapter 22, commencing with § 26220] .  An association shall be deemed incorporated pursuant to this chapter, or organized pursuant to this chapter and shall be deemed a cultivator of a cannabis product within the meaning of this chapter, if it is functioning under, or is subject to, the provisions of this chapter, irrespective of whether it was originally incorporated pursuant to those provisions or was incorporated under other provisions.

Amazingly, the legislature has apparently seen fit to grant these associations a blanket exemption from the California Corporate Securities Law (Cal. Corp. Code § 25000 et seq.):

An association is not subject in any manner to the terms of the Corporate Securities Law (Division 1 (commencing with Section 25000) of Title 4 of the Corporations Code), and any association may issue its membership certificates or stock or other securities as provided in this chapter without the necessity of any qualification under that law.

Bus. & Prof. Code § 26228.  Note that the statute isn’t limited to an exemption from the qualification requirements of the CSL.  Thus, the legislature seems to have granted the association a pass on the antifraud provisions as well.  Moreover, the exemption isn’t limited to the offer and sale of its stock or memberships.  Seemingly, therefore, an association could sell millions, or even billions, of dollars of promissory notes to the public without qualification under the CSL.  It is beggars belief that the legislature intended to countenance such a result.

Of course, this California statute does not provide any exemptions from the federal securities laws or the securities laws of other states.  Nor does the statute provide an exemption from other California laws, including anti-fraud statutes outside of the CSL.  Finally, I expect that courts will do their best to construe the statute as narrowly as possible.  Therefore, no association should interpret this blog as advice that it is now free to lie, cheat and steal with impunity.

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