In May, Ohio enacted a number of changes to its corporation and limited liability company statutes. This update provides an overview of the more significant changes, which include:
- A new limitation on a corporation's ability to rescind articles providing for the indemnification of employees, officers and directors.
- A reduction in the minimum number of corporate directors from three to one.
- A more structured process for voluntary corporate dissolution and winding up.
- New limitations on dissenters' rights in transactions involving publicly traded shares and a new dissent procedure.
- The institution of mandatory fiduciary duties for members of limited liability companies, including a broad duty not to compete with the company.
This update also summarizes two recent Ohio Supreme Court cases that address Ohio corporation law. The first, Acordia of Ohio, L.L.C. v. Fishel, No. 2012 Ohio 2297 (Ohio Jan. 2012), addressed the enforceability of employee noncompete agreements with a corporate employer in the event of a subsequent statutory merger. The second, Miller v. Miller, No. 2012 Ohio 2928 (Ohio July 2012), clarified the scope of a corporation's duty to advance the litigation expenses of directors who may be entitled to indemnification.
Ohio's statutory changes arise out of House Bill 48, which became effective May 4, 2012. The bill contains a number of amendments to the Ohio General Corporation Law (Ohio Revised Code, Title XVII, Chapter 1701) (Corporation Law) and the Ohio Limited Liability Company Law (Ohio Revised Code, Title XVII, Chapter 1705) (Limited Liability Company Law). On June 26, 2012, Ohio also shortened the statute of limitations for actions on written contracts, which is discussed in Section III.
- OHIO GENERAL CORPORATION LAW
House Bill 48 amended four substantive areas of the Corporation Law: the indemnification of directors, officers and employees; the number of corporate directors; voluntary dissolution and winding up; and dissenters' rights. These topics are addressed in order below.
- Indemnification of Directors, Officers and Employees
Revised Section 1701.13(E)(6) limits a corporation's ability to retroactively extinguish a director's, officer's or employee's right to indemnification. The new final sentence of Section 1701.13(E)(6) provides:
A right to indemnification or to advancement of expenses arising under a provision of the articles or the regulations shall not be eliminated or impaired by an amendment to that provision after the occurrence of the act or omission becomes the subject of the ... action, suit, or proceeding for which the indemnification or advancement of expenses is sought, unless the provision in effect at the time of that act or omission explicitly authorizes that elimination or impairment after the act or omission.
(emphasis added). House Bill 48 also added this sentence to the end of the corresponding section of the Nonprofit Corporation Law, O.R.C. 1702.12(5)(b)(6). Corporations that want the flexibility to rescind an officer's or director's right to indemnification and advancement should revise their articles and regulations in accordance with Section 1701(E)(6). Such amendments will, however, come at a cost. The increased risk of shouldering their own litigation expenses may discourage officers and directors from serving. Corporations and their counsel should carefully weigh this drawback against the benefit of increased flexibility.
- Number of Directors
Prior to House Bill 48, Ohio required corporations to have at least three directors, with the caveat that "the number of directors may be less than three but not less than the number of shareholders." The amended version of Section 1701.56(A) simply provides: "the number of directors may be fixed by the articles or the regulations, but the number so fixed shall not be less than one."
- Voluntary Dissolution and Winding Up
House Bill 48 made a number of changes to the mechanics of voluntarily dissolving an Ohio corporation. Corporate counsel, especially the lawyers and professionals with primary responsibility for documenting and executing a voluntary dissolution, should review the rules carefully. The amendments change the corporation's filing requirements, the claim-notification procedure, and the schedule and deadline for claim resolution. The overall dissolution process is also more structured, which should allow counsel to provide more accurate time and cost estimates to clients.
- Resolution of dissolution
New Sections 1701.86(B)(1) and (2) give directors and officers more flexibility. First, directors and officers may now authorize future or contingent dissolutions; the resolution of dissolution may now include the "date on which the certificate of dissolution is to be filed or the conditions or events that will result in the filing of the certificate." Second, the resolution of dissolution can also "[a]uthoriz[e] ... the officers or directors to abandon the proposed dissolution before the filing of the certificate of dissolution." (emphasis added).
- Certificate of dissolution
House Bill 48 made changes to the information a corporation must provide in its certificate of dissolution. First, the corporation must now include the "internet address of each domain name held or maintained by or on behalf of the corporation" instead of the names and addresses of the corporation's officers, directors or incorporators. O.R.C. § 1701(F)(5). Second, a corporation that is not required to pay taxes may now evidence this fact with an affidavit from an appropriate officer rather than a certificate from the department of taxation. O.R.C. §§ 1701.86(H)(2) and (3). With respect to future dissolutions, new Section 1701.86(F)(7) provides that the date of dissolution may not be more than 90 days after the filing of the certificate.
- Notice of dissolution
House Bill 48 changed the claimant-notice procedure for voluntary dissolutions from publication to a more targeted process. Instead of taking out a newspaper advertisement, a voluntarily dissolving corporation must now provide notice of its voluntary dissolution "to each known creditor and to each person that has a claim against the corporation."1 O.R.C. § 1701.87(A) . The notice must, among other things, provide a deadline for the creditor's or claimant's notice of claim. O.R.C. § 1701.87(B)(3). A claim is barred if the creditor or claimant does not respond by the deadline. O.R.C. § 1701.87(D).
If, on the other hand, a claimant provides a timely notice of claim, a corporation may still "reject, in whole or in part, any mature claim" by providing "notice of the rejection ... to the claimant within  days after receipt of the claim and at least  days before the expiration of the five-year period specified in [O.R.C. § 1701.89]." O.R.C. § 1701.881(A). The claimant must "commence an action to enforce the claim within  days after the corporation mails the rejection notice" or his or her claim will be barred.
The corporation must post a copy of the notice to creditors and claimants on the corporation's website and provide a copy to the Ohio secretary of state. O.R.C. § 1701.87(E).
Along with the notice of voluntary dissolution, a corporation may now "offer security to any claimant whose claim is contingent, conditional, or unmatured as the corporation determines is sufficient to provide compensation to the claimant if the claim matures." O.R.C. § 1701.881(B). The corporation must provide the offer of security within 90 days after receiving the claimant's notice of claim and at least 30 days prior to the expiration of the five-year dissolution period specified in O.R.C. § 1701.89. Id.
If the claimant does not reject the offer of security within 30 days, the claimant shall be deemed to have accepted the proposed security "as the sole source from which to satisfy claimant's claim" under new Section 1701.881(B).
If the corporation and the claimant cannot agree on a satisfactory offer of security, a corporation may ask the Court of Common Pleas to determine "the amount and form of insurance or other security" that would satisfy the adequacy requirements specified in O.R.C. §§ 1701.87(C)(1) and (2). O.R.C. § 1701.881(C).
- Winding-up deadline
New Section 1701.88(A) sets a deadline for the winding-up process. It provides that a corporation may do "such acts as are required to wind up its affairs ... for a period of five years from the [corporation's] dissolution, [the] expiration [of the corporation's articles], or [the] cancellation [of the corporation's existence]." Id. (emphasis added). A court may extend this five-year period pursuant to Section 1701.89. Given the risk of losing a claim, parties should instruct their legal staffs to be alert to notices of dissolution and institute procedures that ensure a timely response.
- Resolving claims and other liabilities
To complete the winding-up process, a corporation must: (1) "pay the claims made and not rejected under [Section 1701.881(A)]," (2) "post the security offered and not rejected under [Section 1701.881(B)]," (3) "post the security ordered by the court" pursuant to Section 1701.881(C) and (4) "make any payment required by a court under [S]ection 1701.89." O.R.C. § 1701.882.
New Section 1701.882(A)(5) also requires corporations to "pay or make provision by insurance or otherwise for all other claims that are mature, known, and uncontested or that have been finally determined to be owing by the corporation and any other claims described in [Section 1701.881(C)(2)]." Absent fraud, the board of directors' determination of how the corporation will pay such claims "shall be conclusive." O.R.C. § 1701.88(C).
Finally, new Section 1701.882(B) provides rules on how a corporation shall apportion resources among claims and shareholder distributions.
- Shareholder liability for claims against a dissolved corporation
House Bill 48 limits the liability of shareholders who receive distributions from dissolved corporations. First, new Section 1701.883(A) affirms that dissolution "shall not affect the limited liability of a shareholder with respect to" corporate actions. Second, new Section 1701.883(C) provides that a shareholder cannot be personally liable for a claim against the corporation unless such claim was brought within five years after the date of dissolution (or a court-extended period). Third, and finally, a shareholder cannot be personally liable for a claim against the corporation "in an amount in excess of the amount of the shareholder's pro rata share of the claim or the amount distributed to the shareholder, whichever is less." O.R.C. § 1701.883(B).
- Dissenters’ Rights
- Limitations for publicly traded shares
House Bill 48 substantially limits dissenters' rights for certain transactions involving publicly traded shares. First, new Section 1701.74(B)(4) abolishes dissenters' rights for holders of publicly traded shares who disagree with amendments to a corporation's articles. Section 1701.74(B)(4) also abolishes dissenters' rights for private-company shareholders who receive "shares ... listed on a national securities exchange" pursuant to the amendment to the corporation's articles. Second, new Sections 1701.76(C) and 1701.84(B)(1) eliminate dissenters' rights in the sale of all, or substantially all, of the corporation's assets, a merger, a consolidation, a combination or an acquisition of a majority of the corporation's shares if:
- [T]he shares ... for which the dissenting shareholder would otherwise be entitled to relief are listed on a national securities exchange [on the relevant date]; and
- [T]he consideration to be received by the shareholders consists of shares or shares and cash in lieu of fractional shares that immediately following the effective time of [the relevant transaction] are listed on a national securities exchange.
- The dissent procedure
House Bill 48 also streamlines the procedure for shareholder dissent. Prior to the amendments, corporations could not determine which, if any, shareholders would dissent prior to a shareholder vote on a transaction. Dissenting shareholders could submit their demands for payment within 10 days after the transaction. O.R.C. § 1701.85(A)(2).
Although the revised Corporation Law maintains the 10-day, post-vote dissent window as a default rule, new Section 1701.85(A)(3) allows corporations to institute a pre-vote dissent procedure. If a corporation provides shareholders with a notice that complies with Sections 1701.85(A)(3)(a) - (c) at least 20 days before the scheduled vote on a proposal, a dissenting shareholder must deliver his or her written demand for payment "before the vote on the proposal is taken." O.R.C. § 1701.85(A)(3).
Corporations and their counsel should strongly consider utilizing the pre-vote dissent procedure. The new procedure offers increased efficiency at little, if any, additional cost. This should be especially true for corporations with a numerically large and diverse body of shareholders.
- Computation of fair cash value
A dissenting shareholder who otherwise complies with the notice and eligibility provisions of the Corporation Law is entitled to demand payment of the "fair cash value of the shares as to which the dissenting shareholder seeks relief." O.R.C. §§ 1701.85(A)(4) and (5). House Bill 48 adds another limitation to what may be considered in the computation of fair cash value. Under new Section 1701.85(C)(1)(b), one may not consider "[a]ny premium associated with control of the corporation, or any discount for lack of marketability or minority status" in the computation of "fair cash value." House Bill 48 also simplifies the computation of "fair cash value" for publicly traded shares. New Section 1701.85(C)(2) provides that the "fair cash value of a share ... listed on a national securities exchange ... shall be the closing sale price on the national securities exchange" on one of the applicable dates specified in subsections (a) - (c).
- THE LIMITED LIABILITY COMPANY LAW
House Bill 48 made a significant addition to the Limited Liability Company Law, in that it codified the fiduciary duties that members owe to the company and to other members.
- Duty of Loyalty
New Section 1705.281(B) specifies that three, and only three, responsibilities comprise a member's duty of loyalty to the company and to other members:
- Duty to account. A member must "account to the [company] and hold as trustee for the [company] any property, profit, or benefit derived by the member in the conduct and winding up of the [company's] business or derived from [the member's use] of the [company's] property, including the appropriation of a [company] opportunity."
- Duty to avoid conflicts of interest. A member must "refrain from dealing with the [company] in the conduct or winding up of the [company's] business as or on behalf of a party having an interest adverse to the [company]."
- Duty to refrain from competiton. A member must "refrain from competing with the [company] in the conduct of the [company's] business."
These duties, especially a member's new duty to refrain from competition with the company, represent a significant expansion of member responsibilities under Ohio law. This is a noteworthy change, as members can no longer waive such duties by agreement, as described below, which may reduce the attractiveness of the Ohio limited liability company as a form of business entity. For example, these new duties do not apply to the members of Delaware limited liability companies that register to conduct business in Ohio. O.R.C. § 1705.53.
- Duty of Care
Section 1705.281(C) limits a member's duty of care to "refraining from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the laws."
- Member-Managed LLCs
New Section 1705.282 distinguishes between the duties owed by member-managers based on the method of appointment. A member who was appointed manager "in writing and has agreed in writing to serve as a manager ... owes the [company] and the other members the duties of a manager." O.R.C. § 1705.282(A). (A manager owes the company the fiduciary duties to "act in good faith, in a manner the manager reasonably believes to be in ... the [company's] best interests," and reasonable care. O.R.C. § 1705.29(B).) If, however, a member-manager is not appointed in writing, he or she owes "the other members only the duties that would be owed by the member." O.R.C. § 1701.281(B).
- No Opting Out
Unlike Delaware law, the revised Limited Liability Company Law does not allow members to opt out of their fiduciary duties in the operating agreement. New Sections 1705.81(B)(3) and (4) provide that the "operating agreement may not ... [e]liminate the duty of loyalty" or "unreasonably reduce the duty of care." The members, however, may exempt particular acts and transactions from the fiduciary duty of loyalty. First, "the operating agreement may identify specific types or categories of activities that do not violate the duty of loyalty if not manifestly unreasonable." O.R.C. § 1705.081(B)(3). Second, "the members or a number or percentage of members specified in the operating agreement may authorize or ratify, after full disclosure of material facts, a specific act or transaction that would otherwise violate the duty of loyalty." Id.
- Counseling Opportunities
Lawyers can help companies and their members manage the risks and obligations associated with the new statutory duties. First, a good, limiting description of the company's business in the operating agreement (instead of language authorizing the company to engage in any legal business) will clarify the scope of a member's duty not to compete with the company. Second, a lawyer can help identify reasonable "types or categories of activities that do not violate a [member's] duty of loyalty" and insert the activities into the company's operating agreement, as provided for in Section 1705.081(A)(3). Third, and finally, lawyers can ensure that member-managed companies appoint their managers in writing. Without a written appointment, member-managers do not owe the company a manager's traditional duty to act with reasonable prudence in the conduct of the business. Orally appointed member-managers only owe the company a member's duty of care, namely a duty to avoid intentional, reckless or grossly negligent conduct.
- STATUTE OF LIMITATIONS
Effective September 28, 2012, Senate Bill 224 shortens Ohio's statute of limitations for actions on written contracts from 15 years to eight. The new eight-year window applies to all claims accruing after September 28, 2012, regardless of the contract's execution date. Claims accruing prior to September 28, 2012 are, on the other hand, subject to a different limitations period. Such claims must be brought by the earlier of September 28, 2020 (eight years after the law becomes effective) or the date 15 years after the claim accrued. The shortened limitations period should factor into contract negotiations. The change will reduce litigation risk for contracting parties, which should encourage parties to select Ohio as the governing body of law. While the change does limit a party's ability to protect his or her contract rights, the limitation appears marginal, as Ohio's claim window remains relatively long - eight years, as opposed to the three years Delaware law provides for actions on written contracts.
Recent Case Law
- Acordia of Ohio, L.L.C. v. Fishel
Acordia addresses a surviving entity's right to enforce employee noncompetition agreements following a merger. While the complete organizational history is complex, the salient transaction in Acordia was the 2001 merger of Acordia, Inc. with and into the plaintiff, Acordia of Ohio L.L.C. (Acordia L.L.C.). Acordia L.L.C. survived the merger and assumed a number of Acordia, Inc.'s employees who had noncompetition agreements with the predecessor corporation, Acordia, Inc. (and certain intermediate entities).
In August 2005, four of the assumed employees went to work for one of Acordia L.L.C.'s competitors. Believing that the merger gave it the right to enforce Acordia, Inc.'s noncompetition agreements, Acordia L.L.C. filed a breach of contract action against the four employees, seeking injunctive relief and damages.
The Ohio Supreme Court rejected Acordia L.L.C.'s claim in a 4-3 decision. Although Acordia L.L.C. "control[ed] the employees' contracts after the merger" pursuant to O.R.C. § 1701.82, Acordia L.L.C. could "not enforce the noncompete agreements as if [it] had stepped into the shoes of the company that originally contracted with the employees." Id. at ¶ 11. The holding was dictated by the common law of contract. The agreements at issue prevented the employees from competing with Acordia, Inc. (or the intermediate entities), not Acordia L.L.C. The agreements also "did not state that they [could] be assigned or [that the noncompetition provisions would] carry over to successors." Id. at ¶ 12. According to the court, the agreements' plain language showed that the parties did not intend to prevent the employees from competing with successor entities.
Acordia follows the Sixth Circuit's affirmation of another limitation on the transfer of contract rights in a corporate merger under Ohio law. In Cincom Systems, Inc. v. Novelis Corp., the Sixth Circuit affirmed its holding in PPG Industries, Inc. v. Guardian Industries Corp., 597 F.2d 1090 (6th Cir. 1979), that (i) a merger pursuant to the Corporation Law effectuates a "transfer" of patent or copyright licenses from the merged entity to the surviving entity and (ii) federal common law prohibits the transfer of copyright or patent licenses in a merger without contractual provisions to the contrary.
Like Acordia, Cincom Systems arose out of a corporate reorganization that included a merger governed by the Corporation Law. Alcan Rolled Products Division (Alcan) licensed two computer programs from Cincom Systems. As part of the reorganization, Alcan merged into a Texas corporation and changed its name to Novelis. Novelis continued to use the two programs without Cincom Systems' consent. It must be noted that the reorganization did not result in an actual change of ownership or control of the business.
After it discovered the post-merger use, Cincom Systems sued Novelis for violating transfer restrictions in the two licenses, citing PPG Industries. The Sixth Circuit upheld a lower court ruling in favor of Cincom Systems. The court held that the merger effectuated a "transfer" of the two software licenses under PPG Industries, which federal law prohibits without the copyright holder's (i.e., Cincom Systems') consent.
Addressing Novelis' statutory argument, the court found that the PPG Industries merger-causes-transfer rule for intellectual property contracts survived a recent change to the controlling merger provision in the Corporation Law. Passed in 1955, the statute originally provided that "all property of a constituent corporation shall be 'deemed to be [t]ransferred to and vested in the surviving corporation without further act or deed." O.R.C. Ann. § 1701.91(A)(4)(1955) (emphasis added). The 2009 version of the statute removed all reference to property transferring to the surviving entity. The statute now provides that the surviving entity "possesses all assets or property of every description ... all of which are vested in the surviving ... entity without further act or deed" (emphasis added). Novelis argued that the removal of the word "transferred" from the statute meant that contracts no longer "transferred" pursuant to the statute but, rather, automatically vested by operation of law in the surviving entity. The Sixth Circuit rejected Novelis' argument, holding that "in the context of a patent or copyright license, a transfer occurs any time an entity other than the one to which the license was expressly granted gains possession of the license," such as in a merger.
The Acordia and Cincom Systems cases highlight the need for careful due diligence in Ohio corporate mergers and for parties to take effective action to preserve valuable contract rights of the constituent entities. Such measures may include amendments as necessary to ensure that contracts continue to be binding on the corporate successors of the parties in the merger.
- Miller v. Miller
Miller clarifies the scope of an Ohio corporation's obligation to advance litigation expenses to officers and directors in connection with the corporation's duty to indemnify them for claims arising out of their duties. Tasked with analyzing the interaction of the Corporation Law's advancement provision, Section 1701.13(E)(5), and the provisions allowing for director indemnification, Sections 1701.13(E)(1) and (2), the Ohio Supreme Court issued two important holdings.
First, it held that a corporation that agrees to indemnify a director pursuant to Sections 1701.13(E)(1) or (2) must advance the director's litigation expenses pursuant to Section 1701.13(E)(5) regardless of whether the director is ultimately entitled to indemnification. This means that a corporation must advance a director's litigation expenses even in cases where the director is accused of misconduct detrimental to the corporation, as happened in Miller. In other words, a corporation cannot "avoid its duty to advance expenses to a director under [Section] 1701.13(E)(5)(a) by claiming that the director's alleged misconduct, if proven, would amount to a violation of his or her fiduciary duties and would therefore foreclose indemnification." Id. at ¶ 39.
The second holding follows from the first. A corporation that receives an undertaking that complies with Section 1701.13(E)(5)(a) must "advance expenses to the director unless the corporation's articles or regulations specifically state that [Section] 1701.13(E) does not apply to the corporation" (emphasis added). The "undertaking" is a writing or other agreement whereby the director agrees to:
- [R]epay such amount if it is proved by clear and convincing evidence in a court of competent jurisdiction that [the director's] action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the corporation or undertaken with reckless disregard for the best interests of the corporation; and
- [R]easonably cooperate with the corporation concerning the action, suit or proceeding.
The Miller holding mirrors Delaware law on the advancement of litigation expenses to corporate directors. As the decision effectively mandates advancement if the corporation has agreed to indemnify, corporations can only avoid the potentially distasteful prospect of advancing monies for the defense of an unscrupulous director by jettisoning indemnification altogether. This may be an unrealistic proposition that could discourage qualified individuals from serving in those capacities.
The preceding highlights recent, notable changes to the Ohio law of corporations and limited liability companies. The new duties for members of limited liability companies is probably the most significant; it has certainly generated the most commentary in the corporate-law community. The new creditor notification and claim resolution procedure for voluntarily dissolved corporations is also significant. And, finally, although more narrow and technical, familiarity with the other changes to the Corporation Law, such as the reduction in the minimum number of directors and the limitation on retroactive removal of indemnification, is necessary to provide comprehensive counsel.