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Business Law
Big Headache
Business law remains a complex
subject, but recent changes reduce some of the pain
By Clifton Barnes |
Business Law Resource
Guide |
Long
before the cloud of public suspicion following the Enron, Arthur Anderson and
Worldcom scandals, Progress Energy was addressing governance issues.
As a result, Sarbanes-Oxley legislation — the broad corporate governance
reform law from 2002 that puts company directors and officers, particularly
audit committee members, in federal regulators’ crosshairs and the public
spotlight in an effort to counteract business corruption — caused a minimum of
interruption to the Raleigh energy company.
“We were a little bit ahead of the game as far as compliance,” says Progress
Energy President Bob McGehee. “We set up our own governance committee in
mid-1998 so we had already started addressing most of the issues in the act.”
While there has been some additional cost of compliance, mostly to outside
auditors, their efforts have added some financial discipline while the act has
highlighted the need for good governance. McGehee says that in general the
impact of Sarbanes-Oxley should be a positive one.
“I think it will help restore investor confidence in companies,” he says,
adding that Progress Energy has, for some time, put a focus on full disclosure
through news releases and responding openly to those seeking information.
While Sarbanes-Oxley continues to have a major impact up most businesses, other
trends in North Carolina are emerging. For instance, the state has seen a
dramatic growth of businesses being formed as limited liability companies.
Efforts are being made to make North Carolina more desirable for business
incorporation. The North Carolina Business Court continues to be a national
trendsetter and is looking to expand. And fewer cases are going to trial as
combatants are settling out of court.
What follows are examinations and explanations of this handful of business law
trends that may be affecting your company’s bottom line:
Sarbanes-Oxley
One of the biggest issues in corporate law, not just in North Carolina but
throughout the country, is the extent to which federal law will occupy the field
of public company corporate governance. “Sarbanes-Oxley and the overall
heightened focus on corporate governance and best practices are definitely
affecting people’s focus and behavior in the board room, the executive suite
and beyond, both for public and private companies,” says attorney Don Reynolds
of Wyrick Robbins Yates & Ponton in Raleigh.
Experts say that most corporate officers are being much less aggressive with
personal gains because of Sarbanes-Oxley. The term itself now connotes a
movement far beyond the letter of the law actually carrying that name, says
attorney A.P. Carlton, a partner in the Raleigh office of Kilpatrick Stockton
and past president of the American Bar Association. “Americans today are
preoccupied with individual accountability whether it be at the corporate board
level, in the professions, in the halls of government or in the courtroom,” he
says.
Carlton adds that a new day of business ethics and economic responsibility is
upon us. A free and fair market doesn’t occur on its own, he says. “Without
rules and restrictions, and without a structure of independent corporate
governance that counteracts corruption effectively,” he says, “the
marketplace will naturally trend in a destructive and decidedly undemocratic
direction, violating the promise and the premise of the American capitalist
system.”
Sarbanes-Oxley, Carlton notes, is only the beginning of statutory and regulatory
corporate governance and securities legislation reform. Sarbanes-Oxley itself
only applies to publicly held and for-profit business corporations, not
privately held companies or nonprofit companies.
However, the ABA has made specific recommendations that go beyond Sarbanes-Oxley
and affect all kinds of businesses. Recommendations include:
 A substantial majority of
board members should be independent of the corporation’s senior executive
officers, both in fact and appearance.
Directors should meet
regularly outside the presence of any senior executive office — not when the
need arises but as a matter of regular course.
The board should establish a
committee to be responsible for the identification and nomination of independent
members of the board.
The board should establish an
audit committee composed of independent directors who meet regularly outside the
presence of management and who meet with company auditors and counsel, and have
authority to bring in additional independent auditors and counsel.
The board should establish a
corporate governance committee and a corporate code of ethics that would
establish lines of communication to oversight bodies.
The directors themselves
should be held accountable. Expectations should be addressed at the outset and
directors should be appropriately trained and oriented. Periodic reviews of
directors’ performance should be established.
Carlton points to Progress Energy as a company that has implemented the
recommendations. However, businesses and lawyers continue to flesh out the
details on how Sarbanes-Oxley may affect them.
While many lawyers admit that Sarbanes-Oxley is an appropriate response to
recent financial scandals, the issue that seems to concern them most is that of
client confidentiality. Proposed Securities and Exchange Commission rules as a
result of Sarbanes-Oxley put client confidence in jeopardy, some attorneys say.
The SEC rules extend the regulations to require attorneys to make public
disclosure of their client’s confidences, attorneys say. Many argue that the
requirements would deter clients from including attorneys in discussions or from
being candid and truthful in dealing with their attorneys, thus hindering
attorneys in providing appropriate legal assistance in the public’s interest.
Even with those concerns, along with time and effort burdens and cost compliance
estimates in the millions of dollars, Jack Derrick, chair of the North Carolina
Bar Association’s Corporate Counsel Section, says he hasn’t seen a lot of
gnashing of teeth or hair pulling over Sarbanes-Oxley. “I think most of us
believe we work for good companies who are good corporate citizens and, by and
large, that’s true,” he says.
Limited Liability
The North Carolina Limited Liability Company Act is now 10 years old and
businesses in the state increasingly are forming as limited liability companies.
Since 1996 the number of new LLCs formed in North Carolina has jumped more than
400 percent. There were 4,189 LLCs formed or receiving authority to do business
in North Carolina in 1996; that figure rose to 12,832 in 2000 and has
skyrocketed to more than 18,000 today.
LLCs combine the most attractive features of corporations and general
partnerships. “LLCs give their investors corporation-like limited liability.
Barring extreme circumstances, exposure is limited to capital invested,” says
Raleigh attorney David Wilke of Wyrick Robbins Yates & Ponton. “In
addition, LLCs provide ‘pass-through,’ or partnership taxation, where there
is only one level of tax, at the investor level. Unlike a corporation, the LLC
itself is not taxed.”
Also, LLCs are not saddled with many of the statutory requirements regarding
their governance and operation. Wilke says that LLCs are primarily “creatures
of contract” and offer maximum flexibility. “They can be set up to function
like a partnership or they can be set up to function like a corporation with
more complicated governance (by a board and officers for example) and capital
structures,” he says. “They also do not pay state franchise taxes but
instead pay an annual report fee.” That report fee is currently $200.
Attorney David B. Whelpley Jr., a partner in the Charlotte office of Kilpatrick
Stockton, says that business owners, executives and lawyers need to stay abreast
of unique tax and legal implications of operating in LLC form. “This is
especially true in the areas of incentive stock option programs, private equity
and venture capital financing, and real estate joint venture arrangements,”
Whelpley says.
Attorney C. Shannon Elliotte, an associate in the Winston-Salem office of
Kilpatrick Stockton, says that CPAs and other tax advisers agree that the tax
regime applicable to LLCs present some of the most challenging and intricate set
of rules under the tax laws. “Without proper planning, these tax and legal
nuances may produce unintended business results and costs for those more
familiar with similar corporate-type economic arrangements,” she says.
LLCs have been popular for real estate ventures, holding companies and wholly
owned corporate subsidiaries, and investment funds (i.e. venture capital funds).
However, Charlotte attorney Ben Baldwin, a partner with Robinson, Bradshaw &
Hinson, says that public securities markets have not yet come to accept the LLC
form. “Generally speaking,” he says, “those beginning a new business will
opt for the LLC form unless it is highly likely that the business will be taken
public or if the decision hinges on the issue of self-employment taxes, as to
which corporate form is preferable.”
While more and more start-up companies, including technology-based ones, have
been forming as LLCs, they have traditionally been reluctant. “They are not
suitable vehicles for ‘going public,’” Wilke says. “Plus, giving equity
incentives to employees of LLCs can be much more complicated (and difficult to
explain to employees) and less favorable from a tax perspective than the
traditional stock-option program of a corporation.”
In addition, he says, many venture capital funds cannot invest in LLCs because
of tax restrictions on the venture fund’s tax-exempt partners.
However, Wilke, who serves as chair of the Business Organizations Committee of
the N.C. Bar Association’s Business Law Section, says that the increase in
LLCs can be attributed in great part to lawyers and business owners simply
becoming more comfortable with LLCs. Business owners and lawyers have a greater
understanding of the issues involved, such as drafting operating agreements with
corporation-like governance features, he says.
Business Friendly N.C.
Back in the mid-1990s or “the old days” as George Jeter of the North
Carolina Secretary of State’s office puts it, you could see lines of people
waiting to file incorporation papers. He says there were people who spent most
of their day simply waiting in line. In addition, there were time-consuming
letters and phone calls to staff to ask questions or get forms.
Today, the Secretary of State’s office has updated its database and developed
a web site that can handle just about anything business-related. “There is no
backlog today,” Jeter says. “People are extremely pleased that they are able
to do what they need to do quickly online. As a result of the improved web site
(www.sec.state.nc.us), the ease and timeliness of starting a business in North
Carolina certainly helps make the state more business friendly.”
There have been numerous legislative efforts to make North Carolina as desirable
a state in which to incorporate as Delaware. “Statutory changes, which have
resulted in further corporate flexibility, arose in part out of a desire to woo
venture capital and investment firms, who might be attracted to our
business-friendly legal landscape,” says Charlotte attorney Ben Baldwin.
However, some experts say that the state continuously falls short and may never
be able to overtake Delaware. Chris Lynch of Wyrick Robbins Yates & Ponton
in Raleigh says that whenever the state legislature amends a statute to make the
state friendlier to incorporate “they always get it slightly wrong.”
For example, a recent amendment to the N.C. shareholder approval statute permits
shareholders to act by “majority” written consent, bringing the state in
line with Delaware in that regard. Prior rules demanded “unanimous” written
consent or that a shareholder meeting be called that required at least 10
days’ advance notice. “That’s an eternity when your company needs money
yesterday,” Lynch says. “This change is important for almost all high-growth
companies, or whenever a company has more than a handful of shareholders.”
Yet, North Carolina got it “slightly wrong” again, Lynch says. For an
existing corporation to take advantage of this provision, it must amend its
articles of incorporation. It isn’t clear whether or not amending the articles
will entitle shareholders to “statutory dissenters’ rights,” meaning that
shareholders would have the right to demand to be cashed out based on the
“fair value” of their shares. “This uncertainty can deter existing
companies from taking advantage of the new flexibility,” Lynch says, an
example that reinforces why Delaware remains the preferred jurisdiction of
incorporation.
Professor Lawrence Hamermesh of the Widener University School of Law in
Wilmington, Del., says that the stockholders’ ability to act by majority
written consent goes back to 1967 in his home state. He says that Delaware is so
far ahead that it will continue to be the leader in incorporation. More than a
century ago, Delaware’s legislature adopted a general corporation law that
emphasized the elimination of outmoded regulatory rules (such as minimum capital
and a minimum number of directors) and the freedom of business participants to
frame their own rules to govern their own economic relations.
Over time, the Delaware courts filled in this framework with a large body of
judicial precedent, primarily from a unique institution called the Court of
Chancery, says Hamermesh, who chairs the Delaware State Bar’s Corporation Law
Section. The court sits without a jury, doesn’t allow punitive damages, has a
docket uncrowded by personal injury and criminal matters (hearing only equitable
claims), and has a tradition of developing written opinions to decide cases.
“With Delaware having achieved preeminence as a state of incorporation for
public companies — with all the financial benefits accompanying that
preeminence — Delaware’s legislature and bench and bar are extraordinarily
careful to assure that its corporate law remains responsive to business needs,
while avoiding radical changes due to political swings,” Hamermesh says.
He says there are very few legislatures that are as willing to update their
business statutes every year, as in Delaware, and to do so in a bipartisan
fashion that respects the recommendations of the corporate bar (including
lawyers who represent both management and shareholders). “Even with the
development of business courts, there really isn’t any state that can match
Delaware’s institutional history and advantages,” Hamermesh contends.
N.C. Business Court
The North Carolina Business Court itself is an attractive feature of the
state’s business culture, according to Baldwin. “In fact, one of the reasons
the court was created was the collective desire on the part of the legislature
and the judiciary to improve North Carolina’s business climate,” he says.
The court was created in 1995 following a recommendation by a blue ribbon
commission on business law. All cases are assigned by the chief justice of the
N.C. Supreme Court and are intended to be complex business litigation cases that
are handled by a single judge. That judge, Ben F. Tennille, former in-house
counsel for Burlington Industries, was appointed in 1996 and was reappointed for
a five-year term in 2001.
There has been great flexibility because there is no fixed definition of a
“complex” case. Through the 2002-2003 fiscal year, the Business Court, based
in Greensboro, has been assigned 179 cases from 33 counties. A total of 116
cases have been closed, 73 of them through settlement.
Because both sides have to agree for a case to go to Business Court, and because
there is only one judge to handle all the cases, the numbers are not as high as
they could be. That could change if the chief justice and the director of the
Administrative Office of the Courts get their way.
AOC Director John Kennedy says the two would like one or more business courts to
be established. “The Business Court has served an important function,”
Kennedy says. “It’s been great for the business community and good for the
courts in general.”
While the court has been a model for other states — in fact, attorneys from
adjacent states have even sought assignment to the North Carolina Business Court
— Kennedy says the court serves as a model for how other North Carolina
courtrooms can use technology. “The Business Court uses technology in a way we
don’t see in any other courtroom,” he says.
The hallmark of the court is its efficiency, Baldwin says. “To some degree
this efficiency is a product of the court’s emphasis on technology and the
desire to create a ‘paperless courtroom.’ ” he says. “But more
important, so many of the delays that are inherent in the litigation process
generally are short-circuited. A single judge hears the motions and the evidence
from the inception of the case to its conclusion, and matters can be handled on
an expedited time frame.”
Spurred in part by the successful implementation of an electronic filing system
for both the business court and the appellate courts, Justice Mark Martin says
he sees a move in the near future to establish electronic filing capability for
all trial courts in North Carolina. “The potential for improving the operation
of our civil and criminal justice system is enormous,” he says. “Also, the
operational savings down the road could be substantial.”
Again, the drawback is that there is only one Business Court and one judge to
hear the cases. That is likely to change. Chief Justice I. Beverly Lake Jr. has
appointed a Task Force on the Future of the North Carolina Business Court,
headed by Martin, that will make recommendations to Lake and the General
Assembly.
While the discussions will run through this year, it is expected that the
commission will recommend additional business courts, probably in Charlotte and
Raleigh. In addition, the commission will discuss whether the court’s
jurisdiction should be expanded to include technology cases and whether the
court should utilize alternative dispute resolution (such as arbitration or
mediation) as a means to encourage settlement of disputes.
More Cases, Fewer Trials
Only about 12 percent of the cases filed in N.C. Superior Civil Court during the
fiscal year ending June 30, 2003, were settled by judges or juries. More than
half of the 26,030 cases filed were voluntarily dismissed. In 1995, about 16
percent were settled by judges and juries.
“Cases are settling — whether through mandatory mediation (which is required
in all Superior Court cases), or through discussions between and among the
parties,” says attorney Joe Nanney of Wyrick Robbins Yates & Ponton.
“The American justice system may be working because the threat of a trial
forces parties to deal with each other.”
Nanney says he’s unsure of the societal implications but the trend seems to be
that more and more cases are being resolved prior to trial. “Whether this is
because of fear of the system, or costs of trial, I don’t know. It’s likely
a combination of the two,” he says.
There were 826 jury trials in Superior Court in 1995 compared to just 481 in
fiscal year 2003. Also, in fiscal year 2003, there were 17 counties that saw no
jury trials in Superior Civil Court at all. Another 16 counties saw only one
jury trial. This is despite there being 5,637 more cases filed in 2003 than in
1995 — another trend that has seen the number of cases filed rise by an
average of 400 cases over each of the past five years.
John Kennedy, director of the Administrative Office of the Courts, says that’s
likely to be a case of an increase in population and the amount of business
being done in the state. “With the technology boom, especially the Research
Triangle area, there is more business being done in North Carolina,” Kennedy
says.
There has also been an increase in the number of cases disposed of by the clerk
— 1,120 in 1995 versus 2,545 in 2003. This is an indication, Kennedy says,
that in a down economy a lot of people are being sued who “don’t have
anything.”
There also has been an increase in the number of cases being discontinued
because officials can’t find the defendant — from 180 in 1995 to 1,650 in
2003. It’s anybody’s guess what that increase means — theories range from
people hiding from the law better to clerks and court administrators pushing
harder to get cases off court dockets.
Lastly, judges today seem more likely to throw out a case or make a judgment
before it goes to trial. “Judgments without trial” rose from 2,504 in 1995
to 3,499 in 2003. Some of that difference may be simply due to more cases being
filed but it appears that it also could be a reflection that there are more
frivolous cases being filed (and thrown out) or that judges are more apt to
consider a case frivolous.
To
Learn More
Interested in learning more about the topics detailed in this story? If so,
you’ll have information available through the following resources:
Administrative Office of the Courts
Phone: 919-733-7107
Web site: www.nccourts.org/Courts/CRS/
Business Friendly Licensing
Phone: 800-228-8443
Web site: www.secretary.state.nc.us/blio/
Limited Liability
Phone: 919-807-2225
Web site: www.secretary.state.nc.us/
Corporations/N.C. Business Court
Phone: 336-334-5252
Web site: www.ncbusinesscourt.net/
Sarbanes-Oxley
Phone: 800-SEC-0330
Web site: www.sec.gov/spotlight/sarbanes-oxley.htm
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