RECENT DEVELOPMENTS IN
OKLAHOMA BUSINESS AND CORPORATE LAW - 2012
Gary W. Derrick
Derrick & Briggs, LLP
Gary W. Derrick 2012©
RECENT DEVELOPMENTS IN
OKLAHOMA BUSINESS AND CORPORATE LAW - 2012
Introduction
The economic recession and the Federal regulatory response have given us much
to discuss. Since 2007, we have talked about the mortgage crisis, the derivatives markets,
the collapse of global financial institutions, an unsettling, world-wide economic
downturn, Federal bailouts and sweeping regulatory changes. One of the most startling
aspects of this area of law is the rapid pace of change. Markets and industries have
opened and closed and shifted in unexpected ways.1 The combination of technological
advances, increased information flows, greater productivity, and globalized expansion
have produced a rate of global economic change not witnessed since the Industrial
Revolution.2 One could argue that the rapid pace of change within the financial markets
– and the inability of investors and regulators to fully understand the changes – was a
principal cause of the financial collapse and resulting recession.3
1
The derivatives markets have expanded in 30 years from a small U.S. market to a globalized
market with an outstanding notional value of $671 trillion at December 31, 2011 for OTC
derivatives and exchange-traded derivatives. Bank for International Settlement, Semiannual
OTC derivatives statistics at end-December 2011 (OTC) and BIS Quarterly Review (exchangetraded) (Sept 2012). The U.S. private equity market grew from approximately $20.8 billion in
new commitments in 1992 to approximately $625 billion in 2008 and $265 billion in 2011.
Preqin, 2012 Preqin Global Private Equity Report (2012). In its Global Private Equity Report
for 2012, Bain & Company reported that global private equity industry had nearly $1 trillion of
uninvested cash and along with $2 trillion in assets.
While derivatives and private equity have shown remarkable growth, others sectors have
retracted. For example, the number of U.S. public companies going public annually fell by half
from 1997 to 2009. Davis, Gerald F., The Twilight of the Berle and Means Corporation, 34
Seattle L. Rev. 1121 (2011).
2
See gen. Carl Dahlman, “Technology, Globalization, and International Competitiveness”,
Industrial Development for the 21st Century (United Nations, 2007) (available at
http://www.un.org/esa/ sustdev/publications/industrial_development/1_2.pdf); and Thomas
Friedman, The World is Flat (2005).
3
See Financial Crisis Inquiry Commission Report, Conclusions of the Financial Crisis Inquiry
Commission (January 2011); see also Financial Crisis Inquiry Commission – Dissenting
Statements by Keith Hennessey, Douglas Holtz-Eakin and Bill Thomas and by Peter J. Wallison
(January 2011). There is a fallacy of belief – at least in an open economy - that good
government policies ensure the success of the economy while poor government policies will
hurt the economy. Government policy may influence an open economy, but cannot control it.
But we have talked enough about the collapse and regulatory response. Other
developments have attracted much less notice, but are intriguing in their own right. We
should examine some of these developments. We shall explore several developments on
the national front, such as crowdfunding and socially responsible entities, before moving
on to cover the Oklahoma developments.
National Developments
Crowdfunding
One of the most interesting parts of the JOBS Act was its endorsement of
crowdfunding.4 What is crowdfunding? It is an internet-based networking process that
matches people willing to contribute funds to people pursuing an identified project. The
matches typically provide seed capital for persons who presumably could not access
conventional debt or equity funding. Its earliest iterations involved musicians and other
artists who solicited funds from their fans to finance a tour or a recording or a film. The
concept grew with websites that would aggregate the projects to facilitate matching. The
better known websites include Kickstarter and Indiegogo.5
The early projects tended to offer contributors tickets or t-shirts, but no true
investment returns. But the success of the some projects indicated that crowdfunding
could be an important vehicle for start-up capital. Many of these crowdfunding projects
raised money from hundreds or even thousands of small contributors.6 Federal and state
securities laws were an impediment. Registration would be too burdensome for relatively
small amounts of funding and the securities laws had no exemption from registration that
would permit crowdfunding. Under the private offering exemptions – the common
exemption for small offerings - a broad-based, internet solicitation of funds would violate
the exemptions’ prohibition on general solicitation and limits on the number of
4
Jumpstart Our Business Startups Act, Pub. L. No: 112-106 (2012) (the “JOBS Act”).
5
At http://www.kickstarter.com/ and http://www.indiegogo.com/.
6
Nearly three million contributors have donated a total of $300 million to fund 30,000 projects
on Kickstarter. Jenna Wortham, Success of Crowdfunding Puts Pressure on Entrepreneurs,
N.Y. Times (Sept. 17, 2012). The contributors to a Kickstarter and IndieGoGo project do not
receive a financial interest in the project, which avoids regulation under the securities laws
since no security is sold. The new JOBS Act provisions would permit the receipt of a financial
interest.
2
investors.7 Whether and how a website could legally charge for its hosting was another
regulatory problem. At issue was whether the website was acting as an unregistered
broker by facilitating the offer and sale of securities.8
The regulatory impediments were addressed in the JOBS Act.9 The JOBS Act
permits companies to raise up to $1.0 million over 12 months. The securities must be
sold through an SEC-registered broker or a registered “funding portal”. Investors with a
net worth or income of less than $100,000 may invest only $2,000 or 5% of their net
worth or income. Investors with a net worth or income of $100,000 or more may invest
up to 10% of their net worth or income, subject to a cap of $100,000. The company must
file a simplified disclosure with the SEC describing its business, the risk factors, and its
intended use of funds and providing financial statements. The number of investors is not
limited and the offering may be advertised through the broker or funding portal.
The broker or funding portal acts as the “gatekeeper” to guard against abuse.
They ensure that investors receive the disclosures, understand the investment and can
bear the investment loss. They also must conduct background checks on the company’s
owners and management to confirm the absence of regulatory infractions. The SEC is
supposed to adopt implementing rules by December 31, 2012.
Crowdfunding is an innovative concept. It expands social networking to the
capital markets. It opens a new avenue for small businesses to access much needed, start-
7
Federal and state securities laws provide an exemption for private offerings, which typically
involves a limited number of sophisticated investors, no advertising or general solicitation, no
commissions or fees paid to unregistered brokers, and an intent that the investors hold the
security for investment and not for resale. See Regulation D, 17 C.F.R. §230.501 et seq., as
promulgated under the Securities Act of 1933, 15 U.S.C. § 77a et seq. (the “Securities Act”),
and Section 1-202.14 of the Oklahoma Securities Act of 2004, 71 O.S. §1-202.14.
8
The broker registration issue was explored by SharesPost, Inc., which provided a platform for
the secondary trading of shares in private, pre-IPO companies, such as Facebook, Groupon and
LinkedIn. SharesPost claimed it was merely a “passive bulletin board” and was not a “broker”
“engaged in the business” of effecting securities transactions, as defined under Section 4(A) of
the Securities Exchange Act of 1934, 15 USC §§78a-77kk. Because SharesPost was receiving
transaction-based compensation, providing investment advice, and facilitating pricing through
an auction process, the Securities and Exchange Commission disagreed and forced SharesPost
to register under threat of enforcement action. See SEC Rel. No. 2012-43 (March 14, 2012)
(SEC Announces Charges from Investigation of Secondary Market Trading of Private Company
Shares).
9
The JOBS Act, supra note 4.
3
up capital from a broad pool of potential investors. The notion that a small business
might raise money from large numbers of small investors without securities registration is
unprecedented. Whether crowdfunding lives to its potential will rely on the willingness
of brokers and funding portals to support the process. The gatekeeper function imposes
much more responsibility than websites bear under the current Kickstarter or Indiegogo
models, which do not deal with disclosures or investor suitability. Much will depend on
the SEC implementing rules and whether the brokers and funding portals can realize
sufficient compensation for the risks and responsibilities assumed.
Private Offering Changes
In addition to opening the crowdfunding door, the JOBS Act liberalized the rules
for exempt private offerings. Under the current Rule 506 of Regulation D, a company
can theoretically raise an unlimited amount of funds from an unlimited number of
accredited investors and up to 35 non-accredited investors.10 The company cannot,
however, advertise its offering or publicly solicit investors.11 As a practical matter,
companies must have some pre-existing relationship with potential investors, which
constrains their access to capital.
The JOBS Act removes the general solicitation and advertising prohibition on
offerings sold only to accredited investors under the revised Rule 506. The removal is a
startling development. In the statutory words, a private offering is one “not involving any
public offering.”12 Any general solicitation or advertising would seem necessarily to
involve a public offering and thus would be incompatible with a private offering. Even
before the general solicitation prohibition was explicitly stated under Rule 146 and later
Regulation D,13 legal authority had long held that private offerings could not engage in
10
17 C.F.R. §230.506. An accredited investor includes a business entity with at least $5.0 million
in assets and an individual with a net worth of at least $1.0 million (excluding the individual’s
primary residence) or an annual income of at least $200,000 (or $300,000 together with the
individual’s spouse). Rule 501(a) of Reg. D, 17 C.F.R. §230.501.
11
Rule 506(b)(1), 17 C.F.R. §230.506(b)(1), applies the general solicitation prohibition of Rule
502(c), 17 C.F.R. §230.502(c).
12
Section 4(2) of the Securities Act, 15 U.S.C. §77d.
13
Rule 146(c), 17 C.F.R. §230.146 (1975), as promulgated under the Securities Act and
Rule 502(c) of Reg. D (17 C.F.R. §230.502). See 44 Fordham L.Rev. (1975).
4
general solicitations.14 Yet legal authority has also long recognized that highly
sophisticated investors have little need for the protections afforded investors generally
and that broader solicitations among these investors should not destroy the private
offering exemption.15 With the JOBS Act opening the door to “accredited investor only”
offerings, we can say that policy has chosen to follow this latter line of authority.
Benefit Corporations
For those who bemoan the loss of ethics in business, let me present “socially
responsible entities”. These are entities spawned from the corporate social responsibility
movement, which urges businesses to create a better society while doing business. CSR
management principles rely upon a premise of moral responsibility to behave ethically
and to improve the quality of life for the business’s workforce, its local community and
the broader society. These principles believe that businesses can and should create a
better society while doing business.
The socially responsible entities come in various forms – the most common being
“benefit corporations” and “low-profit LLCs” or “L3Cs”. They are crosses between forprofit and not-for-profit entities. They are like for-profit entities, but with the stated
purpose to create a general public benefit. This is a compulsory undertaking, not a
permissive one. They are required to consider the public benefit. They differ from notfor-profit entities because they receive no tax benefits or other economic benefit and can
distribute profits to their owners.16
14
SEC v. Ralston Purina Co., 346 U.S. 119 (1953); SEC v. Sunbeam Gold Mines Co., 95 F.2d
699 (9th Cir. 1938) (private offerings under state securities laws prohibit broad solicitations).
15
Ralston Purina Co, id. 124-25 (the private offerings availability should turn on “whether the
particular class of persons affected needs the protection of the [Securities] Act. An offering to
those who are shown to be able to fend for themselves is a transaction ‘not involving any public
offering.’”). In the years after adoption of the Securities Act, the SEC had permitted private
institutional offerings to 100 or more offerees. See “Institutional Private Placements under the
Securities Act of 1933”, ABA Committee on Developments in Business Finance, 31 Bus. Law.
515 (1975); and Robert A. Kessler, Private Placement Rules 146 and 240--Safe Harbor?, 44
Fordham L. Rev. 37, 40 (1975) (noting the practice of large institutional offerings).
16
Benefit corporations are comprehensively discussed in J. William Callison’s article, Putting
New Sheets on a Procrustean Bed: How Benefit Corporations Address Fiduciary Duties, the
Dangers Created, and Suggestions for Change, at http://papers.ssrn.com/sol3/papers.cfm?
abstract_id=2102655 (July 9, 2012). This paper will discuss benefit corporations. The
popularity of L3Cs has faded recently. They were designed to be treated as “program related
5
Maryland was the first state to adopt benefit corporation legislation, which it did
in 2010. Since then, benefit corporation legislation has been adopted in California,
Hawaii, Illinois, Louisiana, Massachusetts, New Jersey, New York, South Carolina,
Vermont and Virginia.17 The California bill is typical.18
A California benefit corporation is a for-profit corporation whose purposes must
include the creation of a “general public benefit,” which is defined as activity having a
“material positive impact on society and the environment.”19 In addition, the benefit
corporation may state a specific public benefit, such as providing low-income or
underserved individuals or communities with beneficial products or services, promoting
economic opportunity for individuals or communities beyond the creation of jobs in the
ordinary course of business, preserving the environment, and improving human health.20
Having stated its purpose, the directors must consider the effect of any action or
proposed action upon the shareholders and employees, upon customers who are
beneficiaries of the general or specific public benefit purposes, and upon the
environment.21
The benefit corporation must prepare an annual benefit report, which includes the
board’s opinion as to whether the benefit corporation fulfilled its public benefit, a
description of the ways in which it pursued those benefits, and the extent to which those
benefits were fulfilled.22 The corporation must apply a “third party standard” for
investments” by non-profit foundations and that goal has been elusive. Unless the IRS
liberalizes the rules for program related investments to include L3Cs, they are unlikely to have
much utility. See Doug Batey, “ABA Business Law Section actively opposes low-profit
LLCs”, LEXOLOGY (July 3, 2012) (at http://www.lexology.com/library/detail.aspx?g=eff5e
177-0924-4824-9601-46c5d9939eff).
17
See http://www.benefitcorp.net/state-by-state-legislative-status.
18
Assembly Bill No. 361(codified at Cal. Corp. Code §§14600–14631). The legislation in these
states is based generally on a Model Benefit Corporation Act, which is promoted by a nonprofit organization called B Lab Corporation. B Lab operates a certification process for
qualifying entities and lobbies for its model act. See http://www.bcorporation.net/.
19
Id. §14610 (“general public benefit” requirement) and §14600(c) (“general public benefit”
definition).
20
Id. §14600(e) (“specific public benefit” definition).
21
Id. §14620.
22
Id. §14621 and §14630.
6
measuring its social and environmental performance and describe the process and
rationale for selecting the standard.23 The corporation must post its annual benefit report
on its website and file it with the Secretary of State.24
As in a for-profit corporation, the officers and directors of a benefit corporation
have fiduciary duties, which are owed to the shareholders. The officers and directors are
specifically protected in considering the needs of constituencies other than
shareholders.25 They are subject to “benefit enforcement proceedings”.26 A shareholder
or beneficiary of the public purpose may claim that the benefit corporation is failing to
pursue its stated public benefit. Neither the corporation nor the officers or directors can
be monetarily liable for the failure, but a court could grant injunctive relief and the
benefit corporation could be ordered to pay the plaintiff’s expenses, including attorney
fees.27
While the altruistic underpinnings of the benefit corporation would seem to be
universal, the concept is not without its critics. They have argued that the concept is
premised on a flawed notion that existing law compels directors to elevate the profitmotive above all else and prevents directors from considering the impact of corporate
decisions on other constituencies, the environment or the community. They say that
businesses can and do act in socially responsible ways under the present law and that
present law allows directors to consider a business’s long-term needs as well as its shortterm needs, and the needs of other constituencies, such as the workforce, in addition to
shareholder needs. They argue that to suggest present laws do not accommodate socially
responsible action is counterproductive. It implies that regular corporations act in
socially irresponsible ways and discourages the very conduct that the benefit corporation
laws seek to promote.28
23
Id. §14630.
24
Id.
25
Id. §14620(i) (no fiduciary duties to beneficiaries of a general or specific public benefit).
26
Id. §14623.
27
Id. §14623(c) and (d).
28
See Noam Noked, Benefit Corporations vs. ‘Regular’ Corporations: A Harmful Dichotomy,
Harvard Law School Forum on Corporate Governance and Financial Regulation (May 13,
7
The benefit corporation laws have also been criticized for adding uncertainty in
the discharge of fiduciary duties. Professor Stephen Bainbridge has noted that
management could use the stated public benefits to entrench itself at shareholder expense.
For example, management could use the stated benefits to discourage potential acquirors
by arguing the acquisition bid would hurt nonshareholder constituencies or that the
acquirer would act irresponsibly. If credence were given these arguments, it would
diminish the existing standards of conduct applied directors when responding to
acquisition bids.29
Oklahoma Developments
Legislation
There was little legislative activity dealing with business law in the 2012 Session.
Two items warrant brief discussion.
The Business Activity Tax (BAT). The BAT is a tax in lieu of ad valorem taxes on
intangible personal property.30 It was enacted in 2010 to moot the decision in
Southwestern Bell Telephone Co. v. Okla. State Bd. of Equalization,31 which held that the
constitutionally-based, intangible personal property exemption was much narrower than
had been presumed.32 The unexpected holding imposed ad valorem taxes on intangible
2012) (at http://blogs.law.harvard.edu/ corpgov/2012/05/13/benefit-corporations-vs-regularcorporations-a-harmful-dichotomy/).
29
Stephen Bainbridge, “The Socially Responsible Entity”, ProfessorBainbridge.com blog
(Nov. 1, 2005) (at http://www.professorbainbridge.com/professorbainbridgecom/2005/11/thesocially-responsible-entity.html). The issue was illustrated in a recent Delaware case, eBay
Domestic Holdings, Inc. v. Newmark, et.al., C.A. No. 3705-CC (Del. Ch. 2010). In that case,
the Craiglist board, which was controlled by the majority shareholders, had adopted a number
of defensive measures including a shareholders rights plan, or poison pill. Ebay, a minority
shareholder of Craigslist, challenged the measures. The court found that the board made “no
serious attempt” to provide evidence that the stated purpose of the poison pill—to preserve
Craiglist’s “unique corporate culture”—would “lead at some point to value for stockholders.”
The court found that the rights plan was instead a matter of the controlling shareholders’
“personal preference” and was invalid.
30
Senate Joint Resolution 61, 2nd Session of the 52rd Legis. (Okla. 2010) (codified as 68 O.S.
§§1215 et seq.).
31
2009 OK 72, 231 P.3d 638.
32
In Southwestern Bell, the difference between all intangible property and the intangible property
specifically described in the Constitution would have subjected to taxation Southwestern Bell’s
“customer lists, customer relationships, assembled work force, databases, goodwill,
employment contracts, patented technology, lease agreements, trademarks, and trade names,
8
property previously thought to be exempt and – if implemented - would have effected a
massive tax increase on Oklahoma businesses.
Two legislative acts in the 2012 Session dealt with this issue. One was Senate
Joint Resolution 52, which became State Question 766.33 If passed, State Question 766
would amend the State Constitution to exempt all intangible personal property from ad
valorem taxation. Another act was Senate Bill 1436, which was a backstop.34 The BAT
was set to expire after 2012. SB 1436 would extend the BAT for an additional year – and
thus defer the effect of the Southwestern Bell Telephone decision - if State Question 766
does not pass.
Annual LLC Reports. The Secretary of State requested Senate Bill 1523.35 The
bill fixes the amount of the annual LLC certificate fee at $25. The superseded statute
authorized an annual fee, but did not fix an amount. The bill also authorizes the
Secretary of State to send the annual notice by email instead of by mail. To facilitate
email transmission, the Secretary of State has changed the annual report form to collect
email addresses.
New Cases
Several recent case decisions in Oklahoma deserve mention, three of which deal
in some way with an agent’s capacity or liability or both. A fourth case deals with a
pastor’s fiduciary duties.
Smoot v. B&J Restoration Services, Inc. is a well-reasoned case involving the sale
of a business.36 Larry and Connie Smoot, through their company, C&L Restoration
Services, LLC, bought a cleaning and restoration business from B&J Restoration
Services, Inc. and its owners, Brandon and Julie Hopper. The plaintiffs alleged that the
Hoppers breached the purchase agreement and a restrictive covenant and defrauded
licensed software, an extensive advertising effort and the attendant copyrights on the
advertising materials [and] technical documentation.” Id. ¶3.
33
Senate Joint Resolution 52, 2nd Session of the 53rd Legis. (Okla. 2012).
34
Senate Bill 1436, 2nd Session of the 53rd Legis. (Okla. 2012).
35
Senate Bill 1523, 2nd Session of the 53rd Legis. (Okla. 2012) (codified at 18 O.S. §2055.2).
36
2012 OK CIV APP 58, 279 P.3d 805.
9
plaintiffs by misrepresenting the business. The jury found that the B&J and the Hoppers
were liable for the contractual breaches, but not for any fraud.
The Hoppers appealed arguing that they could not be personally liable for the
contractual breaches as they were only acting in their corporate capacities. The Smoots
countered that the Hoppers had signed the purchase agreement in their individual
capacities and had initialed each page individually. The Hoppers presented testimony
from the business broker’s counsel, who prepared the documents and stated that the lack
of corporate capacity was an inadvertent omission. Faced with this ambiguity, the court
reviewed the purchase agreement and noted that B&J was described in the preamble as
the seller and the representations addressed the signer’s authority to bind B&J. Other
closing documents indicated a corporate capacity, such as the corporate resolutions
authorizing the sale, an assignment of the tradename, an agreement to split a franchise
fee, and a settlement statement. Taken together, the court held that the Hoppers intended
to sign in their corporate capacities and not individually.
This did not resolve, however, the issue of whether the Hoppers were individually
liable. While an agent is not normally liable for acting as such, the court notes that
officers or other corporate agents can be individually liable if “they agreed to be bound,
their conduct was tortious, or they exceeded their authority.”37 Under the non-compete
provisions of the purchase agreement, the agreements states, “Seller covenants not to
compete as an individual, officer, employee, investor, or in any other capacity.” The
applicable provisions closed with an undertaking that the non-compete obligations
“extend to each officer, director and shareholder . . . of Seller, and Seller represents and
warrants that it has the authority to bind such officers, directors [and] shareholders . . ..”38
In light of these provisions, the court then held that the Hoppers had bound themselves
individually even though they signed in their representative capacities.
The court then examined whether the Hoppers were personally liable because
they engaged in tortious conduct or exceeded their authority. As to the tortious conduct,
the court noted that the jury had rejected the fraud claims against the Hoppers and found
37
Id. ¶19.
38
Id. ¶11.
10
only on the breach of contract claims. That finding indicated their conduct was not
tortious.39 Did they exceed their authority? Plaintiffs claimed the Hoppers did so by
failing to disclose that B&J was doing business beyond the scope of the cleaning
franchise, which inflated the business’s revenues. But this claim, the court reasoned, is
an alleged misrepresentation about the business, not about the Hoppers’ capacities. The
court further reasoned that B&J was not legally limited in the work it could do and
neither were the Hoppers. B&J could remodel as well as clean and the Hoppers could
carry out this work. Hence they did not exceed their authority. The Hoppers were
personally liable for breach of the non-competes, but not for breach of the purchase
agreement generally.40
The dissenting opinion in Smoot further examines the issue of when an officer can
be personally liable. The dissent states that when an agent acts for a principal, the
principal is bound but not the agent.41 Since the Hoppers signed the purchase agreement,
which included the non-competes, in their representative capacities, the dissent would
hold that B&J was bound, but not the Hoppers. As officers, they are not bound
individually and cannot be personally liable. The dissent cites the case of Carter v.
Schuster.42 In Carter, the court held that Schuster could not be compelled to arbitrate
when he signed the arbitration agreement only as an officer, not as an individual. But the
facts in Smoot differ. The arbitration provision in Carter was only between the parties
and did not include the officers. In Smoot, the purchase agreement contained express
language obligating the officers individually to the non-competes. Should the law permit
an officer to sign an agreement knowing that it purports to obligate him and escape the
39
Id. ¶19.
40
Id. ¶20.
41
This is true as a general rule. Restatement (Third) of Agency, §6.01 (2006) (“When an agent
acting with actual or apparent authority makes a contract on behalf of a disclosed principal,
(1) the principal and the third party are parties to the contract; and (2) the agent is not a party to
the contract unless the agent and third party agree otherwise.”).
42
2009 OK 94, 227 P.3d 149 (holding at ¶26). Cf. BAP, LLP v. Pearman, 2011 OK CIV APP 30,
250 P.3d 332 (Under the partnership agreement, the partners and partnership manager are
“parties” and the manager can enforce an arbitration clause; the non-signatory officer of the
manager can enforce the arbitration clause against the signatory partners and partnership).
11
obligation by claiming he signed only as an officer and not as an individual? The dissent
would say yes. Others would say no: the result is inequitable.
Non-signatories may be bound contractually under several theories.43 Estoppel is
often applied to an officer or other principal of a signatory corporation when enforcement
of a provision against the officer is presumed or foreseeable.44 In Smoot, the Hoppers
signed as officers knowing that the non-compete provisions in the purchase agreement
and the separate restrictive covenant agreement applied to the officers. As owners of the
seller, B&J, they benefited from these agreements. The Smoots undoubtedly relied on
the Hoppers not competing against them after the sale. The author believes the law
should estop the Hoppers from receiving the benefit of their bargain while depriving the
Smoots of their bargain. It should not allow the Hoppers to say nothing at closing and
later claim the freedom to compete. In the memorable words of an earlier case, “If you
do not speak when you ought to speak, you shall not speak when you want to speak.”45
The rights and duties of non-signatories are also addressed in High Sierra Energy,
L.P. v. Hull.46 The case involved High Sierra’s purchase of related oil and gas service
businesses in 2007. Certain principals of the sellers, David Hull and Bill Hare, continued
to manage the businesses after the sale. In late 2008, High Sierra allegedly learned that
Kellie Hull, David Hull, Bill Hare and others were improperly competing against it and
misusing High Sierra assets and confidential information for personal gain. High Sierra
sued in April 2009 naming Kellie Hull and four other individuals as defendants along
with four companies associated with these individuals.47 The defendants filed a motion
43
The Court wrote in Arthur Andersen LLP v. Carlisle, 556 U.S. 624, 129 S.Ct. 1896 (2009), that
“‘Traditional principles’ of state law allow a contract to be enforced by or against nonparties to
the contract through ‘assumption, piercing the corporate veil, alter ego, incorporation by
reference, third-party beneficiary theories, waiver and estoppel’ . . . .” 129 S.Ct. at 1902
(quoting 21 R. Lord, Williston on Contracts, §57:19, p. 183 (4th ed. 2001).
44
Recurrent Capital Bridge Fund I, LLC v. ISR Systems and Sensors Corp., No. 12 Civ. 772
(SAS), 2012 WL 2402621, at *5 (S.D.N.Y., 2012); Firefly Equities, LLC v. Ultimate
Combustion Co., Inc., 736 F. Supp. 2d 797, 799 (S.D.N.Y. 2010); Thibodeau v. Pinnacle FX
Invs., No. 08 Civ. 1662, 2008 WL 4849957, at *5 n. 4 (E.D.N.Y., 2008).
45
Darrough v. Davis, 135 Okl. 263, 275 P. 309 (1929) (describing the theory of estoppel).
46
2011 OK CIV APP 77, 259 P.3d 902.
47
A month earlier, High Sierra had sued David Hull and Bill Hare under their employment
agreements with similar allegations. Hull and Hare filed a motion to arbitrate in that
12
to arbitrate based on the arbitration provision in the purchase agreement. The district
court denied the motion to arbitrate and the defendants appealed.
The court faced two issues. One was whether the alleged conduct related to the
purchase agreement, which could bring the conduct within the scope of the arbitration
provisions. Second was whether High Sierra could be compelled to arbitrate when only it
and Kellie Hull were signatories to the purchase agreement. The other eight defendants
were not signatories.
As to the first issue, the court held that the alleged claims against Kellie Hull
“clearly related to the [purchase agreement].” It states that “High Sierra’s claims all rest
upon the benefits High Sierra expected to receive from the [purchase agreement].” These
bare conclusions appear to say that High Sierra would have no claims but for its purchase
of the businesses and thus the claims relate to the purchase agreement. But the logic is
strained. The claims arise from the conduct. The conduct may or may not arise out of
the purchase agreement. High Sierra never alleged a contractual breach of the purchase
agreement. All of its claims sound in tort.48 Of the tort claims, none relate directly to the
purchase agreement, such as claims for fraudulent inducement or bad faith negotiation.
Further, most of the conduct appears to have occurred after the purchase, which closed on
September 10, 2007. High Sierra said it learned of the wrongful conduct in December
2008. The court’s conclusion that the claims related to the purchase agreement seems
surprising without a closer link to the purchase agreement.49
Having determined that the claims related to the purchase agreement, the court
then examined whether High Sierra must arbitrate with non-signatories. To understand
this issue, it is helpful to note that there are two lines of cases dealing with nonsignatories and arbitration: those in which non-signatories are being compelled to
proceeding, which was denied. They appealed and the Court of Appeals reversed. High Sierra
Energy, L.P. v. Hull, 2010 OK CIV APP 96, 241 P.3d 1139.
48 The claims were for “misappropriation of trade secrets and confidential information, unfair
competition, unjust enrichment, misappropriation of assets and property, constructive trust,
breach of fiduciary duty, and negligence.” High Sierra, supra ¶4.
49
The opinion does not analyze the connection between the claims and the purchase agreement.
The opinion also does not address whether the purchase agreement had a survival clause
describing what provisions would survive closing. For post-closing conduct to relate to the
purchase agreement, it would presumably tie to a surviving representation or covenant.
13
arbitrate and those in which non-signatories are compelling signatories to arbitrate.50
High Sierra deals with the latter.
The court cites authority permitting non-signatories to compel a signatory to
arbitrate when the signatory has invoked the arbitration clause and the claims between
signatories and non-signatories are “so ‘intertwined’ [that] equitable estoppel is
warranted. Otherwise, arbitration proceedings between the signatories ‘would be
rendered meaningless and the federal policy in favor of arbitration effectively
thwarted.’”51 In High Sierra, the plaintiff signatory invoked the arbitration clause when
it asserted claims arising from the purchase agreement against a signatory defendant,
Kellie Hull. Since alleged conduct involved Hull and the other non-signatory defendants,
judicial economy would be thwarted by having an arbitration for Hull and a court
proceeding for the other defendants.
The court’s holding on this issue is less surprising. Courts generally have been
more lenient in allowing non-signatories to compel signatories to arbitrate than in
allowing signatories to compel non-signatories to arbitrate.52
The final case examining an agent’s capacity or liability is AT&T Advertising,
L.P. v. Winningham.53 The case involves a lawyer, Willingham, who contracted for
Yellow Page advertising on behalf of a professional LLC. The LLC was cancelled by the
Secretary of State on July 1, 2007, for failure to file annual reports and pay annual fees.
The Yellow Pages contracts were signed later. Willingham filed Articles of Conversion
in July 2009, which purported to convert the LLC into a professional corporation. In
September 2009, AT&T filed suit for non-payment under the contracts, all of which were
signed before July 2009.
50
See Note, Equitable Estoppel and the Compulsion of Arbitration, 60 Vand. L. Rev. 711 (2007).
51
2011 OK CIV APP 77 at ¶23 (citing Cinocca v. Orcrist, Inc., 2002 OK CIV APP 123, ¶18, 60
P.3d 1072, 1074).
52
Cf. Carter v. Shuster, supra note 42, which denied a signatory’s effort to include a nonsignatory officer in the arbitration proceeding, with BAP, LLP v. Pearman, supra note 42, in
which the non-signatory officer of the manager could enforce the arbitration clause against the
signatory partners and partnership.
53
2012 OK CIV APP 51, 280 P.3d 360.
14
Willingham defended by claiming he was not liable as a manager or member for
the obligations of the LLC, regardless of whether it had been administratively cancelled.
AT&T responded arguing that the statute Willinghman cited protected members and
managers only during an LLC’s initial suspension and loss of good standing for failure to
file or pay. It did not protect him after the LLC was cancelled. The court agreed with
AT&T. Under the statutory scheme, an LLC that fails to file or pay initially loses its
good standing and is suspended. During that time, its existence continues. If the LLC
does not restore its good standing within three years, the Secretary of State cancels the
LLC and it ceases to exist.54 Such was the state of Willingham’s LLC. It had been
cancelled and did not legally exist. If it did not exist, Willingham was the agent of a nonexistent principal and was liable for his acts.55
Willingham next argued that the 2009 conversion to a P.C. reinstated the LLC and
the liability shield related back to protect him during the period of cancellation. The
court rejected this argument too. It noted that reinstatement of a cancelled LLC was not
possible in 2009.56 The articles of conversion – which the Secretary of State appears to
have accepted erroneously – could not have effected a reinstatement since the conversion
statute presumes the good standing of the converted entity and makes no provision for
reinstatement.57 The court cites the absence of any statutory authority for a relation back
54
The process and its implications are described in Libby Mercer, Avoiding the Premature Death
of an LLC, OBJ 79 45 (Jan. 12, 2008).
55
When an agent contracts for a non-existent principal, the agent is liable under the contract since
the contracting party would otherwise have no recourse. In essence, there is no agency.
Restatement (Third) of Agency, §6.04 (2006).
56
Before 2010, a cancelled LLC could not be reinstated. See Mercer, supra note 54. The
applicable sections were amended in 2010 to permit the reinstatement of suspended and
cancelled LLCs. See 18 O.S. §2012.1 (“C. A limited liability company whose articles of
organization have been canceled under subsection B of this section may apply for reinstatement
under subsection G of Section 2055.2 of this title.”) and §2055.2 (“G. A domestic limited
liability company not in good standing for failure to file an annual certificate and pay the annual
certificate fees or registered agent fees, including a domestic limited liability company whose
articles of organization have been canceled under subsection B of Section 2012.1 of this title, or
a foreign limited liability company whose registration was withdrawn for failure to file an
annual certificate and pay the annual certificate fees or registered agent fees may apply to the
Secretary of State for reinstatement . . .(emphasis added).”).
57
Like corporations, LLCs cannot file articles or other instruments with the Secretary of State
unless they are in good standing. 18 O.S. §2055.2.F (subsection E after Nov. 1, 2102). Since
Willingham’s LLC had been cancelled, it could not have been reinstated and restored to good
15
of the liability shield and notes that reinstatement does not protect corporate officers from
debts incurred during a corporation’s suspension.58
A final case deals with fiduciary duties – in this instance, of a pastor to a church
congregation – and the standards by which a court will determine church disputes. In
Griffin v. Cudjoe,59 the pastor Cudjoe was accused of misappropriating church funds for
personal use. In response, Cudjoe caused his critics to be removed as deacons and
members and denied their access to church funds and records. The critics sued
derivatively for the church. The trial court found against Cudjoe and awarded plaintiffs
damages for Cudjoe’s breach of fiduciary duties and misuse of funds.
Cudjoe claimed on appeal that the court had no jurisdiction to adjudicate
“internal, ecclesiastical matters.”60 For support, he cited the case of Fowler v. Bailey.61
standing, and it should have been incapable of filing the articles of conversion. A conversion
from an entity from one type to another continues the existence of the underlying entity and the
rights and duties of the underlying entity are unaffected by the conversion. 18 O.S. §2054.1.F.
A conversion would not reinstate an entity that had ceased to exist.
Regarding the liability of officers during a corporate suspension, the court cites Bethlehem Steel
Corp. v. Giese, 1984 OK 28, 681 P.2d 769.
58
Section 2055.2 of the Oklahoma LLC Act provides that a member or manager is not liable for
the LLC’s obligations during a suspension for lack of good standing. The protection
presumably ceases when the LLC is cancelled since the LLC would no longer exist. The 2010
amendments providing for reinstatement do not explicitly provide for a relation back of the
liability shield to protect the members and managers of an LLC that had been cancelled.
59
2012 OK CIV APP 46, 276 P.3d 1064 (“Griffin”). This paper will generally follow the
terminology in Griffin, which refers to a “pastor” and “church members”. The term “pastor”
should be understood to include a “minister”, “preacher”, “priest”, “rabbi” or “clergy”. A
“church member” would include a “parishioner”, “lay person” or “congregant”.
60
Id. ¶18. Although not denominated as such, Cudjoe’s defense is the so-called Watson rule or
the rule of “compulsory deference”, in which secular courts defer to the judgments of the
church’s governing authority when dealing with internal disputes, including certain property
disputes. The rule comes from Watson v. Jones, 80 U.S. (13 Wall.) 679, 20 L.Ed. 666 (1871)
and has been followed in Oklahoma. See Presbytery of Cimarron v. Westminster Presbyterian
Church of Enid, 1973 OK 114, 515 P.2d 211 (Okla. 1973). The courts will, however, intervene
to adjudicate what are essentially civil or property rights unrelated to religious dogma. See
Wolozyn et al. v. Begarek et al., 1963 OK 35, 378 P.2d 1007; First English Lutheran Church of
Oklahoma City v. Bloch, 1945 OK 175, 159 P.2d 1006.
The U.S. Supreme Court adopted an alternative to the Watson compulsory deference rule in
Jones, v. Wolf, 443 U.S. 595, 99 S. Ct. 3020, 61 L. Ed. 2d. 775 (1979) (“Jones”), which has
become known as the “neutral principles” approach. Under the neutral principles, a court may
apply the same legal principles to church disputes as they would apply in a proceeding
involving secular parties if the application does not require a determination of religious
doctrine. The use of neutral principles has diminished the degree of deference traditionally
shown by the courts.
16
In Fowler, certain church members complained about the misuse of church assets and
were dismissed from membership. The Fowler court held that determinations of
membership were ecclesiastical issues and were not appropriate for civil courts. It further
stated that the plaintiffs were not a majority of the church and thus were not entitled to
control church property.62 The Fowler court further held that church members have no
statutory right of inspection under the Oklahoma Business Corporation Act.63
The Griffin court held that the plaintiffs had standing to pursue the claims. Unlike
the Fowler plaintiffs, the Griffin plaintiffs represented a majority of the church
membership, which was a standing requirement under Fowler.64 The court rejected
Cudjoe’s attempted removal of the plaintiffs from membership, presumably because the
removal vote was improper procedurally.65 The court then found that this was not a
dispute about ecclesiastical matters, but a dispute simply about money, which the civil
courts have long held the authority to decide.66
Having held that the plaintiffs had standing, the court then held that they could
maintain breach of fiduciary duty claims against Cudjoe and were entitled to inspect the
church records. While the author believes the holdings in Griffin are correct, the court
61
1992 OK 160, 844 P.2d 141 (“Fowler”).
62
Id. at ¶20, relying upon Cape v. Moore, 122 Okl. 229, 253 P. 506 (1927) (allowing a majority
of the membership to determine the use of church property).
63
Id. ¶¶23 and 24. Whether the Fowler court was correct, the Oklahoma General Corporation Act
clearly applies to non-profit corporations, including religious corporations, and affords
members of non-profit corporations the right to inspect corporate records for any proper
purpose at any reasonable time. 18 O.S. §1065. See discussion at notes 72 through 74.
64
The compulsory deference rule defers to those within the church who have authority to
determine the matter. In a congregational church – that is, a church that does not have a
hierarchical authority – a majority of the congregation would presumably be the authority to
which a court would defer. Jones, supra note 60, at 607, 608.
65
The courts typically will not review the grounds for removing a member from the church, but
may determine whether the removal was proper procedurally. Bouldin v. Alexander, 82 U.S.
(15 Wall.) 131 (1872) (courts may determine if an ouster was the act of the church or merely
persons purporting to act for the church); Griffin at ¶19 (“[A] civil court may determine the
regularity of a church meeting and who is a member of a church for the purpose of determining
the identity of those individuals who collectively represent the church and are entitled to control
church property (citing Fowler).”).
66
Griffin at ¶21.
17
offers little analysis in determining these unique and unsettled issues.67 For example,
whether a pastor or church owes fiduciary duties to the members was an open issue in
Oklahoma. The fiduciary issue had arisen previously in Bladen v. First Presbyterian
Church of Sallisaw,68 N.H. v. Presbyterian Church (U.S.A.),69 and Schovanec v.
Archdiocese of Oklahoma City.70 The prior cases each involved a claim of fiduciary
breach against the church (not the individual pastor) and each case was resolved without
a determination of whether the church owed a fiduciary duty to its members. The Griffin
court presumes a fiduciary duty between the pastor and the members without discussion.
The holding does not say whether the pastor’s duty arose from the facts or was per se.71
Still unsettled is whether and when a church would owe an institutional fiduciary duty to
its members.72
67
Examples of fiduciary and derivative claims against non-profit corporation are unusual, and
little legal authority exists to guide us. See gen., John E. Black, Jr., Directors and Officers of
Non-Profit Corporations – Liabilities, Rights and Insurance, ABA (available at
http://www.abanet.org/buslaw/newsletter/0014/materials/npdirectors03.pdf).
68
1993 OK 105, 857 P.2d 789 9 (the court need not decide the fiduciary claims against the pastor
since the claims were premised upon alienation of affection and seduction, which are not legally
cognizable in Oklahoma; claims against the church were based on respondeat superior).
69
1999 OK 88, 998 P.2d 592, at note 48.
70
2008 OK 70, 188 P.3d 158 (the record shows no evidentiary support for fiduciary relationship).
71
Oklahoma law is clear that directors and officers owe fiduciary duties to the corporation and its
shareholders, including duties to a non-profit corporation and its donors. Warren v. Century
Bankcorporation, Inc., 1987 OK 14, 741 P.2d 846 (for-profit directors and officers); see Reneé
DeMoss and Melissa Taylor, Oklahoma Lawyers Serving on Nonprofit Boards, 83 O.B.J. 1217
(May 19, 2012) (“Directors of nonprofit boards must comply with the same legal and fiduciary
duties that have developed over time to govern the conduct of directors of for-profit
corporations.”). While the relationship of pastor to church member would seem analogous to
the fiduciary relationships of a director or officer to a corporation and its shareholders, the
fiduciary relationship between a pastor and church members is not commonly understood to be
per se. Some courts have held that the fiduciary relationship will arise only if the facts indicate
a position of trust was created between the parties. See Moses v. Diocese of Colorado, 863 P.2d
310 (Colo. 1993); Emily L. Short, Note, Torts: Praying for the Parish or Preying on the
Parish? Clergy Sexual Misconduct and the Tort of Clergy Malpractice, 57 Okla. L. Rev. 183,
194-196 (2004).
72
The duty between the members and the church as an institution is more ambiguous. An
example of an institutional duty would be a counseling practice, which owes a fiduciary duty to
its patients because of the trust the patients repose in the practice. If a counselor breaches the
trust by making sexual advances toward a patient, the patient might sue the counseling practice
for breaching its fiduciary duty by not taking appropriate action to ensure that advances do not
occur. No court has determined that the church has a per se fiduciary duty to its members, but
the duty can arise when the church assumes an obligation for the member that creates a position
of trust and reliance. In the clergy sexual abuse cases, plaintiffs often allege that the church
18
The right to inspect is not a clear-cut issue either. In Wolozyn et al. v. Begarek et
al.,73 a church member was denied inspection rights when apparent purpose related to
matters of dogma and belief rather than any property interest. The Fowler court also
denied inspection rights.74 The Wolozyn and Fowler cases were both decided under the
Oklahoma Business Corporation Act, which offered no statutory authority for inspection
of non-profit corporate records. The statutory inspection rights under the Oklahoma
General Corporation Act clearly extend to non-profit corporations, including religious
corporations, and afford members of non-profit corporations the right to inspect corporate
records for any proper purpose at any reasonable time.75 Yet, courts have considered the
interplay between statutory inspection rights and the constitutional protect of religion.76
Griffin did not address the source of authority for permitting inspection or the
constitutional interplay.
In Griffin, the plaintiffs’ assertion of fiduciary claims is derivative. They are
asserting claims on the church’s behalf against the pastor. Examples of derivative claims
in a non-profit corporation context are rare. Griffin appears to be the first Oklahoma case
to have considered a derivative action involving a non-profit corporation.77 Under the
normal rules for derivative actions, a court would first determine if the plaintiffs were
members of the church at the time of the alleged wrongs and whether the plaintiffs have
alleged “with particularity” what demands they have made on the corporation for action
failed to investigate accusations of a clergy’s wrongdoing, to warn people who might be
exposed to such wrongdoing, or to take immediate action against the clergy known to have
committed wrongful acts. See John H. Mansfield, Constitutional Limits on the Liability of
Churches for Negligent Supervision and Breach of Fiduciary Duty. 44 B.C.L.Rev. 1167 (2003).
73
1963 OK 35, 378 P.2d 1007. While the court denied the inspection rights for lack of a proper
purpose, it did presume that the statute would otherwise apply to the plaintiff and create a duty
within the church.
74
Id. ¶¶23 and 24.
75
18 O.S. §1065.
76
Griffin did not state whether the inspection rights arose from statute or common law and did not
address the extent to which the Watson deference rule might limit those rights. Cf. Lacy v.
Bassett, 132 S.W.3d 119 (Tex. Ct. App., Houston (14 th Dist.), 2004) (ecclesiastical abstention
doctrine did not bar the court’s consideration of a financial records inspection claim).
77
See A-Plus Janitorial & Carpet Cleaning v. Employers' Workers' Compensation Assoc., 1997
OK 37, 936 P.2d 916 (a derivative action could be maintained on behalf of an unincorporated
workers’ compensation group).
19
or why such demands would be futile.78 In this case, the court ignored the attempt to
remove the plaintiffs from membership and assumes the plaintiffs were members at the
time of the alleged wrongs. Given Cudjoe’s treatment of the plaintiffs, a demand that
Cudjoe take action would presumably be futile, but the issue is not addressed. Griffin
offered a rare opportunity to address these issues and missed.
Despite its brevity, the Griffin decision is still significant. Griffin is the first
Oklahoma decision to have applied the “neutral principles” approach.79 The decision
loosens the compulsory deference approach, adopts a neutral principles approach, and
rejects the degree of deference shown in Fowler. The neutral principles approach
expands the courts’ options in dealing with church disputes, and give the courts more
flexibility in dealing with clergy misconduct, as in Griffin. But the greater significance
may come in deciding property cases, such as those in which a local church leaves its
affiliated national church and claims ownership of the local property. These cases have
become common throughout the United States, and the Oklahoma courts will likely see
one.80 If so, the Griffin decision could affect its outcome.81
78
12 O.S. §2023.1.
79
Griffin, at ¶21. Under the neutral principles approach, a court may apply its own reading of
documents, such as deeds, charters or bylaws, as it would in a secular case, if the reading does
not require an interpretation of religious doctrine. The court need not accept the church’s
interpretation of those documents. See discussion of Jones, supra note 60.
Griffin’s application of the neutral principles approach must be reconciled with Presbytery of
Cimarron v. Westminster Presbyterian Church of Enid, 1973 OK 114, 515 P.2d 211, which
dealt with a property dispute between the local and national church. See a discussion of this
issue at note 79.
Cudjoe asserted that the First Amendment protections enable him to create a church “in which
he was [the] autonomous authority.” Griffin, at ¶20. In other words, he argued that he could be
accountable to no one but himself (and presumably God). While the assertion might seem
outlandish to some, the position is consistent with the compulsory deference position taken by
the Fowler court, which essentially gave the plaintiffs no recourse but to leave the church. In a
separate concurring opinion, Justice Opala explained that the church was a voluntary
association and the majority could remove whomever it wanted for whatever reason.
80
See “Churches in Court: The Legal Status of Religious Organizations in Civil Lawsuits”, The
Pew Forum on Religion & Public Life (2011) (available at http://www.pewforum.org/ChurchState-Law/Churches-in-Court(2).aspx).
81
The Oklahoma Supreme Court dealt with a property case in Presbytery of Cimarron v.
Westminster Presbyterian Church of Enid, supra note 77. Facing a financial crisis, the local
church consulted the affiliated national church, which determined that the local church should
dissolve and turn over its property to the national church, which the local church refused to do.
The local church argued that it held legal title to the property and, under an application of
20
Conclusion
While many interesting changes have and will occur at the Federal level, the
Oklahoma cases we have just reviewed remind us that state laws do matter. Thousands
of new businesses are formed each year in Oklahoma. Add to those the existing
businesses. Each of these many businesses depends on Oklahoma statutes and case law
to guide their formation and operation. The law guides relationships among owners,
between owners and managers, and between the entity and persons with whom it does
business. As lawyers, we are uniquely positioned to assist these business and to
encourage best business practices. Good corporate governance means better
relationships. It also makes for a better marketplace.82 Markets are more efficient where
transparency and trust are found, and transactional risk decreases. The resulting
economic benefits help us all.
Gary W. Derrick
November 1, 2012
“neutral principles”, it was the owner of the property. The court declined to follow the local
church’s approach, citing the Watson rule of compulsory deference to the church’s hierarchical
authority. Id. ¶20. But the court continued to analyze the local deeds and the constituent
documents of the national church to determine that the local church had submitted to the
authority of the national church. It also stated that the root of the dispute was financial, not
doctrinal, which freed the court from strict deference to the hierarchical authority. Id. ¶22.
Despite its ostensible holding, the court’s analysis of the documents and the cited cases appears
to apply a neutral principles approach. One wonders if the court’s analysis in 1973 would have
changed had the U.S. Supreme Court’s 1979 adoption of the neutral principles approach in
Jones, supra note 60, had been available. Cf. First English Lutheran Church of Oklahoma City
v. Bloch, 1945 OK 175, 159 P.2d 1006 (in which the national church deferred to the civil courts
to determine a church property dispute, effectively requiring the court to adopt a neutral
principles approach).
82
See Down on the Street: A Special Report on American’s Capital Markets, The Economist
(Nov. 25, 2006) (“In theory, a higher standard of corporate governance should result in a higher
valuation, since listing in a well-regulated market shows a commitment from a company that it
will not abuse investors. One study, conducted post-Sarbanes-Oxley, found that the premium
placed on the value of an emerging-market firm listing in New York can reach 37%;
preliminary research suggests the value of a London listing is not as high.”)
21