Global Transactions Practice Group

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1 January 11, 2010 The Sun Sets on the Texas Business Corporation Act Implications for Domestic and Foreign Business Organizations in Texas Introduction For more information, contact: Ken Culotta (713) John Crespo (713) Ned Crady (713) Archie Fallon (713) King & Spalding Houston 1100 Louisiana Street Suite 4000 Houston, Texas Tel: (713) Fax: (713) On January 1, 2010, the Texas Business Organizations Code (TBOC or the Code) became the exclusive statute governing foreign and domestic business organizations in Texas. Business organizations which were formed in Texas prior to January 1, 2006, or foreign companies that obtained authority to do business in Texas prior to January 1, 2006, which were previously operating under the Texas Business Corporations Act (TBCA) or another similar governance statutes, have now automatically become subject to the TBOC, unless they previously elected to become governed by the TBOC. This Client Alert will (i) summarize the purpose and format of the TBOC and (ii) provide practice pointers for avoiding problems related to the transition to the TBOC. I. Purpose and Format of the TBOC In 2003, the Texas Legislature passed the TBOC with the purpose of modernizing and centralizing 11 Texas statutes applicable to various for-profit and non-profit, private-sector business organizations. Statutes replaced by the TBOC include, among others, the TBCA, the Texas Limited Liability Company Act (TLLCA) and the Texas Revised Limited Partnership Act (TRLPA). The TBOC does not, for the most part, substantively change the laws governing the various types of business organizations. Instead, the goal of the TBOC is to provide what the Texas Secretary of State calls a hub and spoke statutory framework: common provisions applicable to most kinds of business organizations are located in a single title (the hub), and provisions specific to each different kind of business organization are located in separate titles (the spokes). i The eight titles of the TBOC are listed below: Title 1 General provisions common to most entities Title 2 Corporations Title 3 Limited Liability Companies Page 1 of 6

2 Title 4 Partnerships (including both general and limited partnerships) Title 5 Real Estate Investment Trusts Title 6 Associations Title 7 Professional Entities Title 8 Miscellaneous and Transition Provisions Each title is further divided into chapters, subchapters and sections. The hub of the statute is Title 1, which contains a centralized code applicable to all entities. Some of the provisions set forth in Title 1 include Definitions (Chapter 1), Formation and Governance (Chapter 3), Filings (Chapter 4), Meetings and Voting (Chapter 6), Liability (Chapter 7), Indemnification and Insurance (Chapter 8), Foreign Entities (Chapter 9), Mergers, Exchanges, Conversions and Sales of Assets (Chapter 10) and Winding Up and Termination of Domestic Entity (Chapter 11). Any entity can identify the requirements for undertaking a business action, such as a merger, by looking to the hub and the spoke applicable to its legal form. By way of contrast, under the prior law, if a Texas corporation planned to merge with and into a Texas limited liability company, the corporation would have had to consider the merger statute under the TBCA, and the limited liability company would have had to separately consider the merger statute under the TLLCA. Now, both entities can begin their merger analysis by reviewing the same merger statute in Title 1 (Chapter 10, Subchapter A). ii The following diagram from the Texas Secretary of State iii illustrates how the Titles and Chapters work together: Page 2 of 6

3 II. Important Differences from Prior Governance Statutes A. New Defined Terminology Title 1 contains a centralized set of new definitions applicable throughout the various titles of the TBOC. Some of the new terms commonly used are listed and explained below: The certificate of formation replaces articles of incorporation, articles of organization, certificates of limited partnership and similar formation instruments. TBOC 1.002(6)(A)-(B). An entity may either be domestic (e.g., formed under Texas law) or foreign (e.g., formed under the laws of another jurisdiction). TBOC 1.002(21). A fundamental business transaction means a merger, interest exchange, conversion, or sale of all or substantially all of an entity s assets. TBOC 1.002(21). A governing authority is the person or group of persons entitled to manage and direct the affairs of an entity. Examples include the board of directors of a corporation, general partner or general partners of a general or limited partnership, and managers or managing members of a limited liability company. Officers are not governing authorities. TBOC 1.002(35)(A)-(B). A governing person is each person serving as part of a governing authority. This term does not include officers. TBOC 1.002(37). A managerial official means an officer or a governing person. TBOC 1.002(52). Governing documents include an entity s certificate of formation and other documents or agreements governing its formation or internal affairs. For limited liability company agreements, the term company agreement replaces regulations. TBOC 1.002(36). Non-code organization means an organization other than a domestic entity. TBOC 1.002(56). Organization means a corporation, limited partnership, general partnership, limited liability company, business trust, real estate investment trust, joint venture, joint stock company, cooperative, association, bank, insurance company, credit union, savings and loan association, or other organization, regardless of whether it is for-profit or nonprofit, domestic or foreign. TBOC 1.002(62). Owner means (1) with respect to a corporation or real estate investment trust, a shareholder, (2) with respect to a limited partnership or general partnership, a partner, (3) with respect to a limited liability company or professional association, a member and (4) with respect to all other foreign and domestic entities, an owner of an equity interest in that entity. TBOC 1.002(63)(A)-(D). Page 3 of 6

4 Ownership interest means an owner s interest in an entity. The term includes the owner s share of profits and losses or similar items and the right to receive distributions. The term does not include an owner s right to participate in management. TBOC 1.002(64). B. Select Changes from Prior Governance Statutes Through the process of integrating prior governance statutes into the TBOC in a modernized fashion, substantive differences arose between the prior laws and the TBOC. Some key differences are highlighted below. Procedure for Drafting Certificates of Formation Practitioners forming new organizations should be mindful of how to apply the hub and spokes of the TBOC when drafting a certificate of formation of the TBOC provides a uniform set of minimum requirements for the certificate of formation of any kind of new business organization. A practitioner drafting a certificate of formation should be careful to inspect the additional, organization-specific requirements found in the later sections of Subchapter A. For example, of the TBOC contains the Supplemental provisions required in certificate of formation of for-profit or professional corporation. By way of contrast, Article 3.02 of the TBCA contained all of the requirements necessary to include in the articles of incorporation for a new corporation. Requirements for Articles of Merger for Corporations Article 5.04.A.4 of the TBCA required the articles of merger to contain the number of shares that voted for and against the plan of merger for each corporation participating in the merger (assuming shareholder approval was required) of the TBOC does not require such a listing of voting results. Instead, the certificate of merger only needs to indicate the plan of merger was approved as required by the laws of the jurisdiction of formation of each organization that is a party to the merger and by the governing documents of those organizations. See TBOC (b)(3). A substantially similar requirement previously existed under Article 5.04.A.6 of the TBCA for a foreign corporation or other entity that was party to the merger. Conversion or Merger of Foreign Organizations A foreign organization that has registered with the Texas Secretary of State to do business in Texas, but which undergoes a merger or conversion in its jurisdiction of organization, may now simply amend its application for registration in order to show such merger or conversion. See TBOC 9.009(a). Under the prior governance statutes, the foreign organization would first need to withdraw its registration from the Texas Secretary of State and then reapply for authorization to do business as the converted organization or post-merger survivor. Filing Mechanics As illustrated by some of the above examples, one of the TBOC s primary goals is to simplify the filing procedure for corporate transactions. Additional measures in the TBOC to effect this goal include removal of the requirement to file multiple copies (including an original copy) of the articles of merger with the Secretary of State. See TBCA Art B. Page 4 of 6

5 Winding Up and Termination of the TBOC provides that a terminated filing entity will continue to exist in Texas until the third anniversary of the effective date of the entity s termination for certain limited purposes, including prosecuting or defending in the terminated filing entity s name an action or proceeding brought by or against the terminated entity. Although similar requirements existed under the prior statutes for corporations (TBCA Art A, C) and limited liability companies (TLLCA Art A), limited partnerships were not previously subject to this survival mechanism. C. Transition Issues As earlier discussed, the TBOC automatically applies to all acts or transactions of any Texas or foreign organization doing business in Texas on or after January 1, However, what is the post-january 1, 2010 effect of the TBCA and other prior governance statutes? Chapter 402 of the TBOC addresses this question, and speaks to specific situations in which the prior governance statutes continue (or cease) to govern business organizations. A few examples of these situations are listed below: The Question of Governing Law Under of the TBOC, unless otherwise provided, all of the provisions of the TBOC govern acts, contracts, or other transactions by an entity subject to the TBOC or its managers or owners that occur on or after January 1, For organizations that were governed by the prior laws, that did not elect to be governed by the TBOC prior to January 1, 2010, the prior governance statutes continue to govern the acts, contracts, or other transactions of the entity or its managers or owners occurring before January 1, Thus, if a potential purchaser of a target corporation governed by the TBCA performs due diligence on the articles of merger filed in 2009 to consummate the merging of another company into the target, the reviewing party should still look to the old statute for the required provisions in such articles (and should locate the breakdown of shareholder votes for and against the merger set forth in such articles). Indemnification Chapter 8 of the TBOC governs any proposed indemnification by a domestic entity after January 1, 2010, regardless of whether the events giving rise to the indemnification occurred before or after January 1, Fundamental Business Transactions The TBCA and prior governance statutes apply to asset sales, mergers, exchanges, and conversions consummated after January 1, 2010 if the owners of an entity governed by the prior governance statutes approved such transaction prior to January 1, For example, if a TRLPA-governed limited partnership received partner approval and entered a purchase agreement on December 1, 2009 to acquire substantially all of the assets of another entity on March 1, 2010, the TRLPA would still govern the acquisition despite its occurrence after January 1, This could be significant because TBOC expressly provides that unless otherwise provided by another statute, a person acquiring property described by this section may not be held responsible or liable for a liability or obligation of the transferring domestic entity that is not expressly assumed by the person. The TRLPA contains no equivalent purchaser protection, nor does the TLLCA (a similar protection does exist in TBCA Art B). Page 5 of 6

6 Winding Up and Termination Prior governance statutes govern actions for involuntary or judicial winding up and termination that are pending prior to the time the TBOC becomes applicable to the organization. The prior statutes also govern voluntary winding up and termination begun before the date the TBOC becomes applicable to the entity. III. Updating Pre-TBOC Governing Documents Under (a) of the TBOC, the governing documents of a domestic entity properly formed under the prior governance statutes are deemed to conform to the TBOC. However, upon any amendment to such entity s certificate of formation after January 1, 2010, the certificate must be conformed to the new requirements under the TBOC or else the Texas Secretary of State may reject it. As a matter of good corporate practice, practitioners should review the governing documents of pre-tboc companies and weigh the relative benefits and risks of conforming such documents to reflect proper cross-references to the TBOC. The risk of an out-dated cross-reference to a prior statute that has not been integrated into the TBOC may justify the time and costs of the amendment, which could require consent from equity or debtholders of the entity. The Texas Secretary of State offers additional information about the TBOC on its website at: King & Spalding is an international law firm with more than 800 lawyers in Abu Dhabi, Atlanta, Austin, Charlotte, Dubai, Frankfurt, Houston, London, New York, Paris, Riyadh (affiliated office), San Francisco, Silicon Valley and Washington, D.C. The firm represents half of the Fortune 100 and, according to a Corporate Counsel survey in August 2009, ranks fifth in its total number of representations of those companies. For additional information, visit This alert provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice. i Texas Secretary of State - Business and Public Filings Division, Background and Structure of the Texas Business Organizations Code (available online at: ii The Texas business organizations participating in the merger would still need to consider entity-specific requirements, if any. For a Texas corporation, these would include Title 2. iii Texas Secretary of State - Business and Public Filings Division, Background and Structure of the Texas Business Organizations Code (available online at: Page 6 of 6