OFFICIAL COMMENT

The short title provided by section 1.01 creates a convenient name for the state's business corporation act.

See the Introduction for a general description of the development of the Model Act, the purposes it is intended to serve, the principles under which the 1984 Revised Model Business Corporation Act was prepared, and the roles of the Cross-References and Official Comments.

Cross References. - For constitutional provisions regarding corporations, see N.C. Const., Art. VIII.

As to executions, see G.S. 1-324.1 et seq.

As to receivers of corporations, see G.S. 1-507.1 et seq.

As to jurisdiction of the superior court division over proceedings under this Chapter, see G.S. 7A-249.

As to provisions relating to nonprofit corporations, see G.S. 55A-1 to 55A-89.1.

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Legal Periodicals. - For article giving comments of draftsmen of the Business Corporation Act adopted in 1955, see 33 N.C.L. Rev. 26 (1954).

For case law survey on business associations, see 41 N.C.L. Rev. 415 (1963).

For article reevaluating the Business Corporation Act adopted in 1955, see 43 N.C.L. Rev. 768 (1965).

For article surveying case law as to corporations, see 44 N.C.L. Rev. 950 (1966).

For note on the liability of directors and officers for negligent management, see 45 N.C.L. Rev. 748 (1967).

For comment on tax and corporate aspects of professional incorporation in North Carolina, see 48 N.C.L. Rev. 573 (1970).

For note, "Glenn v. Wagner: Instrumentality Rule versus the Balancing Test in Piercing the Corporate Veil," see 64 N.C.L. Rev. 1265 (1986).

For article, "The Corporate Fox and the Shareholders' Hen House: Reflections on Alford v. Shaw," see 65 N.C.L. Rev. 569 (1987).

For article, "The Uncertain Case Against the Double Taxation of Corporate Income," see 68 N.C.L. Rev. (1990).

For business symposium, "Management Buyouts: Strategies, Ethics and Other Considerations," see 25 Wake Forest Law Rev. 1 (1990).

For article discussing changes in theories of the corporation over the last 150 years, see "Theories of the Corporation," 1990 Duke L.J. 201.

For article, "The Corporate Persona, Contract (and Market) Failure, and Moral Values," see 69 N.C.L. Rev. 273 (1991).

For article, "Discrimination, Managerial Discretion and the Corporate Contract," see 26 Wake Forest L. Rev. 541 (1991).

For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For a comment on the acquisition, abandonment, and preservation of rail corridors in North Carolina, see 75 N.C.L. Rev. 1989 (1997).

For article, "Silencing the Shareholder's Voice," see 80 N.C.L. Rev. 1897 (2002).

For article, "Corporate Governance and Climate Change: Empirical Study: The Doctrine of Defective Incorporation and its Tenuous Coexistence with the Model Business Corporation Act," see 44 Wake Forest L. Rev. 833 (2009).

For article, "Overcoming the Rippy Effect: Why the North Carolina Business Corporations Act Should Allow Permissive Officer Exculpation," see 94 N.C.L. Rev. 2155 (2016).

For article, "Shareholder Voting and the Symbolic Politics of Corporation as Contract," see 53 Wake Forest L. Rev. 512 (2018).

OFFICIAL COMMENT

Provisions similar to section 1.02 have their genesis in Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat) 518 (1819), which held that the United States Constitution prohibited the application of newly enacted statutes to existing corporations while suggesting the efficacy of a reservation of power similar to section 1.02. The purpose of section 1.02 is to avoid any possible argument that a corporation has contractual or vested rights in any specific statutory provision and to ensure that the state may in the future modify its corporation statutes as it deems appropriate and require existing corporations to comply with the statutes as modified.

All articles of incorporation or certificates of authority granted under the Model Act are subject to the reservation of power set forth in section 1.02. Further, corporations "governed" by this Act - which includes all corporations formed or qualified under earlier, general incorporation statutes that contain a reservation of power - are also subject to the reservation of power of section 1.02 and bound by subsequent amendments to the Act.

Many states have constitutional provisions mandating the reservation of power to amend or modify corporate statutes and charters. In these states section 1.02 is also supported by specific constitutional authorization.

NORTH CAROLINA COMMENTARY

This section is substantially the same, in effect, as former G.S. 55-174.

This reserved power also appears in the North Carolina Constitution. See N.C. Const. Art. VIII, § 1; The Yadkin River Power Co. v. Whitney Co. , 150 N.C. 31, 63 S.E. 820 (1906).

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

OFFICIAL COMMENT

As described in the Official Comment to section 1.20, documents are entitled to filing under the Model Act if they meet the substantive and formal requirements of the Act; they may also contain additional information if the person submitting the document so elects. See the Official Comments to sections 1.20 and 1.25. In these circumstances it is not appropriate to vest the secretary of state with general authority to establish mandatory forms for use under the Model Act. Certain types of reports and requests for documents may be processed efficiently only if uniform forms are prescribed by the secretary of state. Certificates of existence, for example, should require specific information located at specific places on the form; similarly, processing of large-volume, largely routine filings is expedited if standardized forms are required. Also, the disclosure requirements of the annual report may be administered on a systematic basis if a standardized form is mandated. Section 1.21(a) recognizes that these considerations may exist in limited cases, and expressly enumerates those forms for which the secretary of state is authorized to establish mandatory forms.

Section 1.21(b) authorizes (but does not require) the secretary of state to prepare forms suitable for use for other documents required or permitted to be filed under the Act. However, the use of these forms is permissive and cannot be required by the secretary of state.

NORTH CAROLINA COMMENTARY

The Model Act was modified by changing "prescribe" to "promulgate," because "prescribe" is inconsistent with the idea of optional forms.

OFFICIAL COMMENT

Section 1.22 establishes in a single section the filing fees for all documents that may be filed under the Model Act. The dollar amounts for each document should be inserted by each state as it adopts the Act.

The list of documents in section 1.22 includes all documents that are authorized to be filed with the secretary of state under the Model Act. The catch-all in subdivision (26) will apply to any document for which a state does not establish a specific filing fee plus any document that later amendments to the statute may authorize or direct be filed with the secretary of state without establishing a specific filing fee.

Subdivision (9) states that no fee is applicable to filing the resignation of a registered agent. This provision permits a person who is named as a registered agent without his consent, or who agrees to serve as registered agent for a fee and the fee is not paid, to eliminate any reference to himself in the records of the secretary of state without expense.

Subdivision (8) contains a maximum fee for filing a change of address of a registered agent. Since corporation service companies serve as registered agents for thousands of corporations in many jurisdictions, their change of address may require a very large number of filings. Hence, the fee is broadly based on the number of corporations affected but a maximum fee is specified to reflect that as the number of changes increases the cost per change should decrease.

Sections 11.07, 15.20, and 15.31 require the secretary of state to serve process on foreign corporations under the circumstances there specified. The fee for this service is set forth in section 1.22(b).

Section 1.22(c) establishes standard fees for coping filed documents and certifying that copies are true copies under section 1.27.

NORTH CAROLINA COMMENTARY

This section contains a new fee schedule covering documents required or permitted to be filed under this Act, and the fees shown here combine the fees and taxes that were separately covered in former G.S. 55-155 and former G.S. 55-156. In some cases the fees are higher than the fees and taxes under the prior law. The sliding scale that applied in some cases under the prior law is eliminated in favor of a flat fee in all cases. The format was adopted from the Model Act.

Editor's Note. - Session Laws 2001-358, s. 53, provided that the act, which amended this section, was effective October 1, 2001, and applicable to documents submitted for filing on or after that date. Section 173 of Session Laws 2001-387 changed the effective date of Session Laws 2001-358 from October 1, 2001, to January 1, 2002. Section 6 of Session Laws 2001-413, effective September 14, 2001, added a sentence to s. 175(a) of Session Laws 2001-387, making s. 173 of that act effective when it became law (August 26, 2001). As a result of these changes, the amendment by Session Laws 2001-358 is effective January 1, 2002, and applicable to documents submitted for filing on or after that date.

Session Laws 2001-387, s. 154(b), provides that "Nothing in the act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form."

Session Laws 2008-194, s. 2(a)-(f), provides: "(a) The following definitions apply in this section:

"(1) Department. - The Department of the Secretary of State.

"(2) Filer. - An individual, entity, or corporation that files a single notice pursuant to this section for more than 20,000 entities on file with the Department.

"(3) Notice. - A bulk filing which includes the information required in G.S. 55D-31(a)(2) through (6) and a certification that the filer has complied with the entity notification requirements of G.S. 55D-31(b). For a notice intended to update information for unincorporated nonprofit associations, 'notice' shall also mean a filing which includes the information required by G.S. 59B-11(b)(4). Any notice filed must be in an electronic form acceptable to the Department and include a written statement that the notice is filed pursuant to this section.

"(b) Upon receipt and filing by the Department, a notice pursuant to this section shall be sufficient as a matter of law under G.S. 55D-31 and G.S. 59B-11 to update registered office and registered agent information for each entity on file with the Department for which the filer is listed on the records of the Department as the registered office, the registered agent, or both.

"(c) The requirements of G.S. 55D-13(a) and (b), 55D-10(b)(8), 55-1-22(a), 55A-1-22(a), 57C-1-22(a) (repealed by Session Laws 2013-157, s.1), 59-35.2(a), 59-1106(a), and 59B-11(f) shall not apply to notices filed pursuant to this section.

"(d) This section shall only apply to one notice for each filer.

"(e) Unless otherwise specified, the change of address shall become effective on the 45th day following the Department's receipt of a notice filed pursuant to this section. A filer may specify in the notice a later effective date for the change of address, but not an earlier effective date.

"(f) A notice filed pursuant to this section shall be delivered to the Department no later than one year after the effective date of this section."

Effect of Amendments. - Session Laws 2007-323, s. 30.6(a), effective September 1, 2007, and applicable to annual reports filed on or after that date, in subsection (a), in subdivision (a)(23), inserted "(paper)" and substituted "25.00" for "20.00"; and added subdivision (a)(23a).

Session Laws 2018-45, s. 1, effective October 1, 2018, added subdivision (a)(28).

Legal Periodicals. - For 1997 legislative survey, see 20 Campbell L. Rev. 389.

CASE NOTES

Applied in Ben Johnson Homes, Inc. v. Watkins, 142 N.C. App. 162, 541 S.E.2d 769 (2001), aff'd, 354 N.C. 563, 555 S.E.2d 608 (2001).

§ 55-1-22.1: Transferred to §§ 55D-11 through 55D-17 by Session Laws 2001-358, s. 3(b).

OFFICIAL COMMENT

Section 1.28 establishes a procedure by which anyone may obtain a conclusive certificate from the secretary of state that a particular domestic or foreign corporation is in existence or is authorized to transact business in the state. The certificate will probably be a standardized form. The secretary of state is to make the judgment whether or not the corporation is in existence or is authorized to transact business from public records only and is not expected to make a more extensive investigation. In appropriate cases, the secretary of state may issue a certificate subject to specified qualifications.

Section 1.28(b)(5) refers only to taxes, fees, or penalties collected by the secretary of state or collected by other agencies and reported to the secretary of state. In some states the secretary of state may ascertain from other agencies that franchise or other taxes have been paid and include this information in the certificate. In states where this procedure does not unduly delay the issuance of certificates, section 1.28 may be revised appropriately. Section 1.28(b)(5) relates only to taxes, fees, or penalties to the extent their nonpayment affects the existence or authorization to transact business of the corporation.

A certificate of existence or authorization that may be relied on as binding and conclusive is of material assistance to attorneys who may be required to give formal legal opinions in connection with corporate transactions.

NORTH CAROLINA COMMENTARY

Although it has no express counterpart in prior law, this section codifies the practice of the Secretary of State of issuing "certificates of good standing." Although subdivision (b)(3) refers only to taxes, fees and penalties collected by the Secretary of State, it is expected that the North Carolina Department of Revenue will continue the practice of giving letters confirming the payment of fees and taxes and penalties collectible by the Department.

OFFICIAL COMMENT

Section 1.30 is intended to grant the secretary of state the authority necessary for his efficient performance of the filing and other duties imposed on him by the Act but is not intended to give him general authority to establish public policy. The most important aspects of a modern corporation statute relate to the creation and maintenance of relationships among persons interested in or involved with a corporation; these relationships basically should be a matter of concern to the parties involved and not subject to regulation or interpretation by the secretary of state. Further, even in situations where it is claimed that the corporation has been formed or is being operated for purposes that may violate the public policies of the state, the secretary of state generally should not be the governmental official that determines the scope of public policy through administration of his filing responsibilities under the Act. Rather, the attorney general may seek to enjoin the illegal conduct or to dissolve involuntarily the offending corporation.

Section 1.30 is more narrowly drafted than earlier versions of the Model Act and the statutes of many states.

NORTH CAROLINA COMMENTARY

This section is substantially the same as former G.S. 55-168.

OFFICIAL COMMENT

Section 1.40 collects in a single section definitions of terms used throughout the Model Act. Subchapters and sections of the Act in a few instances contain specialized definitions applicable only to those subchapters or sections.

Most of the definitions of section 1.40 are drawn directly from earlier versions of the Model Act and are reasonably self-explanatory. A number of definitions, however, are new or deserve further explanation.

1. Conspicuous
2. Corporation, domestic corporation, and foreign corporation
3. Distribution
4. Entity
5. Principal office
6. Shareholder
7. Secretary
8. Person
9. Voting group
   1. For the sake of uniformity with other states, this Act does not use the term "charter," but instead defines "articles of incorporation" to include all amendments.
   2. This section does not contain general definitions of the terms "assets," "dominant shareholder," "liabilities," "net assets," or "preferred share," as did prior law, because such terms have no special significance in the Model Act.
   3. The definition of "dividend credit" was brought forward with minor modifications from prior law.
   4. The Model Act's definition of "employee" was deleted as unnecessary and undesirable.
   5. The Model Act's definition of "entity" was expanded to include professional corporations.
   6. "Means" was substituted for "denotes" in the definition of "includes."
   7. The definition of "individual" was expanded.
   8. Definitions were included for "mail" and "merger" to clarify possible confusion in the use of those terms.
   9. "Notice" was defined to include "demand."
   10. A definition of "public corporation" was added for ease of reference in those provisions of the Act that are applicable only to corporations having a class of shares registered under the Securities Exchange Act of 1934.

"Conspicuous" is defined in section 1.40(3) basically as defined in section 1-201(10) of the UNIFORM COMMERCIAL CODE. Even though the definition indicates some of the methods by which a provision may be made attention-calling, the test is whether attention can reasonably be expected to be called to it.

"Corporation," "domestic corporation," and "foreign corporation" are defined in sections 1.40(4) and (10). The word "corporation," when used alone, refers only to domestic corporations. In a few instances, the phrase "domestic corporation" has been used in order to contrast it with a foreign corporation.

The term "distribution" defined in section 1.40(6) is a fundamental element of the financial provisions of the Model Act as amended in 1980. Section 6.40 sets forth a single, unitary test for the validity of any "distribution." Section 1.40(6) in turn defines "distribution" to include all transfers of money or other property made by a corporation to any shareholder in respect of the corporation's shares, except mere changes in the unit of interest such as share dividends and share splits. Thus, a "distribution" includes the declaration or payment of a dividend, a purchase by a corporation of its own shares, a distribution of evidences of indebtedness or promissory notes of the corporation, and a distribution in voluntary or involuntary liquidation. If a corporation incurs indebtedness in connection with a distribution (as in the case of a distribution of a debt instrument or an installment purchase of shares), the creation, incurrence, or distribution of the indebtedness is the event which constitutes the distribution rather than the subsequent payment of the debt by the corporation.

The term "indirect" in the definition of "distribution" is intended to include transactions like the repurchase of parent company shares by a subsidiary whose actions are controlled by the parent. It also is intended to include any other transaction in which the substance is clearly the same as a typical dividend or share repurchase, no matter how structured or labeled.

The term "entity," defined in section 1.40(9), appears in the definition of "person" in section 1.40(16) and is included to cover all types of artificial persons. See also the definitions of "governmental subdivision," in section 1.40(11), "state," in section 1.40(23), and "United States," in section 1.40(25).

Section 1.40(17) defines the principal office of a corporation to be the office, within or without the state, where the principal executive office of the corporation is located. Many corporations maintain numerous offices, but there if usually one office, sometimes colloquially referred to as the home office, headquarters, or executive suite, where the principal corporate officers are located. The corporation must designate its principal office address in the annual report required by section 16.22. In case of doubt as to which corporate office is the principal office, the designation by the corporation in its annual report should be accepted as establishing the principal office of the corporation.

The definition of "shareholder" in section 1.40(22) includes a beneficial owner of shares named in a nominee certificate under section 7.23, but only to the extent of the rights granted the beneficial owner in the certificate - for example, the right to receive notice of, and vote at, shareholders' meeting. Various substantive sections of the Model Act also permit holders of voting trust certificates or beneficial owners of shares (not subject to a nominee certificate under section 7.23) to exercise some of the rights of a "shareholder." See, for example, section 7.40 (derivative proceedings).

The term "secretary" is defined in section 1.40(20) since the Model Act does not require the corporation to maintain any specific or titled officers. See section 8.40. However, some corporate officer, however titled, must perform the functions described in this definition, and that officer is referred to as the "secretary" in various sections of the Act that impose a duty on him.

The term "person" is defined in section 1.40(16) to include an individual or an entity. In the case of an individual the Model Act assumes that the person is competent to act in the matter under general state law independent of the corporation statute.

Section 1.40(26) defines "voting group" for purposes of the Act as a matter of convenient reference. A "voting group" consists of all shares of one or more classes or series that under the articles of incorporation or the revised Model Act are entitled to vote and be counted together collectively on a matter. Shares entitled to vote "generally" on a matter under the articles of incorporation or this Act are for that purpose a single voting group. The word "generally" signifies all shares entitled to vote on the matter by the articles of incorporation or this Act that do not expressly have the right to be counted or tabulated separately. "Voting groups" are thus the basic units of collective voting at a shareholders' meeting, and voting by voting groups may provide essential protection to one or more classes or series of shares against actions that are detrimental to the rights or interests of that class or series.

The determination of which shares form part of a single voting group must be made from the provisions of the articles of incorporation and of this Act. In a few instances under the Model Act, the board of directors may establish the right to vote by voting groups. On most matters coming before shareholders' meetings, only a single voting group, consisting of a class of voting or common shares, will be involved, and action on such a matter is effective when approved by that voting group pursuant to section 7.25. See section 7.26(a). If a second class of shares is also entitled to vote on the matter, then a further determination must be made as to whether that class is to vote as a separate voting group or whether it is to vote along with the other voting shares as part of a single voting group.

Members of the board of directors are usually elected by the single voting group of shares entitled to vote generally; in some circumstances, however, some members of the board may be selected by one voting group and other members by one or more different voting groups. See section 8.03.

The definition of a voting group permits the establishment by statute of quorum and voting requirements for a variety of matters considered at shareholders' meetings in corporations with multiple classes of shares. See sections 7.25 and 7.26. Depending on the circumstances, two classes or series of shares may vote together collectively on a matter as a single voting group, they may be entitled to vote on the matter separately as two voting groups, or one or both of them may not be entitled to vote on the matter at all.

AMENDED NORTH CAROLINA COMMENTARY

This section defines more terms than were defined in former G.S. 55-2 and in some cases the definitions are different. The following differences should be noted:

This section differs from the Model Act in certain respects:

(i) The phrase "unless otherwise specifically provided" was added to the introduction to allow for different definitions in Article 9.

(ii) Except for the final clause thereof, the definition of "corporation" was brought forward with minor modifications from prior law. The final clause, relating to the use of the term "corporation" in G.S. 55-9-01, was considered necessary because that section, which was brought forward from prior law, uses the term "corporation" in certain cases to refer to any corporation, foreign or domestic. In the remainder of Article 9, the term "corporation" refers to domestic corporations only.

The Model Act uses the term "not-for-profit corporation" rather than the term "nonprofit corporation," which is used in this Act. The terms "not-for-profit corporation" and "nonprofit corporation" are interchangeable in Chapter 55A. "Non-profit corporation" and "nonprofit association" were therefore used throughout this Act.

Cross References. - As to the North Carolina Limited Liability Company Act, see G.S. 57D-1-01.

Editor's Note. - The subdivision added by Session Laws 1999-369, s. 1.3, has been designated as (24a) pursuant to directions from the Revisor of Statutes.

Session Laws 2001-358, s. 53, provided that the act which amended this section, was effective October 1, 2001, and applicable to documents submitted for filing on or after that date. Section 173 of Session Laws 2001-387 changed the effective date of Session Laws 2001-358 from October 1, 2001, to January 1, 2002. Section 6 of Session Laws 2001-413, effective September 14, 2001, added a sentence to s. 175(a) of Session Laws 2001-387, making s. 173 of that act effective when it became law (August 26, 2001). As a result of these changes, the amendment by Session Laws 2001-358 is effective January 1, 2002, and applicable to documents submitted for filing on or after that date.

Session Laws 2001-387, s. 154(b), provides that "Nothing in the act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form."

Section 57C-1-03, referred to in subdivisions (6b) and (10b), was repealed by Session Laws 2013-157, s. 1, effective January 1, 2014. For present comparable provisions, see G.S. 55D-1.

The preamble to Session Laws 2017-90, provides: "Whereas, over 770,000 veterans reside across all of North Carolina's one hundred counties; and

"Whereas, North Carolina proudly has one of the largest veteran populations in the country; and

"Whereas, the number of veterans across our State underscores the importance and impact of the State's current military base populations to our State and how veterans and their families continue to reside in the State after the conclusion of their military service to further contribute to the State's workforce and economy; Now, therefore,"

Session Laws 2017-90, s. 7, made the repeal of subdivision (1), and the addition of subdivisions (1a), (20a), (20b), (25a), and (25b) by Session Laws 2017-90, s. 1(a), effective January 1, 2018, and applicable to annual reports filed by business entities on or after that date.

Pursuant to the authority of the Revisor of Statutes, subdivision (1a) as added by Session Laws 2017-90, s. 1, was redesignated as subdivision (1), which was its original location.

Session Laws 2017-102, s. 14.2(b), would have repealed the amendment in s. 14.2(a), contingent upon SB 622 becoming law, but SB 622 has not yet become law.

Effect of Amendments. - Session Laws 2001-358, s. 5(a), effective January 1, 2002, and applicable to documents submitted for filing on or after that date, rewrote subdivision (9).

Session Laws 2013-157, s. 3, effective January 1, 2014, substituted "the term 'LLC' in G.S. 57D-1-03" for "in G.S. 57C-1-03" in subdivision (6b) and substituted "the term 'foreign LLC' in G.S. 57D-1-03" for "in G.S. 57C-1-03" in subdivision (10a).

Session Laws 2017-90, s. 1(a), deleted former subdivision (1); and added subdivisions (1a), (20a), (20b), (25a), and (25b). For effective date and applicability, see editor's note.

Session Laws 2017-102, s. 14.2(a), effective July 12, 2017, substituted " 'Mail,' when used as a verb, means to deposit" for "An item is 'mailed' when it is deposited" in the first sentence of subdivision (13a).

Session Laws 2018-45, s. 33.1, effective October 1, 2018, substituted "'Mail,' when used as verb, means to deposit" for "An item is 'mailed' when it is deposited" in subdivision (13a).

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For article, "Legislative Survey: Business & Banking," see 22 Campbell L. Rev. 253 (2000).

For article, "Agency Theory: Still Viable? Proposals for Corporate Governance Reform: Six Decades of Ineptitude and Counting," see 48 Wake Forest L. Rev. 673 (2013).

For article, "Agency Theory: Still Viable? The Impact of National Culture on Corporate Financial Decisions," see 48 Wake Forest L. Rev. 697 (2013).

CASE NOTES

Applied in T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012); TD Bank, N.A. v. Crown Leasing Partners, LLC, 224 N.C. App. 649, 737 S.E.2d 738 (2012).

Cited in Parsons v. Jefferson-Pilot Corp., 106 N.C. App. 307, 416 S.E.2d 914 (1992).

OFFICIAL COMMENT

Section 1.41 establishes rules for determining how notice may be given and when notice is effective for a variety of purposes under the Model Act.

1. Notice by a corporation to its shareholders
2. Notice to the corporation
3. Miscellaneous provisions
   1. Subsection (a) requires that notice be in writing unless oral notice is authorized by the corporation's articles of incorporation or bylaws; the Model Act permits oral notice if it is "reasonable under the circumstances."
   2. Subsection (b) specifically allows notice to be given by facsimile transmission. When the specified modes of communication of notice are impracticable as to one or more persons, subsection (b) is more limited than the Model Act in that it permits dispensing with the specified mode only as to those persons with respect to whom it is impracticable.
   3. Subsections (c) and (f) do not contain the Model Act's reference to notices being "comprehensible" because this language was deemed unnecessary. Subsection (f) was rewritten to provide that oral notice is effective when actually communicated to the person entitled to it.
   4. Subsections (c) and (e) use "with postage thereon prepaid" instead of "postpaid."
   5. Subsection (d) permits notice to be mailed to a principal office listed in an annual report only after the report is on file in the Secretary of State's office; the Model Act apparently permits otherwise.

Section 1.41(c) provides that notice by a corporation to its shareholders is effective when mailed if correctly addressed with sufficient postage. The correct address for this purpose is the address shown in the corporation's records. The effect of this section is to permit the corporation to compute the statutory time periods for notice of shareholders' meetings and other actions from the date the notice is mailed without regard to where its shareholders are located or the time it takes for the mail to reach them.

Written notice to shareholders by persons other than the corporation is effective as provided in section 1.41(e). Notice by the corporation to its shareholders that is not addressed to the record address of the shareholder is effective when received under section 1.41(e).

Section 1.41(d) provides that notice to a corporation may be addressed to the registered agent of the corporation at its registered office or to the corporation or its secretary at the principal office of the corporation as shown in its most recent public filing. An officer, director, or shareholder of a corporation will normally give written notice to the corporation by delivering or mailing a copy of that notice to the corporation or to the secretary of the corporation at its principal office. Such a notice is effective when it is received. Such notice may be given for a variety of purposes under this Act, e.g., giving notice of intent to dissent (section 13.21), notice of a demand to inspect books and records (section 16.02), and notices of resignation (sections 8.07 and 8.43). This method of giving notice to the corporation, however, is not exclusive, and an officer, director, or shareholder may give notice in other ways as well.

Persons who have no prior relationship with the corporation may give notice either to the registered agent of the corporation, or if they wish, to the corporation or its secretary at its principal office.

Section 1.41 also contains a variety of general provisions dealing with notice. It recognizes, for example, that notice on some occasions may be given orally if that is reasonable under the circumstances. It also deals with situations where notice may be sought to be given to persons for whom no current address is available, or where personal notice is impractical. Notice delivered to the person's last known address is effective as described in section 1.41(e) even though never actually received by the person. Section 1.41(b) also authorizes notice by publication in some circumstances, including radio, television, or other form of public wire or wireless communication.

Section 1.41(g) recognizes that other sections of the Act prescribe specific notice requirements for particular situations - e.g., service of process on a corporation's registered agent under section 5.04 - and that these specific requirements, rather than the general requirements of section 1.41, control. Finally, the second sentence of subsection 1.41(g) permits a corporation's articles of incorporation or bylaws to prescribe the corporation's own notice requirements, if they are not inconsistent with the general requirements of this section or specific requirements of other sections of the Act.

The rules set forth in section 1.41 permit many other sections of the Model Act to be phrased simply in terms of giving or delivering notice without repeating details with respect to how notice should be given and when it is effective in various circumstances.

NORTH CAROLINA COMMENTARY

The prior law contained no general definition of "notice."

The present section differs from the Model Act in the following respects:

Editor's Note. - Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

CASE NOTES

Cited in Nissan Div. of Nissan Motor Corp. in United States v. Nissan, 111 N.C. App. 748, 434 S.E.2d 224 (1993).

OFFICIAL COMMENT

Section 1.42 provides rules for determining the number of shareholders in a corporation. The Model Act generally avoids provisions that are based on the number of shareholders of a corporation, since these provisions may encourage individual shareholders to divide or combine their holdings for private strategic advantage. But in two instances the number of shareholders is critical: to permit a corporation to dispense with a board of directors as its principal form of corporate governance under section 8.01 and to elect close corporation status under the Model Statutory Close Corporation Supplement. The determination of the precise number of shareholders may also become important in other contexts in the future.

NORTH CAROLINA COMMENTARY

This section has no counterpart in prior law.

The section is different from the Model Act in that it counts all co-owners as a single shareholder, whereas the Model Act counts as a single shareholder only "three or fewer co-owners."

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

The definitions of "corporate action," "defective corporate action" and "failure of authorization" are intentionally broad so as to permit ratification of any corporate action purportedly taken that would have been within the power granted to a corporation under the Act.

The term "defective corporate action" includes an "overissue" of shares and other defects in share issuances that could cause shares to be treated as void. For purposes of determining which shares are overissued, only those shares issued in excess of the number of shares permitted to be issued under section 6.01 of the Act would be deemed overissued shares. If it cannot be determined from the records of the corporation which shares were issued before others, all shares included in an issuance that is or results in an overissue would be overissued shares.

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Session Laws 2018-45, s. 34, made this Part effective October 1, 2018.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Subchapter E provides a statutory ratification procedure for corporate actions that may not have been properly authorized and shares that may have been improperly issued. The statutory ratification procedure is designed to supplement common law ratification. Corporate actions ratified under this subchapter remain subject to equitable review.

Examples of defective corporate actions subject to ratification include the failure of the incorporator to validly appoint an initial board of directors, corporate action taken in the absence of board resolutions authorizing the action, the failure to obtain the requisite shareholder approval of a corporate action, issuance of shares in the absence of evidence that consideration payable to the corporation for shares was received, the failure to comply with appraisal requirements and the issuance of shares without complying with preemptive rights. The ratification procedure is intended to be available only where there is objective evidence that a corporate action was defectively implemented. For example, subchapter E would permit ratification of shares previously issued but subsequently determined to have been issued improperly. It would not permit the corporation to issue shares retroactively as of an earlier date, however, where there is no objective evidence that those shares had previously been issued. Objective evidence may include resolutions, issuance of share certificates, subscription or share purchase agreements, entries in a share ledger or other correspondence indicating that shares were issued or intended to have been issued.

Section 1.46(a) does not distinguish between void and voidable actions. Instead it provides that any defective corporate action that is ratified in accordance with section 1.47 or validated under section 1.52 shall not be void or voidable. Section 1.47 is not the exclusive means by which a defective corporate action may be ratified. Thus, the general common law doctrine of ratification, as applied to a board of directors' adoption of actions taken by officers who may not have had the actual authority to take such actions, continues to be an effective mode of ratification. Section 1.46(b) makes clear that the corporation's ratification of a defective corporate action that is voidable but not void using common law methods of ratification rather than under section 1.47 will not, standing alone, affect the validity of the action or create a presumption that the action is not valid. In addition, ratification under subchapter E is distinct from correction of an already filed document under section 1.24.

Section 1.46(c) provides that an overissue can be remedied by the adoption of articles of amendment or other corporate action that has the effect of authorizing, designating or creating shares of a series or class, such that the putative shares that resulted in the overissue are deemed to be validly issued from the date of original issuance. This provision enables a corporation to cure an overissue occurring when shares have been duly authorized but are issued before articles of amendment are filed. It also permits a corporation to remedy an overissue even if it cannot specifically identify the putative shares.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

The information required by section 1.47(a)(1)(a)(1) regarding the listing of putative shares may be satisfied by attaching a table, including a capitalization table, listing the putative shares. Section 1.47(b) permits the ratification of the initial election of the board of directors by the persons who are acting as the current board of directors, recognizing that if the corporation's initial board of directors was defectively appointed, there may be no effective method of ratification because a duly elected board of directors does not exist.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Notwithstanding the shareholder notice required by section 1.48(b), only valid shares are entitled to vote on the ratification action or counted for quorum purposes. The retroactive effect of a ratification of putative shares does not invalidate the quorum or voting result of the ratification.

For matters other than the election of directors, the quorum and voting requirements applicable to shareholder approval of ratification are the quorum and voting requirements applicable to the corporate action being ratified at the time of such approval. For example, if the defective corporate action being ratified is an amendment to the articles of incorporation, whether in connection with an overissue or otherwise, the vote required would be governed by section 10.03. If the defective corporate action involves a merger, the vote required would be the vote required by section 11.04.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Ratification is effective as of the validation effective time and is not dependent on the expiration of the 120-day time period in which an action challenging the ratification must be brought. The ratification of a defective corporate action has the additional effect of ratifying corporate actions that are defective as a result of the original defective corporate action. For example, an overissue which results in subsequent director elections being invalid calls into question all actions by the invalidly elected board members. The ratification of the overissue, however, would cure any such additional defects.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Section 1.51 requires that in the event any filing is or would have been required under the Act to effect the defective corporate action, such filing (if no filing was previously made), such corrected filing (if correction to a previous filing is required), or such original filing (if no correction to a previous filing is required) be attached as an exhibit to the articles of validation. This is intended to provide a clear public record of the actions relating to the ratification.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Section 1.52 confers plenary jurisdiction on a designated court to hear and determine claims regarding the validity of any corporate action or any shares, rights, options or warrants. The court's jurisdiction is not limited to reviewing corporate actions ratified or purportedly ratified under section 1.47, and includes the ability of a corporation or other permitted person to obtain a declaration regarding the validity of any corporate actions or shares that are potentially defective. In determining the validity of a corporate action or reviewing a corporate action ratified under section 1.47, the court may consider any factors or considerations it deems proper under the circumstances. These might include whether the person originally taking the defective corporate action believed that the action complied with corporate requirements, whether the corporation and board of directors has treated the defective corporate action as a valid action, whether any person has acted in reliance on the public record that such defective corporate action was valid and whether any person will be or was harmed by the ratification of the defective corporate action or will be harmed by the failure to ratify or validate the defective corporate action.

OFFICIAL COMMENT

The only functions of incorporators under the Model Act are (1) to sign the articles of incorporation, (2) to deliver them for filing with the secretary of state, and (3) to complete the formation of the corporation to the extent set forth in section 2.05. One or more "persons" may serve as incorporator; "person" is defined in section 1.40 to include both individuals and entities; "entity" is also defined in that section to include corporations, unincorporated associations, partnerships, trusts, estates, and governments.

The Model Act also simplifies the formalities of execution and filing. The requirement in earlier versions of the Model Act and in many state statutes that articles be acknowledged or verified has been eliminated. Also, the requirement that "duplicate originals" (each being executed as an original document) be submitted has been replaced with the requirement that a signed original and an "exact or conformed" copy be submitted. See the Official Comment to section 1.20.

NORTH CAROLINA COMMENTARY

Under former G.S. 55-6, only natural persons could act as incorporators.

Legal Periodicals. - For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For article, "Start-Ups: Why Investors Prefer the Corporate Form to the L.L.C. for Tax Purposes," see 9 Elon L. Rev. 311 (2017).

For article, "Corporate Disobedience," see 68 Duke L.J. 710 (2019).

CASE NOTES

Editor's Note. - The case below was decided under prior law.

Duties and Obligations of Promoters. - The promoters of a corporation are held to the duties of trustees and the obligation of directors. They may not take a secret or undisclosed profit in the organization by way of shares therein or otherwise. Goodman v. White, 174 N.C. 399, 93 S.E. 906 (1917).

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

1. Introduction
2. Required Provisions
3. Optional Provisions
4. List of Options in the Act That May Be Elected Only in the Articles of Incorporation
5. List of Options in the Act That May Be Elected Either in the Articles of Incorporation or in the Bylaws

A corporation will have perpetual duration unless a special provision is included in its articles of incorporation providing for a shorter period. See section 3.02. Similarly, a corporation with articles of incorporation which do not contain a purpose clause will have the purpose of engaging in any lawful business under section 3.01(a). The option of providing a narrower purpose clause is also preserved in sections 2.02(b)(2)(i) and 3.01, with the effect described in the Official Comment to section 3.01.

If a single class of shares is authorized, only the number of shares authorized need be stated; if more than one class of shares is authorized, however, both the number of authorized shares of each class and a description of the rights of each class must be included. See the Official Comment to sections 6.01 and 6.02. It is unnecessary to specify par value, expected minimum capitalization, or contemplated issue price.

The corporation's initial registered office and agent must be included, and a mailing address alone, such as a post office box, is not sufficient since the registered office is the designated location for service of process. See chapter 5.

No reference need be made to a variety of other matters such as preemptive rights. See section 6.30 and its Official Comment. Generally, no substantive effect should be given tot he absence of a specific reference to such matters in section 2.02. They are referred to in other sections of the Act that usually provide an "opt in" privilege. See particularly the list of optional provisions set forth in parts 4 and 5 of this Official Comment.

Section 2.02(b) allows the articles of incorporation to contain optional provisions deemed sufficiently important to be of public record or subject to amendment only by the processes applicable to amendments of articles of incorporation.

A. BUSINESS OR AFFAIRS

Provisions relating to the business or affairs of the corporation that may be included in the articles may be subdivided into four general classes:

ì provisions that under the Act may be elected only by specific inclusion in the articles of incorporation (a list of these provisions is set forth in part 4 of this Official Comment);

ì provisions that under the Act may be elected by specific inclusion in either the articles of incorporation or the bylaws, as listed in part 5 of this Official Comment;

ì other provisions not referred to in the Act, including any provision that the Act requires or permits to be set forth in the bylaws (see section 2.02(b)(b)(3)); and

ì other provisions that are inconsistent with one or more provisions of the Act but are nonetheless permitted by section 7.32 for inclusion in a shareholders' agreement, if the requirements of that section are met.

B. CORPORATE POWERS

Section 2.02(c) makes in unnecessary to set forth any corporate powers in the articles of incorporation in view of the broad grant of power in section 3.02. This grant of power, however, may be overbroad for particular corporations; if so, it may be qualified or narrowed by appropriate provisions in the articles of incorporation.

C. PAR VALUE

Although par value is no longer a mandatory statutory concept under the Act, section 2.02(b)(b)(2)(iv) permits optional "par value" provisions with regard to shares. Other than being permitted by section 2.02(b)(b)(2)(iv), however, "par value" is not mentioned in the Act. Special provisions may be included to give effect or meaning to "par value" essentially as a matter of contract between the parties. These provisions, whether appearing in the articles of incorporation or in other documents, have only the effect any permissible contractual provision has in the absence of a prohibition by statute. Provision in the articles of incorporation establishing an optional par value may also be of use to corporations which are to be qualified or registered in foreign jurisdictions that compute franchise or other taxes upon the basis of par value.

For general discussion of capitalization, see the Official Comment to section 6.21.

D. SHAREHOLDER LIABILITY

The basic tenet of corporation law is that shareholders are not liable for the corporation's liabilities by reason of their status as shareholders. Section 2.02(b)(b)(2)(iv) nevertheless permits a corporation to impose that liability under specified circumstances if that is desirable. If no provision of this type is included, shareholders have no liability for corporate liabilities except to the extent they become liable by reason of their own conduct or acts. See section 6.22(b).

E. LIMITATIONS OF DIRECTOR LIABILITY

Section 2.02(b)(4) authorizes the inclusion of a provision in the articles of incorporation eliminating or limiting, with certain exceptions, the liability of the directors to the corporation or its shareholders for money damages. This section is optional rather than self-executing and does not apply to equitable relief. Likewise, nothing in section 2.02(b)(4) in any way affects the right of the shareholders to remove directors, under section 8.08(a), with or without cause. The phrase "as a director" emphasizes that section 2.02(b)(4) applies to a director's actions or failures to take action in the director's capacity as a director and not in any other capacity, such as officer, employee or controlling shareholder. However, it is not intended to exclude coverage of conduct by individuals, even though they are also officers, employees or controlling shareholders, to the extent they are acting in their capacity as directors.

Shareholders are given considerable latitude in limiting directors' liability for money damages. The statutory exceptions to permitted limitations of director liability are few and narrow and are discussed below.

Financial Benefit

Corporate law subjects transactions from which a director could benefit personally to special scrutiny. The financial benefits exception is limited to the amount of the benefit actually received. Thus, liability for punitive damages could be eliminated, except in cases of intentional infliction of harm or for violation of criminal law (as described below) where, in a particular case (for example, theft), punitive damages may be available. The benefit must be financial rather than in less easily measured and more conjectural forms, such as business goodwill, personal reputation, or social ingratiation. The phrase "received by a director" is not intended to be a "bright line." As a director's conduct moves toward the edge of what may be exculpated, the director should bear the risk of miscalculation. Depending upon the circumstances, a director may be deemed to have received a benefit that the director caused to be directed to another person, for example, a relative, friend, or affiliate.

What constitutes a financial benefit "to which the director is not entitled" is left to judicial development. For example, a director is entitled to reasonable compensation for the performance of services or to an increase in the value of stock or stock options held by the director; on the other hand, a director is not entitled to a bribe, a kick-back, or the profits from a corporate opportunity improperly taken by the director. See section 8.70 as to procedures for disclaiming the corporation's interest in a business opportunity by action of qualified directors or shareholders. See section 2.02(b)(6) for optional provisions permitted in the articles of incorporation to limit or eliminate, in advance, any duty of directors and others to bring business opportunities to the corporation. If the corporation declines the opportunity after it has been presented to the corporation by the director in accordance with the provisions of section 8.70(a)(1)(i) or (ii), or if a provision under section 2.02(b)(6) limits or eliminates the duty to bring the particular opportunity to the corporation, the corporation will have no right to participate in any financial benefit arising from the opportunity if the director pursues or takes the opportunity.

Intentional Infliction of Harm

There may be situations in which a director intentionally causes harm to the corporation even though the director does not receive any improper benefit. The use of the word "intentional," rather than a less precise term such as "knowing," is meant to refer to the specific intent to perform, or fail to perform, the acts with actual knowledge that the director's action, or failure to act, will cause harm, rather than a general intent to perform the acts which cause the harm.

Unlawful Distributions

Section 8.32(a) indicates a strong policy in favor of liability for unlawful distributions approved by directors who have not complied with the standards of conduct of section 8.30. Accordingly, the exception in section 2.02(b)(4)(iii) prohibits the shareholders from eliminating or limiting the liability of directors for a violation of section 8.32.

Intentional Violation of Criminal Law

Even though a director committing a crime may intend to benefit the corporation, the shareholders should not be permitted to exculpate the director for any harm caused by an intentional violation of criminal law, including, for example, fines and legal expenses of the corporation in defending a criminal prosecution. The use of the word "intentional," rather than a less precise term such as "knowing," is meant to refer to the specific intent to perform, or fail to perform, the acts with actual knowledge that the director's action, or failure to act, constitutes a violation of criminal law.

F. DIRECTOR IDEMNIFICATION

Section 2.02(b)(5) specifically prohibits provisions for indemnification of director liability arising out of improper financial benefit received by a director, an intentional infliction of harm on the corporation or the shareholders, an unlawful distribution or an intentional violation of criminal law. These excepted liabilities parallel those a corporation is not permitted to limit or eliminate under section 2.02(b)(4). See "E. Limitations of Director Liability" above. Officers are not included in the language of section 2.02(b)(5) because the expansion of indemnification for directors that section permits must be set forth in the articles of incorporation as required by section 8.51(a)(2); section 8.56 allows a similar expansion of indemnification for officers to be set forth also in the bylaws, resolutions or contracts.

G. BUSINESS OPPORTUNITIES

Section 2.02(b)(6) authorizes the inclusion of a provision in the articles of incorporation to limit or eliminate, in advance, the duty of a director or other person to bring a business opportunity to the corporation. The limitation or elimination may be blanket in nature and apply to any business opportunities, or it may extend only to one or more specified classes or categories of business opportunities. The adoption of such a provision constitutes a curtailment of the duty of loyalty which includes the doctrine of corporate opportunity. If such a provision is included in the articles, taking advantage of a business opportunity covered by the provision of the articles without offering it to the corporation will not expose the director or other person to whom it is made applicable either to monetary damages or to equitable or any other relief in favor of the corporation upon compliance with the requirements of section 2.02(b)(6).

This provision may be useful, for example, in the context of a private equity investor that wishes to have a nominee on the board but conditions its investment on an advance limitation or elimination of the corporate opportunity doctrine because of the uncertainty over the application of the corporate opportunity doctrine inherent when investments are made in multiple enterprises in specific industries. Another example is a joint venture in corporate form where the participants in the joint venture want to be sure that the corporate opportunity doctrine would not apply to their activities outside the joint venture.

The focus of the advance limitation or elimination is on the duty of the director which extends indirectly to the investor through the application of the related party definition in section 8.60. This provision also permits extension of the limitation or elimination of the duty to any other persons who might be deemed to have a duty to offer business opportunities to the corporation. For example, courts have held that the corporate opportunity doctrine extends to officers of the corporation. Although officers may be included in a provision under this subsection, the limitation or elimination of corporate opportunity obligations of officers must be addressed by the board of directors in specific cases or by the directors' authorizing provisions in employment agreements or other contractual arrangements with such officers. Accordingly, section 2.02(b)(6) requires that the application of an advance limitation or elimination of the duty to offer a business opportunity to the corporation to any person who is an officer of the corporation or a related person of an officer also requires action by the board of directors acting through qualified directors. This action must be taken subsequent to the inclusion of the provision in the articles of incorporation and may limit the application. This means that if the advance limitation or elimination of the duty of an officer to offer business opportunities to the corporation is included in the articles by an amendment recommended by the directors and approved by the shareholders, that recommendation of the directors does not serve as the required authorization by qualified directors; rather, separate authorization by qualified directors after the amendment is included in the articles is necessary to apply the provision to a particular officer or any related person of that officer. See sections 1.43(a)(1) and 8.60 for the definition of "qualified directors" and "related persons," respectively.

Whether a provision for advance limitation or elimination of duty in the articles of incorporation should be a broad "blanket" provision or one more tailored to specific categories or classes of transactions deserves careful consideration given the particular circumstances of the corporation.

Limitation or elimination of the duty of a director or officer to present a business opportunity to the corporation does not limit or eliminate the director's or officer's duty not to make unauthorized use of corporate property or information or to compete unfairly with the corporation.

A. OPTIONS WITH RESPECT TO DIRECTORS

ì Board of directors may be dispensed with entirely, § 7.32, or its functions may be restricted, § 8.01.

ì Power to compensate directors may be restricted or eliminated, § 8.11.

ì Election of directors by cumulative voting may be authorized, § 7.28.

ì Election of directors by greater than plurality vote may be authorized, § 7.28.

ì Directors may be elected by classes or series of shares, § 8.04.

ì Director's term may be limited by failure to receive specified vote for election, § 8.05.

ì Power to remove directors without cause may be restricted or eliminated, § 8.08.

ì Terms of directors may be staggered so that all directors are not elected in the same year, § 8.06.

ì Power to fill vacancies may be limited to the shareholders, § 8.10.

ì Power to indemnify directors, officers, and employees may be limited, §§ 8.50 through 8.59.

ì Prohibition on adoption of bylaw provision under § 10.22.

B. OPTIONS WITH RESPECT TO SHAREHOLDERS

ì Action by shareholders may be taken without a meeting, § 7.04.

ì Special voting groups of shareholders may be authorized, § 7.25.

ì Elimination or restriction of separate voting groups for mergers and share exchanges, § 11.04, and for domestications, § 9.21.

ì Quorum for voting groups of shareholders may be increased or reduced, §§ 7.25, 7.26, and 7.27.

ì Quorum for voting by voting groups of shareholders may be prescribed, see § 7.26.

ì Greater than majority vote may be required for action by voting groups of shareholders, § 7.27.

C. OPTIONS WITH RESPECT TO SHARES

ì Shares may be divided into classes and classes into series, §§ 6.01 and 6.02.

ì Cumulative voting for directors may be permitted, § 7.28.

ì Distributions may be restricted, § 6.40.

ì Share dividends may be restricted, § 6.23.

ì Voting rights of classes or series of shares may be limited or denied, § 6.01.

ì Classes or series of shares may be given more or less than one vote per share, § 7.21.

ì Terms of a class or series of shares may vary among holders of the same class or series, so long as such variations are expressly set forth in the articles, § 6.01.

ì The board of directors may allocate authorized but unissued shares of a class or series of shares to another class or series without shareholder approval, § 6.02.

ì Shares may be redeemed at the option of the corporation or the shareholder, § 6.01.

ì Reissue of acquired or redeemed shares may be prohibited, § 6.31.

ì Shareholders may be given preemptive rights to acquire unissued shares, § 6.30.

ì Redemption preferences may be ignored in determining lawfulness of distributions, § 6.40.

A. OPTIONS WITH RESPECT TO DIRECTORS

ì Number of directors may be fixed or changed within limits, § 8.03.

ì Qualifications for directors may be prescribed, § 8.02.

ì Notice of regular or special meetings of board of directors may be prescribed, § 8.22.

ì Power of board of directors to act without meeting may be restricted, § 8.21.

ì Quorum for meeting of board of directors may be increased or decreased (down to onethird) from majority, § 8.24.

ì Action at meeting of board of directors may require a greater than majority vote, § 8.24.

ì Power of directors to participate in meeting without being physically present may be prohibited, § 8.20.

ì Board of directors may create board committees and specify their powers, § 8.25.

ì Board of directors may create safe harbor for consideration of corporate opportunities, § 8.70.

ì Power of board of directors to amend bylaws may be restricted, §§ 10.20 and 10.21.

ì Election of directors may be governed by the optional rules under section 10.22.

B. OPTIONS WITH RESPECT TO SHARES

ì Shares may be issued without certificates, § 6.26.

ì Procedure for treating beneficial owner of street name shares as record owner may be prescribed, § 7.23.

ì Transfer of shares may be restricted, § 6.27.

NORTH CAROLINA COMMENTARY

The Model Act was modified by inserting a cross-reference in subdivision (a)(2) for clarity and by revising subdivision (a)(3) to require more specific information regarding the corporation's address and registered office.

In addition, the Model Act was modified to add more optional provisions available for articles of incorporation, including a limitation on duration (subdivision (b)(2)(vi)) and a provision limiting or eliminating the personal liability of directors in certain circumstances (subsection (b)(3)), which existed under former G.S. 55-7(2) and (11). The phrase "not made in good faith" in former G.S. 55-7(11)(i) was deleted solely because it was thought to be redundant.

Editor's Note. - Session Laws 2001-358, s. 53, provided that the act, which amended this section, was effective October 1, 2001, and applicable to documents submitted for filing on or after that date. Section 173 of Session Laws 2001-387 changed the effective date of Session Laws 2001-358 from October 1, 2001, to January 1, 2002. Section 6 of Session Laws 2001-413, effective September 14, 2001, added a sentence to s. 175(a) of Session Laws 2001-387, making s. 173 of that act effective when it became law (August 26, 2001). As a result of these changes, the amendment by Session Laws 2001-358 is effective January 1, 2002, and applicable to documents submitted for filing on or after that date.

Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2001-358, s. 16, effective January 1, 2002, and applicable to documents submitted for filing on or after that date, substituted "G.S. 55D-20 and G.S. 55D-21" for "G.S. 55-4-01" in subdivision (a)(1).

Session Laws 2018-45, s. 2, effective October 1, 2018, in subsection (b), added "any or all of the following" at the end of the lead-in language, added subdivision (b)(4), and made minor stylistic changes.

Legal Periodicals. - For article on corporate directors' accountability, see 66 N.C.L. Rev. 171 (1987).

For article, "Should Corporate Statutes Providing Special Protection for Directors Be Limited to Publicly Traded Corporations?," see 24 Wake Forest L. Rev. 79 (1989).

For comment, "North Carolina's Statutory Limitation on Directors' Liability," see 24 Wake Forest L. Rev. 117 (1989).

For article, "The Corporate Persona, Contract (and Market) Failure, and Moral Values," see 69 N.C.L. Rev. 273 (1991).

For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For article, "Good Faith, State of Mind, and the Outer Boundaries of Director Liability in Corporate Law," see 41 Wake Forest L. Rev. 1131 (2006).

For article, "Duties of the Modern Corporate Executive: Article & Essay: Fiduciary Constraints: Correlating Obligation with Liability," see 42 Wake Forest L. Rev. 697 (2007).

For article, "Agency Theory: Still Viable? Proposals for Corporate Governance Reform: Six Decades of Ineptitude and Counting," see 48 Wake Forest L. Rev. 673 (2013).

For article, "Overcoming the Rippy Effect: Why the North Carolina Business Corporations Act Should Allow Permissive Officer Exculpation," see 94 N.C.L. Rev. 2155 (2016).

CASE NOTES

Editor's Note. - Most of the cases below were decided under prior law.

Corporation Held Limited to Objects Stated. - A charter of incorporation creating a company for the purpose of effecting a communication by a plank-road between designated points, with the privilege of taking tolls, did not authorize the company to establish a stage line upon their road, nor to contract for carrying the United States mail. Wiswell v. Greenville Plank-Road Co., 56 N.C. 183 (1857).

Use of All Powers Not Required. - The fact that a corporation avails itself of only one of several privileges granted by its charter does not invalidate the act of incorporation. Wadesboro Cotton Mills Co. v. Burns, 114 N.C. 353, 19 S.E. 238 (1894).

Limit of Corporate Existence. - A corporation whose term of existence is fixed and limited in the act which creates it cannot endure beyond the prescribed time, unless its existence is prolonged by the same authority or continued for the purpose of adjusting and closing its business, and no judicial proceedings are required to terminate it. Asheville Div. No. 15 v. Aston, 92 N.C. 578 (1885).

De Jure and De Facto Existence. - A corporation de jure is said to exist when persons holding a charter have made substantial compliance with the provisions of the same, looking to its proper organization, while a corporation de facto is one where the parties having a charter or law authorizing it have in good faith made a colorable compliance with such requirements, and have proceeded in the exercise of the corporate powers or a part of them. Wood v. Staton, 174 N.C. 245, 93 S.E. 794 (1917).

Existence of a corporation may be proved by reputation. Existence or nonexistence is a fact and may be proved as other facts. Gulf States Steel Co. v. Ford, 173 N.C. 195, 91 S.E. 844 (1917).

Proof of Existence by Written Contract. - Where a written contract entered into between the parties furnishes evidence that the defendant was dealing with the plaintiff as a corporation, and the plaintiff's existence as a corporation is denied, the contract may properly be introduced upon this disputed fact. Otis Elevator Co. v. Cape Fear Hotel Co., 172 N.C. 319, 90 S.E. 253 (1916).

Copies of Letters of Incorporation as Proof of Existence. - Copies of letters of incorporation are admissible to show prima facie the existence of a corporation, and the corporation cannot avoid its liability for debts because in fact it had but an inchoate existence. Marshall v. Macon County Bank, 108 N.C. 639, 13 S.E. 182 (1891).

Exculpatory Clause. - Federal Deposit Insurance Corporation-Receiver (FDIC-R) argued only that the evidence suggested that the Director Appellees took actions harmful to the bank, in part by making decisions without adequate information; this was insufficient. The exculpatory clause protected directors from monetary liability unless the directors "knew or believed that their acts or omissions were clearly in conflict" with the bank's best interests; actions that might have been harmful or decisions that could have been better made did not rise to the level of bad faith in this context, especially in light of the fact that the bank received "CAMELS" scores of "2" from both of its regulators despite the Director Appellees' actions. FDIC v. Rippy, 799 F.3d 301 (4th Cir. 2015).

OFFICIAL COMMENT

Section 2.03(a) provides that the existence of a corporation begins when the articles of incorporation are filed, unless a delayed effective date is specified under section 1.23. Chapter 1 contains detailed rules for the filing and effective dates of documents, all of which are applicable to articles of incorporation and other documents. These filing rules simplify the process of creating a corporation in several respects.

1. What to file
2. Nature of filing
3. Certificate of incorporation eliminated
4. Precise time of incorporation
5. Conclusiveness of secretary of state's action on question of individual liability for corporate actions

Section 1.20 requires that only one executed original and an exact or conformed copy of the articles need be delivered to the secretary of state for filing. This delivery must be accompanied by the applicable filing fee.

Section 1.25 provides that the secretary of state files the articles by stamping them "filed" and recording the date and time of receipt; he then retains the signed original articles of incorporation for his records and returns the exact or conformed copy to the incorporators along with a receipt for the fee. The return of this copy and the fee receipt establishes that the articles have been filed in the form of the copy.

Section 1.25 provides that approval by the secretary of state is in the form of return of the copy of the articles with a fee receipt rather than a certificate of incorporation, as was the older practice still followed in many states. See the Official Comment to section 1.25.

Section 2.03(a) ties the precise time of incorporation to the date and time stamped on the articles. Section 1.23 provides in turn that this is the date and time the articles are received by the secretary of state; in other words, consistent with the practice of many secretaries of state, processing time is ignored and the date and time of receipt of the articles are the date and time of incorporation. The creators of the corporation may, however, specify that the corporation's existence will begin on a later date than the date of filing, and at a precise time on such a date, to the extent permitted by section 1.23.

Under section 2.03(b) the filing of the articles of incorporation as evidenced by return of the stamped copy of the articles with the fee receipt is conclusive proof that all conditions precedent to incorporation have been met, except in proceedings brought by the state. Thus the filing of the articles of incorporation is conclusive as to the existence of limited liability for persons who enter into transactions on behalf of the corporation. If articles of incorporation have not been filed, section 2.04 generally imposes personal liability on all persons who prematurely act as or on behalf of a "corporation" knowing that articles have not been filed. Section 2.04 may protect some of these persons to a limited extent, however; see the Official Comment to that section.

NORTH CAROLINA COMMENTARY

Subsection (c) was added to the Model Act's provisions to bring forward the provisions of former G.S. 55-3.1.

Editor's Note. - Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Legal Periodicals. - For article, "Branch Office of the Prosecutor: The New Role of the Corporation in Business Crime Prosecutions," 89 N.C.L. Rev. 23 (2010).

CASE NOTES

Editor's Note. - Most of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Corporation as Alter Ego of Dominant Shareholder. - The mere fact that one person owns all of the stock of a corporation does not make its acts the acts of the stockholder so as to impose liability therefor upon him. However, when the corporation is so operated that it is a mere instrumentality or alter ego of the sole or dominant shareholder and a shield for his activities in violation of the declared public policy or statute of the State, the corporate entity will be disregarded and the corporation and the shareholder treated as one and the same person, it being immaterial whether the sole or dominant shareholder is an individual or another corporation. Henderson v. Security Mtg. & Fin. Co., 273 N.C. 253, 160 S.E.2d 39 (1968).

When Corporation Regarded as an Association of Persons. - When the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons. Henderson v. Security Mtg. & Fin. Co., 273 N.C. 253, 160 S.E.2d 39 (1968).

Personal liability of stockholder created before the effective date of former G.S. 55-3.1 because corporation did not have three shareholders would not be defeated by virtue of former G.S. 55-3.1. Lester Bros. v. Pope Realty & Ins. Co., 250 N.C. 565, 109 S.E.2d 263 (1959).

For case decided before the passage of former G.S. 55-3.1 and dealing with the effect of the acquisition of all stock in a corporation by one person, see Park Terrace, Inc. v. Phoenix Indem. Co., 243 N.C. 595, 91 S.E.2d 584 (1956), commented on in 34 N.C.L. Rev. 471, 531 (1956).

Chattel Mortgage Executed in Name of Corporation by Person Acquiring All Stock as Corporate Act. - Acquisition of the entire capital stock of a corporation by one person does not affect the corporate entity, and the execution in the name of the corporation by such person of a chattel mortgage is a corporate act and binding, provided the rights of its then existing creditors are not affected. Wall v. Colvard, Inc., 268 N.C. 43, 149 S.E.2d 559 (1966).

Cited in Statesville Stained Glass, Inc. v. T.E. Lane Constr. & Supply Co., 110 N.C. App. 592, 430 S.E.2d 437 (1993).

OFFICIAL COMMENT

Following incorporation, the organization of new corporation must be completed so that it may engage in business. This usually requires adoption of bylaws, the appointment of officers and agents, the raising of equity capital by the issuance of shares to the participants in the venture, and the election of directors.

Earlier versions of the Model Act required initial directors to be named in the articles and provided that they complete the organization of the corporation. Many states followed this pattern, but others provided that the incorporators organize the corporation or meet to elect a board of directors to organize the corporation. The goal of all these provisions was usually to permit the completion of the organization of the corporation with minimum expense and formality, though in many cases it was felt necessary for business decisions to be made at an early stage by the persons with responsibility for business operation.

Experience in states followed the Model Act pattern revealed that multiple organizational meetings were often necessary, particularly where for reasons of convenience or secrecy both the incorporators and initial directors were "dummies" without any financial interest in the enterprise who were not expected to make any significant business decisions. In this situation, the initial directors formally organized the corporation, including issuing of at least some shares; immediately following this organizational meeting, the new shareholders met to elect a permanent board of directors who were to manage the business. In many instances, the permanent board of directors also had to meet immediately after its selection by the shareholders to consider business questions that must be resolved promptly, such as authorization of employment contracts or the valuation of property or services to be accepted as consideration for shares.

Section 2.05 simplifies the formation process by allowing alternative methods of completing the formation of the corporation.

First, section 2.05(a)(1) contemplates that if the draftsman elects to set forth the names of the initial directors in the articles of incorporation, the persons so named will organize the corporation. It is expected that initial directors will be named only if they will be the permanent board of directors and there is no objection to the disclosure of their identity in the articles of incorporation.

Second, section 2.05(a)(2) provides alternative methods for completing the organization of the corporation if initial directors are not named in the articles of incorporation. The incorporators may themselves complete the organization, or they may simply meet to elect a board of directors who are then to complete the organization. It is contemplated that in routine incorporations, the first alternative will be elected, while in more complex situations when prompt business decisions must be made, the second alternative will be chosen and the completion of the organization will be turned over to the board of directors representing the investment interests in the corporation.

Sections 2.05(b) and (c) are limited to meetings of incorporators since sections 8.21 and 8.22 permit the same actions by the board of directors. If a meeting of shareholders is necessary, sections 7.01 and 7.04 give them the same flexibility that is given incorporators under sections 2.05(b) and (c).

NORTH CAROLINA COMMENTARY

This section, unlike prior law, permits the incorporator or incorporators to hold the organizational meeting of the corporation under certain circumstances. The last sentence of subsection (b) was added to the Model Act's provisions for clarification.

Legal Periodicals. - For article, "Agency Theory: Still Viable? The Impact of National Culture on Corporate Financial Decisions," see 48 Wake Forest L. Rev. 697 (2013).

OFFICIAL COMMENT

The responsibility for adopting the original bylaws is placed on the person or persons completing the organization of the corporation.

Section 2.06(b) restates the accepted scope of bylaw provisions. For a list of Model Act provisions that become effective only if specific reference is made to them in the bylaws, see the Official Comment to section 2.02. Provisions set forth in bylaws may additionally be contained in shareholder or board resolutions unless this Act requires them to be set forth in the bylaws.

The power to amend or repeal bylaws, or adopt new bylaws after the formation of the corporation is completed, is addressed in sections 10.20 through 10.22 of the Model Act.

NORTH CAROLINA COMMENTARY

The Model Act's use of the word "shall" in subsection (a) requires that a corporation have bylaws, whereas, under prior law, the adoption of bylaws was at least theoretically optional. Use of the word "shall," however, is not intended to imply that a North Carolina corporation not adopting bylaws is not a valid corporation.

Legal Periodicals. - For note on unanimous approval of corporate bylaws and creation of shareholder agreements, see 1 Campbell L. Rev. 153 (1979).

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Statutory Norms Control Amendments Where Bylaws Fail to Control. - In the absence of a valid provision in the charter or bylaws controlling amendment, statutory or common-law norms governing amendment apply. Blount v. Taft, 295 N.C. 472, 246 S.E.2d 763 (1978).

Shareholders' agreement which is part of the charter or bylaws is subject to amendment as provided therein or, in the absence of an internal provision governing amendments, as provided by statutory norms. Blount v. Taft, 295 N.C. 472, 246 S.E.2d 763 (1978).

When parties to a shareholders' agreement choose to embody it in the charter or bylaws, it must be concluded that they intended for statutory or common-law norms governing amendment to apply absent an expressed intention to deviate from them. Blount v. Taft, 295 N.C. 472, 246 S.E.2d 763 (1978).

Principle by which a shareholder is bound by a corporate resolution, regularly passed pursuant to charter and bylaws, prevails only in reference to his status and rights as a shareholder, and not where he deals independently with corporation as one of its customers in the line of its business. Cardwell v. Garrison, 179 N.C. 476, 103 S.E. 3 (1920).

Bylaws as Evidence Against Strangers. - The bylaws of a corporation are usually not evidence for it against strangers who deal with it, unless they are brought home to their knowledge and assented to by them. Smith & Melton v. N.C.R.R., 68 N.C. 107 (1873).

OFFICIAL COMMENT

Section 2.07 is no longer an optional provision (as was the case with its predecessor in earlier versions of the Model Act) but is unqualifiedly recommended for adoption. The problem it addresses is potentially present in every state and in every corporation, and the widespread acceptance of the earlier provision to date by a number of states argues that it be uniformly adopted.

The adoption of emergency bylaws in advance of an emergency not only clarifies lines of command and responsibility but also tends to ensure continuity of responsibility. The board of directors may be authorized by the emergency bylaws, for example, to designate the officers or other persons, in order of seniority and subject to various conditions, who may be deemed to be directors during the emergency.

The definition of "emergency" adopted by subsection (d) is broader than a nuclear disaster or attack on the United States. It includes any catastrophic event, such as an airplane crash or fire, that makes it difficult or impossible for a quorum of the corporation's board of directors to be assembled. While there apparently has been no recent illustration of a public corporation facing such a catastrophic event, its possibility should not be ignored. In order to encourage corporations to adopt emergency bylaws, section 2.07(c) broadly validates all corporate actions taken "in good faith" pursuant to them and immunizes all corporate directors, officers, employees, and agents from liability as a result of these actions. The phrase "action taken in good faith in accordance with the emergency bylaws" has been substituted for "willful misconduct," the language of the earlier Model Act provision. This change is designed to conform the standard for immunity here and elsewhere in the Model Act and represents no substantive change.

A corporation that does not adopt emergency bylaws under this section may nevertheless exercise the powers described in section 3.03 in the event of an emergency as defined in section 2.07(d).

NORTH CAROLINA COMMENTARY

This section has no equivalent under prior law. The Model Act was rewritten in subsection (c) to clarify that the limitation on liability contained in that subsection is limited to liability arising by reason of action taken by special procedures under emergency bylaws.

OFFICIAL COMMENT

Section 3.01(a) provides that every corporation automatically has the purpose of engaging in any lawful business unless a narrower purpose is described in the articles of incorporation. The specification of an "any lawful business" clause has become so nearly universal in states that permit the clause that no reason exists for treating it otherwise than as the norm for the "standard" corporation.

The option of a narrower purpose clause is most likely to be elected only in situations where one or more participants in the corporation desire to limit or retain a check on the business operations of the corporation. The articles of incorporation may limit lines of business in which the corporation may engage. It should be recognized, however, that the limited scope of the ultra vires concept in litigation between the corporation and outsiders means that a third person entering into a transaction that violates the restrictions in the purpose clause may be able to enforce the transaction in accordance with its terms if he was unaware of the narrow purpose clause when he entered the transaction. See the Official Comment to section 3.04.

Many corporations may also find it desirable to supplement a general purpose clause with an additional statement of business purposes. This may be necessary for licensing or for qualification purposes in some states.

Section 3.01(b) is designed to tie in the limitless lawful purpose corporation permitted by section 3.01(a) with the numerous state statutes that impose regulations or limitations on corporations formed to, or actually engaging in, certain lines of business. These state statutes are of various types.

Some of these statutes, particularly those relating to banking and insurance, establish a separate incorporation process and incorporating agency. These special incorporating states may refer back to or incorporate by reference portions of the general business corporation statute.

Other regulatory statutes may permit incorporation under the general business corporation act if the corporation imposes restrictions or limitations in its articles of incorporation; these restrictions may relate to the business in which the corporation may engage, its manner of internal governance, or the persons who may or may not be shareholders and participate in the venture. The language of section 3.01(b) is designed to cover all these multiple variations and is a substitute for the narrower language "except for the purpose of banking or insurance" that appeared in earlier versions of the Model Act and the statutes of many states.

Traditionally, incorporation was not permitted at all for the purpose of practicing the learned professions - e.g., law, medicine, and dentistry - primarily because of the personal skills and confidential relationships between lawyer and client or physician and patient. In the early 1960s, however, a significant movement toward incorporation of professionals surfaced as part of an effort by professionals to obtain employee federal tax benefits. Professionals hoped to form corporations to conduct their practice as employees of the corporation rather than as independent entrepreneurs. Early efforts by professionals to form entities to conduct their practice (despite the lack of state statutory authority to incorporate) met with opposition from the Internal Revenue Service. In 1960 the I.R.S. issued the "Kintner" regulations, which in effect provided that federal tax status would be determined on the basis of the organization's characterization under state law. TREAS. REGS. § 301.7701-2 (1960). In response, a number of states passed legislation specifically authorizing professionals to incorporate. Recognition of the corporate tax status of professional corporations was eventually conceded. REV. RUL. 70-101, 1970-1 C.B. 278. All jurisdictions now have statutes providing for incorporation for the purpose of practicing a profession, and in 1977 a Professional Corporation Supplement to the Model Act was approved. For further consideration of professional corporation acts, see the Annotations to the Model Professional Corporation Supplement.

Other types of corporations, such as nonprofit corporations, cooperatives, and unions, usually may not incorporate under the business corporation act. Many states have enacted special statutes for these classes entities: a Model Nonprofit Corporation Act was approved in 1952 and has been periodically revised since then.

Section 3.01(b) is designed to preserve all statutory requirements applicable to all of these various classes of specialized and nonbusiness corporations.

NORTH CAROLINA COMMENTARY

This section is substantially the same as former G.S. 55-5.

Legal Periodicals. - For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For article, "Duties of Nonprofit Corporate Directors - Emphasizing Oversight Responsibilities," see 90 N.C. L. Rev. 1845 (2012).

OFFICIAL COMMENT

The law of corporations has always proceeded on the fundamental assumption that corporations are creations with limited power; such an assumption was articulated by the United States Supreme Court as early as 1804, Head & Armory v. Providence Insurance Co., 6 U.S. (2 Cranch) 127, 169 (1804), and appears never to have been seriously questioned as a judicial matter.

It is clear that narrow and limited powers clauses are undesirable: they encourage litigation by bringing into question reasonable transactions that further the business and interests of the corporation and to the extent transactions are unauthorized, may defeat valid and reasonable expectations. The history of the Model Act and of many state statutes in this area is largely one ensuring that corporate powers are broad enough to cover all reasonable business transactions.

In developing section 3.02, serious consideration was given to whether there was a continued need for a long list of corporate powers or whether a general provision granting every corporation power to act to the same extent as an individual might be substituted. Because of the long history of these powers, however, it was feared that no matter how broadly phrased a general provision might be, a court might conclude that some power might not exist because no specific reference to it was made in the statute. It was also feared that cautious attorneys might begin to restore power clauses to articles of incorporation out of concern that a general clause of the type in question might not be interpreted literally. Hence, the present language, which is similar to that included in the statutes of California and other states, was adopted. The general clause granting the corporation essentially the same powers as an individual is coupled with a nonexclusive listing of powers, including the traditional power clauses that appear in many state statutes.

The general philosophy of section 3.02 is thus that corporations formed under the Model Act provisions should be automatically authorized to engage in all acts and have all powers that an individual may have. Because broad grants of power of this nature may not be desired in some corporations, section 3.02 generally authorizes articles of incorporation to deny or limit specific powers to a specific corporation if that is felt desirable. This power to exclude specific powers does not reflect a substantive change from earlier versions of the Model Act (which did not contain an express provision to this effect) but simply makes explicit what was always implicit. Illustrative of the powers that may be appropriate for limitation in specific corporations are the powers (discussed below) to make political contributions to the extent permitted by law or to make expenditures to influence elections affecting the corporate business to the extent permitted by law.

The powers listed in section 3.02 were broadened in several significant respects:

1. All limitations on loans to directors have been eliminated. The wisdom and propriety of these loans should be evaluated on the basis of general fiduciary standards and the benefits to the corporation. See sections 8.30, 8.31, and 8.32. Section 3.02(11) thus rejects the conceptual argument that because certain transactions are subject to abuse, all such transactions should be prohibited.
2. It is made clear in section 3.02(12) that former as well as present directors, officers, employees, and agents may participate in pension, option, and similar benefit plans.
3. Section 3.02(15) permits payments or donations or other acts "that further the business and affairs of the corporation." This clause, which is in addition to and independent of the power to make charitable and similar donations under section 3.02(13), permits contributions for purposes that may not be charitable, such as for political purposes or to influence elections. This power exists only to the extent consistent with law other than the Model Act. It is the purpose of this section to authorize all corporate actions that are lawful or not against public policy.

The powers of a corporation under the Model Act exist independently of whether a corporation has a broad or narrow purpose clause. A corporation with a narrow purpose clause nevertheless has the same powers as an individual to do all things necessary or convenient to carry out its business. Many actions are therefore intra vires even though they do not directly affect the limited purpose for which the corporation is formed. For example, a corporation may generally make charitable contributions without regard to the purpose for which the charity will use the funds or may invest money in shares of other corporations without regard to whether the corporate purpose of the other corporation is broader or narrower than the limited purpose clause of the investing corporation. In some instances, however, a limited or narrow purpose clause may be considered to be a restriction on corporate powers as well as a restriction on purposes. Since the same ultra vires rule is applicable to corporations that exceed their purposes or powers (see the Official Comment to section 3.04), it is not necessary to determine whether a narrow purpose clause also limits the powers of the corporation but simply whether the purpose of the transaction in question is consistent with the purpose clause. Of course, these issues cannot arise in corporations with an "any lawful business" purpose clause.

NORTH CAROLINA COMMENTARY

This section contains essentially all of the powers enumerated in former G.S. 55-17, but it avoids the distinction that the prior law made between unconditional powers and those exercisable by a corporation "only in connection with the purposes stated in its charter," and lists all powers in a single sequence. The words "or this act" were added to the Model Act's introductory language in subsection (a) to emphasize that there may be limiting provisions elsewhere in Chapter 55. Subdivision (a)(11) was modified to incorporate language from former G.S. 55-17(a)(4) that was believed to be less restrictive than the Model Act's language, and subdivision (12) was modified by changing the Model Act's reference to "share" bonus and "share" option plans to the more commonly used terms, "stock" bonus and "stock" option plans. Subdivision (13) was modified to add donations for religious and cultural purposes, which were permitted under former G.S. 55-17(a)(6). Subdivision (16) brings forward former G.S. 55-17(b) (4), and is more specific than the Model Act in authorizing insurance on the corporation's directors, officers, employees and security holders.

In addition, former G.S. 55-17(c) was added to this section as subsection (b) to avoid any negative inference by its omission. It does not appear in the Model Act.

Legal Periodicals. - For note, "Glenn v. Wagner: Instrumentality Rule versus the Balancing Test in Piercing the Corporate Veil," see 64 N.C.L. Rev. 1265 (1986).

CASE NOTES

• I. In General.
• II. Suits by and Against Corporations.
• III. Rights as to Property.
• IV. Corporate Seal.

OFFICIAL COMMENT

Section 3.03 should be read in conjunction with section 2.07, which authorizes a corporation to adopt emergency or standby bylaws. Section 3.03 grants every corporation limited powers to act in an emergency even though it has failed to enact emergency bylaws under section 2.07.

An "emergency" for purposes of section 3.03 is defined in subsection (d) as any catastrophic event that makes it difficult or impossible to assemble a quorum of directors. In this situation, section 3.03(b) dispenses with or relaxes notice requirements and permits corporate officers to serve as directors in order to achieve a quorum. The section also authorizes the board of directors, either before or during an emergency, to modify lines of succession and relocate the principal business office of the corporation. These actions may be taken only by the board of directors at a meeting at which a quorum is present after giving effect, if necessary, to section 3.03(b).

These minimal provisions, it is believed, should permit a corporation to continue to function in the face of an emergency even if no emergency bylaws have been adopted under section 2.07.

NORTH CAROLINA COMMENTARY

This section has no counterpart in prior law. The Model Act was rewritten in subsection (c) to conform to changes made to G.S. 55-2-07(c)(2).

OFFICIAL COMMENT

The basic purpose of section 3.04 - as has been the purpose of all similar statutes during the 20th century - is to eliminate all vestiges of the doctrine of inherent incapacity of corporations. See Campbell, "The Model Business Corporation Act," 11-4 BUS. LAW. 98, 102 (1956). Under this section it is unnecessary for persons dealing with a corporation to inquire into limitations on its purposes or powers that may appear in its articles of incorporation. A person who is unaware of these limitations when dealing with the corporation is not bound by them. The phrase in section 3.04(a) that the "validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act" applies equally to the use of the doctrine as a sword or as a shield: a third person may no more avoid an undesired contract with a corporation on the ground the corporation was without authority to make the contract than a corporation may defend a suit on a contract on the ground that the contract is ultra vires.

The language of section 3.04 extends beyond contracts and conveyances of property; "corporate action" of any kind cannot be challenged on the ground of ultra vires. For this reason it makes no difference whether a limitation in articles of incorporation is considered to be a limitation on a purpose or a limitation on a power; both are equally subject to section 3.04. Corporate action also includes inaction or refusal to act. The common law of ultra vires distinguished between executory contracts, partially executed contracts, and fully executed ones; section 3.04 treats all corporate action the same - except to the extent described in section 3.04(b) - and the same rules apply to all contracts no matter at what stage of performance.

Section 3.04, however, does not validate corporate conduct that is made illegal or unlawful by statute or common law decision. This conduct is subject to whatever sanction, criminal or civil, that is provided by the statute or decision. Whether or not illegal corporate conduct is voidable or rescindable depends on the applicable statute or substantive law and is not affected by section 3.04.

Section 3.04 also does not address the validity of essentially intra vires conduct that is not approved by appropriate corporate action. It does not deal, for example, with the enforceability of an executory contract to sell substantially all the assets of a corporation not in the ordinary course of business that was not approved by the shareholders as required by section 12.02. This type of transaction is not beyond the purposes or powers of the corporation; it simply has not been approved by the corporate authorities as required by law. Similarly, section 3.04 does not deal with whether a corporation is bound by the action of a corporate agent if the action requires, but has not received, approval by the board of directors. Whether or not the corporation is bound by this action depends on the law of agency, particularly the scope of apparent authority and whether the third person knew or should have known of the defect in the corporate approval process. These actions may be ultra vires with respect to the agent's authority but they are not ultra vires with respect to the corporation and are not controlled by section 3.04.

Similarly, corporate action is not ultra vires under section 3.04 merely because it constitutes a breach of fiduciary duty. For example, a misuse of corporate assets for personal purposes by an officer or director is a breach of fiduciary duty and may be enjoined. Similarly, in some circumstances a lien on corporate assets and a contract entered into by the corporation may be cancelled or enjoined if they constitute breaches of fiduciary duty and the third person is charged with knowledge that they were improper. These transactions, however, are not ultra vires with respect to the corporation, and cannot be attacked under section 3.04. They may be enjoined because of breach of the fiduciary duty, not because the transaction exceeds the powers or purposes of the corporation.

Section 3.04(b), like the prior Model Act provisions, permits challenges to the corporation's lack of power in three limited classes of cases:

1. In suits by the attorney general under section 14.30. This provision does not answer the question whether or not a corporation may be dissolved or enjoined by the attorney general for committing an ultra vires act; it simply preserves the power of the state to assert that certain corporate action was ultra vires.
2. In a suit by the corporation, either directly or through a legal representative, against incumbent or former officers or directors for authorizing or causing the corporation to engage in an ultra vires act. Again, this section does not address whether or not there is liability for causing the corporation to enter into an ultra vires act; it simply preserves the power of the corporation to assert that certain corporate action was ultra vires.
3. In a suit by a shareholder against the corporation to enjoin an ultra vires act. This suit, however, is subject to the requirements of section 3.04(c). Under this subsection an ultra vires act may be enjoyed only if all "affected parties" are parties to the suit. The requirement that the action be "equitable" generally means that only third persons dealing with a corporation while specifically aware that the corporation's action was ultra vires will be enjoined. The general phrase "if equitable" was retained because of the possibility that other circumstances may exist in which it may be equitable to refuse to enforce an ultra vires contract. Further, if enforcement of the contract is enjoined, either the third person or the corporation may in the discretion of the court be awarded damages from the other for loss (excluding anticipated profits).

Section 3.04(c) thus authorizes a court to enjoin or set aside an ultra vires act or grant other relief that may be necessary to protect the interests of all affected persons, including the interests of third persons who deal with the corporation.

NORTH CAROLINA COMMENTARY

This section contains no change of substance from former G.S. 55-18 except that the new section applies only to North Carolina corporations whereas the prior statute purported to apply to foreign corporations as well.

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Doctrine of ultra vires has been very much modified, and many contracts made in the course of business, especially when executed and benefits are received or liabilities are incurred, will be upheld and enforced which were once declared absolutely void. Hutchins v. Bank, 128 N.C. 72, 38 S.E. 252 (1901).

The doctrine of ultra vires has been curtailed to a considerable degree. Piedmont Aviation, Inc. v. S & W Motor Lines, 262 N.C. 135, 136 S.E.2d 658 (1964).

Question whether acts are ultra vires is a conclusion of law to be drawn from the facts stated. Spencer v. Seaboard Air Line Ry., 137 N.C. 107, 49 S.E. 96 (1904).

State May Enjoin Threatened Ultra Vires Act. - Modification of the doctrine does not involve the right in an appropriate case of the State to enjoin a threatened ultra vires act. Victor v. Louise Cotton Mills, 148 N.C. 107, 61 S.E. 648 (1908).

Stockholder May Bring Action. - If an act of a corporation is ultra vires, any one or more stockholders may by some appropriate method call it in question, and, unless barred by having consented to or acquiesced in it, have relief. Victor v. Louise Cotton Mills, 148 N.C. 107, 61 S.E. 648 (1908); Lutterloh v. City of Fayetteville, 149 N.C. 65, 62 S.E. 758 (1908).

CASE NOTES

Editor's Note. - The case below was decided under the Business Corporation Act adopted in 1955.

The listing of an agent for corporate service of process is not a voluntary action, subject to the discretion of the corporation. This listing is legislatively mandated. South Carolina Ins. Co. v. Hallmark Enters., Inc., 88 N.C. App. 642, 364 S.E.2d 678, cert. denied, 322 N.C. 482, 370 S.E.2d 228 (1988), (decided under prior law).

Failure to Notify Insurer of Suit Where Corporation Without Agent Received No Notice Thereof. - Corporation could not rely on its violation of former G.S. 55-13 to justify its failure to receive notice of suit. Consequently, it did not give notice of suit to its insurer at the time it was reasonably expected to receive actual notice thereof, thus failing to notify insurer as soon as practicable. South Carolina Ins. Co. v. Hallmark Enters., Inc., 88 N.C. App. 642, 364 S.E.2d 678, cert. denied, 322 N.C. 482, 370 S.E.2d 228 (1988), (decided under prior law).

§ 55-5-02: Transferred to G.S. 55D-31 through 55D-33 by Session Laws 2001-358, s. 44.

OFFICIAL COMMENT

Section 6.01 adopts a new terminology from that traditionally used in corporation statutes to describe classes of shares that may be created, but makes only limited substantive changes from earlier versions of the Model Act. Traditional corporation statutes work from a perceived inheritance of concepts of "common shares" and "preferred shares" that at one time may have had considerable meaning but that today often do not involve significant distinctions. It is possible under modern corporation statutes to create classes of "common" shares that have important preferential rights and classes of "preferred" shares that are subordinate in all important economic aspects or that are indistinguishable from common shares in either voting rights or entitlement to participate in the assets of the corporation upon dissolution. The revised Model Act breaks away from the inherited concepts of "common" and "preferred" shares and develops more general language to reflect the actual flexibility in the creation of classes of shares that exists in modern corporate practice. The words "common shares" or "preferred shares" are no longer used in the revised Model Act, though the words appear in a few instances in examples appearing in the Official Comment.

1. Section 6.01(a)
2. Section 6.01(b)
3. Section 6.01(c)
   1. In general
   2. Voting of shares
   3. Redemption of shares
   4. Convertibility of shares

Section 6.01(a) requires that the articles of incorporation prescribe the classes of shares and the number of shares of each class that the corporation is authorized to issue. If the articles authorize the issue of only one class of shares, no designation or description of the shares is required, it being understood that these shares have both the power to vote and the power to receive the net assets of the corporation upon dissolution. See section 6.01(b). Shares with both of these characteristics are usually referred to as "common shares" or "common stock," but no specific designation is required by the Model Act.

If more than one class of shares is authorized, the preferences, limitations, and relative rights of each class of shares must be described in the articles of incorporation before any shares of that class are issued, or the board of directors may be given authority to establish them under section 6.02. These descriptions constitute the "contract" of the holders of those classes of shares with respect to their interest in the corporation and must be set forth in sufficient detail reasonably to define their interest. The designations, preferences, limitations, and relative rights of shares with one or more special or preferential rights which may be authorized are further described in section 6.01(c).

If more than one class is authorized (or if only one class is originally authorized but at some future time one or more other classes of shares are added by amendment), the preferences, limitations, and relative rights of each class or classes of shares, including the class or classes that possess the fundamental characteristics of voting and residual equity financial interests, must be described before shares of those classes are issued. If both fundamental characteristics are placed exclusively in a single class of shares, that class may be described simply as "common shares" or by statements such as the "shares have general distribution and voting rights," the "shares have all the rights of common shares," or the "shares have all rights not granted to the class A shares."

If the articles of incorporation create classes of shares that divide these fundamental rights among two or more classes of shares, it is necessary that the rights be clearly allocated among the classes. Specificity is required only to the extent necessary to differentiate the relative rights of the respective classes. For example, where one class has a liquidation preference over another, it is necessary to specify only the preferential liquidation right of that class; in the absence of a contrary provision in the articles, the remaining class would be entitled to receive the net assets remaining after the liquidation preference has been satisfied.

More than one class of shares may be designated as "common shares;" however, each must have a "distinguishing designation" under section 6.01(a), e.g., "nonvoting common shares" or "class A common shares," and the rights of the classes must be described. For example, if a corporation authorizes two classes of shares with equal rights to share in all distributions and with identical voting rights except that one class is entitled exclusively to elect one director and the second class is entitled exclusively to elect a second director, the two classes may be designated, e.g., as "Class A common" and "Class B common," and described, e.g., as "a class of common shares with the right to elect one director." What is required is language that makes the location of these rights clear.

Rather than describing the terms of each class of shares in the articles of incorporation, the corporation may delegate to the board of directors under section 6.02 the power to establish the terms of a class of shares (or of a series within a class of shares (if no shares of that class (or series) have previously been issued. Those terms, however, must be set forth in an amendment to the articles of incorporation before the shares are issued.

Section 6.01(b) requires that every corporation authorize one or more classes of shares that have the two fundamental characteristics of having unlimited voting rights and the right to receive the net assets of the corporation upon its dissolution. These two fundamental characteristics need not be placed in a single class of shares but may be divided as desired. It is nevertheless essential that the corporation always have authorized shares with these two characteristics, and section 6.03 requires that shares having in the aggregate these characteristics always be outstanding.

Section 6.01(b) ensures that there is always in existence one or more classes of shareholders who share in the ultimate residual interest in the corporation and who are entitled to elect a board of directors and make other fundamental decisions with respect to the corporation.

Section 6.01(c) lists the principal features that are customarily incorporated into classes of shares. Section 6.01(d) makes clear that this listing is not exhaustive.

Section 6.01(c) authorizes creation of classes of shares with limited or residual rights without significant limitation. In earlier versions of the Model Act and in the statutes of many states, certain types of rights or privileges are not permitted. Many such statutes, for example, prohibit the creation of a class of voting shares without preferential financial rights that is callable at the discretion of the corporation ("callable common shares"). Another common prohibition is against shares that have the power to be converted at the option of the shareholder into other classes of shares that have preferential financial rights, or into debt securities of the corporation ("upstream" conversion privileges). For the reasons set forth below, these restrictions are not preserved in the revised Model Act.

Any class of shares may be granted multiple or fractional votes per share without limitation. See section 7.21. Shares of any class may also be made nonvoting "except to the extent prohibited by this Act." This "except" clause refers to the provisions in the Model Act that permit shares that are designated to be nonvoting to vote as separate voting groups on amendments to articles of incorporation and other organic changes in the corporation that directly affect that class (sections 7.26 and 10.04). In addition, shares may be given voting rights that are limited or conditional (e.g., on the passing of a specified number of dividends). Section 6.01(b), however, requires that there always be one or more classes of shares that together have unlimited voting rights.

Section 6.01(c)(2) permits classes of shares to be made redeemable on the terms set forth in the articles of incorporation. Under this section, shares may be made "redeemable" at the option of the holder, the corporation, or another person; shares redeemable at the option of the corporation are sometimes called "callable shares," while shares redeemable at the option of the shareholder are sometimes described as involving a "put." The Model Act permits either type of redemption for any class of shares and thereby permits the creation of redeemable or callable shares without limitation (subject only to the provisos that the class or classes of shares described in section 6.01(b) must always exist and that at least one share of each class with those rights or powers must be outstanding under section 6.03).

Earlier versions of the Model Act and the statutes of many states contain a direct or indirect prohibition against callable voting shares or callable common shares. Even where such a prohibition exists, however, the same effect can be obtained by the use of consensual share transfer restrictions (see section 6.27). If it is possible to create what is essentially a callable voting share by agreement, there is no reason why such provisions should not be built directly and publicly into the capital structure of the corporation if that is desired.

The recognition of a redemption that is a "put" exercisable by the holders of the shares (or a third person such as holders of other classes of shares) is also new to the Model Act and is not permitted in many states. However, consensual share transfer restrictions may create a right that is indistinguishable from such a right of redemption, and a right of redemption is expressly recognized by many states in connection with certain specialized classes of corporations such as open-end investment companies. As described below, if a right of redemption is recognized, prohibitions in earlier versions of the Model Act and many state statutes against "upstream" conversions serve no purpose.

The amount to be paid upon the redemption of shares under section 6.01(c)(2) may be fixed in the articles of incorporation or "determined in accordance with a designated formula or by reference to extrinsic data or events." The reference to "extrinsic data or events" is intended to permit the redemption price to be established on the basis of matters external to the corporation, such as the purchase price of other shares, the level of the prime rate, the effective interest rate at which the corporation may obtain short- or long-term financing, the consumer price index or a designated currency ratio. While a designated price formula or references must be set out in the articles of incorporation, the board of directors may be given limited authority to implement the provisions.

All redemptions of shares are subject to the restrictions on distributions set forth in section 6.40. See section 6.03(b).

Section 6.01(c)(2) also permits shares of any class to be made convertible into shares of any other class or into cash, indebtedness, securities, or other property of the corporation or another person.

As described above, earlier versions of the Model Act and the statutes of many states prohibit so-called "upstream" conversions, that is, shares convertible into debt securities or into a class of shares having prior or superior preference rights. See, e.g., N.Y. BUS. CORP. LAW ANN. § 519(a)(1) (McKinney 1963). This restriction was eliminated from the Model Act since it was recognized that the power to make shares redeemable at the option of the shareholder for cash (see section 6.01(c)(2)(ii)) should logically permit the shares to be redeemable or convertible at the option of the shareholder into other shares with senior preferential rights. Creditors of the corporation and holders of shares with preferential rights are less seriously affected by a conversion of shares into debt or into shares with preferential rights than they would be by the redemption of the shares for money, which is permitted by the revised Model Act, subject to the limitations of section 6.40. Shares made "redeemable" for debt under section 6.01(c)(2)(ii), achieve the same effect as a right to "convert" shares into debt securities.

4. Examples of classes of shares permitted by section 6.01

Section 6.01 authorizes the creation of new or innovative classes of shares without limitation or restriction. The section is basically enabling rather than restrictive since corporations often find it necessary to create new and innovative classes of shares for a variety of reasons, and with the disclosure of the terms of the new classes in the articles of incorporation that are a matter of public record there is no reason to restrict the power to create these classes. Innovative classes of shares may be created in connection with raising debt or equity capital. Securities with novel provisions are often created to meet perceived corporate needs in specific circumstances or because of financial problems generated by market conditions for capital. Novel classes of shares may also be created in order to effectuate desired control relationships among the participants in a venture. Classes of shares are likely to be used for this purpose in closely held corporations, whether or not statutory close corporation status is elected, but may also be used for this purpose by publicly held corporations.

Examples of innovative classes of shares are the following:

1. Shares of one class may be authorized to elect a specified number of directors while shares of a second class may be authorized to elect the same or a different number of directors.
2. Shares of one class may be entitled to vote as a separate voting group on certain transactions, but shares of two or more classes may be only entitled to vote together as a single voting group on the election of directors and other matters.
3. Shares of one class may be nonvoting or may be given multiple or fractional votes per share.
4. Shares of one class may be entitled to different dividend rights or rights on dissolution than shares of another class.

These examples are intended to be illustrative only and not to exhaust the variations permissible under the Model Act.

A corporation has power to issue debt securities under section 3.02(7). Although section 6.01 authorizes the creation of interests that usually will be classed as "equity" rather than "debt," it is permissible to create classes of securities under section 6.01 that have some of the characteristics of debt securities. These securities are often referred to as "hybrid securities." Section 6.01 of the Model Act does not limit the development of hybrid securities, and equity securities may be created under the Model Act that embody any characteristics of debt that may be desired. Unlike some state statutes, however, the Model Act restricts the power to vote to securities classed as "shares" in the articles of incorporation.

NORTH CAROLINA COMMENTARY

The Model Act was modified in this section to deal only with the kind of shares that are authorized and, in G.S. 55-6-02, to deal only with blank shares where the board of directors fixes or determines the terms of a series within a class of shares. The Model Act blends these provisions by providing the authority to issue a series within a class in section 6.02 instead of section 6.01. Subsection (a) of this section incorporates subsection (b) of section 6.02 of the Model Act, slightly modified for clarity, while subsection (c) of section 6.02 was incorporated as subsection (b) of this section.

The last sentence of subsection (a) was added to dispel any possible conflict between this section and Article 9.

Former G.S. 55-40(c), relating to dividend credits, was brought forward as subdivision (d)(5), to continue providing for the permanent grandfathering of dividend credits.

Other minor modifications to the Model Act's language were made for clarification.

Cross References. - As to rights of holders of debt securities, see G.S. 55-7-21.1.

Legal Periodicals. - For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For article, "The Power to Issue Stock," see 46 Wake Forest L. Rev. 701 (2011).

CASE NOTES

Editor's Note. - Some of the cases below were decided under prior law.

Preferred stock forms a part of the capital stock of the corporation, entitling the holders to all rights of the stockholder subject to the terms and conditions on which their stock was issued. Kistler v. Caldwell Cotton Mills Co., 205 N.C. 809, 172 S.E. 373 (1934).

Preferred stockholder is not a creditor of the corporation, and must be confined to his rights as a stockholder. Weaver Power Co. v. Elk Mt. Mill Co., 154 N.C. 76, 69 S.E. 747 (1910).

Priorities of preferred stock are always subject to the rights of creditors. So an attempt of the corporation to give the preferred stockholders a lien upon its realty in the nature of a mortgage or deed of trust under the provisions of its charter is ineffectual as to the prior rights of creditors. Ellington v. Raleigh Bldg. Supply Co., 196 N.C. 784, 147 S.E. 307 (1929).

Voting Rights Not to Be Restricted. - When a corporation through its articles has authorized only one class of stock, any provision in the articles of incorporation that serves to restrict the voting rights of its shareholders is void as violative of subsection (c). Byrd v. Raleigh Golf Ass'n, 123 N.C. App. 272, 472 S.E.2d 395 (1996).

Provisions in defendant's articles of incorporation were void to the extent that they purported to condition each shareholder's right to vote upon the payment of annual dues. Byrd v. Raleigh Golf Ass'n, 123 N.C. App. 272, 472 S.E.2d 395 (1996).

Applied in Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

Cited in Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262 (2013).

OFFICIAL COMMENT

Section 6.02 permits the board of directors, if authority to do so is contained in the articles, to fix the terms of a class of shares to meet corporate needs, including current requirements of the securities market or the exigencies of negotiations for acquisition of other corporations or properties, without the necessity of holding a shareholders' meeting to amend the articles. This section therefore permits prompt action and gives desirable flexibility. The articles of incorporation may also create "series" of shares within a class (rather than designating that "series" as a separate class) if that is deemed desirable.

The board of directors may create new series within a class or set the terms of a class or series only if there are no outstanding shares of that class or series. This section recognizes that in some contexts there is no substantive difference between a "class" and a "series within a class," and that the labels are often a matter of convenience. In appropriate circumstances, a series may be treated as a class of shares that has one or both of the fundamental characteristics described in section 6.01(b).

Shares of stock to be issued in different classes or series that vary in terms to be set by the board of directors are sometimes referred to as "blank stock." The granting of the power to vary the terms gives the board of directors broad power to affect the capital structure of the corporation. Exercise of this power may in some circumstances dilute the interest of existing shareholders. But on balance it is desirable to permit this flexibility.

The power to vary the terms of "blank stock" for series of the same class extends to all the permitted variables set forth in section 6.01(c).

Subsection (e) requires a simple official filing to amend the articles so there will be a public record of the class or series the corporation intends to issue. The amendment may be made without shareholder action. See section 10.02.

NORTH CAROLINA COMMENTARY

Subsection (a) is identical to the Model Act's subsection 6.02(a), and subsection (b) is the same as the Model Act's subsection 6.02(d). As explained in the North Carolina Comment to G.S. 55-6-01, subsections (b) and (c) of the Model Act's section 6.02 were incorporated into G.S. 55-6-01 rather than this section.

OFFICIAL COMMENT

Section 6.03 permits the corporation to issue shares up to the number of shares authorized in the articles of incorporation and provides that shares that are issued are outstanding shares for purposes of this Act until they are reacquired, redeemed, converted, or cancelled. The determination of the number of shares to be issued is usually made by the board of directors but may be reserved by the articles of incorporation to the shareholders. The only requirements are that no class of shares be overissued and that one or more shares of a class or classes that together have unlimited voting power and one or more shares of a class or classes that together are entitled to the net assets of the corporation upon dissolution at all times must be outstanding.

Shares of any class that are outstanding may be made subject to share transfer restrictions that may result in contractual obligations by the corporation to reacquire shares. The validity of such share transfer restriction is today not open to serious question. See section 6.27. The corporation may also acquire outstanding shares of any class pursuant to a voluntary transaction between the shareholder and the corporation. All contractual or voluntary reacquisitions are subject to the restrictions set forth in subsection (c) of this section and to section 6.40. The corporation may also reacquire shares pursuant to a right of redemption (or an obligation to redeem) established in the articles of incorporation. See section 6.01(c)(2). All such redemptions of shares are also subject to the restrictions of subsection (c) of this section and to section 6.40. Shares of the class or classes described in section 6.01(b) may be reacquired or redeemed by the corporation in any of the foregoing ways to the same extent as shares of any other class, subject, however, to the overriding requirement of section 6.03(c) that at all times at least shares that meet the requirements of section 6.01(b) be outstanding.

The provisions of the revised Model Act are consistent with the specialized class of corporation known as the open-end investment company, which permits unlimited redemptions of shares at net asset value at the request of shareholders. Sections 6.01 and 6.03 permit the classes of shares with voting and dissolution rights to be made redeemable without limitation. The requirement of section 6.03(c) that at least one share be outstanding is also consistent with an unlimited right of redemption since that section only applies while there are shares of stock outstanding. If an open-end investment company or any other corporation should redeem all of its outstanding shares, it should file articles of dissolution under chapter 14 at or before the time the last share is redeemed.

NORTH CAROLINA COMMENTARY

A minor stylistic change from the Model Act was made in subsection (c).

CASE NOTES

Cited in Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262 (2013).

OFFICIAL COMMENT

Fractional shares may arise from a share dividend that, as applied to a particular holder, does not produce an even multiple of shares; they may also result from fractional stock splits, from reverse splits, and from reclassifications and mergers. Although corporations are authorized to issue fractional shares, which are vested proportionately with the same rights as full shares, the creation of fractional shares often creates administrative difficulties, particularly for voting and dividend purposes.

Section 6.04 authorizes handling fractional shares in various ways, including:

1. The corporation may issue scrip instead of fractional shares. Scrip confers none of the substantive rights of shareholders, but only authorizes holders to combine scrip certificates in amounts aggregating a full share and then to exchange them for a full share. This aggregation must occur within the time and subject to the conditions set initially by the board of directors and stated in the scrip certificate. Scrip that is not combined and exchanged becomes void. To protect shareholders against forfeiture of their interest, however, it is usually provided that the shares represented by scrip certificates not exchanged by the expiration date are to be sold and the proceeds held, either indefinitely or for a stated period, for the benefit of the scripholders and paid to them on surrender of their scrip certificate.
2. The corporation may authorize the immediate sale of all fractional share interests, thereby avoiding the expense and delay of scrip and the inconvenience of recognizing fractional shares. While this procedure denies shareholders the benefit of any subsequent rise in the market, it protects them against any subsequent decline and ensures them of recognition based on market values contemporaneous with the transaction. Since these transactions necessarily involve less than one full share for each shareholder, the amount involved in subsequent price changes is usually modest.

Scrip has been widely used in lieu of fractional shares. The New York Stock Exchange, while not requiring the use of any particular method for the settlement of fractional share interests, has established a policy relating to the minimum rights and privileges that scrip issued by registered companies must provide. N.Y.S.E. LISTED COMPANY MANUAL § 703.02(B).

One variation of "going private" transactions to eliminate public shareholders in a corporation largely owned by management interests involves a reverse share split at a ratio that reduces all public shareholders' interest to a fractional share, followed by the reduction of the fractional interests to cash under this section. See "Guidelines on Going Private," 37 BUS. LAW. 313 (1981).

Under this section fractional shares may be certificated or uncertificated. There is no difference in treatment of certificated or uncertificated shares for this purpose. See sections 6.25 and 6.26.

OFFICIAL COMMENT

Agreements for the purchase of shares to be issued by a corporation are typically referred to as "subscriptions" or "subscription agreements." Section 6.20 deals exclusively with preincorporation subscriptions, that is, subscriptions entered into before the corporation was formed. Preincorporation subscriptions have often been considered to be revocable offers rather than binding contracts. Since the corporation is not in existence, it cannot be a party to the agreement and the consideration established for the shares is not determined by the board of directors. While preincorporation subscriptions entered into simultaneously by several subscribers may be considered a binding contract between or among the subscribers, not all factual situations lend themselves to contractual analysis. Because of the uncertainty of the legal enforceability of these transactions, section 6.20 provides a simple set of legal rules applicable to the enforcement of preincorporation subscriptions by the corporation after its formation. It does not address the extent to which preincorporation subscriptions may constitute a contract between or among subscribers, and other subscribers may enforce whatever contract rights they have without regard to section 6.20.

Section 6.20(a) provides that preincorporation subscriptions are irrevocable for six months unless the subscription agreement provides that they are revocable or that they are irrevocable for some other period. Nevertheless, all the subscribers to shares may agree at any time that a subscriber may withdraw in part from his commitment to subscribe for shares, that a subscriber may revoke his subscription entirely, or that the period of irrevocability may continue for an additional stated period. If the corporation accepts the subscription during the period of irrevocability, the subscription becomes a contract binding on both the subscribers and the corporation. The terms of this contract are set forth in sections 6.20(b) and (d).

Section 6.20(b) provides that after incorporation the board of directors may determine the payment terms of subscriptions but these calls must be uniform so far as practicable as to all shares of the same class or series unless the subscriptions provide otherwise. Section 6.20(d) provides alternative methods of enforcement of preincorporation subscriptions by the corporation. If the consideration for the subscription involves the payment of money or conveyance of property, the corporation may, in the event of nonpayment, collect the amount due as any other debt. Alternatively, unless the subscription agreement provides otherwise, the corporation may rescind the agreement and may resell the shares after 20 days' notice to the subscriber.

Section 6.20(c) provides that shares issued pursuant to preincorporation subscriptions are fully paid and nonassessable when the corporation receives the subscription price. The liability of the subscriber to pay the purchase price is addressed in section 6.22. Section 6.20 does not address the liability of transferees of shares which may be issued before the subscription price is paid for the power of the corporation to cancel for nonpayment shares that have been issued before payment for the full subscription price. Issued shares represented by unpaid subscriptions are subject to cancellation for nonpayment to the same extent as shares issued for promissory notes or shares issued before the consideration therefor is paid. See the Official Comment to sections 6.21 and 6.22.

Post-incorporation subscriptions are contracts between the corporation and the investor by which the corporation agrees to issue shares for a stated consideration and the investor agrees to purchase the shares for that consideration. Post-incorporation subscriptions are simple contracts subject to the power of the board of directors and they may contain any mutually acceptable provisions subject to section 6.21. Section 6.20(e) states, for completeness, that post-incorporation subscriptions are contracts between the corporation and the subscriber subject to section 6.21.

NORTH CAROLINA COMMENTARY

The liquidated damages provision of former G.S. 55-43(i) was not brought forward. Under that provision, it was more disadvantageous for a subscriber to pay some money than to pay no money for shares under a subscription agreement, and the drafters concluded that this result was undesirable.

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Purpose. - The purpose of any statute of frauds type of provision, such as former G.S. 55-43, is to prevent fraud by requiring certain important transactions to be evidenced by a writing. Penley v. Penley, 65 N.C. App. 711, 310 S.E.2d 360 (1984), rev'd on other grounds, 314 N.C. 1, 332 S.E.2d 51 (1985).

Physician Held Not an Equitable Stockholder in Professional Association. - Assuming, arguendo, that professional association and physician entered into a binding post-incorporation subscription agreement, under the facts, where physician neither tendered payment within a reasonable time nor demonstrated circumstances excusing such tender, he was not an equitable stockholder in the professional association. Buchele v. Pinehurst Surgical Clinic, 80 N.C. App. 256, 341 S.E.2d 772, aff'd, 318 N.C. 503, 349 S.E.2d 579 (1986).

Former Section Held Inapplicable. - Former G.S. 55-43 did not apply in an action by a former husband against his former wife and her incorporated fast food restaurant franchise for a declaration that he was entitled to an ownership interest. This was not an action in which a defendant was trying to enforce a plaintiff 's promise to take shares in a corporation, but an action in which the plaintiff attempted to enforce the defendant's promise or contract to issue shares to the plaintiff, the number of shares to represent a certain percentage of ownership within the corporation being formed. Penley v. Penley, 314 N.C. 1, 332 S.E.2d 51 (1985).

Conditional Subscription. - A subscription to stock of a corporation may be made on condition that there shall be no liability until the corporation has received actual subscriptions to its capital stock to a specified amount. Alexander v. North Carolina Sav. Bank & Trust Co., 155 N.C. 124, 71 S.E. 69 (1911). See Penniman v. Alexander, 111 N.C. 427, 16 S.E. 408 (1892); Kelly v. Oliver, 113 N.C. 442, 18 S.E. 698 (1893); Queen City Printing & Paper Co. v. McAden, 131 N.C. 178, 42 S.E. 575 (1902).

OFFICIAL COMMENT

The financial provisions of the Model Act reflect a modernization of the concepts underlying the capital structure and limitations on distributions of corporations. This process of modernization began with amendments in 1980 to the 1969 Model Act that eliminated the concepts of "par value" and "stated capital," and further modernization occurred in connection with the development of the revised Act in 1984. Practitioners and legal scholars have long recognized that the statutory structure embodying "par value" and "legal capital" concepts is not only complex and confusing but also fails to serve the original purpose of protecting creditors and senior security holders from payments to junior security holders. Indeed, to the extent security holders are led to believe that it provides this protection, these provisions may be affirmatively misleading. The Model Act has therefore eliminated these concepts entirely and substituted a simpler and more flexible structure that provides more realistic protection to these interests. Major aspects of this new structure are:

1. the provisions relating to the issuance of shares set forth in this and the following sections;
2. the provisions limiting distributions by corporations set forth in section 6.40 and discussed in the Official Comment to that section; and
3. the elimination of the concept of treasury shares described in the Official Comment to section 6.31.

Section 6.21 incorporates not only the elimination of the concepts of par value and stated capital from the Model Act in 1980 but also eliminates the earlier rule declaring certain kinds of property ineligible as consideration for shares. The caption of the section, "Issuance of Shares by the Board of Directors," reflects the change in emphasis from imposing restrictions on the issuance of shares to establishing general principles for their issuance. The section replaces two sections captioned, respectively, "Consideration for Shares" (section 18) and "Payment for Shares" (section 19) in the 1969 Model Act.

Since shares need not have a par value, under section 6.21 there is no minimum price at which specific shares must be issued and therefore there can be no "watered stock" liability for issuing shares below an arbitrarily fixed price. The price at which shares are issued is primarily a matter of concern to other shareholders whose interests may be diluted if shares are issued at unreasonably low prices or for overvalued property. This problem of equality of treatment essentially involves honest and fair judgments by directors and cannot be effectively addressed by an arbitrary doctrine establishing a minimum price for shares such as "par value" provided under older statutes.

Section 6.21(b) specifically validates contracts for future services (including promoters' services), promissory notes, or "any tangible or intangible property or benefit to the corporation," as consideration for the present issue of shares. The term "benefit" should be broadly construed to include, for example, a reduction of a liability, a release of a claim, or benefits obtained by a corporation by contribution of its shares to a charitable organization or as a prize in a promotion. In the realities of commercial life, there is sometimes a need for the issuance of shares for contract rights or such intangible property or benefits. And, as a matter of business economics, contracts for future services, promissory notes, and intangible property or benefits often have value that is as real as the value of tangible property or past services, the only types of property that many older statutes permit as consideration for shares. Thus, only business judgment should determine what kind of property should be obtained for shares, and a determination by the directors meeting the requirements of section 8.30 to accept a specific kind of valuable property for shares should be accepted and not circumscribed by artificial or arbitrary rules.

The issuance of some shares for cash and other shares for promissory notes, contracts for past or future services, or for tangible or intangible property or benefits, like the issuance of shares for an inadequate consideration, opens the possibility of dilution of the interests of other shareholders. For example, persons acquiring shares for cash may be unfairly treated if optimistic values are placed on past or future services or intangible benefits being provided by other persons. The problem is particularly acute if the persons providing services, promissory notes, or property or benefits of debatable value are themselves connected with the promoters of the corporation or with its directors. Protection of shareholders against abuse of the power granted to the board of directors to determine that shares should be issued for intangible property or benefits is provided in part by the requirement that the board must act in accordance with the requirements of section 8.30, and, if applicable, section 8.31, in determining that the consideration received for shares is adequate, and in part by the requirement of section 16.21 that the corporation must inform all shareholders annually of all shares issued during the previous year for promissory notes or promises of future services.

Accounting principles are not specified in the Model Act, and the board of directors is not required by the statute to determine the "value" of noncash consideration received by the corporation (as was the case in earlier versions of the Model Act). In many instances, property or benefit received by the corporation will be of uncertain value; if the board of directors determines that the issuance of shares for the property or benefit is an appropriate transaction that protects the shareholders from dilution, that is sufficient under section 6.21. The board of directors does not have to make an explicit "adequacy" determination by formal resolution; that determination may be inferred from a determination to authorize the issuance of shares for a specified consideration.

Section 6.21 also does not require that the board of directors determine the value of the consideration to be entered on the books of the corporation, though the board of directors may do so if it wishes. Of course, a specific value must be placed on the consideration received for the shares for bookkeeping purposes, but bookkeeping details are not the statutory responsibility of the board of directors. The statute also does not require the board of directors to determine the corresponding entry on the right-hand side of the balance sheet under owner's equity to be designated as "stated capital" or be allocated among "stated capital" and other surplus accounts. The corporation, however, may determine that the shareholders' equity accounts should be divided into these traditional categories if it wishes.

The second sentence of section 6.21(c) describes the effect of the determination by the board of directors that consideration is adequacy for the issuance of shares. That determination, without more, is conclusive to the extent that adequacy is relevant to the question whether the shares are validly issued, fully paid, and nonassessable. Section 6.21(c) provides that shares are fully paid and nonassessable when the corporation receives the consideration for which the board of directors authorized their issuance. Whether shares are validly issued may depend on compliance with corporate procedural requirements, such as issuance within the amount authorized in the articles of incorporation or holding a directors' meeting upon proper notice and with a quorum present. The Model Act does not address the remedies that may be available for issuances that are subject to challenge. This somewhat more elaborate clause replaces the provision in earlier versions of the Model Act and many state statutes that the determination by the board of directors of consideration for the issuance of shares was "conclusive in the absence of fraud in the transaction."

Shares issued pursuant to preincorporation subscriptions are governed by section 6.20 and not this section.

The revised Model Act does not address the question whether validly issued shares may thereafter be cancelled on the grounds of fraud or bad faith if the shares are in the hands of the original shareholder or other persons who were aware of the circumstances under which they were issued when they acquired the shares. It also leaves to the Uniform Commercial Code other questions relating to the rights of persons other than the person acquiring the shares from the corporation. See the Official Commercial to section 6.22.

Section 6.21(e) permits the board of directors to determine that shares issued for promissory notes or for contracts for future services or benefits be placed in escrow or their transfer otherwise restricted until the services are performed, the benefits received, or the notes are paid. The section also defines the rights of the corporation with respect to these shares. If the shares are issued without being restricted as provided in this subsection, they are validly issued insofar as the adequacy of consideration is concerned. See section 6.22 and its Official Comment.

Section 6.21(a) provides that the powers granted to the board of directors by this section may be reserved to the shareholders by the articles of incorporation. No negative inference should be drawn from section 6.21(a) with respect to the efficacy of similar provisions under other sections of the Model Act.

NORTH CAROLINA COMMENTARY

Except for a minor stylistic change, this section is identical to section 6.21 of the Model Act. It differs in three main respects from former G.S. 55-46. First, the provisions of this section do not tie the minimum amount of consideration that must be received upon the issuance of the shares to their par or stated value. Second, the form that such consideration may take has been expanded to include future services and promissory notes, which were prohibited by former G.S. 55-46(b). Third, the board of directors is no longer required to state its determination of the fair value to the corporation of noncash consideration paid for shares; it is required only to determine that the noncash consideration is adequate.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2013-153, s. 1, effective January 1, 2014, added the second sentence in subsection (a).

Legal Periodicals. - For article, "The Power to Issue Stock," see 46 Wake Forest L. Rev. 701 (2011).

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Purpose Is to Prevent Fraud. - Former G.S. 55-62 was passed in order that stock subscriptions should be protected in their integrity and not become a means of deceiving those who dealt with the corporation. Goodman v. White, 174 N.C. 399, 93 S.E. 906 (1917).

Effect of Charter Provision That Stock Be Issued as Fully Paid. - A provision in the charter of an incorporated company that the capital stock "shall be issued as full-paid stock" does not permit shares of stock to be issued to stockholders without payment in money or its equivalent in property at an honest valuation. Clayton v. Ore Knob Co., 109 N.C. 385, 14 S.E. 36 (1891).

Cash Payment Unnecessary. - It is not essential to a bona fide subscription to stock in a corporation that there be a present payment in cash by the subscriber, or that he be solvent; a subscription is considered bona fide whenever made by one who subscribes in good faith, with reasonable expectation and apparent prospect of being able to pay assessments on his stock as they may thereafter be called for. Boushall v. Myatt, 167 N.C. 328, 83 S.E. 352 (1914).

Burden of Proof as to Value of Property. - The burden of proving that property was taken in payment at its true value, and, further, that such value was approved by a board of directors acting independently in the interest of the corporation, is upon the person who alleges payment. Goodman v. White, 174 N.C. 399, 93 S.E. 906 (1917).

Proceedings Where Property Fraudulently Overvalued. - Although a margin may be allowed for an honest difference of opinion as to value, a valuation grossly excessive, knowingly made, while its acceptance may bind the corporation, is a fraud on creditors, and they may proceed against the stockholders who sell the property individually, as for an unpaid subscription. Hobgood v. Ehlen, 141 N.C. 344, 53 S.E. 857 (1906); Goodman v. White, 174 N.C. 399, 93 S.E. 906 (1917).

Evidence of Fraud. - In an action by the receivers of an insolvent corporation to compel the payment of a subscription to stock issued for property acquired by the corporation for the conduct of the business, evidence tending to show a grossly excessive valuation of the property by the directors, knowingly made, is strong evidence of fraud, and may be conclusive thereof. Whitlock v. Alexander, 160 N.C. 465, 76 S.E. 538 (1912).

Nonsuit Properly Granted Absent Fraud. - The judgment of the board of directors, in fixing the value of property to be accepted in lieu of money, is conclusive in the absence of fraud; and in a suit to recover on a stock subscription, where there is no evidence of fraud, a judgment as of nonsuit is properly granted. Gover v. Malever, 187 N.C. 774, 122 S.E. 841 (1924).

Illegal Transaction by Promoter. - A transaction whereby a promoter borrowed a certain sum and bought a half interest in a company, and let the company that he was promoting take it over as soon as it was incorporated, and pay his note, and also issue to him stock as the consideration, was illegal. Goodman v. White, 174 N.C. 399, 93 S.E. 906 (1917).

The word "rendered" in former statute indicated that the services had to be performed prior to the issuance of the shares; so the requirement that the shares be taken for an agreed price has been satisfied by previous years of work in the business. Penley v. Penley, 65 N.C. App. 711, 310 S.E.2d 360 (1984), rev'd on other grounds, 314 N.C. 1, 332 S.E.2d 51 (1985).

Cancellation of Officer's Shares for Nonpayment of Consideration. - Where the trial court specifically found as fact that officer and director paid no consideration for stock and caused a dilution of the shares of the other shareholders, the trial court properly cancelled his shares. Stone v. Martin, 85 N.C. App. 410, 355 S.E.2d 255, appeal dismissed and cert. denied, 320 N.C. 638, 360 S.E.2d 105 (1987).

Cited in Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262 (2013).

OFFICIAL COMMENT

With the elimination of the concepts of par value and watered stock in 1980, the sole obligation of a purchaser of shares from the corporation, as set forth in section 6.22(a), is to pay the consideration established by the board of directors (or the consideration specified in the subscription, in the case of pre-incorporation subscriptions). The consideration for the shares may consist of promissory notes, contracts for future services, or tangible or intangible property or benefits, and, if the board of directors so decide, the delivery of the notes, contracts, or accrual of the benefits constitutes full payment for the shares. See the Official Comment to section 6.21. Upon the transfer to the corporation of the consideration so determined or specified, the shareholder has no further responsibility to the corporation or its creditors "with respect to the shares," though the shareholder may have continuing obligations under a contract or promissory note entered into in connection with the acquisition of shares.

Section 6.22(a) deals only with the responsibility for payment by the purchaser of shares from the corporation. The revised Model Act leaves to the Uniform Commercial Code questions with respect to the rights of subsequent purchasers of shares and the power of the corporation to cancel shares if the consideration is not paid when due. See sections 8-202 and 8-301 of the UNIFORM COMMERCIAL CODE.

Section 6.22(b) sets forth the basic rule of nonliability of shareholders for corporate acts or debts that underlies modern corporation law. Unless such liability is provided for in the articles of incorporation, see section 2.02(b)(v), shareholders are not liable for corporate obligations, though the last clause recognizes that such liability may be assumed voluntarily or by other conduct.

NORTH CAROLINA COMMENTARY

Former G.S. 55-53, a unique North Carolina provision dealing with "watered shares," has not been brought forward. Its provisions were deemed unnecessary in light of the provisions of G.S. 55-6-21. Former G.S. 55-53 basically codified fundamental legal principles of fiduciary duty that have not been changed by this Act.

Legal Periodicals. - For note on close corporations and personal liability from execution of shareholder agreements, see 16 Wake Forest L. Rev. 975 (1980).

For note discussing the liability of members of a professional corporation, in light of Nelson v. Patrick, 73 N.C. App. 1, 326 S.E.2d 45 (1985), see 64 N.C.L. Rev. 1216 (1986).

For article, "Defining the Scope of Controlling Shareholders' Fiduciary Responsibilities," see 22 Wake Forest L. Rev. 9 (1987).

For article, "Close Corporation Shareholder Reasonable Expectations: The Larger Context," see 22 Wake Forest L. Rev. 41 (1987).

For article, "The Statutory Protection Of Minority Shareholders In The United Kingdom," see 22 Wake Forest L. Rev. 81 (1987).

For article, "Using Alternative Dispute Resolution Techniques To Settle Conflicts Among Shareholders Of Closely Held Corporations," see 22 Wake Forest L. Rev. 105 (1987).

For comment, "North Carolina's Limited Liability Company Act: A Legislative Mandate for Professional Limited Liability," see 29 Wake Forest L. Rev. 857 (1994).

CASE NOTES

Editor's Note. - Some of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Stockholders of an insolvent corporation are liable pro rata for their unpaid subscriptions to an amount necessary to liquidate the corporate debts. McIver v. Young Hdwe. Co., 144 N.C. 478, 57 S.E. 169 (1907); Whitlock v. Alexander, 160 N.C. 465, 76 S.E. 538 (1912); Claypoole v. McIntosh, 182 N.C. 109, 108 S.E. 433 (1921).

Unpaid Balances to Be Collected. - As the capital stock, paid or unpaid, of a corporation is a trust fund for the benefit of creditors, it is the duty of the courts, at the suit of creditors, to require unpaid subscriptions to be collected at least to the extent necessary to pay the unpaid debts of the corporation. Wilson Cotton Mills v. Randleman Cotton Mills, 115 N.C. 475, 20 S.E. 770 (1894).

And Used to Settle Outstanding Claims. - In case of insolvency any unpaid balance may, by proper proceedings, be made available to the extent required for the settlement of outstanding claims. Whitlock v. Alexander, 160 N.C. 465, 76 S.E. 538 (1912).

As to action by corporation to recover amount spent to purchase stock from shareholders, see Park Terrace, Inc. v. Burge, 249 N.C. 308, 106 S.E.2d 478 (1959), discussing right of creditors to require payment of purchase price.

Agreement for Release Ineffective Against Creditors. - No agreement or arrangement between a corporation and its stockholders, whereby the latter are to be released from indebtedness on their subscriptions, will be valid or of any force as against creditors. Marshall Foundry Co. v. Killian, 99 N.C. 501, 6 S.E. 680 (1888); Heggie v. People's Bldg. & Loan Ass'n, 107 N.C. 581, 12 S.E. 275 (1890). See also Gilmore v. Smathers, 167 N.C. 440, 83 S.E. 823 (1914).

Suspension of Corporate Enterprise Does Not Excuse Subscriber. - The mere fact that a proposed corporate enterprise has been suspended affords a subscriber to the capital stock no excuse for not paying his subscription according to his agreement. Raleigh Imp. Co. v. Andrews, 176 N.C. 280, 96 S.E. 1032 (1918), aff'd, 178 N.C. 328, 100 S.E. 514 (1919).

No Defense That Corporation Not Legally Organized. - Where a person has agreed to become a stockholder in a corporation and has enjoyed the benefits and privileges of membership, he cannot, in a suit by the corporation to recover his unpaid subscription, set up as a defense that the corporation was not legally organized. Tar River Nav. Co. v. Neal, 10 N.C. 520 (1825); Elizabeth City Academy v. Lindsey, 28 N.C. 476 (1846); Wilmington, C.R.R.R. v. Thompson, 52 N.C. 387 (1860); Marshall Foundry Co. v. Killian, 99 N.C. 501, 6 S.E. 680 (1888); Wadesboro Cotton Mills Co. v. Burns, 114 N.C. 353, 19 S.E. 238 (1894).

Setoffs Against Unpaid Subscriptions. - In a receiver's action to collect unpaid stock subscriptions, a subscriber cannot set off a debt due him by the corporation, nor can he credit himself with amounts he paid on another subscription. Vaughan-Robertson Drug Co. v. Grimes-Mills Drug Co., 173 N.C. 502, 92 S.E. 376 (1917).

Personal Liability. - Corporation's appeal of the denial of its motion for summary judgment, which argued that the North Carolina Workers' Compensation Act precluded an administratrix's negligence claims against it, was dismissed because it could not be determined whether the corporation's liability was inseparable from that of the owner of the asphalt plant where a decedent's died; the administratrix did not allege that the corporation controlled and directed the actions of the owner or the limited liability company (LLC) that was the sole member-manager of the owner and did not make the same claims against the owner or the LLC as she did against the corporation but alleged that the corporation acted negligently out of its own interests, not in its management or conduct of the owner's business, and as sole shareholder in the LLC, the corporation was shielded from liability for the acts of the LLC but not from liability for its own negligent acts or conduct under G.S. 55-6-22(b). Van Dyke v. CMI Terex Corp., 201 N.C. App. 437, 689 S.E.2d 459 (2009).

Shareholders Not Personally Liable for Corporation's Acts. - Third-party plaintiff developer's indemnity complaint against third-party defendant shareholders concerning actions taken by their corporation in arranging for the excavation of a certain ditch failed because, pursuant to G.S. 55-6-22(b), and absent the application of certain exceptions that did not apply to the facts, the shareholders could not be personally liable for the corporation's acts. BNT Co. v. Baker Precythe Dev. Co., 151 N.C. App. 52, 564 S.E.2d 891 (2002), cert. denied, 356 N.C. 159, 569 S.E.2d 283 (2002).

Shareholders in a corporation are insulated from personal liability for acts of the corporation pursuant to G.S. 55-6-22(b). Ron Medlin Constr. v. Harris, 364 N.C. 577, 704 S.E.2d 486 (2010).

OFFICIAL COMMENT

A share dividend is solely a paper transaction: No assets are received by the corporation for the shares and any "dividend" paid in shares does not involve the distribution of property by the corporation to its shareholders. Section 6.23 therefore recognizes that such a transaction involves the issuance of shares "without consideration," and section 1.40(6) excludes it from the definition of a "distribution." Such transactions were treated in a fictional way under the old "par value" and "stated capital" statutes, which treated a share dividend as involving transfers from a surplus account to stated capital and assumed that par value shares could be issued without receiving any consideration by reason of that transfer of surplus.

The par value statutory treatment of share dividend transactions distinguished a share "split" from a dividend. In a share "split" the par value of the former shares was divided among the new shares and there was no transfer of surplus into the stated capital account as in the case of a share "dividend." Since the Model Act has eliminated the concept of par value, the distinction between a "split" and a "dividend" has not been retained and both types of transactions are referred to simply as "share dividends." A distinction between "share dividends" and "share splits," however, continues to exist in other contexts - for example, in connection with transactions by publicly held corporations, see N.Y.S.E. LISTED COMPANY MANUAL § 703.02(a), or corporations that have optionally retained par value for their shares. The change made in the Model Act is not intended to affect the manner in which transactions by these corporations are handled or described but simply reflects the elimination of artificial legal distinctions based on the par value statutes.

A "reversed stock split" is not a share dividend under this section of the Model Act. A reverse split involves an amendment to the articles of incorporation reducing the number of authorized shares, not the issuance of additional shares.

Share dividends may create problems when a corporation has more than a single class of shares. The requirement that a share dividend be "pro rata" only applies to shares of the same class or series; if there are two or more classes entitled to receive a share dividend in different proportions, the dividend will have to be allocated appropriately.

The distribution of shares of one class to holders of another class may dilute the equity of the holders of the first class. Therefore, subsection (b) permits the distribution of shares of one class to the holders of another class only if one or more of the following conditions are met: (1) the articles of incorporation expressly authorize the transaction, (2) the holders of the class being distributed consent to the distribution, or (3) there are no holders of the class being distributed.

NORTH CAROLINA COMMENTARY

This section was clarified by rewriting subsection (b) to provide for a more specific authorization and to limit the effectiveness of the authorization to one year, whenever shares of one class or series are to be distributed to the holder of another class or series. This modification to the Model Act carries forward the limitations of former G.S. 55-51(b)(2).

As used in this section and throughout this Act, share dividends and share splits are equivalent.

OFFICIAL COMMENT

A specific provision authorizing the creation of share options and share rights appears in many states statutes. Even though corporations doubtless have the inherent power to issue share options and share rights, specific authorization is desirable because of the economic importance of options and rights, and because of the need to establish the primacy of the board of directors in determining the consideration received by the corporation for rights and options. The creation of incentive compensation plans for directors, officers, agents, and employees is basically a matter of business judgment and the good faith determination by the board of directors should therefore be conclusive. This is as true for incentive plans that involve the issuance of share options or rights as for those that involve the payment of cash. In appropriate cases incentive plans may involve the granting of options at prices below the current market prices of the shares.

Section 6.24 does not require shareholder approval of share options or rights as incentive plans. Of course, prior shareholder approval may be required as a discretionary matter, in order to comply with the requirements of national security exchanges for the listing of securities, see N.Y.S.E. LISTED COMPANY MANUAL § 309.00, or to acquire the benefits of federal law conditioned upon shareholder approval of such plans, see S.E.C. Rule 16b-3(a), 17 C.F.R. § 240.16b-3(a).

The reference to the "form" of a right, option, or warrant in section 6.24 permits the board of directors to designate the interest issued under section 6.24 as options, warrants, rights, or by some other name, and to evidence these interests by certificates, contracts, letter agreements, or in other forms that are appropriate under the circumstances. Rights, options, or warrants may be issued together with or independently of the corporation's issue and sale of its shares or other securities.

Some publicly held corporations have delegated administration of programs involving incentive compensation in the form of share rights or options to compensation committees composed of nonmanagement directors, subject to the general authority of the board of directors.

NORTH CAROLINA COMMENTARY

Subsection (a) is identical to section 6.24 of the Model Act and is intended to be very broad in authorizing the creation and issuance of options, convertible securities and rights to acquire shares and other kinds of securities and property. The Model Act's catchline for the section was changed to reflect this broad scope. Unlike former G.S. 55-45(a), the statute itself does not require shareholder approval of any options granted thereunder; but, as noted in the Official Comment, such approval may be required by other rules or regulations.

Subsection (b) contains special provisions that do not appear in either the prior law or the Model Act and are designed to eliminate uncertainty as to the validity of certain rights plans created by companies with a class of securities registered under the Securities Exchange Act of 1934. Such plans usually contain features that might otherwise be held to violate the letter or intent of the corporate statute as a whole. Specifically, the rights plans typically used as defenses to hostile takeovers (called "poison pills") create purchase or conversion rights that are not exercisable in the hands of a hostile bidder. Without explicit statutory language to the contrary, for example, such a discriminatory feature might be held to violate the requirement of G.S. 55-6-01 that all shares of the same class have the same rights, or the requirement of G.S. 55-6-23(a) that share dividends be issued pro rata. The drafters were of that view that rights plans should not be generally prohibited. Several states, including New York, Pennsylvania, Ohio, Wisconsin and Hawaii, have adopted explicit validating language similar to that included in this section.

The last sentence of subsection (b) was included to make it clear that the broad enabling language of the subsection was not intended to eliminate or limit the directors' duty, under G.S. 55-8-30(a) and otherwise, to act in good faith, with due care and in the best interests of the corporation. Thus, their action in creating and using a "poison pill" as a defensive device would be subject to judicial review in an appropriate proceeding in which the court may formulate or apply appropriate standards to insure that the directors' actions are in the best long-term interests and short-term interests of the corporation and its shareholders considering, without limitation, the prospects for potential growth, development, productivity and profitability of the corporation.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2013-153, s. 2, effective January 1, 2014, added ", or officers of the corporation who are designated by the board of directors pursuant to G.S. 55-6-21(a)," in the second sentence of subsection (a).

Legal Periodicals. - For article, "Competing Interests in the Corporate Opportunity Doctrine," see 67 N.C.L. Rev. 435 (1989).

OFFICIAL COMMENT

This section sets forth the minimum requirements for share certificates. A corporation whose shares are not publicly traded will normally issue certificates that meet these minimum requirements and little more. Securities that are publicly traded, on the other hand, must contain reasonable safeguards against fraudulent duplication; for this reason, regulations by exchanges contain technical requirements relating to design, workmanship, engraving, and printing. Also, exchange requirements may require signatures of a transfer agent and registrar as well as designated corporate officers. All these requirements are in addition to the minimum requirements of the Model Act.

Certificateless shares are permitted under section 6.25(a) upon compliance with section 6.26. Section 6.25(a) makes it clear that there are no differences in the rights and obligations of shareholders, whether or not their shares are represented by certificates, other than mechanical differences, such as the means by which instructions for transfer are communicated to the issuer, necessitated by the use or nonuse of certificates. If share transfer restrictions are imposed, conspicuous references must appear on the certificate if they are to be binding on third persons without knowledge of the restrictions. See section 6.27.

Under section 6.25 all signatures on a share certificate may be facsimiles. This change, which has been adopted recently in several states, gives recognition to the fact that a purchaser of publicly traded shares will hardly ever be in a position to determine whether a manual signature on a stock certificate is in fact the authorized signature of an officer or the transfer agent or registrar. From the standpoint of the issuing corporation of publicly traded securities, if a share certificate requiring a manual signature is stolen and the signature thereafter forged, the corporation may defend on lack of genuineness under section 8-202(3) of the UNIFORM COMMERCIAL CODE. But this defense is not effective against a bona fide purchaser when the forged signature has been placed on the certificate by an employee of the issuer or registrar or transfer agent entrusted with handling the certificates (UCC § 8-205). It is likely that a corporation would therefore follow the same security precautions for blank certificates requiring manual signatures as for those not requiring them. At the same time, the time and expense required for manual signatures has been eliminated.

NORTH CAROLINA COMMENTARY

This section and G.S. 55-6-26 authorize the issuance of uncertificated shares, which is a major change from the former law. Except for the addition of the words "in any capacity" to subsection (e) to make it clear that transfer agents and registrars are covered by the section, the section is identical to section 6.25 of the Model Act. Article 8 of the North Carolina UCC has been amended to add provisions dealing with uncertificated shares.

Cross References. - As to replacement certificates, see G.S. 25-8-405.

CASE NOTES

Editor's Note. - Some of the cases below were decided under prior law.

Nature of Stock Certificate. - A certificate of stock is simply a written acknowledgment by a corporation of the interest of the holder in its property and franchises. It has no value except that derived from the company issuing it, and its legal status is in the nature of a chose in action. Person v. Board of State Tax Comm'rs, 184 N.C. 499, 115 S.E. 336 (1922).

Evidence of Ownership of Stock. - A certificate for shares is not the stock itself, but constitutes only prima facie evidence of the ownership of that number of shares. Misenheimer v. Alexander, 162 N.C. 226, 78 S.E. 161 (1913).

Issuance of stock certificates is unnecessary to existence of the corporation. Powell Bros. v. McMullan Lumber Co., 153 N.C. 52, 68 S.E. 926 (1910).

Or to confer title to the stockholder. Powell Bros. v. McMullan Lumber Co., 153 N.C. 52, 68 S.E. 926 (1910).

Whether Stock Actually Issued in Consideration for Covenant-Not-To-Compete and Other Agreements. - In a business dispute involving asserted allegations of breach of a covenant-not-to-compete and other claims, a trial court erred by granting defendants summary judgment on the issue of whether there was consideration offered to defendants in exchange for signing the covenant-not-to-compete, confidentiality and non-solicitation agreement, and shareholders' agreement, as a genuine issue of material fact remained as to whether plaintiff actually issued stock shares promised to defendants, such that they constituted valuable consideration to make the covenant-not-to-compete and confidentiality and non-solicitation agreement valid and enforceable. Kinesis Adver., Inc. v. Hill, 187 N.C. App. 1, 652 S.E.2d 284 (2007), review denied, appeal dismissed, 362 N.C. 177, 658 S.E.2d 485 (2008).

Shareholders Without Certificates Could Not Prevail in Action Against Corporation. - Alleged shareholders' claims against a corporation and their stepmother for the sale of corporate property were properly subject to summary judgment. The shareholders could not prevail because they were unable to provide any evidence that certificates were issued to them in compliance with G.S. 55-6-25. Collier v. Collier, 204 N.C. App. 160, 693 S.E.2d 250 (2010).

OFFICIAL COMMENT

Section 6.26(a) authorizes the creation of uncertificated shares either by original issue or in substitution for shares previously represented by certificates. This subsection gives the board of directors the widest discretion so that a particular class and series of shares might be entirely represented by certificates, entirely uncertificated, or represented partly by each. The second sentence ensures that a corporation may not treat as uncertificated, and accordingly transferable on its books without due presentation of a certificate, any shares for which a certificate is outstanding.

The statement required by section 6.26(b) ensures that holders of uncertificated shares will receive from the corporation the same information that the holders of certificates receive when certificates are issued. There is no requirement that this information be delivered to purchasers of uncertificated shares before purchase.

Detailed rules with respect to the issuance, transfer, and registration of both certificated and uncertificated shares appear in article 8 of the UNIFORM COMMERCIAL CODE. In general terms there are no differences between certificated and uncertificated securities except in matters such as their manner of transfer. See the Official Comment to section 6.25.

CASE NOTES

Whether Stock Actually Issued in Consideration for Covenant-Not-To-Compete and Other Agreements. - In a business dispute involving asserted allegations of breach of a covenant-not-to-compete and other claims, a trial court erred by granting defendants summary judgment on the issue of whether there was consideration offered to defendants in exchange for signing the covenant-not-to-compete, confidentiality and non-solicitation agreement, and shareholders' agreement, as a genuine issue of material fact remained as to whether plaintiff actually issued stock shares promised to defendants, such that they constituted valuable consideration to make the covenant-not-to-compete and confidentiality and non-solicitation agreement valid and enforceable. Kinesis Adver., Inc. v. Hill, 187 N.C. App. 1, 652 S.E.2d 284 (2007), review denied, appeal dismissed, 362 N.C. 177, 658 S.E.2d 485 (2008).

Cited in Collier v. Collier, 204 N.C. App. 160, 693 S.E.2d 250 (2010).

OFFICIAL COMMENT

Share transfer restrictions are widely used by both publicly held and closely held corporations for a variety of appropriate purposes. Although most courts have upheld reasonable share transfer restrictions, a few have rigidly followed the common law rule that they constituted restraints on alienation and should be strictly construed. As a result, some cases have invalidated restrictions outright or construed them narrowly so as not to cover specific transfers. By prescribing reasonable rules to govern the use of transfer restrictions, section 6.27 should guide practitioners in their use and encourage a more uniform and favorable judicial reception.

Examples of the uses of share transfer restrictions include:

1. a close corporation may impose share transfer restrictions to qualify for the close corporation election under the Model Statutory Close Corporation Supplement;
2. a corporation with relatively few shareholders may impose share transfer restrictions to ensure that current shareholders will be able to control who may participate in the corporation's business;
3. a corporation with relatively few shareholders may impose share transfer restrictions to ensure that shareholders who wish to retire will be able to liquidate their investment without disrupting corporate affairs;
4. a corporation with few shareholders may impose share transfer restrictions in an effort to ensure that estates of deceased shareholders will be able to liquidate the closely held shares and that the Internal Revenue Service will accept the liquidated value of the shares as their value for estate tax purposes;
5. a professional corporation may impose share transfer restrictions to ensure that its treatment of retiring or deceased shareholders is consistent with the canons of ethics applicable to the profession in question;
6. a corporation may impose share transfer restrictions to ensure that its election of subchapter S treatment under the Internal Revenue Code will not be unexpectedly terminated; and
7. a publicly held or closely held corporation issuing securities pursuant to an exemption from federal or state securities act registration may impose share transfer restrictions to ensure that subsequent transfers of shares will not result in the loss of the exemption being relied upon.

This listing, while not exhaustive, illustrates the flexibility of share transfer restrictions, their widespread use, and the importance of having a statute dealing with them.

Section 6.27(a) generally authorizes the imposition of transfer restrictions on "shares," although the caption of the section refers to "shares and other securities." Section 6.27(e) defines "shares" for purposes of section 6.27 to include securities "convertible into or carrying a right to subscribe for or acquire shares;" the phrase "other securities" in the title thus describes the broader scope of this section resulting from the definition in section 6.27(e).

Share transfer restrictions are usually created by provisions in the bylaws or articles of incorporation but may also be created by contract between the corporation and some or all the shareholders or between or among the shareholders themselves. However, if shares are originally issued free of restriction, they may not thereafter be subjected to a transfer restriction without the consent of the holder, evidenced by a vote in favor of the amendment to the articles or bylaws creating the restriction, or by being a party to the contract creating the restriction.

The terms of a restriction on transfer do not need to be set forth in full or summarized in detail on a certificate or information statement required by section 6.26(b) for uncertificated securities. Rather, section 6.27(b) provides that in the case of a certificated security, the existence of the restriction must be conspicuously set forth on the front or back of the certificate; in the case of an uncertificated security, the existence of the restriction must be noted in the information statement. There is no requirement that the notation on an information statement be conspicuous.

If a transferee knows of the restriction he is bound by it even though the restriction is not noted on the certificate or information statement.

Section 6.27(c) describes the purposes for which restrictions may be imposed while section 6.27(d) describes the types of restrictions that may be imposed.

Section 6.27(c) enumerates certain purposes for which share transfer restrictions may be imposed, but does not limit the purposes since section 6.27(c)(3) permits restrictions "for any other reasonable purpose." Examples of the "status" referred to in section 6.27(c)(1) are the election of close corporation status under the Model Statutory Close Corporation Supplement, the subchapter S election under the Internal Revenue Code, and entitlement to a program or eligibility for a privilege administered by governmental agencies or national securities exchanges. Specific references in section 6.27 to subchapter S and other statutes were not made because of the possibility that the Internal Revenue Code or other statute may be amended or recodified after the adoption of the Model Act.

Section 6.27(c)(2) permits restrictions on transfers of shares to ensure availability of exemptions under state or federal securities acts. Share transfer restrictions for other purposes are permitted by section 6.23(c)(3) so long as the purpose is reasonable. It is unnecessary to inquire into the reasonableness of the purposes specifically enumerated in section 6.27(c)(1) and (2).

The types of restrictions referred to in section 6.27(d)(1) (buy-sell agreements) and (2) (option agreements) are imposed as a matter of contractual negotiation and do not prohibit the outright transfer of shares. Rather, they designate to whom shares or other securities must be offered at a price established in the agreement or by a formula or method agreed to in advance. By contrast, the restrictions described in sections 6.27(d)(3) and (4) may permanently limit the market for shares by disqualifying all or some potential purchasers. As a result the restrictions imposed by these two provisions must not be "manifestly unreasonable."

NORTH CAROLINA COMMENTARY

The Model Act was modified in subsection (b) by inserting the language "it is not unconscionable under the circumstances." This modification addressed a concern that the Model Act's section 6.27 may allow the enforcement of unconscionable restrictions. The drafters noted that the Model Act's language in section 6.27 may not allow judicial discretion in a situation where there was initially a reasonable purpose in imposing a restriction but over time the effect of the restriction had become unreasonable because of a change in circumstances. Judicial discretion would allow a court in such a situation to judge the restriction at the time its validity and enforceability are questioned. The amendment does not represent an attempt to change the prior law in North Carolina with respect to unconscionable agreements, but rather to preserve expressly the equitable power of the courts to deny enforcement of agreements that are unconscionable under the circumstances.

Subsection (b) was also modified so that a restriction on transfer not noted on the certificate or in the information statement is enforceable only against a person who received actual written notice of the restriction.

The introductory language of subsection (d) was modified for clarity. Subdivision (d)(5) was added to clarify that subdivisions (1) through (4) are not exclusive. The use of the word "reasonably" in this subsection was not thought to conflict with the "unconscionable" language in subsection (b), because the two subsections have different purposes.

CASE NOTES

Stock Restriction Upheld. - When considering the enforcement of a stock restriction agreement pursuant to this section, a trial court may decline to specifically enforce the agreement if there has been a change of circumstances since its execution, such that its enforcement would be unconscionable; and found that where defendant, an employee at will, was terminated prior to the full vesting of his stock but for a justifiable business purpose, where the parties had discussed but rejected a "buy-out" formula based on fair market value, and where defendant entered freely into an agreement based on adjusted book value, no change of circumstances existed rendering the arm's length agreement unconscionable and unenforceable. Crowder Constr. Co. v. Kiser, 134 N.C. App. 190, 517 S.E.2d 178 (1999), cert. denied, 351 N.C. 101, 541 S.E.2d 142 (1999).

Applied in Whitacre P'ship v. BioSignia, Inc., 153 N.C. App. 608, 574 S.E.2d 475 (2002), cert. granted, 356 N.C. 695, 579 S.E.2d 103 (2003).

OFFICIAL COMMENT

The original purpose of this section was to deal with the problems created by the concepts of "par value" and "stated capital;" it permitted the corporation to expend its capital for "the reasonable charges and expenses of " organization without fear of making the shares not fully paid or assessable because the assets were reduced below the aggregate par value of the issued shares.

Under the modern capitalization principles set forth in the Model Act (see the Official Comment to section 6.21), there is no basis for the fear that shares issued properly under section 6.21 can be made assessable because of the subsequent use of the proceeds. While section 6.28 thus may be technically unnecessary, it was believed to be desirable to retain in the Model Act a general authorization to the corporation to pay its expenses of formation and raising capital out of its original capitalization. The reference to "reasonable" charges and expenses was deleted on the theory that the test for these expenses should be no different from the test for expenses of any other type.

The concluding language in the original Model Act, "without rendering the shares not fully paid or assessable," was also deleted as unnecessary and confusing in the context of the revisions to the financial provisions of the Model Act.

This section has been rarely cited or referred to in court decisions even though it appears in a large number of state statutes.

OFFICIAL COMMENT

Section 6.30(a) adopts an "opt in" provision for preemptive rights: Unless an affirmative reference to these rights appears in the articles of incorporation, no preemptive rights exist. Whether or not preemptive rights are elected, however, the directors' fiduciary duties extend to the issuance of shares. Issuance of shares at favorable prices to directors (but excluding other shareholders) or the issuance of shares on a nonproportional basis for the purpose of affecting control rather than raising capital may violate that duty. These duties, it is believed, form a more rational structure of regulation than the technical principles of traditional preemptive rights.

Section 6.30(b) provides a standard model for preemptive rights if the corporation desires to exercise the "opt in" alternative of section 6.30(a). The simple phrase, "the corporation elects to have preemptive rights," or words of similar import, results in the rest of subsection (b) becoming applicable to the corporation. But a corporation may qualify or limit any of the rules set forth in subsection (b) by express provisions in the articles of incorporation if the rules are felt to be undesirable or inappropriate for the specific corporation. The purposes of this standard model for preemptive rights are (1) to simplify drafting articles of incorporation and (2) to provide a simple checklist of business considerations for the benefit of attorneys who are considering the inclusion of preemptive rights in articles of incorporation.

The provisions of sections 6.30(b) establish rules for most of the problems involving preemptive rights. Thus subsection (b)(1) defines the general scope of the preemptive right giving appropriate recognition to the discretion of the board of directors in establishing the terms and conditions for exercise of that right. Subsection (b)(2) creates rules with respect to the waiver of these rights. Subsection (b)(3) lists the principal exceptions to preemptive rights, including a six-month period during which initial capital can be raised by a newly formed corporation without regard to the preemptive rights of persons who have previously acquired shares. Subsections (b)(4) and (b)(5) provide rules for the often-difficult problems created when preemptive rights are recognized in corporations with more than a single class of shares. These problems are discussed further below. Subsection (b)(6) defines the status of preemptive rights after a shareholder has elected not to exercise a proffered preemptive right: for a period of one year thereafter the corporation may dispose of the shares at the same or a higher price. A corporation deciding to offer shares at a lower price must reoffer the shares preemptively to the shareholders before selling them to third persons.

As indicated above, any portion of section 6.30(b) that is felt not to be appropriate for a specific corporation may be amended or deleted by appropriate provision in the articles of incorporation.

The model provision dealing with preemptive rights in section 6.30(b) is primarily designed to protect voting power within the corporation from dilution. For this reason, section 6.30(c) contains a special definition of "shares" to ensure that the preemptive rights of shareholders, if these rights are granted, apply to all securities that are convertible into or carry a right to acquire voting shares.

On the other hand, preemptive rights also may serve in part the function of protecting the equity participation of shareholders. This combination of functions creates no problem in a corporation that has authorized only a single class of shares but may occasionally create problems in corporations with more complex capital structures. In many multiple-class corporate financial structures, the issuance of additional shares of one class does not adversely affect other classes. For example, the issuance of additional general voting shares without preferential rights normally does not affect either the limited voting power or equity participation of holders of shares with preferential rights; holders of shares with preferential equity participation rights but without general voting rights should therefore have no preemptive rights with respect to general voting shares without preferential rights. See subsections (b)(4) and (b)(5). Classes of shares that may give rise to possible conflict between the protection of voting interests and equity participation when the board of directors desires to issue additional shares include classes of nonvoting shares without preferential rights and classes of shares with both preferential rights to distributions and general voting rights. Attorneys who draft articles of incorporation with classes of shares that may give rise to these conflicts should consider the precise application of section 6.30(b) with respect to preemptive rights for these classes and define more carefully the scope of the preemptive rights desired.

NORTH CAROLINA COMMENTARY

For corporations incorporated on or after July 1, 1990, this section adopts an "opt in" election for preemptive rights. In contrast to the prior law, unless an affirmative reference to these rights appears in the articles of incorporation, no preemptive rights exist. Former G.S. 55-56 provided for preemptive rights unless limited or denied by the articles of incorporation. Subsection (d) grants preemptive rights under this section to shareholders of corporations incorporated before July 1, 1990, except to the extent the articles of incorporation expressly provide otherwise.

The Model Act was modified in subdivision (b)(3)(iv) to require that the issuance of shares for consideration other than money be advantageous to the corporation's business.

The drafters concluded that subdivisions 6.30(b)(4) and (5) of the Model Act are unclear. They omitted subdivision (b)(5) and rewrote subdivision (b)(4) to make it clear that holders of one class of shares do not have any preemptive rights with respect to shares of another class.

OFFICIAL COMMENT

The elimination of the concepts of "par value" and "stated capital" in the 1980 amendments to the Model Act (see the Official Comment to section 6.21) permitted the simplification of a number of other sections of the Act and the elimination of several historical concepts that primarily served the purpose of ameliorating problems created by retention of the concepts of "par value" and "stated capital."

One concept eliminated by the 1980 amendments was that of treasury shares. The status of once-issued but reacquired shares was an uneasy one under the traditional statutes. It was universally recognized that a corporation's shares in its own hands are not an asset any more than authorized but unissued shares. As an economic matter payments made by a corporation to repurchase its own shares must be viewed as a distribution of corporate assets by the corporation rather than as an acquisition of an asset. Further, conventional statutes gave treasury shares an intermediate status between issued and unissued: they were treated as outstanding shares for some purposes, and they could be resold or disposed of by the corporation (presumably) without regard to restrictions that might be imposed on the original issuance of shares by the corporation. Finally, the accounting treatment for treasury shares was complex, confusing, and to some extent unrealistic since the capital accounts often did not reflect transactions in treasury shares.

Under the 1980 revisions of the financial provisions in the Model Act the concept of treasury shares is unnecessary. Authorized but unissued shares of the corporation may be issued on the same basis and with the same freedom as treasury shares under earlier statutes. Attorneys' opinions on the legality of the issuance of shares under the revised Model Act will therefore be unaffected by the elimination of the technical distinction between original shares and treasury shares. A possible exception to these statements is that the concept of treasury shares may have permitted listed companies to save modestly on stock exchange listing fees in some cases that may not be available under the revised Model Act provisions.

Section 6.31(a) restates the fundamental power of a corporation to reacquire its own shares. Such a transaction constitutes a "distribution" by the corporation (see the definition of that term in section 1.40) and is subject to the limitations of section 6.40.

Shares that are reacquired by the corporation become authorized but unissued shares under section 6.31(b) unless the articles prohibit reissue, in which event they are cancelled. Section 6.31(c) requires a simplified official filing to reflect the reduction of authorized shares. This provision is included in order that there be a public record of the number of authorized shares that a corporation may issue. The amendment may be made without shareholder action. See section 10.02.

Until the amendment referred to in section 6.31(c) is effective, the corporation has power to reissue the reacquired shares despite a prohibition in the articles of incorporation. In such a case, the action of the directors in issuing the shares may be challengeable but the shares so issued would be fully paid and nonassessable if issued in conformity with section 6.21.

NORTH CAROLINA COMMENTARY

The concept of treasury shares is eliminated in this section.

The Model Act was modified in subsection (c) to provide that, when a corporation is prohibited from reissuing acquired shares, it must amend its articles of incorporation to reduce the number of authorized shares by the number of acquired shares. Such reduction is effective upon the filing of articles of amendment with the Secretary of State.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

The provision for amending articles of incorporation to reflect a reduction in authorized shares when the corporation is prohibited from reissuing acquired shares referred to in the Official Comment is relocated to G.S. 55-10-02 effective October 1, 2005.

Effect of Amendments. - Session Laws 2005-268, s. 1, effective October 1, 2005, repealed subsection (c), regarding adoption of the Articles of Amendment required by subsection (b) by the board of directors without shareholder action.

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

CASE NOTES

Editor's Note. - The cases below were decided under prior law.

Former Law. - Under former law, a corporation, unless restrained by some provision of its organic law, could purchase its own stock from holders thereof, and the latter were entitled to all rights of other creditors of the corporation for the protection and enforcement of their demand for payment. Blalock v. Kernersville Mfg. Co., 110 N.C. 99, 14 S.E. 501 (1892).

Purpose of 1985 Amendment to Former G.S. 55-52. - The 1985 amendment to former G.S. 55-52 was established to enable corporations to enter into written agreements with shareholders at the outset of the relationship for the issuance of stock redeemable at the shareholder's option. The statute was not designed to simply allow the corporation to enter into a written agreement with a shareholder to redeem stock out of and as an impairment to stated capital, which stock was already being held by the shareholder as common stock; rather, the purpose was to provide a new method for North Carolina corporations to raise needed capital by readily available cash infusions from shareholders in exchange for stock redeemable at their request. In re N.W. Oxygen, Inc., 99 Bankr. 703 (Bankr. M.D.N.C. 1989).

Agreement Entered into Prior to Amendment. - Where former shareholder had a note in exchange for the redemption of his shares in corporation, the note was unenforceable under former G.S. 55-52, as subdivision (c)(3), rather than subdivision (b)(4) thereof, applied. First, subdivision (b)(4) was an amendment to the original provision and was effective in 1985, while the agreement between former shareholder and debtor corporation was executed before the amendment was in effect; second, subdivision (b)(4) was established to enable corporations to enter agreements with shareholders for the issuance of stocks. In the instant case former shareholder and debtor entered into a written agreement some ten years after the issuance of the shares for the sale of the common stock which former shareholder owned. In re N.W. Oxygen, Inc., 99 Bankr. 703 (Bankr. M.D.N.C. 1989).

Solvency Test for Each Payment Under Former G.S. 55-52(c). - Since former G.S. 55-52 specifically included the words "and pay for" in subsection (c), a solvency test for surplus had to occur each time a corporation made a payment on the indebtedness out of the assets of the corporation. In re N.W. Oxygen, Inc., 99 Bankr. 703 (Bankr. M.D.N.C. 1989).

Redemption Agreement Held Unenforceable. - Promissory note to a former shareholder in exchange for the redemption of his shares in corporation and underlying security interest were rendered unenforceable due to the corporation's subsequent insolvency and inability to make payment on the obligation out of sufficient surplus of corporate assets. In re N.W. Oxygen, Inc., 99 Bankr. 703 (Bankr. M.D.N.C. 1989).

OFFICIAL COMMENT

The reformulation of the statutory standards governing distributions is another important change made by the 1980 revisions to the financial provisions of the Model Act. It has long been recognized that the traditional "par value" and "stated capital" statutes do not provide significant protection against distributions of capital to shareholders. While most of these statutes contained elaborate provisions establishing "stated capital," "capital surplus," and "earned surplus" (and often other types of surplus as well), the net effect of most statutes was to permit the distribution to shareholders of most or all of the corporation's net assets - its capital along with its earnings - if the shareholders wished this to be done. However, statutes also generally imposed an equity insolvency test on distributions that prohibited distributions of assets if the corporation was insolvent or if the distribution had the effect of making the corporation insolvent or unable to meet its obligations as they were projected to arise.

The financial provisions of the revised Model Act, which are based on the 1980 amendments, sweep away all the distinctions among the various types of surplus but retain restrictions on distributions built around both the traditional equity insolvency and balance sheet tests of earlier statutes.

1. The scope of section 6.40
2. Equity insolvency test
3. Relationship to the federal bankruptcy act and other fraudulent conveyance statutes
4. Balance sheet test
   1. Generally accepted accounting principles
   2. Other principles
   3. Priority of debt distributed directly or incurred in connection with a redemption

Section 1.40 defines "distribution" to include virtually all transfers of money, indebtedness of the corporation or other property to a shareholder in respect of the corporation's shares. It thus includes cash or property dividends, payments by a corporation to purchase its own shares, distributions of promissory notes or indebtedness, and distributions in partial or complete liquidation or voluntary or involuntary dissolution. Section 1.40 excludes from the definition of "distribution" transactions by the corporation in which only its own shares are distributed to its shareholders. These transactions are called "share dividends" in the revised Model Business Corporation Act. See section 6.23.

Section 6.40 imposes a single, uniform test on all distributions. Many of the old "par value" and "stated capital" statutes provided tests that varied with the type of distribution under consideration or did not cover certain types of distributions at all.

As noted above, older statutes prohibited payment of dividends if the corporation was, or as a result of the payment would be, insolvent in the equity sense. This test is retained, appearing in section 6.40(c)(1).

For an on-going business enterprise the equity insolvency test requires that decisions be based on a cash flow analysis that is itself based on a business forecast and budget for a sufficient period of time to permit a conclusion that known obligations of the corporation can reasonably be expected to be satisfied over the period of time that they will mature. It is not sufficient simply to measure current assets against current liabilities, or determine that the present estimated "liquidation" value of the corporation's assets would produce sufficient funds to satisfy the corporation's existing liabilities.

In determining whether a corporation is, or as a result of a proposed distribution would be rendered, insolvent, the board of directors may rely on information supplied by the officers of the corporation. It is not necessary for them to know of the details of the cash flow analysis if the proposed distribution involves no significant risk of equity insolvency. Judgments, further, must of necessity be made on the basis of information in the hands of the board of directors when a distribution is authorized. See section 8.30.

The revised Model Business Corporation Act establishes the validity of distributions from the corporate law standpoint under section 6.40 and determines the potential liability of directors for improper distributions under sections 8.30 and 8.33. The federal Bankruptcy Act and state fraudulent conveyance statutes, on the other hand, are designed to enable the trustee or other representative to recapture for the benefit of creditors funds distributed to others in some circumstances. In light of these diverse purposes, it was not thought necessary to make the tests of section 6.40 identical with the tests for insolvency under these various statutes.

Section 6.40(c)(2) requires that, after giving effect to any distribution, the corporation's assets equal or exceed its liabilities plus (with some exceptions) the dissolution preferences of senior equity securities. Section 6.40(d) authorizes asset and liability determinations to be made for this purpose on the basis of either (1) financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or (2) a fair valuation or other method that is reasonable in the circumstances. The determination of a corporation's assets and liabilities and the choice of the permissible basis on which to do so are left to the judgment of its board of directors. In making a judgment under section 6.40(d), the board may rely under section 8.30 upon opinions, reports, or statements, including financial statements and other financial data prepared or presented by public accountants or others.

Section 6.40 does not incorporate technical accounting terminology and specific accounting concepts. Accounting terminology and concepts are constantly under review and subject to revision by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission, and others. In making determinations under this section, the board of directors may make judgments about accounting matters, taking into account its right to rely upon professional or expert opinion and its obligation to be reasonably informed as to pertinent standards of importance that bear upon the subject at issue.

In a corporation with subsidiaries, the board of directors may rely on unconsolidated statements prepared on the basis of the equity method of accounting (see American Institute of Certified Public Accountants, APB Opinion No. 18 (1971)) as to the corporation's investee corporations, including corporate joint ventures and subsidiaries, although other evidence would be relevant in the total determination.

The directors will normally be entitled to use generally accepted accounting principles and to give presumptive weight to the advice of professional accountants with respect to their application. But section 6.40 only requires the use of accounting practices and principles that are reasonable in the circumstances, and does not constitute a statutory enactment of generally accepted accounting principles. The widespread controversy concerning various accounting principles, and their continuous reevaluation, suggest that a statutory standard of reasonableness, rather than of generally accepted accounting principles, is appropriate. The Model Act does not reject generally accepted accounting principles; on the contrary, it is expected that their use will be the basic rule in most cases. The statutory language does, however, require informed business judgment applying particular accounting principles to the entire circumstances that exist at the time.

If a corporation's financial statements are not presented in accordance with generally accepted accounting principles, a board of directors should normally consider the extent to which the assets may not be fairly stated or the liabilities may be understated in determining the aggregate amount of assets and liabilities.

Section 6.40(d) specifically permits determinations to be made under section 6.40(c)(2) on the basis of a fair valuation or other method that is reasonable in the circumstances. Thus the statute authorizes departures from historical cost accounting and sanctions the use of appraisal methods to determine the funds available for distributions. No particular method of valuation is prescribed in the statute, since different methods may have validity depending upon the circumstances, including the type of enterprise and the purpose for which the determination is made. For example, it is inappropriate to apply a "quick-sale liquidation" value to an enterprise in most cases, particularly with respect to the payment of normal dividends. On the other hand, a "quick-sale valuation" might be appropriate in certain circumstances for an enterprise in the course of liquidation or of reducing its asset or business base by a material degree. In most cases, a fair valuation method or a going-concern basis would be appropriate if it is believed that the enterprise will continue as a going concern.

In determining the value of assets, all of the assets of a corporation, whether or not reflected in the financial statements (e.g., a valuable executory contract), should be considered. Ordinarily a corporation should not selectively revalue assets. Likewise, all of a corporation's obligations and commitments should be considered and quantified to the extent appropriate and possible. In any event, section 6.40(d) imposes upon the board of directors the responsibility of applying under section 6.40(c)(2) a method of determining the aggregate amounts of assets and liabilities that is reasonable in the circumstances.

Section 6.40(d) also refers to some "other method that is reasonable in the circumstances." This phrase is inserted to comprehend within section 6.40(c)(2) the wide variety of possibilities that might not be considered to fall under a "fair valuation" but might be reasonable in the circumstances of a particular case.

5. Preferential dissolution rights and the balance sheet test

Section 6.40(c)(2) provides that a distribution may not be made unless the total assets of the corporation exceed its liabilities plus the amount that would be needed to satisfy any shareholders' superior preferential rights upon dissolution if the corporation were to be dissolved at the time of the distribution. This requirement in effect treats preferential dissolution rights of classes or series of shares for distribution purposes as equivalent to liabilities rather than as equity interests, and carries forward analogous treatment of shares having preferential dissolution rights from earlier versions of the Model Act. In making the calculation of the amount that must be added to the liabilities of the corporation to reflect the preferential dissolution rights, the assumption should be made that the preferential dissolution rights are to be established pursuant to the articles of incorporation (or resolution creating a series having preferential dissolution rights) as of the date of the distribution or proposed distribution. The amount so determined must include arrearages in preferential dividends if the articles of incorporation or resolution require that they be paid upon the dissolution of the corporation. In the case of shares having both a preferential right upon dissolution and additional nonpreferential rights, only the preferential portion of the rights should be taken into account. The treatment of preferential dissolution rights of classes of shares set forth in section 6.40(c)(2) is applicable only to the balance sheet test and is not applicable to the equity insolvency test of section 6.40(c)(1). The treatment of preferential rights mandated by this section may always be eliminated by an appropriate provision in the articles of incorporation.

6. Time of measurement

Section 6.40(e)(3) provides that the time for measuring the effect of a distribution for compliance with the insolvency and balance sheet tests for all distributions not involving the reacquisition of shares of the distribution of indebtedness is the date of authorization, if the payment occurs within 120 days following the authorization; if the payment occurs more than 120 days after the authorization, however, the date of payment must be used. If the corporation elects to make a distribution in the form of its own indebtedness under section 6.40(e)(2), the validity of that distribution must be measured as of the time of distribution.

Section 6.40(e)(1) provides a different rule for the time of measurement when the distribution involves a reacquisition of shares. See part 8a. below.

7. Record date

Section 6.40(b) fixes the record date (if the board of directors does not otherwise fix it) for distributions other than those involving a repurchase or reacquisition of shares as the date the board of directors authorizes the distribution. No record date is necessary for a repurchase or reacquisition of shares from one or more specific shareholders. The board of directors has discretion to set a record date for a repurchase or reacquisition if it is to be pro rata and to be offered to all shareholders as of a specified date.

8. Application to repurchases or redemption of shares

The application of the equity insolvency and balance sheet tests to distributions that involve the purchase or redemption of shares creates unique problems; section 6.40 provides specific rules for the resolution of these problems as described below.

a. Time of measurement

Section 6.40(e)(1) provides that the time for measuring the effect of a distribution under section 6.40(c), if shares of the corporation are reacquired, is the earlier of (i) the payment date, or (ii) the date the shareholder ceased to be a shareholder with respect to the shares.

b. When tests are applied to redemption-related debt

In an acquisition of its shares, a corporation may transfer property or incur debt to the former holder of the shares. The case law on the status of this debt is conflicting. However, share repurchase agreements involving payment for shares over a period of time are of special importance in closely held corporate enterprises. Section 6.40(e) provides a clear rule for this situation: the legality of the distribution must be measured at the time of the issuance or incurrence of the debt, not at a later date when the debt is actually paid. Of course, this does not preclude a later challenge of a payment on account of redemption-related debt by a bankruptcy trustee on the ground that it constitutes a preferential payment to a creditor.

Section 6.40(f) provides that indebtedness created to purchase shares or issued as a distribution is on a parity with the indebtedness of the corporation to its general, unsecured creditors, except to the extent subordinated by agreement. General creditors are better off in these situations than they would have been if cash or other property had been paid out for the shares or distributed (which is proper under the statute), and no worse off than if cash had been paid out to the shareholders, which was then lent back to the corporation, making the shareholders creditors. The parity created by section 6.40(f) therefore is logically consistent with the rule established by section 6.40(e) that these transactions should be judged at the time of the issuance of the debt.

AMENDED NORTH CAROLINA COMMENTARY

This section introduces significant changes from prior law in the criteria used to determine a corporation's legal capacity to pay dividends and reacquire its shares. The former surplus tests no longer apply. In addition, the provisions of former G.S. 55-52, which limited the circumstances under which a corporation could reacquire its shares, were not brought forward. All distributions to shareholders, whether by dividends or repurchases of shares, are determined by that distribution's impact on the corporation's solvency and the relationship between its assets and liabilities.

The Model Act was modified in subsection (d) to make it clear that for purposes of determining asset values under the equity insolvency and balance sheet tests of subsection (c), the board of directors may use either book values or a current valuation if it is reasonable under the circumstances. For purposes of determining liabilities and assets that are not revalued, the board of directors may rely on financial statements prepared in accordance with reasonable accounting practices and principles.

The Model Act was modified in subsection (f) to clarify that a corporation may agree to secure its indebtedness to a shareholder by granting a deed of trust or other security interest. The shareholder may also agree to subordinate the indebtedness, in whole or in part, to the corporation's indebtedness to its general, unsecured creditors. Absent an agreement either to secure or to subordinate a corporation's indebtedness to a shareholder, such indebtedness will be at parity with the corporation's indebtedness to its general, unsecured creditors.

Subsection (g) was added to the Model Act's provisions to address the question of how to treat a liability that by its own terms cannot be paid if its payment would violate this section. This change required the cross-reference added to subsection (e).

"Nimble dividends" (dividends paid out of current earnings) were expressly authorized under former G.S. 55-50(a)(2). That provision was not brought forward.

Subsections (h), (i), and (j) bring forward the provisions of former G.S. 55-50(k) through (m).

CASE NOTES

Editor's Note. - Most of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Former G.S. 55-50 allowed suit for improper withholding of dividend payments against corporation, directors, majority shareholders and officers of the corporation. Wilson v. Wilson-Cook Medical, Inc., 720 F. Supp. 533 (M.D.N.C. 1989).

Joinder of Suit for Failure to Declare Dividends with Cause of Action for Liquidation. - A stockholder in a corporation may sue the corporation, and join its directors as defendants, for failure to declare adequate dividends from the corporation's earnings; and may join therewith a second cause of action for liquidation and involuntary dissolution of the corporation based upon bad faith management in suppressing dividends and in deflating the value of the corporation's assets, thus precluding the plaintiff stockholder from obtaining either a fair dividend or a fair market value for his stock. Dowd v. Charlotte Pipe & Foundry Co., 263 N.C. 101, 139 S.E.2d 10 (1964).

Failure to State a Cause of Action. - Claim against director of dissolved corporation did not state a cause of action where plaintiff only alleged that director was officer when corporation dissolved and where there was no allegation that corporation's assets were distributed by officers without providing for known or reasonably ascertainable liabilities. Heather Hills Home Owners Ass'n v. Carolina Custom Dev. Co., 100 N.C. App. 263, 395 S.E.2d 154 (1990), decided under former G.S. 55-32.

Shareholder Held Entitled to Attorneys' Fees. - Plaintiff who brought action as the record owner of 42,748 shares of Preferred A stock of defendant corporation to recover a dividend was entitled to recover attorneys' fees under subsection (h) of former G.S. 55-50. McGladrey, Hendrickson & Pullen v. Syntek Fin. Corp., 98 N.C. App. 151, 389 S.E.2d 636 (1990), aff'd, 330 N.C. 602, 411 S.E.2d 585 (1992).

Disregard of Corporate Entity Upheld. - Trial court was justified in disregarding the corporate entity and holding defendant personally liable to the extent of plaintiff 's damages under the contract where defendant, who was president and sole shareholder of company, received substantial compensation from the sale of the corporation's assets without informing plaintiff of the sale or making provision for contractual debt to plaintiff. Hudson v. Jim Simmons Pontiac-Buick, Inc., 94 N.C. App. 563, 380 S.E.2d 612 (1989), decided under the former Business Corporation Act.

As to suits in equity to compel declaration and payment of dividends, see Gaines v. Long Mfg. Co., 234 N.C. 331, 67 S.E.2d 355 (1951).

Creditors Lacked Standing. - Plaintiffs lacked standing to assert claims (1) that the joinder agreements executed by two defendants were fraudulent transfers in violation of G.S. 39-23.1 and unlawful distributions in violation of G.S. 55-8-33 and G.S. 55-6-40, for which all defendants were liable, or alternatively, (2) for unauthorized execution, because such claims could have been brought by any of the corporation's creditors who, like plaintiffs, were denied timely payment of the corporation's debts when execution of the joinder agreements led to its insolvency. Angell v. Kelly, 336 F. Supp. 2d 540 (M.D.N.C. 2004).

Bankruptcy Trustee Had Standing. - There is no case law in North Carolina delineating who has standing to sue a shareholder under G.S. 55-6-40; however, dividends are transfers of corporate property. Since the statute declares such distributions to be "invalid," it would appear that the bankruptcy trustee would have standing to sue, under two alternate grounds: (1) as an effort to recover property under 11 U.S.C.S. § 541, if the transfer is legally void, or (2) if it had legal effect, as a transfer avoidance under 11 U.S.C.S. § 544. Mitchell v. Greenberg (In re Creative Entm't, Inc.), - Bankr. - (Bankr. W.D.N.C. May 27, 2003).

Cited in McGladrey, Hendrickson & Pullen v. Syntek Fin. Corp., 330 N.C. 602, 411 S.E.2d 585 (1992).

Applied in Applied Sci. Int'l, LLC v. Torres (In re Steel Network, Inc.), - Bankr. - (Bankr. M.D.N.C. July 30, 2010).

OFFICIAL COMMENT

Section 7.01(a) requires every corporation to hold an annual meeting each year of shareholders entitled to participate in the election of directors and to consider other matters coming before the meeting of shareholders. In most instances, the meeting will involve only the holders of a single class of voting shares. The principal action to be taken at the annual meeting is the election of directors pursuant to section 8.03, but the purposes of an annual meeting are not limited and all matters appropriate for shareholder action may also be considered at that meeting. An annual meeting is also the appropriate forum for a shareholder to raise any relevant question about the corporation's operations.

The requirement of section 7.01(a) that an annual meeting be held is phrased in mandatory terms to ensure that every shareholder entitled to participate in the meeting has the unqualified rights (1) to demand that the annual meeting be held and (2) to compel the holding of the meeting under section 7.03 if the corporation does not promptly hold the meeting. Many corporations, such as non-public subsidiaries and closely held corporations, do not regularly hold annual meetings, and if no shareholder objects, that practice creates no problem under section 7.01, since section 7.01(c) provides that failure to hold an annual meeting does not affect the validity of any corporate action. Rather than holding an annual meeting, the shareholders may elect directors and take other appropriate action by unanimous written consent under section 7.04. And, even if the shareholders fail to elect directors, the directors currently in office continue in office under section 8.05 beyond the expiration of their terms.

The time and place of the annual meeting may be "stated in or fixed in accordance with the bylaws." If the bylaws do not themselves fix a time and place for the annual meeting, authority to fix them may be delegated to the board of directors or to a specified corporate officer. This section thus gives corporations the flexibility to hold annual meetings in varying places at varying times as convenience may dictate.

The annual meeting may be held either inside or outside the state or in a foreign country, but if the bylaws do not fix, or state the method of fixing, the place of the meeting, the meeting must be held at the "principal office" of the corporation. The principal office is defined in section 1.40 as the location of the principal executive office of the corporation and may or may not be its registered or official office under section 5.01. Section 16.22 requires that the address of the principal office be specified in the corporation's annual report.

If the annual meeting is not held either within 6 months of the close of the corporation's fiscal year or within 15 months of the last annual meeting, a shareholder may compel an annual meeting to be held under section 7.03. In the absence of a demand for a meeting, a corporation can operate indefinitely without actually holding an annual meeting. The shareholders may act by unanimous consent under section 7.04, and in any event directors, once duly elected, remain in office until their successors are qualified. See section 8.05.

Authority granted to the board of directors or some individual to fix the time and place of the annual meeting must be exercised in good faith. See Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971).

NORTH CAROLINA COMMENTARY

The second sentence of subsection (c) was added to the Model Act's provisions to bring forward the provisions of former G.S. 55-61(b) regarding the holding of a substitute annual meeting. Subsection (d), which brings forward former G.S. 55-61(d), was added to make it clear that any matter appropriate for shareholder action is a proper subject for action at an annual meeting of shareholders.

Legal Periodicals. - For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

OFFICIAL COMMENT

1. Any meeting other than an annual meeting is a special meeting under section 7.02. The principal formal differences between an annual and a special meeting are that at an annual meeting directors are elected and, subject to the special notice requirements of section 7.05(b), any relevant issue pertaining to the corporation may be considered, while a special meeting must be called for specific purposes and may only consider matters within those purposes.
2. Discretion as to calls of special meeting
3. The business that may be conducted at a special meeting

A special meeting may be called under section 7.02(a) by the board of directors or the person or persons authorized to do so by the articles of incorporation or bylaws. Typically, the person or persons holding certain designated offices within the corporation, e.g., the president, chairman of the board of directors, or chief executive officer, are given authority to call special meetings of the shareholders. In addition, the holders of at least 10 percent of the votes entitled to be cast on a proposed issue at the special meeting may require the corporation to hold a special meeting by signing, dating, and delivering one or more writings that demand a special meeting and set forth the purpose or purposes of the desired meeting. Shareholders demanding a special meeting do not have to sign a single piece of paper, but the writings signed must all describe essentially the same purpose or purposes. Upon receipt of writings evidencing a demand by holders of 10 percent of the votes, the corporation (through an appropriate officer) must call the special meeting at a reasonable time and place. The shareholders' demand may suggest a time and place but the final decision on such matters is the corporation's. If no meeting is held within the time periods specified in section 7.03, the shareholders may obtain a summary court order under that section requiring that the meeting be held.

Section 7.02(b) fixes a record date for determining the shareholders entitled to sign a demand for a special shareholders' meeting. Unless a record date is otherwise fixed for this purpose, the record date is the date the first shareholder signs the demand. If a shareholder initially signs a demand but later seeks to withdraw his demand, the corporation may permit the shareholder to do so.

Under section 7.02(a)(2) it is possible that more than one faction of shareholders may demand meetings at roughly the same time or that a single (or changing) faction of shareholders may request consecutive, overlapping, or repetitive meetings. The responsible corporate officers have some discretion as to the call and purposes of a meeting, and where demands are repetitious or overlapping, they may refuse to call a meeting for a purpose identical or similar to a purpose for which a previous special meeting was held in the recent past. Similarly, they may decline to call a special meeting when an annual meeting will be held in the near future. This limited discretion of the corporation to deny repetitive or overlapping demands may ultimately be tested under section 7.03, which itself gives the court discretion whether or not to compel the holding of a special meeting under these circumstances. See the Official Comment to section 7.03.

Section 7.05(c) provides that a notice of a special meeting must include a "description of the purpose or purposes for which the meeting is called." Section 7.02(d) states that only business that is within that purpose or those purposes may be conducted at the special meeting. The word "within" was chosen, rather than a broader phrase like "reasonably related to," to describe the relationship between the notice and the authorized business to assure a shareholder who does not attend a special meeting that new or unexpected matters will not be considered in his absence.

NORTH CAROLINA COMMENTARY

The provision following the semicolon in subdivision (a)(2) was added to the Model Act's provisions to bring forward former G.S. 55-61(c), modified to change the threshold test from companies listed on a national securities exchange or held of record by more than 2000 shareholders to all public corporations (as defined in G.S. 55-1-40(18a)). This modification was designed to provide a clearer, "bright line" test, which has been employed throughout this Act.

Legal Periodicals. - For article, "Silencing the Shareholder's Voice," see 80 N.C.L. Rev. 1897 (2002).

OFFICIAL COMMENT

Section 7.03 provides the remedy for shareholders if the corporation refuses or fails to hold a shareholders' meeting as required by section 7.01 or 7.02. A shareholder entitled to participate in a meeting may apply for a summary court order to command the holding of a meeting if (1) an annual meeting is not held within 6 months after the end of the corporation's fiscal year or 15 months after its last annual meeting, or (2) a special meeting is not properly noticed within 30 days after a valid demand is delivered to the secretary of the corporation or, if properly noticed, is not held in accordance with the notice. Since a meeting must be held within 60 days of the notice date under section 7.05, the maximum delay between the demand for a special meeting and the right to petition a court for a summary order is 90 days.

1. The court with jurisdiction to administer section 7.03
2. The discretion of the court
3. Burden of proof
4. Notice, time, place, and quorum requirements
5. Status as annual meeting

The identity of the specific court with jurisdiction to order a shareholder's meeting under section 7.03(a) must be supplied by each state when enacting this section. It is intended that this should be a court of general civil jurisdiction. Generally, all matters relating to a corporation should be addressed to the court in the county where the corporation's principal office is located in the state or, if the corporation does not have a principal office in the state, to the court in the county in which its registered office is located.

The court has discretion under section 7.03 since the language of the statute is that the court "may summarily order" that a meeting be held. A court, for example, may refuse to order a special meeting if the specified purpose is repetitive of the purpose of a special meeting held in the recent past. See the Official Comment to section 7.02. Alternatively, the court may view the demand as a good faith request for reconsideration of an action taken in the recent past and may order a meeting to be held. Similarly, even though a demand for an annual meeting is not a formal prerequisite for an application for a summary order under this section, the court may withhold setting a time and date for the annual meeting for a reasonably short period in order to permit the corporation to do so.

In any event, a shareholder applying for a summary order to hold a meeting has the burden of showing that he is entitled to the order. In the case of a special meeting, he has the burden of showing that the demand was executed by the holders of at least 10 percent of the votes entitled to be cast on the record date and that the demand was duly delivered to the corporation's secretary.

If the court orders that a meeting be held, it may fix the time and place of the meeting, determine the voting groups entitled to participate in the meeting, set the record date, order notice to be given as required by section 7.05, and enter such other orders as may be appropriate for the holding of the meeting. The court may also establish the quorum requirements for specific matters to be considered at the meeting or direct that the votes represented at the meeting automatically constitute a quorum for the taking of any action without regard to section 7.25 or any provision to the contrary in the corporation's articles of incorporation or bylaws. The latter alternative prevents a holder of the majority of the votes (who may not desire that a meeting be held) from frustrating the court-ordered meeting by not attending to prevent the existence of a quorum. In order to prevent misunderstanding about a special quorum requirement, if one is imposed, it is appropriate for the court to order that the notice of the meeting state specifically and conspicuously that a special quorum requirement is applicable to the court-ordered meeting.

The court may provide that a meeting it has ordered is to be the annual meeting. If so provided, the meeting should be viewed as compliance with section 7.01, precluding all other shareholder requests for an annual meeting for that year.

NORTH CAROLINA COMMENTARY

The language of the Model Act in the introductory clause of subsection (a) was modified to clarify that notice must be given to a corporation before a shareholders' meeting can be summarily ordered.

The Model Act was modified in subdivision (a)(1) to allow any shareholder, not just those entitled to participate in the meeting, to apply for a court-ordered annual meeting of shareholders if the meeting is not held within 15 months after the corporation's last annual meeting. The change reflects the principle that all shareholders have an interest in the corporation's holding shareholders' meetings. In addition, the Model Act permits a shareholder to petition for a court-ordered meeting if no annual meeting is held within the earlier of six months after the close of the corporation's fiscal year or 15 months after the last annual meeting. The drafters concluded that the six months' limitation was undesirably restrictive and effectively mandated meetings during a particular part of the year. This provision was therefore omitted.

The Model Act was modified in subdivision (a)(2) to clarify that a demand must actually be received by the corporation's secretary.

The Model Act was modified in subsection (b) to allow reasonable expenses, including attorneys' fees, to be awarded to an applying shareholder in the discretion of the court.

OFFICIAL COMMENT

Section 7.04 provides that all the shareholders entitled to vote on an issue may validly act by unanimous written consent without a meeting. Unanimous written consent is obtainable, as a practical matter, only on matters on which there are only a relatively few shareholders entitled to vote.

Section 7.04 is based on the fundamental premise that if all the voting shareholders desire some action to be taken, no purpose is served by requiring the formality of holding a meeting of shareholders. Action by unanimous written consent has the same effect as a meeting vote and may be described as such in any document, including documents delivered to the secretary of state for filing. Section 7.04 is applicable to any shareholder action, including, without limitation, election of directors, approval of mergers or sales of substantially all the corporate property not in the ordinary course of business, amendments of articles of incorporation, and dissolution.

1. Form of written consent
2. Revocation of consent
3. Consent to fundamental corporate changes

To be effective, consents must be in writing, signed by all the shareholders entitled to vote, and delivered to the secretary of the corporation. The phrase "one or more written consents" is included in section 7.04(a) to make it clear that all shareholders do not need to sign the same piece of paper. The record date for determining who is entitled to vote, if not otherwise fixed by or in accordance with the bylaws, is the date the first shareholder signs the consent.

Action by unanimous written consent is effective only when the last shareholder has signed the appropriate written consent and all consents have been delivered to the secretary of the corporation. Before that time, any shareholder may withdraw his consent simply by advising the secretary of that fact. Cf. Calumet Industries, Inc. v. McClure, 464 F. Supp. 19 (N.D. Ill. 1978). The withdrawal of a single consent, of course, destroys the unanimous written consent required by this section. If a shareholder seeks to withdraw his consent after all shareholders have signed written consents and filed them with the secretary of the corporation, the corporation may treat the attempted withdrawal as too late or give it effect, thereby requiring the matter to be presented at a shareholders' meeting.

Section 7.04 is applicable to all shareholder actions, including the approval of fundamental corporate changes described in chapters 10, 11, 12, and 14. If these actions were taken at an annual or special meeting, shareholders who were not entitled to vote on the matter would nevertheless be entitled to receive notice of the meeting, including a description of the transaction proposed to be considered at the meeting. See, e.g., sections 10.03 (notice of proposed amendment), 11.03 (notice of proposed merger). In order to ensure that nonvoting shareholders have essentially the same right if action is taken by consent rather than at a meeting, section 7.04(d) provides that all nonvoting shareholders must be given at least 10 days' written notice of the fundamental corporate changes that are proposed for approval by consent.

NORTH CAROLINA COMMENTARY

The Model Act was modified in subsection (a) to incorporate the provisions of former G.S. 55-63, which provided that unanimous written consent to action without a meeting can be given either before or after the date of the action.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2001)

Effective January 1, 2002, this section was amended to permit less than unanimous shareholder action without meeting for corporations other than public corporations. Subsection (b) was amended to add a requirement that written consents to an action must be obtained from shareholders within a period of 60 days. Subsection (d) was amended to require advance notice of proposed shareholder action on certain fundamental corporate changes to all shareholders (other than shareholders who consent to the action) rather than only to holders of nonvoting shares. Advance notice is not required if the articles of incorporation so provided. Subsection (e) was added to provide that if action is taken by less than unanimous written consent, notice of the action must be given within 10 days after the action is taken to all shareholders who have not consented to the action and who would have been entitled to notice of the proposed action if the action had been taken at a meeting.

Editor's Note. - Session Laws 2001-387, s. 154(a) authorizes the Revisor of Statutes to cause to be printed all explanatory comments of the drafters of the act as the Revisor deems appropriate.

Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Effective October 1, 2005, this section is amended to add a provision recognizing that a shareholder may revoke in writing the shareholder's written consent to action before the corporation has received consents sufficient to take the action. The Official Comment indicates that this was the case even before this amendment. However, the Official Comment also indicates that a corporation may elect to give effect to a revocation received after the corporation has received consents sufficient to take the action. In keeping with changes in the Model Business Corporation Act made since the Official Comment was written, this section as amended provides that the revocation must be received by the corporation before the corporation has received consents sufficient to take the action.

Effect of Amendments. - Session Laws 2005-268, ss. 2 and 3, effective October 1, 2005, in subsection (a), deleted "the number" following "signature and signed by" and inserted "unrevoked" preceding "written consents" in the second sentence, and inserted "or revocation thereof" following "taken without meeting" in the last sentence; and in subsection (b), inserted "unrevoked" following "corporation has received" in the first sentence, added the last sentence and made a minor stylistic change.

Legal Periodicals. - For article, "Silencing the Shareholder's Voice," see 80 N.C.L. Rev. 1897 (2002).

OFFICIAL COMMENT

Shareholders entitled to notice must be given notice of annual and special meetings pursuant to section 7.05 unless the notice is waived pursuant to section 7.06. Notice must be given at least 10 but not more than 60 days before the meeting date.

1. Shareholders entitled to notice
2. Statement of matters to be considered at an annual meeting
3. Record date
4. Notice of adjourned meetings

Generally, only shareholders who are entitled to vote at a meeting are entitled to notice. Thus, notice usually needs to be sent only to holders of shares entitled to vote for an election of directors or generally on other matters (in the case of an annual meeting), and on matters within the specified purposes set forth in the notice (in the case of a special meeting), and only to holders of shares of those classes or series of shares on the record date. The last sentence of section 7.05(a), however, recognizes that other sections of the Act require that notice of meetings at which certain types of fundamental corporate changes are to be considered must be sent to all shareholders, including holders of shares who are not entitled to vote on any matter at the meeting. See sections 10.03, 11.03, 12.02, and 14.02. In addition, the articles of incorporation may require that notice of meetings be given to all or specified voting groups of shareholders who are not entitled to vote on the matters considered at those meetings.

Notice of all special meetings must include a description of the purpose or purposes for which the meeting is called and the matters acted upon at the meeting are limited to those within the notice of meeting. By contrast, the notice of an annual meeting usually need not refer to any specific purpose or purposes, and any matter appropriate for shareholder action may be considered. As recognized in subsection (b), however, other provisions of the revised Model Act provide that certain types of fundamental corporate changes may be considered at an annual meeting only if specific reference to the proposed action appears in the notice of meeting. See sections 10.03, 11.03, 12.02, and 14.02. In addition, if the board of directors chooses, a notice of an annual meeting may contain references to purposes or proposals not required by statute. In either event, if a notice of an annual meeting refers specifically to one or more purposes, the meeting is not limited to those purposes.

Section 7.05(d) is a catch-all record date provision for both annual and special meetings. If the record date for notice and for voting entitlement is not otherwise fixed pursuant to sections 7.03 or 7.07, the record date for purposes of determining who is entitled to notice and to vote at the meeting is the close of business on the day before the notice is mailed to the voting groups of shareholders. If notice is mailed to shareholders over a period of more than one day, the day before the notice is delivered to the first shareholders is the record date.

The selection of the close of business on the day before the notice is mailed as the catch-all record date is intended to permit the corporation to mail notices to shareholders on a given day without regard to any requests for transfer that may have been received during that day. For this reason, this section is not inconsistent with the general principle set forth in the last sentence of section 7.07(a) that the board of directors may not fix a retroactive record date.

Section 7.05(e) provides rules for adjourned meetings and determines whether new notice must be given to shareholders. Under this subsection a meeting may be adjourned to a different date, time, or place without additional notice to the shareholders (unless the bylaws require otherwise) if the new date, time, or place is announced before adjournment. But new notice is required if a new record date is or must be fixed under section 7.07(c). If a new record date is or must be fixed, the 10-to-60-day notice requirement and all other requirements of section 7.05 must be complied with as notice is given to the persons who are shareholders as of the new record date. A new quorum for the adjourned meeting must also be established. See section 7.25.

Section 7.25 provides that if a quorum exists for a meeting, it is deemed to continue to exist automatically for an adjourned meeting unless a new record date is or must be set for the adjourned meeting.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2013-153, s. 3, effective January 1, 2014, added the second sentence in subsection (a).

OFFICIAL COMMENT

Section 7.06(a) permits any shareholder to waive any notice required by section 7.05 by a written waiver, signed by the shareholder and delivered to the corporation. A waiver is effective even though it is signed at or after the time set for the meeting.

1. Informal waiver of notice
2. Waiver of notice where fundamental corporate actions are considered

A notice of shareholder meetings serves two principal purposes: (1) it advises shareholders of the date, time, and place of the annual or special meeting, and (2) in the case of a special meeting (or an annual meeting at which fundamental changes may be made), it advises shareholders of the purposes of the meeting. If a shareholder attends a meeting, he has probably received some form of notice of the date, time, and place of the meeting whether from the corporation or from another source. As a result, section 7.06(b)(1) provides that attendance at a meeting constitutes waiver of any failure to receive the notice or defects in the statement of the date, time, and place of any meeting. Defects waived by attendance for this purpose include a failure to send the notice altogether, delivery to the wrong address, a misstatement of the date, time, or place of the meeting, and a failure to notice the meeting within the time periods specified in section 7.05(a). If a shareholder believes that the defect in or failure of notice was in some way prejudicial, he may preserve his objection by stating at the beginning of the meeting that he objects to holding the meeting or transacting any business. If this objection is made, the corporation may correct the defect by sending proper notice to the shareholders for a subsequent meeting or by obtaining written waivers of notice from all shareholders who did not receive the notice required by section 7.05.

For purposes of this section, "attendance" at a meeting involves the presence of the shareholder in person or by proxy. A shareholder who attends a meeting solely for the purpose of objecting to the notice may be counted as present for purposes of determining whether a quorum is present. See the Official Comment to section 7.25.

In the case of special meetings, or annual meetings at which fundamental corporate changes are considered, a second purpose of the notice is to tell shareholders what is to be considered at the meeting. An objection that a particular matter is not within the stated purposes of the meeting obviously cannot be raised until the matter is presented. Thus section 7.06(b)(2) provides that a shareholder waives this kind of objection if he fails to object promptly after the matter is first presented. If this objection is made, the corporation may correct the defect by sending proper notice to the shareholders for a subsequent meeting or obtaining written waivers of notice from all shareholders. Of course, whether or not a specific matter is within a stated purpose of a meeting is ultimately a matter for judicial determination, typically in a suit to invalidate action taken at the meeting brought by a shareholder who was not present at the meeting or who was present at the meeting and preserved his objection under section 7.06(b).

The purpose of both waiver rules in section 7.06(b) is to require shareholders with technical objections to holding the meeting or considering a specific matter to raise them at the outset and not reserve them to be raised only if they are unhappy with the outcome of the meeting. The rules set forth in this section differ in some respects from the waiver rules for directors set forth in section 8.23 where a waiver is inferred if the director acquiesces in the action taken at a meeting even if he raised a technical objection to the notice of a meeting at the outset.

Other sections of the Model Act require that shareholders who are not entitled to vote are entitled to notice of meetings at which certain fundamental corporate changes are to be considered. See sections 10.03, 11.03, 12.02, and 14.02. In order to obtain an effective waiver of notice for these meetings under this section, waivers must be obtained from the nonvoting shareholders who are entitled to notice as well as from the voting shareholders.

NORTH CAROLINA COMMENTARY

At the end of subdivision (b)(2), the more specific words "before it is voted upon" were substituted for the Model Act's language "when it is presented."

OFFICIAL COMMENT

Section 7.07 authorizes the board of directors to fix record dates for any action unless the bylaws themselves fix or provide for the fixing of a record date. A separate record date may be established for each voting group entitled to vote separately on a matter at a meeting, or a single record date may be established for all voting groups entitled to participate in the meeting. If neither the bylaws nor the board of directors fix a record date for a specific action, the section of this Act that deals with that action itself fixes the record date. For example, section 7.05(d), relating to giving notice of a meeting, provides that the record date for determining who is entitled to notice of a meeting (if not fixed by the directors or the bylaws) is the close of business on the day before the date the corporation first gives notice to shareholders of the meeting.

A record date may not be fixed more than 70 days before the meeting or action in question and may not be fixed retroactively. Once set, the same record date may be utilized for an adjournment of the meeting that reconvenes within 120 days after the date fixed for the original meeting or the board of directors may fix a new record date. If the adjourned meeting takes place more than 120 days after the date fixed for the original meeting, section 7.07(c) requires that a new record date be fixed. But if an adjournment is ordered by a court, section 7.07(d) allows the court to provide that the original record date continues to be applicable or to fix a different date. In any event, if a different record date is or must be fixed under this section, section 7.05 requires that new notice be given to the persons who are shareholders as of the new record date, and section 7.25 requires that a quorum be reestablished for that meeting.

OFFICIAL COMMENTS (2013)

Section 7.09 permits shareholders to participate in annual and special shareholder meetings by means of remote communication, such as over the Internet or through telephone conference calls, subject to the conditions set forth in section 7.09(b) and any other guidelines and procedures that the board of directors adopts. This would include the use of electronic ballots to the extent authorized by the board of directors. This authorization extends as well to anyone to whom such shareholder has granted a proxy. Section 7.09 does not eliminate the requirement that corporations hold meetings at a physical location. See sections 7.01 and 7.02. Section 7.09 expressly provides that participation by remote means is permitted only if it is authorized by the board of directors. This limitation is meant to ensure that the board of directors has the sole discretion to determine whether to allow shareholders to participate by means of remote communication. Thus, a corporation may not be compelled to allow such participation either through amendments to the bylaws, shareholder resolutions, or otherwise.

Section 7.09 allows the board of director s to limit participation by means of remote communication to all share holders of a particular class or series, but does not permit the board of directors to limit such participation to particular shareholders within a class or series.

Section 7.09 requires the board of directors to implement certain procedures when allowing shareholder participation by means of remote communication. First, the board of directors must create reasonable measures for verifying those entitled to vote. Second, the board of directors must institute reasonable measures to ensure that all shareholders and their proxies within the authorized class or series have the opportunity to participate in the meeting, including measures that provide them with an opportunity to communicate with management and other shareholders present at the meeting, and to read or hear the proceedings. While this provision is aimed at approximating as much as possible shareholder participation in person or by proxy, including interacting with management during the meeting, it does not require that all can so participate and interact. In addition, Section 7.09 is not intended to expand the rights to participate in meetings or otherwise alter the ability of the board of directors or the chair to conduct meetings pursuant to section 7.08 in a manner that is fair and orderly. For example, many corporations limit or cut-off shareholder comments and, if such practice is fair to shareholders consistent with section 7.08, such practice is not changed by section 7.09. The two requirements under section 7.09(b) reflect the minimum deemed necessary to safeguard the integrity of the shareholders' meeting. Section 7.09 specifically gives the board of directors the flexibility and discretion to adopt additional guidelines and procedures for allowing shareholders to participate in a meeting by means of remote communication.

In order to give corporations the flexibility to choose the most efficient means of remote communication, the board may require that shareholders communicate their desire to participate by a certain date and condition the provision of remote communication or the form of communication to be used on the affirmative response of a certain number or proportion of shareholders eligible to participate. If the board of directors authorizes shareholder participation by means of remote communication pursuant to this section, such authorization and the process for participating by remote means of communication, must be included in the meeting notice required by section 7.05.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

OFFICIAL COMMENT

Section 7.20 requires the preparation of a list of shareholders entitled to notice of a meeting and requires that this list be made available on request to shareholders within two business days after the meeting notice is given.

The list of shareholders is often referred to as the "voting list" and usually the list will include only the names of those shareholders entitled to vote at the meeting. The list, however, must also include the names and shareholdings of shareholders of nonvoting shares if they are entitled to notice of the meeting by reason of the nature of the actions proposed to be taken at the meeting. See section 7.05 and its Official Comment.

Making the list of shareholders available before the meeting marks a change from the 1969 version of the Model Act. Through this device, a shareholder may learn the identity of the owners of substantial blocks of shares or the owners of shares similarly situated and communicate with them to see if his concerns are shared and should be pursued.

1. When the list must be available
2. Where the list must be maintained
3. The form in which the list is maintained
4. Consequences of failing to prepare the list or refusal to make it available
5. The right to obtain a copy of the list
6. Relationship to right to inspect corporate records generally

The list must generally be available for inspection two business days after notice of the meeting is given and continuously thereafter until the meeting occurs. If, however, notice of the meeting is waived by all the shareholders, the list need be available only at the meeting itself under section 7.20(c) unless one or more waivers are conditioned upon receipt of the list.

Section 7.20(b) permits the list to be maintained either at the corporation's principal office or at another location in the city in which the meeting is to be held, the precise location to be designated in the notice of meeting. If the corporation changes the location of its annual meeting, it thus may correspondingly change the location of the list of shareholders pursuant to this subsection.

Section 7.20(c) also requires a copy of the shareholders' list to be available at the meeting itself for inspection. This list may be used to determine attendance, the presence or absence of a quorum, and the right to vote.

Section 7.20 does not require the list of shareholders to be in any particular form. It may be maintained, for example, in electronic form. If the list is maintained in other than written form, however, suitable equipment must be provided so that a comprehensible list may be inspected by a shareholder as permitted by this section.

Section 7.20 creates a corporate obligation rather than an obligation imposed upon a corporate officer. If the corporation fails to prepare the list or refuses to permit a shareholder to inspect it, either before the meeting as required by section 7.20(b) or at the meeting itself as required by section 7.20(c), a shareholder may apply to the appropriate court under section 7.20(d) for a summary order permitting inspection of the list; the court may further order the meeting to be postponed for a reasonable time. If the court orders a copy of the list to be provided to the shareholders, the copying is at the corporation's expense; if the corporation produces the list voluntarily pursuant to section 7.20(b) or (c), any inspection and copying are at the shareholder's expense.

This judicial remedy is the only sanction for violation of section 7.20 since section 7.20(e) provides that the failure to prepare, maintain, or produce the list does not affect the validity of any action taken at the meeting.

Section 7.20(b) permits shareholders to "inspect" the list without limitation, but permits the shareholder to "copy" the list only if the shareholder complies with the requirement of section 16.02(c), that the demand be "made in good faith and for a proper purpose." The right to copy the list includes, if reasonable, the right to receive a copy of the list upon payment of a reasonable charge. See sections 16.03(b) and (c). The distinction between "inspection" and "copying" set forth in section 7.20(b) reflects an accommodation between competing considerations of permitting shareholders access to the list before a meeting and possible misuse of the list.

Section 7.20 creates a right of shareholders to inspect a list of shareholders in advance of and at a meeting that is independent of the rights of shareholders to inspect corporate records under chapter 16A. A shareholder may obtain the right to inspect the list of shareholders as provided in chapter 16A without regard to the provisions relating to the pendency of a meeting in section 7.20, and similarly the limitations of chapter 16A are not applicable to the right of inspection created by section 7.20 except to the extent the shareholder seeks to copy the list in advance of the meeting.

The right to inspect under chapter 16A is also broader in the sense that in some circumstances the shareholder may be entitled to receive copies of the documents he may inspect. See section 16.03.

NORTH CAROLINA COMMENTARY

An "or" was inserted in the second sentence of subsection (b) following the word "shareholders" in order to clarify that the disjunctive is either the shareholder or his agent or attorney. Subsection (d) was modified from the Model Act to make it clear that notice must be given to the corporation before a court enters a summary order.

Editor's Note. - Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Section 55-7-08, referred to in subsection (c), was repealed by Session Laws 2013-153, s. 4, effective January 1, 2014. For present provisions pertaining to remote participation in shareholder meetings, see G.S. 55-7-09.

Effect of Amendments. - Session Laws 2013-153, s. 6, effective January 1, 2014, substituted "G.S. 55-7-09" for "G.S. 55-7-08" at the end of subsection (c).

CASE NOTES

Editor's Note. - The case below was decided under the Business Corporation Act adopted in 1955.

As to applicability of former section relating to shareholders' voting list to building and loan associations, see White v. Smith, 256 N.C. 218, 123 S.E.2d 628 (1962).

OFFICIAL COMMENT

Section 7.21 deals with the entitlement of shareholders to vote, while section 7.22 deals with voting by proxy and section 7.24 establishes rules for the corporation's acceptance or rejection of proxy votes.

1. Voting power of shares
2. Voting power of nonshareholders
3. Circular holdings
4. Shares held in a fiduciary capacity
5. Redeemable shares

Section 7.2(a) provides that each outstanding share, regardless of class, is entitled to one vote per share unless otherwise provided in the articles of incorporation. See section 6.01 and its Official Comment. The articles of incorporation may provide for multiple or fractional votes per share, and may provide that some classes of shares are nonvoting on some or all matters, or that some classes have multiple or fractional votes per share while other classes have a single vote per share or different multiple or fractional votes per share, or that some classes constitute one or more separate voting groups and are entitled to vote separately on the matter.

The articles of incorporation may also authorize the board of directors to create classes or series of shares with preferential rights, which may be voting or nonvoting in whole or in part. See section 6.02 and its Official Comment.

Fractional or multiple votes per share, or nonvoting shares, are often used in the planning of business ventures, particularly closely held ventures, when the contributions of participants vary in kind or quality. It is possible through these devices, for example, to give persons with relatively small financial contributions a relatively large voting power within the corporation.

The power to vary or condition voting power is also often used to give increased protection to financial interests in the corporation. It is customary, for example, to make classes of shares with preferential rights nonvoting, but the power to vote may be granted to those classes if distributions are omitted for a specified period. This conditional right to vote may permit the class of shares with preferential rights to vote separately as a voting group to elect one or more directors or to vote with the shares having general voting rights in the election of the directors.

In order to reflect the possibility that shares may have multiple or fractional votes per share, all provisions relating to quorums, voting, and similar matters in the Model Act are phrased in terms of "votes" rather than "shares."

Under the last sentence of section 7.21(a), the power to vote cannot be granted generally to nonshareholders. The statutes of some states permit bondholders to be given the power to vote under certain specified circumstances; this option is not available under the Model Act. But creditors may in effect be given the power to vote, e.g., by creating a special class of redeemable voting shares for them, by creating a voting trust at the time the credit is extended with power in the creditors to name the voting trustees, by registering the shares in the name of the creditors as pledgees with power to vote, or by granting the creditors a revocable or irrevocable proxy to vote some or all of the outstanding shares. See the Official Comment to section 7.22.

Section 7.21(b) prohibits the voting of shares held by a domestic or foreign corporation that is itself a majority-owned subsidiary of the corporation issuing the shares. The purpose of this prohibition is to prevent management from using a corporate investment to perpetuate itself in power. Similar public policy considerations may be present in situations where the issuing corporation owns a large but not a majority interest in the corporation voting the shares. The inclusion of section 7.21(b) is not intended to affect the possible application of common law principles that may invalidate circular holding situations not within its literal prohibition. As to the possible existence of these common law principles, see, e.g., Cleveland Trust Co. v. Eaton, 11 Ohio Misc. 151, 229 N.E.2d 850 (1967), rev'd on the basis of statutory amendment, 20 Ohio St.2d 129, 256 N.E.2d 198 (1970). The phrase "absent special circumstances" is included to enable a court to permit the voting of shares where it deems that the purpose of the section is not violated.

Section 7.21(c) makes the prohibition against voting of circularly-owned shares of section 7.21(b) inapplicable to shares held in a fiduciary capacity. Compare DEL. GEN. CORP. LAW § 160(c). The Ohio statute involved in the Eaton case authorized a bank to vote its own shares that were held by it in a fiduciary capacity. A state may grant or prohibit such voting by another statute; section 7.21(c) provides only that such voting is not prohibited by the Model Act.

Redeemable shares are often redeemed in connection with a transaction such as a merger or the issuance of a new senior class of shares that requires shareholder approval. Section 7.21(d) avoids subjecting a transacting to approval by a class of redeemable shares that will be redeemed as a result of the transaction if adequate provision has been made to ensure that the holders of the redeemable shares will in fact receive the amount payable to them on redemption.

NORTH CAROLINA COMMENTARY

The last sentence of subsection 7.21(a) of the Model Act, which specifies that only shares are entitled to vote, was omitted because G.S. 55-7-21.1 permits a corporation to provide to holders of debt securities the right to vote in certain circumstances. Subsection (d) was modified by substituting "given" for the Model Act's word "mailed" in order to make the provision consistent with the definition of "notice" in G.S. 55-1-41.

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Agreement Depriving Stockholders of Right to Vote. - See Harvey v. Linville Imp. Co., 118 N.C. 693, 24 S.E. 489 (1896); Sheppard v. Rockingham Power Co., 150 N.C. 776, 64 S.E. 894 (1909).

When Trustee May Vote. - See Haywood v. Wright, 152 N.C. 421, 67 S.E. 982 (1910).

Vote of One Trustee as Act of All Trustees. - The vote of one trustee ordinarily is the act of all the trustees where the trust owns shares of corporate stock. Fulk & Needham, Inc. v. United States, 411 F.2d 1403 (4th Cir. 1969).

OFFICIAL COMMENT

Section 7.22 provides that shareholders may vote in person or by proxy and establishes the basic rules for appointing a proxy. As business organizations have increased in size and complexity, the number of shareholders has also increased. As a result, proxy voting is an essential step in the governance of many corporations.

1. Nomenclature
2. Appointment of proxy
3. Duration of proxy
4. Irrevocable proxies

The word "proxy" is often used ambiguously, sometimes referring to the grant of authority to vote, sometimes to the document granting the authority, and sometimes to the person to whom the authority is granted. In the revised Model Act the word "proxy" is used only in the last sense; the term "appointment form" is used to describe the document appointing the proxy; and the word "appointment" is used to describe the grant of authority to vote.

A shareholder may appoint a proxy to vote for him simply by signing an appointment form, either personally or by his attorney-in-fact. The appointment is effective when it is received by the secretary or other officer or agent authorized to receive and tabulate votes. The proxy has the same power to vote as that possessed by the shareholder, unless the appointment form contains an express limitation on the power to vote or direction as to how to vote the shares on a particular matter, in which event the corporation must tabulate the votes in a manner consistent with that limitation or direction. See section 7.22(h).

An appointment form that contains no expiration date is valid for 11 months. See section 7.22(c). This ensures that in the normal course a new appointment will be solicited at least once every 12 months. But an appointment form may validly specify a longer period if the parties agree.

The appointment of a proxy is essentially the appointment of an agent and is revocable in accordance with the principles of agency law unless it is "coupled with an interest." See section 7.22(d). Thus, an appointment may be revoked either expressly or by implication, as when a shareholder later executes a second appointment form inconsistent with an earlier one, or attends the meeting in person and seeks to vote on his own behalf. The revised Model Act does not attempt to codify these common law principles of agency law.

While death or incapacity of the appointing shareholder revokes an agency appointment under common law principles, section 7.22(e) modifies the common law rule to provide that the corporation may accept the vote of the proxy until the appropriate corporate officer or agent receives notice of the shareholder's death or incapacity. In view of the widespread dispersal of shareholders in many corporations, it is not feasible for the corporation to learn of these events independently of notice. On the other hand, section 7.22(e) does not affect the validity of the proxy appointment or its manner of exercise as between the proxy and the personal representatives of the decedent or incompetent. That relationship is governed by the law of agency independent of the Model Act.

Section 7.22(d) deals with the irrevocable appointment of a proxy. The general test adopted is the common law test that all appointments are revocable unless "coupled with an interest." But section 7.22(d) provides considerable certainty since it describes several accepted forms of relationship as examples of "proxies coupled with an interest." These examples are not exhaustive and other arrangements may also be held to be "coupled with an interest." See Comment, "The Irrevocable Proxy and Voting Control of Small Business Corporations," 98 U. PA. L. REV. 401, 405-7 (1950); see generally I RESTATEMENT OF AGENCY (SECOND) § 138 (1958).

Section 7.22(f) provides that an irrevocable proxy is revoked when the interest with which it was coupled is extinguished - for example, by repayment of the loan or release of the pledge.

A transferee for value of shares that are subject to an irrevocable appointment takes free of the appointment if (1) he did not know of the existence of the appointment and (2) the existence of the irrevocable appointment was not noted conspicuously on the certificate or information statement. See section 7.22(g). Under this subsection, both the appointment and the irrevocable nature of the appointment must conspicuously appear on the certificate.

NORTH CAROLINA COMMENTARY

The second sentence of subsection (b), which was contained in substance in former G.S. 55-68, was added to the Model Act's provisions to broaden the permissible forms of proxies. The use of a variety of methods of modern communication to transmit a proxy is especially useful for public corporations.

The Model Act was modified in the second sentence of subsection (c) by changing "longer" to "different" to permit proxy appointments for less than 11 months.

The Model Act was modified in subsection (f) to provide that an irrevocable proxy appointment is revocable (but not automatically revoked) when the interest with which it is coupled is extinguished. The drafters concluded that the automatic revocation in the Model Act could create reliance problems for third parties.

Former G.S. 55-68(b) provided that no proxy was valid for more than 10 years from the date of its execution unless it was renewed or extended for an additional period of not more than 10 years. This limitation was not brought forward.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2001)

Effective January 1, 2002, subsection (b) was amended to coordinate this section with the North Carolina Uniform Electronic Transactions Act.

Editor's Note. - Session Laws 2001-387, s. 154(a) authorizes the Revisor of Statutes to cause to be printed all explanatory comments of the drafters of the act as the Revisor deems appropriate.

Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Legal Periodicals. - For comment on the proxy system in the corporate electoral process, see 60 N.C.L. Rev. 145 (1981).

For article, "Should Corporate Statutes Providing Special Protection for Directors Be Limited to Publicly Traded Corporations?," see 24 Wake Forest L. Rev. 79 (1989).

CASE NOTES

Editor's Note. - The case below was decided under prior law.

Assignment Reserving Possession and Right to Dividends. - A written agreement assigning stock in a corporation with authority to vote, reserving to the assignors who retain possession the right to all dividends, amounts only to a proxy. Bridgers v. Staton, 150 N.C. 216, 63 S.E. 892 (1909).

OFFICIAL COMMENT

Traditionally, a corporation recognizes only the registered owner as the owner of shares. Indeed, section 1.40 defines "shareholder" basically as the registered owner of shares. But it has become a common practice for persons purchasing shares to have them registered in the "street name" of a broker-dealer or other financial institution, principally to facilitate transfer by eliminating the need for the beneficial owner's signature and delivery. In addition, in order to avoid the burdens of processing securities transfers, which caused a crisis in the securities industry in the late 1960s, a system of securities depositories (defined as "clearing corporations" in section 8-102(3) of the UNIFORM COMMERCIAL CODE) has been developed. In this system, financial institutions deposit securities with the depository, which becomes the registered owner of the shares. Transfers between depositories are then accomplished by book entry of the depository. As a result, there may be two entities interposed between the corporation and the beneficial owner with the depository being the registered owner for the account of the brokerage firm that in turn holds the shares for the account of the beneficial owner.

The purpose of section 7.23 is to facilitate direct communication between the corporation and the beneficial owner by authorizing the corporation to create a procedure for bypassing both the registered owner and intermediate brokerage firms. The adoption of this procedure is discretionary with each corporation and affirmative action by the corporation is necessary to accomplish it. The procedure is also discretionary with the shareholder, who must elect to follow the applicable procedure prescribed by the corporation. The shareholder retains all of his rights except those granted to the beneficial owner.

The corporation may limit or qualify the procedure as it deems appropriate. For example, the corporation may:

1. limit the procedure to certain classes of shareholders, such as depositories, broker-dealers and banks, or their nominees, or make the procedure available to all shareholders;
2. permit a shareholder to adopt the procedure with respect to some but not all of the shares registered in his name (and in that case he continues to be treated as the shareholder with respect to the balance);
3. specify the purpose or purposes for which the certification is effective, e.g., for giving notice of, and voting at, shareholders' meetings, for the distribution of proxy statements and annual reports, or for payment of cash dividends;
4. specify the form of the certification, e.g., a written list, computer tape, or some other form of compatible input;
5. specify the type of information that must be provided, e.g., the name and address of the beneficial owner, his taxpayer identification number, and the number of shares registered directly in his name;
6. establish deadlines for receipt of the certifications after the establishment of a record date so that the corporation may schedule its mailings;
7. provide that a new certification is required following each record date or that a certification as of a certain date may continue until changed by the certifying shareholder.

This listing is illustrative and not exhaustive. It is expected that experimentation with various devices under this section may reveal other areas which the corporation's plan should address.

The definition of "shareholder" in section 1.40 includes beneficial owners to the extent they obtain the rights of shareholders pursuant to the procedure authorized by this section.

OFFICIAL COMMENT

Corporations are often asked to accept written instrument as evidence of action by a shareholder. These instruments usually involve appointment forms for a proxy to vote the shares, but may also include waivers of notice, consents to action without a meeting, requests for a special meeting of shareholders, and similar instruments involving action by the shareholders. Usually the corporation or its officers will have no personal knowledge of the circumstances under which the instrument was executed and no way of verifying whether the signature on the instrument is in fact the signature of the shareholder. This problem is particularly acute in large corporations with thousands of shareholders.

Section 7.24 establishes general rules permitting the corporation and its officers or agents to accept these instruments if they appear to be executed by the shareholder or by a person who has authority to execute the instrument for the shareholder and they are accompanied by whatever authenticating evidence the corporation reasonably requests. The rules set forth in this section are not exclusive and may be supplemented by additional rules established by the corporation pursuant to section 2.06(b). Section 7.24(a) authorizes acceptance of an instrument if the name appearing on the instrument "corresponds" to the name of the shareholder, while section 7.24(b) permits the acceptance of an instrument executed by a person other than the shareholder if there is a designation or evidence of the capacity of the person executing the instrument that indicates the act of the person is the act of the shareholder. On the other hand, section 7.24(c) permits rejection of an instrument if the officer or agent tabulating votes has a "reasonable basis for doubt" about the validity of the signature or about the authority of the person acting on behalf of the shareholder. These principles are described in greater detail below.

The purpose of section 7.24 is to protect the corporation and its officers or agents from liability for damages to the shareholder if action is taken in accordance with the section. Thus section 7.24(d) provides that there is no liability to the shareholder if the corporation's officer or agent, acting in good faith, accepts an instrument that meets the requirements of section 7.24(a) or (b), even if it turns out that the execution was invalid or unauthorized; similarly, no liability exists if the officer or agent, again acting in good faith, rejects an instrument because of a "reasonable basis for doubt," even though it turns out that the instrument was properly executed by the shareholder. But section 7.24 does not address the question whether an action was properly or improperly taken or approved, and section 7.24(e) makes clear that the validity or invalidity of corporate action is ultimately a matter for judicial resolution through review of the results of an election in a suit to enjoin or compel corporate action. It is contemplated that any such suit will be brought promptly, typically before the corporate action is consummated or the corporation's position otherwise changes in reliance on the vote, and that any suit that is not brought promptly under the circumstances would normally be barred because of laches.

Similarly, section 7.24 does not address the liability of the proxy to the shareholder for exercising authority beyond that granted to him or for disobeying instructions. These matters are governed by the law of agency and not by section 7.24.

The American Society of Corporate Secretaries has established principles for the acceptance of proxy appointments in routine elections in which there is no proxy contest. Many of the examples of the application of section 7.24 set forth below are based on these principles.

1. Examples of executions "corresponding with" the name of the shareholder
   1. Assuming that shares are registered in the name of an individual, an instrument may be accepted as corresponding to the name of the shareholder:

1. Whether executed in ink, pencil, ballpoint, crayon, etc.
2. Regardless of where the signature appears on the instrument (whether or not in the space provided), if there is no reason to doubt the intent to execute.
3. Whether the name is handwritten, handprinted, or rubberstamped in facsimile-signature or printed form.
4. Whether there are deviations between the registered name and the signature, provided that the deviations are not inconsistent with the registered name. For example, if the shares are registered in the name of "John F. Smith," the following are acceptable: "J. Foster Smith," "J. Smith," "J.F. Smith," "J.F.S.," "J.S.," "John F.," and even simply "Smith." Similarly, if "John Smith" is the name of the shareholder, "John F. Smith" and "J. Foster Smith" are also acceptable.
5. If marked by an "X" and witnessed by one other person.
6. If not executed at all, a signed letter or telegram from the shareholder states that he has signed the instrument or approves of the action taken by the instrument.
7. The signature is illegible, unless it cannot reasonably be considered to be the signature of the shareholder. For example, if shares are registered in the name of "John F. Smith," the signature is not acceptable if the first letter of the signature is clearly an "M" or the first word is "Mark."
   1. Assuming that the shares are registered in the name of a partnership, e.g., "Smith Bros.," an instrument may be accepted if executed either in the form "Smith Bros. by John Able, Partner" or simply "Smith Bros."
   2. Assuming that the shares are registered in the name of a corporation, e.g., "Smith Corporation," an instrument may be accepted if executed in the name of the corporation, by an officer or agent designated as holding a responsible position, by a person with a surname similar to the corporate name, or simply in the name of the corporation, e.g., "Smith Corporation by John Able, President," "Smith Corporation by Peter Apt, Agent," "Smith Corporation by John Smith," or "Smith Corporation."
   3. Assuming that the shares are registered in the name of an individual who is deceased, incompetent, a minor, in bankruptcy, or in receivership, an instrument may be accepted if it is executed by an executor, administrator, guardian, receiver, or trustee who signs as such. Shares registered in the name of a minor may be voted by a parent of the shareholder if he is identified as such, e.g., "Ralph Able by John Able, Father."
   4. Assuming that the shares are registered in the name of an individual, an instrument may be accepted if it is executed by another individual who indicates (1) that he is signing as an agent or attorney-in-fact for the shareholder (see section 7.22); (2) that he has a close family or other relationship with the shareholder from which authority can be inferred; or (3) that he is the beneficial owner of shares, a pledgee of the shares, or a donee of the shares. For example: if shares are registered in the name of "Peter Jones," "Ed Smith, Agent," "Paul Smith, Son," "Mary Smith Jones, Wife," "Emelia Able, Attorney," "Arthur Peters, Private Secretary," "Paul Jones, Trustee under Deed of Trust dated April 1, 1980," or "Mary Smith, Donee," are all acceptable absent some indication that the execution was unauthorized.
   5. Assuming that the shares are registered in the names of two or more persons - as joint tenants or tenants in common, executors or administrators, guardians or conservators, a committee for an incompetent, or trustees - an instrument may be accepted if signed by or on behalf of fewer than all the persons named. This conclusion proceeds on the assumption that the signer or signers have authority to act for the others and there is nothing on the face of the instrument that rebuts this assumption.

b. If the shares are registered in the maiden name of a woman, e.g., Mary Smith, and the instrument is executed:

(1) In her married name, clearly indicated as such, e.g., "Mary Smith Jones (formerly Mary Smith)" or "Mary Smith (now Mrs. Mary Smith Jones)."

(2) In her married name or in a form that implies her married status, e.g., "Mary Smith Anderson," "Mrs. Mary S. Anderson," "Mrs. Mary Smith Anderson," or "Mrs. Mary Anderson."

c. If the shares are registered in the name "Peter Smith, Sr." but the designation "Sr." is omitted, e.g., "Peter Smith." The execution "Peter Smith, Jr.," however, does not correspond with the shareholder.

2. Examples of executions that "indicate the capacity" of the person signing

In all the following instances, the corporation may request additional evidence of authority but is not required to do so; officers and agents are protected from liability if they routinely accept the instrument without requiring additional evidence.

3. Examples of "reasonable basis for doubt"

The phrase "reasonable basis for doubt" about the validity of a signature or about the signer's authority creates an objective standard for the exercise of the authority granted by section 7.24(c) to reject proffered instruments. In the absence of a proxy fight or a seriously contested issue, instruments should be rejected only if there seems to be no basis for finding the execution regular on its face. In a proxy fight or other contested issue, the possibility of illegal or unauthorized execution is greatly increased, and a more cautious attitude should therefore be adopted. The following are examples in which a "reasonable basis for doubt" could be found to exist:

a. The shares are registered in the name of "John F. Smith" and the instrument is executed by "Joseph F. Smith" or by "Frank W. Smith."

b. The shares are registered in the name of "Ellen Smith, a Minor" or "John Smith, Custodian for Ellen Smith, a Minor," and the instrument is executed by "Ellen Smith." There is no "reasonable basis for doubt," however, if the instrument is accompanied by evidence satisfactory to the corporation that the shareholder is no longer a minor.

c. A proxy appointment is received that is regular on its face, and the secretary or other corporate officer or agent receives a telephone call from a person who identifies himself as the shareholder and says either that he wishes to revoke the appointment or that he did not authorize its original execution.

d. Shares are registered in the name of two or more persons as co-owners, the instrument is executed by fewer than all of them, and the instrument shows on its face that not all the registered owners granted authority to the signers, as where the instrument states that it was not possible to obtain all the coowners' signatures or that some refused to sign. For the normal rule of acceptability of proxies executed by fewer than all co-owners, however, see section 7.24(b)(5) and part 2.e of this Official Comment.

e. The corporation receives a copy of letters of appointment of a receiver, executor, administrator or other fiduciary, and the instrument is executed in the name of the shareholder rather than by the fiduciary.

4. Other principles applicable to proxy appointments

As indicated in the Official Comment to section 7.22, a proxy is simply an agent of the shareholder, and his appointment therefore involves primarily the law of agency. The law of agency determines the rights and duties of the shareholder and the proxy, and it is important to recognize that section 7.24 is not intended to affect these rights and duties. Rather, it recognizes that the great bulk of instruments executed in the name of a shareholder or on his behalf are in fact authorized and the corporation and its officers should be encouraged to accept them rather than to adopt unduly narrow requirements.

NORTH CAROLINA COMMENTARY

The word "pledgee," which appears immediately prior to the words "beneficial owner" in subdivision 7.24(b)(4) of the Model Act, was omitted as misleading, since a pledgee does not automatically have the right to vote pledged shares.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, subdivision (b)(4) is amended to refer to "pledgee" in conformity with the Model Business Corporation Act. A corporation may require evidence that the pledgee has been granted authority to sign for the pledgor but the corporation is not obligated to do so. Also effective October 1, 2005, a reference to the proxy appointment provisions in G.S. 55-7-22(b) is added to subsection (d).

Effect of Amendments. - Session Laws 2005-268, ss. 4 and 5, effective October 1, 2005, substituted "pledge, beneficial, owner" for "beneficial owner" in subdivision (b)(4); and inserted "or G.S. 55-7-22(b)" in subsection (d).

Legal Periodicals. - For article on joint ownership of corporate securities in North Carolina, see 44 N.C.L. Rev. 290 (1966); 46 N.C.L. Rev. 520 (1968).

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Section 7.25 establishes general quorum and voting requirements for voting groups for purposes of the Act. As defined in section 1.40, a "voting group" consists of all shares of one or more classes or series that under the articles of incorporation or the Act are entitled to vote and be counted together collectively on a matter. Shares entitled to vote "generally" on a matter (that is, all shares entitled to vote on the matter by the articles of incorporation or the Act that do not expressly have the right to be counted separately) are a single voting group. On most matters coming before shareholders' meetings, only a single voting group, consisting of a class of voting shares, will be involved, and action on such a matter is effective when approved by that voting group pursuant to section 7.25. See section 7.26(a).

Section 7.25 covers quorum and voting requirements for all actions by the shareholders of a corporation with a single class of voting shares. It also covers quorum and voting requirements for a matter on which only a class or series of shares is entitled to vote under the articles of incorporation, for example, when a class with preferential rights may vote to elect directors because of a default in the payment of dividends (a vote which is often described as a "class vote"). Finally, section 7.25 also covers quorum and voting requirements for a matter on which both common and preferred shares or separate classes or series of common or preferred shares are entitled to vote, either together as a single voting group under the articles of incorporation or separately as two or more voting groups under either the articles of incorporation or the Act. See section 7.26(b).

1. Determination of Voting Groups under the Act
2. Quorum and Voting Requirements in General
3. Quorum Requirements for Action by Voting Group
4. Voting Requirements for Approval by Voting Group
5. Modification of Standard Requirements

Under the Act, classes or series of shares are generally not entitled to vote separately by voting group except to the extent specifically authorized by the articles of incorporation. But sections 9.21, 9.32, 10.04, and 11.04 of the Act grant classes or series of shares the right to vote separately when fundamental changes are proposed that may adversely affect that class or series. Section 10.04(c) further provides that when two or more classes or series are affected by an amendment covered by section 10.04 in essentially the same way, the classes or series are grouped together and must vote as a single voting group rather than as multiple voting groups on the matter, unless otherwise provided in the articles of incorporation or required by the board of directors. Section 7.25(f) provides that the group voting rule of section 10.04(c), including the ability to vary that rule in the articles of incorporation or by action of the board of directors, also applies to the group voting provisions in sections 9.21, 9.32, and 11.04. Under the Act even a class or series of shares that is expressly described as nonvoting under the articles of incorporation may be entitled to vote separately on an amendment to the articles of incorporation that affects the class or series in a designated way. See section 10.04(d).

In addition to the provisions of the Act, separate voting by voting group may be authorized by the articles of incorporation (except that the statutory privilege of voting by separate voting groups cannot be diluted or reduced). On some matters, the board of directors may condition its submission of matters to shareholders on their approval by specific voting groups designated by the board of directors. Sections 7.25 and 7.26 establish the mechanics by which all voting by single or multiple voting groups is carried out.

In some situations, shares of a single class or series may be entitled to vote in two different voting groups. See the Official Comment to section 7.26.

A corporation's determination of the voting groups entitled to vote, and the quorum and voting requirements applicable to that determination, should be determined separately for each matter coming before a meeting. As a result, different quorum and voting requirements may be applicable to different portions of a meeting, depending on the matter being considered. In the normal case where only a single voting group is entitled to vote on all matters coming before a meeting of shareholders, a single quorum and voting requirement will usually be applicable to the entire meeting. To reflect the possibility that shares may have multiple or fractional votes per share, the provisions relating to quorums are phrased in terms of votes represented by shares.

Under section 7.25(b), once a share is present at a meeting, it is deemed present for quorum purposes throughout the meeting. Thus, a voting group may continue to act despite the withdrawal of persons having the power to vote one or more shares.

The shares owned by a shareholder who comes to the meeting to object on grounds of lack of notice are considered present for purposes of determining the presence of a quorum. Similarly, shares owned by a shareholder who attends a meeting solely for purposes of raising the objection that a quorum is not present are considered present for purposes of determining the presence of a quorum. Attendance at a meeting, however, does not constitute a waiver of other objections to the meeting such as the lack of notice. Such waivers are governed by section 7.06(b).

If a new record date is set, new notice must be given to holders of shares of a voting group and a quorum must be established from within the holders of shares of that voting group as of the new record date.

Section 7.25(c) provides that an action (other than the election of directors, which is governed by section 7.28) is approved by a voting group at a meeting at which a quorum is present if the votes cast in favor of the action exceed the votes cast opposing the action, unless the articles of incorporation require a greater number of votes. This default rule differs from a formulation appearing in some state statutes that an action is approved at a meeting at which a quorum is present if it receives the affirmative vote of a majority of the shares represented at that meeting. That formulation in effect treats abstentions as negative votes; the Act treats them truly as abstentions. For example, if a corporation (that has not, through the articles of incorporation, modified quorum and voting requirements) has 1,000 shares of a single class outstanding, each share entitled to cast one vote, a quorum consists of 501 shares; if 600 shares are represented at the meeting and the vote on a proposed action is 280 in favor, 225 opposed, and 95 abstaining, the action would not be approved in a state following the formulation that treats abstentions as negative votes because fewer than a majority of the 600 shares attending voted in favor of the action. Under section 7.25(c) the action would be approved and not be defeated by the 95 abstaining votes.

The articles of incorporation may modify the quorum and voting requirements of section 7.25 for a single voting group or for all voting groups entitled to vote on any matter. The articles of incorporation may increase the quorum and voting requirements to any extent desired up to and including unanimity, subject to section 7.27. They may also require that shares of different classes or series are entitled to vote separately or together on specific issues or provide that actions are approved only if they receive the favorable vote of a majority of the shares of a voting group present at a meeting at which a quorum is present. The articles may also decrease the quorum requirement as desired, subject to section 7.25(a) and section 7.27.

NORTH CAROLINA COMMENTARY

The Model Act was modified in subsection (a) to bring forward the provisions of former G.S. 55-65(d), which permitted adjournment of a meeting in the absence of a quorum until a quorum is present. Subsections (a), (c) and (d) were modified to provide that special quorum and voting requirements can be established by a bylaw adopted by the shareholders, as well as by the articles of incorporation or the provisions of this Act.

Editor's Note. - Session Laws 2001-387, s. 154(a), authorizes the Revisor of Statutes to cause to be printed all explanatory comments of the drafters of the act as the Revisor deems appropriate.

Section 55-7-08, referred to in the commentary, was repealed by Session Laws 2013-153, s. 4, effective January 1, 2014.

Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 4, effective October 1, 2018, added subsection (f).

CASE NOTES

Editor's Note. - Some of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Derivative Action by FDIC. - Plaintiff FDIC, which had suffered a loss as an equitable shareholder in defendant corporation, was entitled to maintain a derivative action, and the FDIC's individual claim did not preclude its derivative claim. FDIC v. Kerr, 650 F. Supp. 1356 (W.D.N.C. 1986).

Effect of Illegal Motion of Adjournment on Election of Officers. - When a motion to adjourn a stockholders' meeting has been carried, and a sufficient number have withdrawn to reduce the number of those present below a majority of all the stock issued and outstanding, an election of officers cannot be lawfully held thereafter at that meeting, though the adjournment was carried by an illegal vote. Bridgers v. Staton, 150 N.C. 216, 63 S.E. 892 (1909).

Cited in Hershner v. N.C. Dep't of Admin., 232 N.C. App. 552, 754 S.E.2d 847 (2014).

OFFICIAL COMMENT

Section 7.26(a) provides that when a matter is to be voted upon by a single voting group, action is taken when the voting group votes upon the action as provided in section 7.25. In most instances the single voting group will consist of all the shares of the class or classes entitled to vote by the articles of incorporation; voting by two or more voting groups as contemplated by section 7.26(b) is the exceptional case.

Section 7.26(b) basically requires that if more than one voting group is entitled to vote on a matter, favorable action on a matter is taken only when it is voted upon favorably by each voting group, counted separately. Implicit in this section are the concepts that (1) different quorum and voting requirements may be applicable to different matters considered at a single meeting and (2) different quorum and voting requirements may be applicable to different voting groups voting on the same matter. See the Official Comment to section 7.25. Thus, each group entitled to vote must independently meet the quorum and voting requirements established by section 7.25. But if a quorum is present for one or more voting groups but not for all voting groups, section 7.26(b) provides that the voting groups for which a quorum is present may vote upon the matter.

A single meeting, furthermore, may consider matters on which action by several voting groups is required and also matters on which only a single voting group may act. Action may be taken on the matters on which the single voting group may act even though no quorum is present to take action on other matters. For example, in a corporation with one class of nonvoting shares with preferential rights ("preferred shares") and one class of general voting shares without preferential rights ("common shares"), a matter to be considered at the annual meeting may be a proposed amendment to the articles of incorporation that reduces the cumulative dividend right of the preferred shares (a matter on which the preferred shares have a statutory right to vote as a separate voting group). Other matters to be considered may include the election of directors and the appointment of an auditor, both matters on which the preferred shares have no vote. If a quorum of the voting group consisting of the common shares but no quorum of the voting group consisting of the preferred shares is present, the common shares may proceed to elect directors and appoint the auditor. The common shares voting group may also vote to approve the proposed amendment to the articles of the incorporation, but that amendment will not be approved until the preferred shares voting group also votes to approve the amendment.

1. Voting requirements on multiple voting group matters
2. Participation of shares in multiple voting groups

In many multiple voting group situations under the Model Act, proposals are adopted only if a majority of all the votes entitled to be cast by each voting group approve the proposal. This percentage of votes is higher than that required by section 7.25, and is required, for example, under sections 10.03(e)(1) and 10.04(b) for all amendments to articles of incorporation that create dissenters' rights with respect to part or all of the shares of the voting group.

As described in section 7.26(b), if voting by multiple voting groups is required, the votes of members of each voting group must be separately tabulated. Normally, each class or series of shares will participate in only a single voting group. But since holders of shares entitled by the articles of incorporation to vote generally on a matter are always entitled to vote in the voting group consisting of the general voting shares, in some instances classes or series of shares may be entitled to be counted simultaneously in two voting groups. This will occur whenever a class or series of shares entitled to vote generally on a matter under the articles of incorporation is affected by the matter in a way that gives rise to the right to have its vote counted separately as an independent voting group under the Act. For example, assume that corporation Y has outstanding one class of general voting shares without preferential rights ("common shares"), 500 shares issued, and one class of shares with preferential rights ("preferred shares"), 100 shares issued, that also have full voting rights under the articles of incorporation, i.e., the preferred may vote for election of directors and on all other matters on which common may vote. The preferred and the common therefore are part of the general voting group. The directors propose to amend the articles of incorporation to change the preferential dividend rights of the preferred from cumulative to noncumulative. All shares are present at the meeting and they divide as follows on the proposal to adopt the amendment:

Yes - Common 230 - Preferred 80 No - Common 270 - Preferred 20. Both the preferred and the common are entitled to vote on the amendment to the articles of incorporation since they are part of a general voting group pursuant to the articles. But the vote of the preferred is also entitled to be counted separately on the proposal by section 10.04(a)(4) of the Model Act. The result is that the proposal passes by a vote of 310 to 290 in the voting group consisting of the shares entitled to vote generally and 80 to 20 in the voting group consisting solely of the preferred shares: (a) First voting group Yes: Common 230 Preferred 80 310 No: Common 270 Preferred 20 290 (b) Second voting group (preferred) Yes: Preferred 80 No: Preferred 20

In this situation, in the absence of a special quorum requirement, a meeting could approve the proposal to amend the articles of incorporation if - and only if - a quorum of each voting group is present, i.e., at least 51 shares of preferred and 301 shares of common and preferred were represented at the meeting.

NORTH CAROLINA COMMENTARY

The Model Act was modified in subsections (a) and (b) to permit a bylaw adopted by the shareholders to provide for voting by a single voting group on a particular matter.

OFFICIAL COMMENT

Section 7.27(a) permits the articles of incorporation to increase the quorum or voting requirements for approval of an action by shareholders up to any desired amount including unanimity. These provisions may relate to ordinary or routine actions by the general voting group (which otherwise may be acted upon under section 7.25 if the number of affirmative votes exceeds the number of negative votes at a meeting at which a quorum of that voting group is present) or to one or more other voting groups or to actions for which the Model Act provides a greater voting requirement - for example, changes of a fundamental nature in the corporation like certain amendments to articles of incorporation (section 10.03), mergers (section 11.03), sales of all or substantially all the property of a corporation not in the ordinary course of business (section 12.02), and dissolution (section 14.02). Generally, the Model Act requires these fundamental changes to receive the affirmative vote of a majority of the votes entitled to be cast on the proposal by each voting group entitled to vote thereon rather than by a majority of the shares voting affirmatively or negatively at a meeting at which a quorum is present.

A provision that increases the requirement for approval of an ordinary matter or a fundamental change is usually referred to as a "supermajority" provision.

Section 7.27(b) requires any amendment of the articles of incorporation that adds, modifies, or repeals any supermajority provision to be approved by the greater of the proposed quorum and vote requirement or by the quorum and vote required by the articles before their amendment. Thus, a supermajority provision that requires an 80 percent affirmative vote of all eligible votes of a voting group present at the meeting may not be removed from the articles of incorporation or reduced in any way except by an 80 percent affirmative vote. If the 80 percent requirement is coupled with a quorum requirement for a voting group that shares representing two-thirds of the total votes must be present in person or by proxy, both the 80 percent voting requirement and the two-thirds quorum requirement are immune from reduction except at a meeting of the voting group at which the two-thirds quorum requirement is met and the reduction is approved by an 80 percent affirmative vote. If the proposal is to increase the 80 percent voting requirement to 90 percent, that proposal must be approved by a 90 percent affirmative vote at a meeting of the voting group at which the two-thirds quorum requirement is met; if the proposal is to increase the two-thirds quorum requirement to three-fourths without changing the 80 percent voting requirement, that proposal must be approved by an 80 percent affirmative vote at a meeting of the voting group at which a three-fourths quorum requirement is met.

NORTH CAROLINA COMMENTARY

This section differs from the Model Act by permitting a bylaw adopted by the shareholders to establish greater quorum or voting requirements for shareholders. If adopted after July 1, 1990, such a bylaw must be approved by a quorum and vote sufficient to amend the articles of incorporation for that purpose. Any such provision, whether in the articles of incorporation or in the bylaws, may not itself be amended by a quorum or vote less than the quorum or vote therein prescribed.

OFFICIAL COMMENT

Section 7.28(a) provides that directors are elected by a plurality of the votes cast in an election of directors at a meeting at which a quorum is present of the voting group entitled to participate in the election. A "plurality" means that the individuals with the largest number of votes are elected as directors up to the maximum number of directors to be chosen at the election. In elections in which several factions are competing within a voting group, the individuals elected may have fewer than a majority of all the votes cast in the election. The articles of incorporation or bylaws of the corporation may, however, provide a different manner of election of directors.

The entire board of directors may be elected by a single voting group or the articles of incorporation may provide that different voting groups are entitled to elect a designated number or fraction of the board of directors. See section 8.04. Elections are contested only within specific voting groups.

Under section 7.28(b) each corporation may determine whether or not to elect its directors by cumulative voting. If directors are elected by different voting groups, the articles of incorporation may provide that specified voting groups are entitled to vote cumulatively while others are not. Cumulative voting affects the manner in which votes may be cast by shares participating in the election but does not affect the plurality principle set forth in section 7.28(a).

1. The manner of electing cumulative voting
2. The mechanics of cumulative voting

Section 7.28(b) provides basically for an "opt in" election. A corporation has cumulative voting with respect to a voting group only if an affirmative provision to that effect appears in its articles of incorporation. Under section 7.28(c) this election may be made simply by inserting a statement that "all directors are elected by cumulative voting" or "holders of class A shares are entitled to cumulate their votes," or words of similar import. The effect of such a statement is to make applicable automatically the detailed provisions of subsections (c) and (d) describing the cumulative right to vote at elections of directors by the voting group or groups specified.

Section 7.28(c) describes the mechanics of cumulative voting: each shareholder may multiply the number of votes he is entitled to cast (based on the number of shares held by him) by the number of directors to be elected by the voting group at the meeting and may cast the product for a single candidate or distribute the product among two or more candidates. By casting all his votes for a single candidate or a limited number of candidates, a minority shareholder increases his voting power and may be able to elect one or more directors.

Section 7.28(d) applies only if cumulative voting is potentially available under section 7.28(b). It is designed to ensure that all shareholders participating in the election understand the rules and to avoid the distortions that may be created when some shareholders vote cumulatively while others do not. Cumulative voting will be employed if the notice of meeting or accompanying proxy statement conspicuously announces that a shareholder is entitled to cumulate his votes or a shareholder who is entitled to vote gives notice to the corporation of his intent to do so at least 48 hours before the meeting. This notice puts the corporation and all shareholders who are entitled to vote in the election with that shareholder on notice that voting will be on a cumulative basis. If this notice is given by any shareholder, all other shareholders who are part of the same voting group are entitled to vote cumulatively without giving further notice.

The proxy regulations of the Securities and Exchange Commission require proxy statements to include a statement that persons have the right to vote cumulatively, if that is the case, and briefly to describe that right.

AMENDED NORTH CAROLINA COMMENTARY

The Model Act was modified in subsection (a) to clarify that an agreement valid under G.S. 55-7-31 may modify the vote by which directors are elected.

For corporations incorporated on or after July 1, 1990, subsection (b) changes prior law, which mandated cumulative voting except with respect to corporations having shares listed on national securities exchanges or held by more than 2,000 holders of record. A corporation may elect to retain cumulative voting by a provision in its articles of incorporation or in a shareholders' agreement complying with G.S. 55-7-31.

The provisions of subdivision (d)(2) were modified from the Model Act to conform with prior law with respect to the manner of electing to vote cumulatively.

Subsection (e) is a transitional provision that preserves cumulative voting for substantially all corporations that had cumulative voting by law prior to July 1, 1990.

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

The right of cumulative voting in an election of corporate directors was granted by former G.S. 55-68(c). Stancil v. Bruce Stancil Refrigeration, Inc., 81 N.C. App. 567, 344 S.E.2d 789, cert. denied, 318 N.C. 418, 349 S.E.2d 601 (1986).

When Cumulative Voting Applies. - See Bridgers v. Staton, 150 N.C. 216, 63 S.E. 892 (1909).

Requirements for Exercise of Cumulative Voting. - Under former G.S. 55-68, before the right of cumulative voting may be exercised, four things must be done: (1) A shareholder must announce in the open meeting, before the voting starts, that he intends to vote cumulatively; (2) upon such an announcement, the chair must declare that all shares have the right to vote cumulatively; (3) the chair must announce the number of shares present in person or by proxy; and (4) the chair must declare a recess of not less than one hour nor more than four hours, unless a different time period is unanimously agreed upon. Stancil v. Bruce Stancil Refrigeration, Inc., 81 N.C. App. 567, 344 S.E.2d 789, cert. denied, 318 N.C. 418, 349 S.E.2d 601 (1986).

Same - Purpose. - The four requirements imposed by former G.S. 55-68(c) for the exercise of cumulative voting were designed, among other things, (1) to prevent a shareholder, by a surprise announcement of his intention to vote cumulatively, from taking unfair advantage of other shareholders, and (2) to permit the shareholders an opportunity to determine how their votes may be distributed to their best advantage. Stancil v. Bruce Stancil Refrigeration, Inc., 81 N.C. App. 567, 344 S.E.2d 789, cert. denied, 318 N.C. 418, 349 S.E.2d 601 (1986).

Lack of Recess. - Where the only person who could possibly have been prejudiced by the fact that no recess was taken after the announcement by the holder of 50% of the stock that he intended to vote cumulatively had been made was the owner of the other 50% of the stock, whose duty it was, as chairman of the meeting, to declare a recess, he would not be permitted, by his own violation of the statute, to defeat his fellow shareholder's proper exercise of a right to vote cumulatively, nor to void an otherwise valid election. Stancil v. Bruce Stancil Refrigeration, Inc., 81 N.C. App. 567, 344 S.E.2d 789, cert. denied, 318 N.C. 418, 349 S.E.2d 601 (1986).

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

A voting trust is a device by which one or more shareholders divorce the voting rights of their shares from the ownership, retaining the latter but transferring the former to one or more trustees in whom the voting rights of all the shareholders who are parties to the trust are pooled. Section 7.30(a) provides a straightforward procedure for the creation of an enforceable voting trust and does not impose narrow or technical requirements. Typically, the voting trust provides that all attributes of beneficial ownership other than the power to vote are retained by the voting trust beneficial owners. In addition, the voting trustees may issue to the voting trust beneficial owners voting trust certificates which may be transferable in the same way as shares. Section 7.30 does not limit the duration of a voting trust, consistent with section 7.32 governing shareholder agreements generally. Section 7.30 permits participants to specify limits but does not establish an automatic sunset provision as a matter of law. Section 7.30(c) addresses voting trusts entered into when the Act limited their duration to 10 years.

NORTH CAROLINA COMMENTARY

The Model Act was modified in the second sentence of subsection (c) to insert "not more than" in order to clarify that a voting trust may be extended for any period less than 10 years.

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 5, effective October 1, 2018, deleted the former last sentence of subsection (b), which read: "A voting trust is valid for not more than 10 years after its effective date unless extended under subsection (c)."; deleted subsection (c), pertaining to extensions of voting trusts for additional terms; and added subsection (d).

Legal Periodicals. - For note, "Voting Trusts - Should Trust Principles Apply to Close Corporations?," see 48 N.C.L. Rev. 342 (1970).

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

Shareholders of some corporations, especially those that are closely held, frequently enter into agreements that govern the operation of the enterprise.

Section 7.32 provides, within the context of the traditional corporate structure, legal certainty to such agreements that embody various aspects of the business arrangement established by the shareholders to meet their business and personal needs. The subject matter of these arrangements includes governance of the entity, allocation of the economic return from the business, and other aspects of the relationships among shareholders, directors, and the corporation which are part of the business arrangement. Section 7.32 also recognizes that many of the corporate norms contained in the Act were designed with an eye towards corporations whose management and share ownership are distinct. These functions are often conjoined in some corporations, such as the close corporation. Thus, section 7.32 validates agreements among shareholders even when the agreements are inconsistent with the statutory norms contained in the Act.

Importantly, section 7.32 only addresses the parties to the shareholder agreement, their transferees, and the corporation, and does not have any binding legal effect on the state, creditors, or other third persons.

Section 7.32 supplements the other provisions of the Act. If an agreement is not in conflict with another section of the Act, no resort need be made to section 7.32 with its requirement of unanimity. For example, special provisions may be included in the articles of incorporation or bylaws with less than unanimous shareholder agreement so long as such provisions are not in conflict with other provisions of the Act. Similarly, section 7.32 would not have to be relied upon to validate typical buy-sell agreements among two or more shareholders or the covenants and other terms of a stock purchase agreement entered into in connection with the issuance of shares by a corporation.

1. Section 7.32(a)
2. Section 7.32(b)
3. Section 7.32(c)
4. Section 7.32(d)
5. Section 7.32(e) through (g)
6. Section 7.32(h)

An agreement authorized by section 7.32 is "not inconsistent with law" within the meaning of sections 2.02(b)(2) and 2.06(b) of the Act.

The range of agreements validated by section 7.32(a) is expansive though not unlimited. Section 7.32 defines the types of agreements that can be validated largely by illustration. The seven specific categories that are listed are designed to cover some of the most frequently used arrangements. There are numerous other arrangements that may be made, and section 7.32(a)(8) provides an additional category for any provisions that, in a manner inconsistent with any other provision of the Act, otherwise govern the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship between and among the shareholders, the directors, and the corporation or any of them, and are not contrary to public policy.

Section 7.32(a) validates virtually all types of shareholder agreements that, in practice, normally concern shareholders and their advisors. Given that breadth, any provision that may be contained in the articles of incorporation with a majority vote under sections 2.02(b)(2)(ii) and (iii), as well as under section 2.02(b)(4), may also be effective if contained in a shareholder agreement that complies with section 7.32.

The provisions of a shareholder agreement authorized by section 7.32(a) will often, in operation, conflict with the language of more than one section of the Act, and courts should in such cases construe all related sections of the Act flexibly and in a manner consistent with the underlying intent of the shareholder agreement. Thus, for example, in the case of an agreement that provides for weighted voting by directors, every reference in the Act to a majority or other proportion of directors should be construed to refer to a majority or other proportion of the votes of the directors.

Although the limits of section 7.32(a)(8) are left uncertain, there are provisions of the Act that may not be overridden if they reflect core principles of public policy with respect to corporate affairs. For example, a provision of a shareholder agreement that purports to eliminate all of the standards of conduct established under section 8.30 might be viewed as contrary to public policy and thus not validated under section 7.32(a)(8). Similarly, a provision that exculpates directors from liability more broadly than permitted by section 2.02(b)(4), or indemnifies them more broadly than permitted by section 2.02(b)(5), might not be validated under section 7.32 because of strong public policy reasons for the statutory limitations on the right to exculpate directors from liability and to indemnify them. The validity of some provisions may depend upon the circumstances. For example, a provision of a shareholder agreement that limited inspection rights under section 16.02 or the right to financial statements under section 16.20 might, as a general matter, be valid, but that provision might not be given effect if it prevented shareholders from obtaining information necessary to determine whether directors of the corporation have satisfied the standards of conduct under section 8.30. The foregoing are examples and are not intended to be exclusive.

As noted above, shareholder agreements otherwise validated by section 7.32 are not legally binding on the state, on creditors, or on other third parties. For example, an agreement that dispenses with the need to make corporate filings required by the Act would be ineffective. Similarly, an agreement among shareholders that provides that only the president has authority to enter into contracts for the corporation would not, without more, be binding against third parties, and ordinary principles of agency, including the concept of apparent authority, would continue to apply.

Section 7.32 minimizes the formal requirements for a shareholder agreement so as not to restrict unduly the shareholders' ability to take advantage of the flexibility the section provides. Thus, it is not necessary to "opt in" to a special class of close corporations to obtain the benefits of section 7.32. An agreement can be validated under section 7.32 whether it is set forth in the articles of incorporation, the bylaws or in a separate agreement, and regardless of whether section 7.32 is specifically referenced in the agreement. Where the corporation has a single shareholder, the requirement of an "agreement among the shareholders" is satisfied by the unilateral action of the shareholder in establishing the terms of the agreement, evidenced by provisions in the articles of incorporation or bylaws, or in a writing signed by the sole shareholder. Although a writing signed by all the shareholders is not required where the agreement is contained in articles of incorporation or bylaws unanimously approved, it may be desirable to have all the shareholders actually sign the instrument to establish unequivocally their agreement. Similarly, although transferees are bound by a valid shareholder agreement, subject to section 7.32(c), it may be desirable to obtain the affirmative written assent of the transferee at the time of the transfer. Section 7.32(b) also establishes and permits amendments by less than unanimous agreement if the shareholder agreement so provides.

Section 7.32(b) requires unanimous shareholder approval of the shareholder agreement regardless of entitlement to vote. Unanimity is required because an agreement authorized by section 7.32 can effect material organic changes in the corporation's operation and structure, and in the rights and obligations of shareholders.

The requirement that the shareholder agreement be made known to the corporation is the predicate for the requirement in section 7.32(c) that share certificates or information statements be legended to note the existence of the agreement. No specific form of notification is required and the agreement need not be filed with the corporation. In the case of shareholder agreements in the articles of incorporation or bylaws, the corporation will necessarily have notice. In the case of a shareholder agreement outside the articles of incorporation or bylaws, the requirement of signatures by all of the shareholders should in virtually all cases be sufficient to make the corporation aware of the agreement, as one or more signatories will normally also be a director or an officer.

Section 7.32(c) addresses the effect of a shareholder agreement on subsequent purchasers or transferees of shares. Typically, corporations with shareholder agreements also have restrictions on the transferability of the shares as authorized by section 6.27, thus lessening the practical effects of the problem in the context of voluntary transferees. Transferees of shares without knowledge of the agreement or those acquiring shares upon the death of an original participant in a close corporation may, however, be heavily affected. Weighing the burdens on transferees against the burdens on the remaining shareholders in the enterprise, section 7.32(c) affirms the continued validity of the shareholder agreement on all transferees, whether by purchase, gift, operation of law, or otherwise. Unlike restrictions on transfer, it may be impossible to enforce a shareholder agreement against less than all of the shareholders. Thus, under section 7.32, one who inherits shares subject to a shareholder agreement must continue to abide by the agreement. If that is not the desired result, care must be exercised at the initiation of the shareholder agreement to ensure a different outcome, such as providing for a buy-back upon death.

Where shares are transferred to a purchaser without knowledge of a shareholder agreement, the validity of the agreement is similarly unaffected, but the purchaser is afforded a rescission remedy against the seller. Under section 7.32(c), the time at which notice to a purchaser is relevant for purposes of determining entitlement to rescission is the time when a purchaser acquires the shares rather than when a commitment is made to acquire the shares. If the purchaser learns of the agreement after committing to purchase but before acquiring the shares, the purchaser may not proceed with the purchase and still obtain the benefit of the remedies in section 7.32(c). Under contract principles and the securities laws, a failure to disclose the existence of a shareholder agreement may constitute the omission of a material fact and may excuse performance of the commitment to purchase. The term "purchaser" includes a person acquiring shares upon initial issue or by transfer, and also includes a pledgee, for whom the time of purchase is the time the shares are pledged.

Section 7.32 addresses the underlying rights of shares and shareholders and the validity of shareholder action which redefines those rights, as contrasted with questions regarding entitlement to ownership of the security, competing ownership claims, and disclosure issues. Consistent with this dichotomy, the rights and remedies available to purchasers under section 7.32(c) are independent of those provided by contract law, Article 8 of the Uniform Commercial Code, the securities laws, and other laws outside the Act.

With respect to the related subject of restrictions on transferability of shares, note that section 7.32 does not directly address or validate such restrictions, which are governed instead by section 6.27 of the Act. However, if such restrictions are adopted as a part of a shareholder agreement that complies with the requirements of section 7.32, a court should apply the concept of reasonableness under section 6.27 in determining the validity of such restrictions.

Section 7.32(c) contains an affirmative requirement that the share certificate or information statement for the shares be legended to note the existence of a shareholder agreement. No specified form of legend is required, and a simple statement that "[t]he shares represented by this certificate are subject to a shareholder agreement" is sufficient. At that point, a purchaser must obtain a copy of the shareholder agreement from the transferor or proceed at the purchaser's peril. In the event a corporation fails to legend share certificates or information statements, a court may, in an appropriate case, imply a cause of action against the corporation in favor of an injured purchaser without knowledge of a shareholder agreement. The circumstances under which such a remedy would be implied, the proper measure of damages, and other attributes of and limitations on such an implied remedy are left to development in the courts.

A purchaser who has no actual knowledge of a shareholder agreement and is not charged with knowledge by virtue of a legend on the certificate or information statement has a rescission remedy against the transferor (which would be the corporation in the case of a new issue of shares).

If the shares are certificated and duly legended, a purchaser is charged with notice of the shareholder agreement even if the purchaser never saw the certificate. In the case of uncertificated shares, however, the purchaser is not charged with notice of the shareholder agreement unless a duly-legended information statement is delivered to the purchaser at or before the time of purchase. This different rule for uncertificated shares is intended to provide an additional safeguard to protect innocent purchasers, and is necessary because section 6.26(b) of the Act and Article 8 of the Uniform Commercial Code permit delivery of statements after a transfer of shares.

Section 7.32(d) recognizes that the terms of a shareholder agreement may provide for its termination upon the happening of a specified event or condition. An example may be when the corporation undergoes an initial public offering. This approach is consistent with the broad freedom of contract provided to participants in such enterprises.

Section 7.32(e) provides a shift of liability from the directors to any person or persons in whom the discretion or powers otherwise exercised by the board of directors are vested under the shareholder agreement. A shareholder agreement which provides for such a shift of responsibility, with the concomitant shift of liability provided by subsection § 7.32(e), could also provide for exculpation from that liability to the extent otherwise authorized by the Act. The transfer of liability provided by subsection § 7.32(e) covers liabilities imposed on directors "by law," which is intended to include liabilities arising under the Act, the common law, and statutory law outside the Act.

Section 7.32(f) provides that shareholders shall not have personal liability for the debts of a corporation arising out of acts or omissions taken pursuant to a shareholder agreement validated by section 7.32. Section 7.32(g) authorizes shareholder agreements for corporations that are in the process of being organized and do not yet have shareholders.

Section 7.32 does not limit the duration of a shareholder agreement. This approach is consistent with the wide freedom of contract provided to participants in such enterprises. For agreements entered into during a time that section 7.32 provided for a 10-year term if no other time limit was specified, section 7.32(h) provides that its duration will be governed by the provisions of section 7.32 concerning duration in force at the time the agreement became effective. This would include, for example, both the default termination rule and the authority under former section 7.32(b)(2) that such an agreement's automatic 10-year term could be amended by all shareholders (unless the agreement had prohibited such amendment).

REVISED NORTH CAROLINA COMMENTARY 2018

The provisions of the Model Act relating to voting agreements were omitted entirely and replaced by the provisions, slightly modified, of former G.S. 55-73, which appear in subsection (a). Subsections (b), (d), (e), (f), (g), (h) and (j) are based on Model Act Section 7.32 subsections (a), (b), (c), (d), (f), (g) and (h), respectively. Model Act Section 7.32 subsection (e) was omitted entirely and replaced in subsection (i) by the provisions of former G.S. 55-31(c).

SUPPLEMENTAL NORTH CAROLINA COMMENTARY 2018

Subsections (b), (d), (e), (f), (g), (h) and (j) are based on Model Act subsections (a), (b), (c), (d), (f), (g) and (h), respectively. Model Act subsection (e) was omitted entirely and replaced in subsection (i) by the provisions of former G.S. 55-31(c).

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 6, effective October 1, 2018, rewrote the section.

Legal Periodicals. - For note, "Voting Trusts - Should Trust Principles Apply to Close Corporations?," see 48 N.C.L. Rev. 342 (1970).

For comment on tax and corporate aspects of professional incorporation in North Carolina, see 48 N.C.L. Rev. 573 (1970).

For note on unanimous approval of corporate bylaws and creation of shareholder agreements, see 1 Campbell L. Rev. 153 (1979).

For note on the amendment of shareholder agreements of close corporations in North Carolina, see 15 Wake Forest L. Rev. 531 (1979).

For note on close corporations and personal liability from execution of shareholder agreements, see 16 Wake Forest L. Rev. 975 (1980).

For article, "Defining the Scope of Controlling Shareholders' Fiduciary Responsibilities," see 22 Wake Forest L. Rev. 9 (1987).

For note discussing shareholder agreements in close corporations, in light of Penley v. Penley, 314 N.C. 1, 332 S.E.2d 51 (1985), see 22 Wake Forest L. Rev. 147 (1987).

CASE NOTES

• I. General Consideration.
• II. Decisions under Former G.S. 55-73(b).
• III. Amendment and Termination.

OFFICIAL COMMENT

Section 7.40 deals with the procedural requirements applicable to derivative suits. A great deal of controversy has surrounded the derivative suit, and widely different perceptions as to the value and efficacy of this litigation continue to exist. On the one hand, the derivative action has historically been the principal method of challenging allegedly improper, illegal, or unreasonable action by management. On the other hand, it has long been recognized that the derivative suit may be instituted more with a view to obtaining a settlement favorable to the plaintiff and his attorney than to righting a wrong to the corporation (the so-called "strike suit").

Earlier versions of section 7.40, and similar statutes in many states, imposed a series of procedural requirements designed in part to deter or prevent strike suits. The FEDERAL RULES OF CIVIL PROCEDURE, rule 23.1, also imposes procedural requirements on derivative litigation brought in federal court. There has thus been a great deal of experience with procedural devices to control abuses of the derivative suit. Section 7.40 reflects a reappraisal of these devices in light of major developments in corporate governance, the public demand for corporate accountability, and the corporate response in the form of greater independence and sense of responsibility in boards of directors.

1. Procedural Requirements
   1. The plaintiff may be either a registered or beneficial owner of shares held by a nominee in his behalf
   2. The plaintiff must have been an owner of shares at the time of the transaction in question
   3. The complaint must be verified
   4. Option holders and convertible debenture holders are not permitted to sue
   5. There must be prior notice and demand on directors in most circumstances
   6. There need be no prior notice to or demand on shareholders
   7. A court may stay a derivative suit while the board of directors investigate
   8. Plaintiffs are not required to post bond as security for expenses
   9. Recovery of reasonable expenses of suit, including attorneys' fees, if suit brought without good cause
   10. Settlement or discontinuance of derivative litigation requires judicial approval

The procedural requirements imposed by section 7.40 are as follows:

Many statutes, including earlier versions of the Model Act, required the plaintiff to be a shareholder "of record." This limiting requirement was dropped in revising section 7.40, in light of the widespread use of street name or nominee ownership of shares. At the same time, it was determined that the beneficial owner of shares held in a voting trust should also be permitted to serve as a plaintiff in a derivative suit. These changes were accomplished by the addition of a special definition of "shareholder" in subsection (e) to broaden the definition of that term in section 1.40.

The Model Act and the statutes of many states have long imposed a "contemporaneous ownership" rule, i.e., the plaintiff must have been an owner of shares at the time of the transaction in question. This rule has been criticized as being unduly narrow and technical and unnecessary to prevent the transfer or purchase of lawsuits. A few states, particularly California, Cal. G.C.L. § 800(B), have relaxed this rule to the extent of allowing some subsequent purchasers of shares to be plaintiffs in limited circumstances.

The decision to retain the contemporaneous ownership rule in section 7.40 was based primarily on the view that it was simple, clear, and easy to apply while the California approach might encourage litigation on peripheral issues like the extent of the plaintiff's knowledge of the transaction in question when he acquired his shares. Further, there has been no persuasive showing that the contemporaneous ownership rule has prevented the litigation of substantial suits since there appear to be many persons who might qualify as plaintiffs to bring suit even if subsequent purchasers are disqualified.

Section 7.40(b) requires the complaint in a derivative suit to be verified, i.e., sworn to. Compare FEDERAL RULES OF CIVIL PROCEDURE, rule 23.1; Surowitz v. Hilton Hotels Corp., 383 U.S. 363 (1966). This requirement provides some protection against groundless litigation without deterring suits brought in good faith.

Arguments may be made that long-term creditors and investors with the privilege of becoming shareholders by the exercise of options or conversion rights should be permitted to bring derivative suits. These arguments, however, appear to involve the substantive rights of these various classes of investors more than the procedures required for the assertion of derivative rights on behalf of the corporation. See, e.g., Harff v. Kerkorian, 324 A.2d 215 (Del. Ch. 1974), rev'd in part, 347 A.2d 133 (Del. 1975). Therefore, section 7.40(a) does not permit option holders or convertible debenture holders to serve as derivative plaintiffs.

The purpose of a demand on the board of directors is to stimulate the board of directors to enforce the rights of the corporation on its own. Modern trends in corporate governance - particularly the increasing number of outside directors and greater directors sensitivity to their roles in the corporation and to the possibility of personal liability - improve the likelihood that the board of directors will weigh carefully the shareholder's demand. Therefore, section 7.40(b) requires an allegation with particularity of the demand made, if any, on the board of directors. On the other hand, there may be circumstances showing that a demand on the board of directors would be useless, and in those circumstances it should be sufficient to allege the reasons why the plaintiff did not make the demand.

Of itself, the rejection by the board of directors of the shareholder's demand neither permits nor precludes the shareholder's suit. See paragraph 2a. below.

Rule 23.1 of the FEDERAL RULES OF CIVIL PROCEDURE requires that, in addition to a demand on the board of directors, a demand be made on shareholders "if necessary." The statutes of a number of states, including California and New York, require demands only on boards of directors.

Although a demand on shareholders seems generally consistent with the broad doctrine of requiring exhaustion of all internal avenues of relief before commencement of suit, the board of directors, not the shareholders, is charged with governance of the corporation, including the commencement and management of litigation. Further, to require a demand on shareholders would virtually require the plaintiff to engage in a preliminary proxy contest and, in the case of publicly held corporations, would greatly increase the costs of filing all derivative suits, discouraging even legitimate cases.

For these reasons, it was concluded that the requirement of a demand on shareholders would add uncertainty, expense, and delay without commensurately improving the prospects of resolving the substantive issues.

The last sentence of section 7.40(b) provides that if the corporation undertakes an investigation, the court may stay the proceeding until the investigation of the charges made in the demand or complaint is completed. The purpose of this stay is to preserve the right of the board of directors to consider whether or not to seek to enforce on its own the corporation's claim.

Earlier versions of the Model Act and the statutes of many states required a plaintiff to give security for reasonable expenses, including attorneys' fees, if his holdings of shares did not reach a specified size or value - five percent of the outstanding shares or a value of $25,000 in the earlier version of the Model Act. This requirement has been deleted. The security for expenses requirement, to the extent it was based on the size or value of the plaintiff's holdings rather than on the apparent good faith of his claim, was subject to criticism that it unreasonably discriminated against small shareholders.

The basic policy question with respect to the requirement of a bond for small shareholders is how far to go in protecting the corporation and its officers and directors from suits. The choice is between making the right to sue widely available, without obstacles except in obviously baseless cases, or imposing obstacles in the way of the small shareholder without imposing a similar obstacle in the way of the large shareholder. Moreover, no bond requirement exists for class actions, antitrust cases, or individual actions for personal injury, all of which involve the corporation in substantial expense of defending against suit.

Several states have concluded on the basis of these considerations that the bond requirement for small plaintiffs should be repealed or not adopted.

In lieu of the bond requirement, section 7.40(d) provides that on termination of a proceeding the court may require the complainant to pay the defendants' reasonable expenses, including attorneys' fees, if it finds that the proceeding "was commenced without reasonable cause." This test is similar to but not identical with the test utilized in section 13.31, relating to dissenters' rights, where the standard for award of expenses and attorneys' fees is that dissenters "acted arbitrarily, vexatiously or not in good faith" in demanding a judicial appraisal of their shares. The derivative action situation is sufficiently different from the dissenters' rights situation to justify a different and less onerous test for imposing costs on the plaintiff. The test of section 7.40 that the action was brought without reasonable cause is appropriate to deter strike suits, on the one hand, and on the other hand to protect plaintiffs whose suits have a reasonable foundation.

Section 7.40(d) does not refer to the award of expenses, including attorneys' fees, to successful plaintiffs. The right of successful plaintiffs in derivative suits to this recovery is so universally recognized, both by statute and on the theory of a recovery of a fund or benefit for the corporation, that specific reference was thought to be unnecessary. The intention is to preserve fully these nonstatutory rights of reimbursement. Therefore, no negative inference should be drawn from section 7.40(d) as to the rights of plaintiffs to reimbursement.

Abuses in the conduct of derivative litigation may occur on the part of defendants and their counsel as well as by plaintiffs and their counsel. Abuses may occur with respect to motions, pleadings, requests for discovery and resistance to discovery when conducted either in bad faith or without good cause. Sanctions to deal with such conduct are not included in this Act because courts possess adequate power to impose appropriate sanctions under rules of civil procedure or the general equity power of courts. See Roadway Express, Inc. v. Piper, 447 U.S. 752 (1980).

Section 7.40(c) follows the FEDERAL RULES OF CIVIL PROCEDURE, and the statutes of a number of states, including New York and Michigan, and requires that all proposed settlements and discontinuances must receive judicial approval. This requirement seems a natural consequence of the proposition that a derivative suit is brought on behalf of the class of all shareholders and avoids many of the evils of the strike suit by preventing the individual shareholder-plaintiff from settling privately with the defendants.

Section 7.40(c) also requires notice to all affected shareholders if the court determines that the proposed settlement may substantially affect the interest of one or more classes of shareholders. Unlike the statutes of some states, however, section 7.40(c) does not address the issue of which party should bear the cost of giving this notice. That is a matter left to the discretion of the court reviewing the proposed settlement.

2. Issues unresolved by section 7.40

Several issues relating to section 7.40 were reserved for future consideration because it was felt that further experience or experimentation was desirable before their resolution was encapsulated in model statutory language. The issues so reserved include the following:

a. Should a decision by the board of directors that maintenance of a derivative suit is against the corporation's interest bar the suit?

The case law concerning the power of the board of directors or of an independent committee of the board to bar a derivative suit without judicial review is in a state of flux. See, e.g., Burks v. Lasker, 441 U.S. 471 (1979); Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 393 N.E.2d 994 (1979); Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981); Aronson v. Lewis, 473 A.2d 805 (Del. 1984). For the present it should be permitted to continue to develop. Moreover, this issue may be the subject of an amendment to the Model Act at a later date.

b. Should the method of calculating attorneys' fees be specified?

Courts are today scrutinizing plaintiffs' fees more closely than they have in the past. This trend should be encouraged, and it was therefore concluded that the subject was not appropriate for statutory language at the present time. It is believed that the problem is more acute with respect to plaintiffs' fees recoverable under general principles of derivative litigation than it is under section 7.40(d).

c. Should there be a maximum limit on an individual's liability?

The sums involved in claims of alleged wrongdoing by a corporation and its officers and directors are often extremely large when viewed in the light of the personal resources of even an affluent person. Claims for millions of dollars may create a high leverage to settle, and the potential exposure to these claims is an undesirable deterrent to service on the board of directors, particularly by outside directors. The proposed Federal Securities Code imposes a limit on individual liability resulting from certain violations of the Code and similar suggestions have also been made by others. On the other hand, where a director's or officer's conduct has proved to be wrongful and detrimental to the corporation, he should clearly be required to disgorge the entire benefit, and it also may be appropriate to require him rather than the victimized corporation and shareholders to bear any other loss suffered.

Since no state has yet adopted a limitation of liability provision, and there is no experience with these provisions, it was thought inappropriate at the present time to discard the principle of unlimited liability.

NORTH CAROLINA COMMENTARY

The provisions of the Model Act relating to the procedures in derivative proceedings were omitted in their entirety. The provisions of former G.S. 55-55, with minor modifications, have become subsections (a), (b), (d), (e), and (f). The second sentence of subsection (b) was added to permit the stay of any proceeding in the discretion of the court during pendency of an investigation by the corporation of the charges made in the demand or complaint.

Subsection (c) permits a recently developed procedure whereby two or more disinterested directors or other disinterested persons determine whether a corporation should pursue a particular legal right or remedy and report their findings to the court, which may then determine whether or not the derivative proceedings should be continued.

Subsection (g), which had no equivalent under prior law, imposes additional conditions upon plaintiffs who bring derivative proceedings on behalf of public corporations.

Subsection (h), which also had no equivalent under prior law, assures availability of the normal corporate attorney-client privilege in derivative proceedings.

Legal Periodicals. - For note, "The Nonprofit Corporation in North Carolina: Recognizing a Right to Member Derivative Suits," see 63 N.C.L. Rev. 999 (1985).

For note, "Alford v. Shaw: North Carolina Adopts a Prophylactic Rule to Prevent Termination of Shareholders' Derivative Suits Through Special Litigation Committees," see 64 N.C.L. Rev. 1228 (1986).

For article, "The Corporate Fox and the Shareholders' Hen House: Reflections on Alford v. Shaw," see 65 N.C.L. Rev. 569 (1987).

For article, "The Perils Of Caesar's Wife: Special Litigation Committees v. The Judiciary; Is Anyone Above Reproach?," see 22 Wake Forest L. Rev. 57 (1987).

For note discussing presumption of good faith in deliberations by special litigation committees, in light of Alford v. Shaw, see 22 Wake Forest L. Rev. 127 (1987).

For article discussing derivative suit litigation, see 66 N.C.L. Rev. 565 (1988).

For note, "Shareholder Derivative Suits Under the New North Carolina Business Corporation Act," see 68 N.C. L. Rev. 1091 (1990).

For article, "Agency Theory: Still Viable? Six Degrees of Separation: From Derivative Suits to Shareholder Class Actions," see 48 Wake Forest L. Rev. 643 (2013).

For article, "How Understanding the Nature of Corporate Norms Can Prevent Their Destruction by Settlements," see 66 Duke L.J. 501 (2016).

CASE NOTES

Editor's Note. - Many of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Derivative actions are brought by one or more shareholders to enforce the rights of the corporation. Robbins v. Tweetsie R.R., Inc., 126 N.C. App. 572, 486 S.E.2d 453 (1997), cert. denied, 347 N.C. 402, 494 S.E.2d 418 (1997).

There is no individual recovery where a shareholder alleges mere injury to the corporation and nothing more. Robbins v. Tweetsie R.R., Inc., 126 N.C. App. 572, 486 S.E.2d 453 (1997), cert. denied, 347 N.C. 402, 494 S.E.2d 418 (1997).

No Standing to Bring Suit Without Beneficial Interest. - Plaintiff had no standing to bring suit challenging action of corporation where he failed to maintain his status as a holder of a beneficial interest in the stock of that corporation throughout the pendency of the litigation. Ashburn v. Wicker, 95 N.C. App. 162, 381 S.E.2d 876 (1989), decided under the former Business Corporation Act.

Plaintiff had no standing to challenge a loan made by defendant corporation to other defendant when plaintiff's beneficial interest, if any, in the defendant corporation consisted of a pledge of stock which secured a debt that was paid by another pledgee of the stock before plaintiff filed suit. Ashburn v. Wicker, 95 N.C. App. 162, 381 S.E.2d 876 (1989), decided under the former Business Corporation Act.

Effect of Futility Doctrine. - The futility doctrine does not allow a shareholder to bring a claim directly. Rather, it simply allows a shareholder to bring a derivative claim without first making demand upon corporate management. Thus, this doctrine offered no support to plaintiff's attempt to recover directly for the breach of his fellow directors' fiduciary duty to corporation. Silverman v. Miller, 155 Bankr. 362 (Bankr. E.D.N.C. 1993).

Pledgee of corporate stock has a significant beneficial interest to have standing to sue the corporation derivatively for mismanagement, provided he maintains an equitable interest in the collateral. Ashburn v. Wicker, 95 N.C. App. 162, 381 S.E.2d 876 (1989), decided under the former Business Corporation Act.

Demand for Action by Directors as Prerequisite. - Former G.S. 55-55(b) codified the prior case law of this and other jurisdictions that in order for an individual as a shareholder to bring suit against the directors of a corporation for breach of their duties to the corporation, he must show that he has exhausted his intracorporate remedies by making demand upon the board to do that which he seeks to have done. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

In the absence of circumstances indicating that such a step would be futile, a demand that the directors act is a prerequisite of a shareholder suing upon behalf of the corporation. Roney v. Joyner, 86 N.C. App. 81, 356 S.E.2d 401 (1987).

Exhaustion of intracorporate remedies (that is, "demand") is a procedural prerequisite to the filing of a derivative action in this State. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Minutes of board of directors meeting introduced into evidence by plaintiff confirmed that plaintiff made a motion that the corporation retain counsel to investigate the usurpation of a commercial leasing deal, and that this motion died for lack of a second. This action satisfied the demand requirement of this section, and any further demand would have been futile. Silverman v. Miller, 155 Bankr. 362 (Bankr. E.D.N.C. 1993).

An equitable exception to the demand requirement may be invoked when the directors who are in control of the corporation are the same ones (or under the control of the same ones) as were initially responsible for the breaches of duty alleged; in such a case, the demand of a shareholder upon the directors to sue themselves or their principals would be futile and therefore is not required for the maintenance of the action. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979); Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Mere negligence of the directors in evaluation of a purchase or in relying upon the advice of accounting and investment experts does not excuse a shareholder from demanding action by the board of directors before suing to enforce a corporate right. Roney v. Joyner, 86 N.C. App. 81, 356 S.E.2d 401 (1987).

Pleading of Damages and Defenses Thereto. - The pleading of the damages is an issue which is central to the merits of a derivative action and was not an area in which the corporation had standing to assert a defense. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Business Judgment Rule. - The business judgment rule, stated simply, provides that when a corporation's decision not to assert a claim represents a good faith business judgment by its directors, a shareholder will not be permitted to substitute his judgment for that of the company's management by asserting the claim in a derivative action. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Business Judgment Defense Involves Question of Good Faith. - Where the business judgment question is presented to the court as a ground for dismissal, the sole issue for determination is whether the decision was made in good faith. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

When Defense of "Business Judgment" Available to Corporation. - The defense of business judgment is not available to the corporation in a derivative action where a majority of its directors are implicated in the allegations of the suit, as it is a defense on the merits which may properly be interposed only by the directors and management of the corporation, unless the corporation is a real defendant as to some meritorious issue in the suit. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Recommendation of Special Litigation Committee. - To rely blindly on the report of a corporation-appointed special litigation committee is to abdicate the judicial duty to consider the interests of shareholders imposed by statute; this abdication is particularly inappropriate in a case where shareholders allege serious breaches of fiduciary duties owed to them by the directors controlling the corporation. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

The fact that a special litigation committee appointed by directors charged with self-dealing recommends that derivative action should not proceed, while carrying weight, is not binding upon the trial court; rather, the court must make a fair assessment of the report of the special committee, along with all the other facts and circumstances in the case, in order to determine whether the defendants will be able to show that the transaction complained of was just and reasonable to the corporation. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

The burden is on the movant, usually the corporation on whose behalf the suit was initiated, to prove the independence, disinterestedness, and appropriate qualifications of the committee and that it conducted a reasonable investigation in good faith of the matters alleged in the complaint. The committee is not entitled to a presumption of independence, disinterestedness, good faith, or reasonableness. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Corporation as Defendant Where Interest Adverse to Plaintiff's. - In some situations, the corporation in whose interest the derivative action is purportedly brought will have interests adverse to those of the nominal plaintiffs bringing the action derivatively, and will of necessity be more than a nominal defendant. Such situations would include an action to enjoin the performance of a contract by the corporation, to appoint a receiver, to interfere with a corporate reorganization, or to interfere with internal management, where there is no allegation of fraud or bad faith. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Corporation's Right to Defend Generally. - A corporation is not powerless in all cases and in all circumstances to resist a derivative action. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Individual and Derivative Action Available to Minority Shareholders in Closely Held Corporation. - Minority shareholders in a closely held corporation who allege wrongful conduct and corruption against the majority shareholders in the corporation may bring an individual action against those shareholders, in addition to maintaining a derivative action on behalf of the corporation. Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000).

Burden of Proving Reasonableness of Transactions. - When a stockholder in a derivative action seeks to establish self-dealing on the part of a majority of the board, the burden should be upon those directors to establish that the transactions complained of were just and reasonable to the corporation when entered into or approved. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Defenses Not on Merits Available to Corporation. - Certain defenses, such as matters of personal jurisdiction, venue and subject matter jurisdiction (which question may arise in the context of alleged existence of prior pending actions involving matters identical to those complained of in the derivative suit) could be asserted by both the corporation and individual defendants where appropriate, as they are not defenses on the merits of the derivative claim. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Additionally, certain defenses which are properly asserted before trial on the merits of the derivative action are peculiar to the corporation alone, and may be properly raised only by the corporate nominal defendant who, for purposes of those matters, ceases to be a nominal defendant and becomes an actual party defendant. These defenses would include the lack of standing of the plaintiffs to sue derivatively for reasons of insufficient representation of shareholders and a failure on plaintiffs' part to make a demand upon the board of directors. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Limits on Corporation's Right to Defend. - In an action brought by a minority shareholder derivatively in the name and right of a corporation, to enforce rights or to seek redress accruing to the corporation, that corporation will be deemed for purposes of the litigation to be aligned as a party plaintiff (except to the extent that the corporation is an actual defendant as to an issue in the action) although for purposes of form it is designated as a nominal defendant. Accordingly, the corporation may not defend itself against the derivative action on the merits and must limit its defenses, if any, to the pre-trial matters proper to it. Where a corporation seeks to extend its defenses beyond those areas in which it may properly conduct them, dismissal will lie against it. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

When Order Not Void for Lack of Notice to Shareholders. - In an action challenging the appointment of operating receivers for a corporation, there was no merit to defendants' contention that the initial order of the trial court appointing the receivers was void because certain shareholders were not given notice of the proceedings and were thereby denied their due process rights to notice prior to a court proceeding, the outcome of which would affect their property interests, since there was no requirement in the statutes, either in the provisions governing the appointment of receivers or in the provisions governing derivative shareholder suits, that notice be given to persons who are not parties to the action. Lowder v. All Star Mills, Inc., 301 N.C. 561, 273 S.E.2d 247 (1981).

The statute sets forth two distinct standards for awarding attorneys' fees to successful litigants and taxing unsuccessful litigants with their opponents' attorney's fees. The court may award attorney's fees to a successful litigant who obtains a compromise and settlement or judgment, and may also assess attorney's fees against an unsuccessful litigant in certain cases. Lowder ex rel. Doby v. Doby, 79 N.C. App. 501, 340 S.E.2d 487, cert. denied, 316 N.C. 732, 345 S.E.2d 388 (1986).

When Fees May Be Awarded. - The statute does not impose a requirement to quantify the financial success of the derivative claim before fees may be awarded. The plaintiff need only succeed, in whole or in part, on behalf of the corporation. Lowder v. All Star Mills, Inc., 82 N.C. App. 470, 346 S.E.2d 695 (1986).

Amount of Award. - The statute does not provide, directly or indirectly, that the award of fees and expenses cannot exceed the specific monetary recovery. Lowder v. All Star Mills, Inc., 82 N.C. App. 470, 346 S.E.2d 695 (1986).

Award Upheld. - The removal of a self-dealing, controlling director from office and the appointment of a permanent receiver to protect the corporation in question conferred a substantial benefit on the corporation, so as to justify an award of attorneys' fees against the corporation. Lowder v. All Star Mills, Inc., 82 N.C. App. 470, 346 S.E.2d 695 (1986).

Merit Bonus Improperly Added to Award. - An award of a merit bonus added by the court to the attorneys' fees awarded, based on factors that were properly considered in the initial determination of the hourly rates and the number of hours reasonably expended, was an abuse of discretion. Lowder v. All Star Mills, Inc., 82 N.C. App. 470, 346 S.E.2d 695 (1986).

The trial court, in its discretion, may charge plaintiffs with defendants' reasonable expenses, including attorneys' fees, incurred in defense of the action. Lowder ex rel. Doby v. Doby, 79 N.C. App. 501, 340 S.E.2d 487, cert. denied, 316 N.C. 732, 345 S.E.2d 388 (1986).

Plaintiffs' actions were brought without reasonable cause where both the federal bankruptcy court and state receivership court had previously, either in Chapter X reorganization proceeding or receivership proceeding, dealt with the merits of the allegations made by plaintiffs in their five complaints, and the record was devoid of evidence to support any reasonable belief that there was a sound chance that plaintiffs' claims in the litigation might be sustained. Lowder ex rel. Doby v. Doby, 79 N.C. App. 501, 340 S.E.2d 487, cert. denied, 316 N.C. 732, 345 S.E.2d 388 (1986).

Calculation of Fees and Expenses. - Where plaintiff filed five lawsuits involving substantially overlapping contentions of law and fact, four of which were virtually identical and were linked together for purposes of appeal, plaintiffs, who created the situation, could not complain that the fees and expenses apportioned by the trial court to each of these nominally separate proceedings were not calculated with precision. Lowder ex rel. Doby v. Doby, 79 N.C. App. 501, 340 S.E.2d 487, cert. denied, 316 N.C. 732, 345 S.E.2d 388 (1986).

Judicial Review. - The plain language of the statute requires thorough judicial review of suits initiated by shareholders on behalf of a corporation. The court is directed to determine whether the interest of any shareholder will be substantially affected by the discontinuance, dismissal, compromise, or settlement of a derivative suit. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Although the statute does not specify what test the court must apply in making its determination, it would be difficult for the court to determine whether the interests of shareholders or creditors would be substantially affected by such discontinuance, dismissal, compromise, or settlement without looking at the proposed action substantively; the court must of necessity evaluate the adequacy of materials prepared by the corporation which support the corporation's decision to settle or dismiss a derivative suit, along with the plaintiff's forecast of evidence. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Court approval is required for disposition of all derivative suits, even where the directors are not charged with fraud or self-dealing, or where the plaintiff and the board agree to discontinue, dismiss, compromise, or settle the lawsuit. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Disposition Where Amount of Recovery Would Not Outweigh Detriment to Corporation. - If it appears likely that plaintiff could prevail on the merits, but that the amount of the recovery would not be sufficient to outweigh the detriment to the corporation, the court may allow discontinuance, dismissal, compromise, or settlement. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

In exercising its own independent business judgment, the court must consider "such ethical, commercial, promotional, public relations and fiscal factors as may be involved in a given situation." Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

The corporation as the party seeking final disposition of the case under former G.S. 55-55(c) (see now this section) has the burden of going forward with evidence, on such items, and to show that continuing the action is more likely than not to be against the interests of the corporation. Of course, the shareholders initiating the suit are also entitled to present evidence and arguments as to their contentions. Ultimately, however, while "the review contemplated does not lend itself to any formula-like approach," it is for the court to decide whether the case begun in the superior court will continue. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Trial judge may allow discovery to enable him to assess the committee of decision-makers, the investigation made by the committee, the findings of the committee, and the recommendation of the committee. After hearing evidence on these matters, the trial court is to determine the independence, disinterestedness, and good faith of the committee in making its investigation, in addition to the reasonableness of the bases relied upon by the committee in concluding and recommending that the cause of action on behalf of the corporation be disposed of as recommended. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Plaintiffs were not required to pursue statutory dissenters' rights under former G.S. 55-113 (see now Art. 13 of ch. 55) to oppose merger during litigation in order to maintain standing. Subdivision (c) of former G.S. 55-113 would have deprived them of all interest in defendant corporation. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Responsibility of Court When Party Challenges Recommendation of Corporation. - Since proceedings under former G.S. 55-55(c) (see now this section) are held before a trial judge sitting without a jury, when a party challenges the recommendation of the corporation in whose name a lawsuit was initiated derivatively, it is the court's responsibility first, to require the party taking issue with the recommendation to outline his contentions so he may receive an appropriate response from the other parties to the suit, and then secondly, to hear evidence on these contentions, in order to be able to determine whether the lawsuit is to be discontinued, dismissed, settled, or turned over to the plaintiff-shareholders or the corporation for litigation. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

There was no requirement of continuing share ownership in former G.S. 55-55 in order for an individual, who was a shareholder at the time of the transaction about which he was complaining and at the time the action was filed, to proceed with a derivative action. Had the legislature intended to include such a requirement in the corporate statutes, it would have done so. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Section Does Not Contain Continuing Share Ownership Requirement. - This section, the new statute, while elaborating some of the procedures set forth in former G.S. 55-55, does not contain a continuing share ownership requirement. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

No State Constitutional Right Exists to Trial by Jury of Factual Issues. - Although a litigant's right to have a jury try issues of fact concerning the merits of the action initiated by the filing of a derivative suit complaint is guaranteed by the Constitution of North Carolina, the procedure required by former G.S. 55-55(c) (see now this section) did not exist before the adoption of the Constitution of 1868, and therefore no State constitutional right exists to a trial by jury of factual issues that might arise during the course of the proceedings required under this statute. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

A litigant has no right to the determination of factual issues by a jury during proceedings occurring pursuant to former G.S. 55-55(c) (see now this section). In this section of the statute, it is clear that the word "court" referred to the trial judge and not to a jury. The remaining sentences of former G.S. 55-55(c) referred to discretionary decisions exercisable properly only by the trial judge; clearly the legislature did not intend that a jury be involved in the procedures required under former G.S. 55-55(c). Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Jury Properly Not Involved in Deciding Future of Case. - The trial judge proceeded properly insofar as he did not involve a jury in the decision whether to allow the case to be discontinued, dismissed, compromised or settled. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Judge May Need to Resolve Fact Issues to Determine Future of Case. - As the judicial official charged under former G.S. 55-55(c) (see now this section) with this authority, the trial judge may well have to resolve issues of fact to decide whether to permit the suit to go forward, be settled, or be dismissed. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Judge, Not Jury, Decides Whether Case Will Be Settled, Dismissed, etc. - The hearing on motions filed under former G.S. 55-55(c) (see now this section) was appropriately held by the trial judge sitting without a jury. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Trial Court's Review of Motions to Settle, Dismiss, Compromise or Discontinue. - The trial court is to undertake a two-step review of motions brought under former G.S. 55-55(c) (see now this section). First, it is to decide whether the proposal for disposition of the case which is submitted to the court was reached by qualified independent disinterested decision-makers who in good faith proceeded to thoroughly investigate and evaluate the claims set forth in the complaint. The second step requires the trial court to exercise its own independent business judgment as to whether the case is to be discontinued, dismissed, compromised or settled. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Procedure and Discovery in Hearing Concerning Motion to Dismiss, Settle, etc. - For a case discussing interplay of rules and statutes governing procedure and discovery in shareholder's derivative action, particularly with respect to former G.S. 55-55(c) (see now this section) and G.S. 1A-1, Rules 12, 23 and 56. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Rule 23.1, Fed. R. Civ. P., is entirely consistent with this section, as this section allows for a device that the federal rule does not contemplate. The terms of Rule 23.1 and the appointment of a committee pursuant to this section both can be fully honored in a federal court sitting in diversity. Crown Crafts, Inc. v. Aldrich, 148 F.R.D. 547 (E.D.N.C. 1993).

Appointment of a committee under subsection (c) of former similar section is generally more appropriate in the context of a publicly held corporation, or at the very least within a close corporation with more than two owners. The appointment of a committee would likely only delay litigation in action brought by minority shareholders of close corporation alleging breach of fiduciary duties and deceptive and unfair trade practices. Crown Crafts, Inc. v. Aldrich, 148 F.R.D. 547 (E.D.N.C. 1993).

Issuance of Stay Pending Committee Report. - The language of subsection (c) of former similar section, while not expressly granting it, contemplates the issuance of a stay pending the committee's report. The appointment of a committee would be meaningless if the litigation were allowed to continue pending its investigation. Crown Crafts, Inc. v. Aldrich, 148 F.R.D. 547 (E.D.N.C. 1993).

Cited in Crown Crafts, Inc. v. Aldrich, 148 F.R.D. 151 (E.D.N.C. 1993); Guess v. Parrott, 160 N.C. App. 325, 585 S.E.2d 464 (2003); Bridges v. Oates, 167 N.C. App. 459, 605 S.E.2d 685 (2004); Burgess v. Burgess, 205 N.C. App. 325, 698 S.E.2d 666 (2010); Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262 (2013); Piazza v. Kirkbride, 246 N.C. App. 576, 785 S.E.2d 695 (2016).

CASE NOTES

Standing. - As 50% shareholder failed to show that her damages differed from those sustained by her corporation, by reason of some special circumstances or special relationship to the defendants, she lacked standing to maintain a direct action against defendants on claims of fraud, constructive fraud, and unfair and deceptive practices. Aubin v. Susi, 149 N.C. App. 320, 560 S.E.2d 875 (2002), cert. dismissed, 356 N.C. 610, 574 S.E.2d 473 (2002), cert. denied, 356 N.C. 610, 574 S.E.2d 474 (2002).

Cited in Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000); Bridges v. Oates, 167 N.C. App. 459, 605 S.E.2d 685 (2004); Ellison v. Alexander, 207 N.C. App. 401, 700 S.E.2d 102 (2010); Burgess v. Burgess, 205 N.C. App. 325, 698 S.E.2d 666 (2010); Fisher v. Flue-Cured Tobacco Coop. Stabilization Corp., 369 N.C. 202, 794 S.E.2d 699 (2016).

CASE NOTES

Cited in Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000); Bridges v. Oates, 167 N.C. App. 459, 605 S.E.2d 685 (2004); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012); Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262 (2013).

CASE NOTES

The enactment of this section has eliminated the futility exception to the demand requirement; that is, all derivative actions based on conduct occurring on or after 1 October 1995 require demand. Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000).

This section does not require that the complaint in a derivative proceeding state how the demand requirement was met, although its predecessor statute (G.S. 55-7-40) required that a plaintiff allege his efforts "with particularity;" consequently, the trial court erred in dismissing the plaintiffs' complaint in the context of a G.S. 1A-1, Rule 12(b)(6) motion for failure to comply with the statutory requirements of a derivative action where the plaintiffs had complied with G.S. 1A-1, Rule 9(c). Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000).

Failure to Satisfy Requirements of This Section Results in Dismissal. - The trial court properly dismissed plaintiff's claims pursuant to G.S. 1A-1, Rule 12(b)(6) for failure to satisfy the shareholder derivative action demand requirement of this section where he was not excused from meeting the requirements because the enactment of it abolished the futility exception under North Carolina law. Allen v. Ferrera, 141 N.C. App. 284, 540 S.E.2d 761 (2000).

Trial court properly dismissed a property owners association's suit against its developer, which asserted claims of constructive fraud and unfair and deceptive trade practices, for lack of standing on the part of the association, because the association failed to obtain a two-thirds vote of its membership authorizing the suit, as was required by its bylaws; as a result, the trial court lacked subject matter jurisdiction and properly granted the developer's motion to dismiss and motion for summary judgment. Peninsula Prop. Owners Ass'n v. Crescent Res., LLC, 171 N.C. App. 89, 614 S.E.2d 351 (2005), cert. denied, 360 N.C. 177, 626 S.E.2d 648 (2005).

The failure to make adequate pre-litigation demand did not bar plaintiffs minority shareholders' claims insofar as they were based on defendant's actions prior to October 1, 1995, the date that this section became effective. Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000).

No Impact on Class Certification Request. - Tobacco cooperative had not shown that the trial court abused its discretion by allowing the motion for class certification notwithstanding the cooperative's contention that the current and former flue-cured tobacco producers' action was derivative in nature as nothing in G.S. 55-7-42 precluded class certification. Fisher v. Flue-Cured Tobacco Coop. Stabilization Corp., 369 N.C. 202, 794 S.E.2d 699 (2016).

Applied in Wright v. Krispy Kreme Doughnuts, Inc., 231 F.R.D. 475 (M.D.N.C. 2005).

Cited in Bridges v. Oates, 167 N.C. App. 459, 605 S.E.2d 685 (2004); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012); LeCann v. Cobham (In re Cobham), 551 B.R. 181 (E.D.N.C. 2015), aff'd, 2016 U.S. App. LEXIS 18523 (2016).

CASE NOTES

Applied in Wright v. Krispy Kreme Doughnuts, Inc., 231 F.R.D. 475 (M.D.N.C. 2005).

Cited in Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000); Bluebird Corp. v. Aubin, 188 N.C. App. 671, 657 S.E.2d 55 (2008), review denied, 362 N.C. 679, 669 S.E.2d 741 (2008); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012).

CASE NOTES

Special Committee Conducted Reasonable Inquiry. - Shareholder derivative action failed because a special committee, which was comprised of independent directors and a law firm, conducted a reasonable inquiry that actually exceeded the scope of the shareholder's allegations of corporate misconduct based on alleged accounting errors, and the committee made a good faith decision that the lawsuit was not in the best interests of the corporation since there was no evidence supporting the shareholder's claims, and damages were questionable while litigation would be costly and disruptive. Madvig v. Gaither, 461 F. Supp. 2d 398 (W.D.N.C. 2006).

In a shareholder derivative case in which a corporation moved to dismiss, a magistrate judge correctly found that the special committee acted reasonably in determining that the derivative suit was not in the corporation's best interest; under G.S. 55-8-30(b)(2), the special committee was entitled to rely in good faith on the outside counsel's report. Borchardt v. King, - F. Supp. 2d - (M.D.N.C. Jan. 29, 2015).

In a shareholder derivative case in which a corporation moved to dismiss, it met its burden of showing that the special committee acted independently, in good faith, and based upon a reasonable inquiry in determining that the derivative suit was not in the corporation's best interest. Borchardt v. King, - F. Supp. 2d - (M.D.N.C. Jan. 29, 2015).

Cited in Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012).

CASE NOTES

Cited in Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000); Bluebird Corp. v. Aubin, 188 N.C. App. 671, 657 S.E.2d 55 (2008), review denied, 362 N.C. 679, 669 S.E.2d 741 (2008); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012).

CASE NOTES

Award of Fees to Non-Prevailing Party. - Under G.S. 55-7-46(1), the party seeking attorney's fees need not necessarily be the prevailing party, nor must the derivative claim have proceeded to a final judgment or order; upon a plaintiff's motion, the trial court is at least required to consider whether the proceeding resulted in a substantial benefit to the corporation, and whether such benefit warranted any award of fees. Aubin v. Susi, 149 N.C. App. 320, 560 S.E.2d 875 (2002), cert. dismissed, 356 N.C. 610, 574 S.E.2d 473 (2002), cert. denied, 356 N.C. 610, 574 S.E.2d 474 (2002).

Cited in Norman v. Nash Johnson & Sons' Farms, Inc., 140 N.C. App. 390, 537 S.E.2d 248 (2000); BellSouth Telecomms., Inc. v. City of Laurinburg, 168 N.C. App. 75, 606 S.E.2d 721, cert. denied, - N.C. - , 615 S.E.2d 660, cert. denied, 359 N.C. 629, - S.E.2d - (2005); In re Wachovia S'holders Litig., 168 N.C. App. 135, 607 S.E.2d 48 (2005), cert. denied, 359 N.C. 411, 613 S.E.2d 25 (2005); Bluebird Corp. v. Aubin, 188 N.C. App. 671, 657 S.E.2d 55 (2008), review denied, 362 N.C. 679, 669 S.E.2d 741 (2008); McMillan v. Ryan Jackson Props., LLC, 232 N.C. App. 35, 753 S.E.2d 373 (2014).

CASE NOTES

Internal Affairs Doctrine. - In a suit between a lender and a broker, a prior New York decision was not overturned when the North Carolina court found that the lender breached fiduciary duties because: (1) collateral estoppel, res judicata, and full faith and credit did not apply since the New York court did not dispose of or address the broker's counterclaims; and (2) the internal affairs doctrine was a conflict of laws principle, not a jurisdictional principal. Bluebird Corp. v. Aubin, 188 N.C. App. 671, 657 S.E.2d 55 (2008), review denied, 362 N.C. 679, 669 S.E.2d 741 (2008).

Suit for Breach of Fiduciary Duty. - In a shareholder's suit asserting breach of fiduciary duties and other violations wherein the substantive law of North Carolina applied, the shareholder's motion to amend the complaint was granted despite the motion being filed without seeking the required leave of court; regardless, the motion to dismiss filed by the defending officers and directors was granted for failure to state a claim because the amended complaint failed to show any misrepresentations made in the 2011 proxy statement sent out with regard to the executive compensation plan. Haberland v. Bulkeley, - F. Supp. 2d - (E.D.N.C. Sept. 26, 2012).

OFFICIAL COMMENT

Section 8.01 requires that every corporation have a board of directors except that a corporation with 50 or fewer shareholders may dispense with or limit the authority of the board of directors by describing in the articles "who will perform some or all of the duties of a board of directors." Section 8.01(c). This election is independent of the various close corporation elections permitted by the Model Statutory Close Corporation Supplement, though the basic standard of 50 shareholders is the same in both section 8.01 and that Supplement.

Obviously, some form of governance is necessary for every corporation. The board of directors is the traditional form of corporate governance but it need not be the exclusive form. Patterns of management may be tailored to specific needs in connection with family controlled enterprises, wholly or partially owned subsidiaries, or corporate joint ventures without the requirement of electing close corporation status under the Model Statutory Close Corporation Supplement. The persons who perform some or all of the duties of the board of directors may be designated "trustees," "agents," or "managers," and they may be selected in ways other than the traditional election by the shareholders. It is necessary, however, that some person or group perform these duties, and the designated persons, while performing them, are subject to the same duties as directors.

An example of the restructuring of the traditional board of directors permitted by section 8.01 is presented by the facts of Lehrman v. Cohen, 43 Del. Ch. 222, 222 A.2d 800 (Del. 1966), where two shareholders (or allied family interests) had equal voting power and wished to permit the corporation's attorney to cast a tie-breaking vote on the board of directors without giving him a participating equity interest in the corporation. While the desired result was successfully achieved in that case by creating a class of voting shares without a significant economic interest in the corporation, the same result may be reached under section 8.01 directly by provision in the articles of incorporation without creating a special class of shares.

Any arrangement under section 8.01(c) may also be established by a close corporation election under the Model Statutory Close Corporation Supplement.

When a corporation has more than 50 shareholders, it must adopt the traditional board of directors as its sole form of governance. Because questions may at least theoretically arise how joint share ownership and other arrangements should be counted in applying a numerical limitation, section 1.42 prescribes rules for calculating the number of shareholders for the purpose of this and other numerical limitations in the Model Act.

Section 8.01(b) states that if a corporation has a board of directors "all corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of," the board of directors. The quoted language is chosen to reflect the role and functions of boards of directors in all varieties of corporations. In a small corporation and in some larger corporations where the board of directors is composed entirely of persons actively involved in the management of the corporate business, it may be reasonable to describe management as being "by" the board of directors. But a different model is appropriate for the boards of directors of publicly held corporations, which usually include individuals not actively involved in management. In these corporations it is not feasible to impose a requirement that the business and affairs of the corporation be managed "by" the board of directors. In these corporations the appropriate model is that the business and affairs be managed "under the direction of" the board of directors, since the role of the board of directors consist principally of the formulation of major management policy with little or no direct involvement in day-to-day management.

As a correlative in large and complex publicly held corporations it is generally recognized that the board of directors may delegate to appropriate officers those powers not required by law to be exercised by the board of directors itself. Although delegation does not relieve the board of directors from its responsibilities of oversight, directors should not be held personally responsible for actions or omissions of officers, employees, or agents of the corporation so long as the directors have relied reasonably upon these officers, employees, or agents. See section 8.30 and its Official Comment. The board of directors has the power to probe to any depth its chooses in day-to-day management, but it has the responsibility to do so only to the extent that section 8.30 requires.

Section 8.01(b) also recognizes that the powers of the board of directors may be limited by express provisions in the articles of incorporation.

NORTH CAROLINA COMMENTARY

This section contains several variations from former G.S. 55-24 and former G.S. 55-73. First, it requires that the board direct the management of the business and affairs of the corporation whereas former G.S. 55-24 required that the board manage the corporation's business and affairs. As pointed out in the Official Comment, the new language clarifies the role of directors as policy makers rather than managers. Also, this section clarifies that all shareholders must assent to an agreement (not contained in the articles of incorporation) which limits or dispenses with the board; and it explicitly provides that those in whom the board's authority is vested under such an arrangement are deemed to be acting as the board for all purposes of this Act (including the duties defined in G.S. 55-8-30 et seq.). Such substitutes for the board would be subject to liability to the same extent as directors.

This section differs from the Model Act in permitting limitation of the board's authority in a shareholders' agreement as well as in the articles of incorporation, and it permits dispensing with or limiting the board of a corporation regardless of the number of shareholders. Any such arrangement accomplished through a shareholders' agreement must comply with G.S. 55-7-31(b). The second clause of subsection (c) relating to rights of third parties without knowledge does not appear in the Model Act; it brings forward former G.S. 55-24(b). Finally, paragraph (d) does not appear in the Model Act, although it is likely that the same result would be reached under the Model Act. See Official Comment, supra, para. 2.

Former G.S. 55-33, which provided for jurisdiction over nonresident directors, was not brought forward because G.S. 1-75.4, the general jurisdiction statute, specifically provides such jurisdiction. It was therefore deemed unnecessary to continue to include a special provision in Chapter 55.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, subsection (b) is amended to recognize that a corporation's business and affairs may be managed by the board of directors.

Effect of Amendments. - Session Laws 2005-268, s. 6, effective October 1, 2005, inserted "by or" following "corporation managed" in subsection (b).

Legal Periodicals. - For note on the liability of directors and officers for negligent management, see 45 N.C.L. Rev. 748 (1967).

For note on the fiduciary duty of interested directors and the business judgment rule, see 45 N.C.L. Rev. 755 (1967).

For comment on promoters of corporations dealing in condominiums, see 12 Wake Forest L. Rev. 979 (1976).

For note on close corporations and personal liability from execution of shareholder agreements, see 16 Wake Forest L. Rev. 975 (1980).

For article on corporate directors' accountability, see 66 N.C.L. Rev. 171 (1987).

For article discussing derivative suit litigation, see 66 N.C.L. Rev. 565 (1988).

For comment, "Fiduciary Duties of Directors, How Far Do They Go?," see 23 Wake Forest L. Rev. 163 (1988).

For comment, "North Carolina's Statutory Limitation on Directors' Liability," see 24 Wake Forest L. Rev. 117 (1989).

For article, "The Corporate Persona, Contract (and Market) Failure, and Moral Values," see 69 N.C.L. Rev. 273 (1991).

For article, "Discrimination, Managerial Discretion and the Corporate Contract," see 26 Wake Forest L. Rev. 541 (1991).

For note, "Ignorance is not Bliss: Responsible Corporate Officers Convicted of Environmental Crimes and the Federal Sentencing Guidelines," see 1992 Duke L.J. 145.

For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For article, "Branch Office of the Prosecutor: The New Role of the Corporation in Business Crime Prosecutions," 89 N.C.L. Rev. 23 (2010).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Diversity and Corporate Performance: A Review of the Psychological Literature," see 89 N.C. L. Rev. 715 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Commentary: The Milieu of the Boardroom and the Precinct of Employment," see 89 N.C.L. Rev. 749 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Dangerous Categories: Narratives of Corporate Board Diversity," see 89 N.C.L. Rev. 759 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Corporate Board Gender Diversity and Stock Performance: The Competence Gap or Institutional Investor Bias?," see 89 N.C.L. Rev. 809 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Commentary: Puzzles about Corporate Boards and Board Diversity," see 89 N.C.L. Rev. 841 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Board Diversity Revisted: New Rationale Same Old Story?," see 89 N.C.L. Rev. 855 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Commentary: Diversity on Corporate Boards: Limits of the Business Case and the Connection Between Supporting Rationales and the Appropriate Response of the Law," see 89 N.C.L. Rev. 887 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Justifying Board Diversity," see 89 N.C.L. Rev. 901 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Commentary: The Mismatch Critique Comment on Fanto, Solan, and Darley," see 89 N.C.L. Rev. 937 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: The Diversity Double Standard," see 89 N.C.L. Rev. 945 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Commentary: Different Strokes for Different Folks: A Different Standard is not Inherently a Double Standard," see 89 N.C.L. Rev. 1003 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Showcasing Diversity," see 89 N.C.L. Rev. 1017 (2011).

For article, "Board Diversity and Corporate Performance: Filling in the Gaps: Commentary: Showcasing: The Positive Spin," see 89 N.C.L. Rev. 1055 (2011).

For article, "Beyond the Board of Directors," see 46 Wake Forest L. Rev. 783 (2011).

For article, "Is the Corporate Director's Duty of Care a 'Fiduciary' Duty? Does it Matter?," see 48 Wake Forest L. Rev. 1027 (2013).

CASE NOTES

Editor's Note. - Many of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Director occupies a fiduciary relation to the company which, by virtue of his office, he represents in the management of its principal functions. Hill v. Pioneer Lumber Co., 113 N.C. 173, 18 S.E. 107 (1893).

Directors are to be considered and dealt with as trustees or quasi trustees. Besseliew v. Brown, 177 N.C. 65, 97 S.E. 743 (1919).

Liability for Gross Mismanagement and Neglect. - Good faith alone will not relieve the directors of a corporation from liability to its creditors for damages caused them by their gross mismanagement and neglect of its affairs. Anthony v. Jeffress, 172 N.C. 378, 90 S.E. 414 (1916).

Duty of Care. - Directors are not, as a rule, responsible for mere errors of judgment, nor for slight omissions from which the loss complained of could not have been reasonably expected; but where they accept these positions of trust they are expected and required to give them the care and attention that a prudent man should exercise in like circumstances, and are charged with a like duty, usually the care that a prudent man shows in the conduct of his own affairs of a similar kind. Besseliew v. Brown, 177 N.C. 65, 97 S.E. 743 (1919).

Same Good Faith Required of Promoters as Directors. - The promoters of a corporation occupy a relation of trust and confidence towards the corporation which they are calling into existence as well as to each other, and the law requires of them the same good faith it exacts from directors and other fiduciaries. Wilson v. McClenny, 262 N.C. 121, 136 S.E.2d 569 (1964).

Right of Corporation to Sue Negligent Directors. - Where the directors or managing officers of a corporation are liable in damages for their willful or negligent failure to exercise the care and attention to corporate affairs entrusted to them and which they have assumed, an action will lie against them in favor of the corporation, and in case of its insolvency and receivership, in favor of its receiver. Besseliew v. Brown, 177 N.C. 65, 97 S.E. 743 (1919).

Directors Establish Policies. - In general, the directors establish corporate policies and supervise the carrying out of those policies through their duly elected and authorized officers. Burlington Indus., Inc. v. Foil, 284 N.C. 740, 202 S.E.2d 591 (1974).

Powers to Borrow Money and Encumber Property. - The directors of a corporation, unless they are specially restrained by the charter or bylaws, have the power to borrow money with which to conduct its business and to secure payment by mortgage on corporate property. Wall v. Rothrock, 171 N.C. 388, 88 S.E. 633 (1916).

Director of a company may lend it money when needed for its benefit, and take a lien upon the corporate property as security for its repayment, provided the transaction is open and entirely fair and capable of strict proof as to its bona fides. Hill v. Pioneer Lumber Co., 113 N.C. 173, 18 S.E. 107 (1893).

Director who is also a creditor of a corporation cannot prefer himself to the other creditors in the application of the corporation's assets to the security or payment of its debts. Hill v. Pioneer Lumber Co., 113 N.C. 173, 18 S.E. 107 (1893); Merchants Nat'l Bank v. Newton Cotton Mills, 115 N.C. 507, 20 S.E. 765 (1894); McIver v. Young Hdwe. Co., 144 N.C. 478, 57 S.E. 169 (1907).

Right of Directors to Security. - By taking a mortgage on corporate property when the corporation is in failing circumstances, directors, occupying a fiduciary relation, are not permitted to secure themselves against preexisting liabilities of the corporation upon which they are already bound. Wall v. Rothrock, 171 N.C. 388, 88 S.E. 633 (1916); Caldwell v. Robinson, 179 N.C. 518, 103 S.E. 75 (1920).

Judgment Liens of Directors. - Where the directors of a corporation made a bona fide sale of property to it, for value and free from fraud, judgments against the corporation for the purchase price, duly docketed, constitute liens in favor of the directors against the corporate property. Caldwell v. Robinson, 179 N.C. 518, 103 S.E. 75 (1920).

Use of Inside Information by Director to Gain Advantage Against Other Creditors. - Where a corporation is insolvent, a director who is a creditor cannot, upon a debt theretofore existing, take advantage of his superior means of information to secure his debt as against other creditors. Hill v. Pioneer Lumber Co., 113 N.C. 173, 18 S.E. 107 (1893).

Stockholder's Agreements on Election of Directors Are Valid Absent Fraud or Prejudice. - North Carolina is aligned with the majority of jurisdictions which hold that a contract entered into between corporate stockholders by which they agree to vote their stock in a specified manner - including agreements for the election of directors and corporate officers - is not invalid unless it is inspired by fraud or will prejudice the other stockholders. Wilson v. McClenny, 262 N.C. 121, 136 S.E.2d 569 (1964).

Agreements for Future Management Must Be "Otherwise Lawful". - Former G.S. 55-24 and former G.S. 55-73 required that contemplated agreements providing for the future management and control of a corporation be "otherwise lawful." Wilson v. McClenny, 262 N.C. 121, 136 S.E.2d 569 (1964).

When Such Agreements Will Be Declared Invalid. - Agreements providing for the future management and control of a corporation which violate express charter or statutory provisions, contemplate an illegal object, involve any fraud, oppression or wrong against other stockholders, or are made in consideration of a private benefit to the promisor will be declared invalid. Wilson v. McClenny, 262 N.C. 121, 136 S.E.2d 569 (1964).

Cited in Ron Medlin Constr. v. Harris, 364 N.C. 577, 704 S.E.2d 486 (2010).

OFFICIAL COMMENT

The elimination of mandatory special qualifications for directors is now nearly universal. The articles of incorporation or bylaws, however, may prescribe special qualifications, an option that is most likely to be utilized in closely held corporations where qualifications for directors may be used as a device for ensuring representation and voting power on the board of directors.

OFFICIAL COMMENT

Section 8.03 prescribes rules for the determination of the size of the board of directors of corporations that have not dispensed with a board of directors under section 8.01(c), and for changes in the size of the board of directors once it is established.

1. Minimum number of directors
2. Changes in the size of the board of directors
3. Annual elections of directors

Section 8.03(a) provides that the size of the initial board of directors may be "specified in or fixed in accordance with" the articles of incorporation or bylaws. The size of the board of directors may thus be fixed initially in the fundamental corporate documents, or the decision as to the size of the initial board of directors may be made thereafter by those authorized in those documents. After shares have been issued, however, the power to increase or decrease the size of the board of directors by more than 30 percent, whether by amendment of the bylaws or otherwise, is reserved to the shareholders.

Before 1969 the Model Act required a board of directors to consist of at least three directors. Since then, however, the Model Act, and the corporation statutes of an increasing number of states, have provided that the board of directors may consist of one or more members. A board of directors consisting of one or more individuals may be appropriate for corporations with one or two shareholders, or for corporations with more than two shareholders where in fact the full power of management is vested in only one or two persons. The requirement that every corporation have a board of directors of at least three directors may require the introduction into these closely held corporations of persons with no financial interest in the corporation.

Section 8.03(b) and (c) prescribe rules for corporations in which the board of directors has authority to establish or change the size of the board of directors. It has no application to corporations in which the size of the board of directors is fixed by the bylaws and the shareholders reserve to themselves the power to amend bylaws. See section 10.20. The basic premise is that the determination of the size of the board of directors should rest with the shareholders. These subsections also prevent the board of directors from manipulating its own size without the approval of the shareholders. But experience has shown, particularly in larger corporations, that it is desirable to grant the board of directors some authority to change its size without incurring the expense of obtaining shareholder approval.

Subsection (b) therefore permits the board of directors to increase or decrease its own size by up to 30 percent without shareholder approval. The 30 percent is calculated from the size last approved by the shareholders, thereby preventing directors from tacking a series of 30 percent increases or decreases to alter the basic composition of a board of directors without shareholder approval. For example, in a board of directors fixed or approved by the shareholders at 15 members, the board may, without shareholder approval, change the size of the board to as few as 11 or as many as 19; a board of 5 may be changed by the board to as few as 4 or as many as 6. The 30-percent limit was established to give the board of directors reasonable leeway in adjusting its own size. Thus, when a director resigns, the board of directors should normally be able to reduce its own size and elect not to fill the vacancy without shareholder action; similarly, if an exceptionally qualified person becomes available (or is invited to serve on the board of directors because of a felt need), he may normally be added to the board of directors without shareholder approval.

Alternatively, subsection (c) authorizes the articles of incorporation or bylaws to establish a variable-range size for the board of directors. If a variable range size is established, either the shareholders or the board of directors may prescribe or change the size of the board of directors within that range. However, only the shareholders may amend the bylaws to change the limits established for the size of the board of directors, or to change from a variable-range size board to a fixed board or vice versa. A variable-range size board is intended to provide essentially the same benefits as the authority granted a board of directors by subsection (b) to change its own size by 30 percent. Many publicly held corporations have established variable-range size boards of directors pursuant to general authority in state statutes. Specific recognition and regulation of this widespread practice seems desirable.

Section 8.03(c) also applies to a variable-range size board of directors whose initial size is established by the articles of incorporation if the articles authorize changing the limits of the size of the board without having to amend the articles.

The limitations on the authority of the board of directors set forth in this section are substantive restrictions that may not be changed by provisions in articles of incorporation or bylaws. For example, a general provision in bylaws granting the board of directors authority to amend bylaws does not authorize a board of directors, after shares are issued, to change the limits of a variable-range board established by the bylaws.

Sections 8.03(b) and (c) are primarily designed for publicly held corporations. In closely held corporations, typically, a change in the size of the board of directors may be accomplished readily by the shareholders if that is desired. In many closely held corporations, on the other hand, a board of directors of a fixed size may be an essential part of a control arrangement. In these situations, an increase or decrease in the size of the board of directors by even a single member may significantly affect control. In order to effectuate control arrangements dependent on a board of directors of a fixed size, the power of the board of directors to change its own size must be negated. This may be accomplished by fixing the size of the board of directors in the articles of incorporation or by expressly negating all powers of the board of directors to change the size of the board, whether by amendment of the bylaws or otherwise. See section 10.22.

Section 8.03(d) makes it clear that all directors are elected annually unless the board is staggered. See section 8.05 and its Official Comment.

NORTH CAROLINA COMMENTARY

This section permits any corporation to have fewer than three directors, whereas former G.S. 55-25(a) permitted it only where there were fewer than three shareholders. In addition, unless there is cumulative voting, this section permits the board to change the number of directors by up to 30% in a 12-month period, whereas former G.S. 55-25(b) required shareholder action or a provision in the articles of incorporation to change the number of directors except within a variable range. Finally, this section eliminates the provision in former G.S. 55-25(e) which allowed a shareholder to demand election by ballot unless the articles of incorporation or bylaws provided otherwise.

Subsection (b) of this section modifies the Model Act's subsection 8.03(b) to retain the former G.S. 55-25(b) protection of the right of cumulative voting if it exists. The Model Act leaves cumulative voting unprotected in this situation unless such protection is written into the articles of incorporation.

Subsection (c) modifies the Model Act by the addition of the parenthetical clause in the second sentence of this subsection.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section's limitations on the authority of the board of directors to set the size of the board are removed, subject to retaining certain limitations if shareholders are entitled to vote cumulatively in the election of directors.

Effect of Amendments. - Session Laws 2005-268, s. 7, effective October 1, 2005, rewrote subsection (b); and deleted former subsection (c), which read: "The articles of incorporation or bylaws may establish a variable range for the size of the board of directors by fixing a minimum and maximum number of directors. If a variable range is established, the number of directors may be fixed or changed from time to time, within the minimum and maximum, by the shareholders or (unless the articles of incorporation or an agreement valid under G.S. 55-7-31 shall otherwise provide) the board of directors. After shares are issued, only the shareholders may change the range for the size of the board or change from a fixed to a variable-range size board or vice versa."

Session Laws 2006-264, s. 44(a), effective August 27, 2006, substituted "applies in which shares are entitled to be voted cumulatively, the number" for "applies, the number" in subsection (b), in subsection (b)(1) substituted "entitled to be voted cumulatively that vote against" for "voting against."

Legal Periodicals. - For recent development, "In re Wachovia Shareholders Litigation: The Case for the Common Benefit Doctrine," see 84 N.C. L. Rev. 2066 (2006).

OFFICIAL COMMENT

Section 8.04 makes explicit that the articles of incorporation may provide that a specified number (or all) of the directors may be elected by the holders of one or more classes of shares. This approach is widely used in closely held corporations to effect an agreed upon allocation of control, for example, to ensure minority representation on the board of directors by issuing to that minority a class of shares entitled to elect one or more directors. A class (or classes) of shares entitled to elect separately one or more directors constitutes a separate voting group for purposes of the election of directors; within each voting group directors are elected by a plurality of votes and quorum and voting requirements must be separately met by each voting group. See sections 7.25, 7.26, and 7.28.

NORTH CAROLINA COMMENTARY

This section is substantially the same as former G.S. 55-25(b) and former G.S. 55-26.

OFFICIAL COMMENT

Section 8.05 provides for the annual election of directors at the annual shareholders' meeting with a single exception that terms may be staggered as permitted in section 8.06.

Section 8.05(c) provides that a decrease in the number of directors does not shorten the term of an incumbent director or divest any director of his office. Rather, the incumbent director's term expires at the annual meeting at which his successor would otherwise be elected.

Section 8.05(d) provides that the terms of all directors elected to fill vacancies expire at the next meeting of shareholders at which directors are elected. Thus, if terms are staggered under section 8.06, the term of a director elected to fill a vacant term with more than a year to run is shorter than the term of his predecessor. The board of directors may take appropriate steps, by designation of short terms or otherwise, to return the rotation of election of directors to the original terms established or fixed by the articles or bylaws.

Section 8.05(e) provides for "holdover" directors so that directorships do not automatically become vacant at the expiration of their terms but the same persons continue in office until successors qualify for office. Thus the power of the board of directors to act continues uninterrupted even though an annual shareholders' meeting is not held or the shareholders are deadlocked and unable to elect directors at the meeting.

NORTH CAROLINA COMMENTARY

This section is substantially the same as former G.S. 55-25(c) and (d).

OFFICIAL COMMENT

Section 8.06 recognizes the practice of "classifying" the board or "staggering" the terms of directors so that only one-half or one-third of them are elected at each annual shareholders' meeting and directors are elected for two- or three-year terms rather than one-year terms.

Under section 8.06 at least three directors must be elected at each annual meeting. These directors may be elected by one or more voting groups, as provided in the articles of incorporation.

The principal justification for staggering the board today is that it protects against sudden change in the management of the corporation despite a change in shareholdings. It also reduces the impact of cumulative voting since a greater number of votes is required to elect a director if the board is staggered than is required if the entire board were elected at each annual meeting.

The staggered board of directors is sometimes used by incumbent management to make unwanted takeover attempts more difficult to effectuate. It is unlikely to be effective alone, however, since the shareholders may in any event remove directors under section 8.08 whether or not their terms are staggered. As a result, a staggered board is likely to be used for this purpose only in conjunction with a provision that directors may be removed only for cause.

NORTH CAROLINA COMMENTARY

This section is substantially the same as former G.S. 55-26. The corresponding provision in the Model Act was modified to permit staggered terms for directors to be fixed in a bylaw adopted by the shareholders, thus continuing the former North Carolina practice.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, the requirement that a board of directors consist of at least nine directors before directors' terms may be staggered is eliminated.

Effect of Amendments. - Session Laws 2005-268, s. 8, effective October 1, 2005, in the first sentence, deleted "If the number of directors is fixed at nine or more directors" from the beginning, inserted "of directors" following "terms" and made a minor stylistic change.

OFFICIAL COMMENT

The resignation of a director is effective when the written notice is delivered unless the notice specifies a later effective date, in which case the director continues to serve until that later date. Since the person giving the notice is still a member of the board, he may participate in all decisions until the specified date, including the choice of his successor under section 8.10. The participation of the retiring director in the decision on his successor may be of importance in closely held corporations where control of the board may be affected by the resignation.

Vacancies created by a resignation effective at a later date may be filled before that date under section 8.10.

NORTH CAROLINA COMMENTARY

This section is more explicit than former G.S. 55-27(a)(1) in specifying the effective time of a director's resignation.

The section is also more explicit than the Model Act in clarifying that notice is effective when communicated unless a later date is specified in writing. The Model Act merely uses the term "delivered." Since "delivered" is defined to include "mail," a more precise term was deemed desirable.

Editor's Note. - Session Laws 2001-358, s. 53, provided that the act, which amended this section, was effective October 1, 2001, and applicable to documents submitted for filing on or after that date. Section 173 of Session Laws 2001-387 changed the effective date of Session Laws 2001-358 from October 1, 2001, to January 1, 2002. Section 6 of Session Laws 2001-413, effective September 14, 2001, added a sentence to s. 175(a) of Session Laws 2001-387, making s. 173 of that act effective when it became law (August 26, 2001). As a result of these changes, the amendment by Session Laws 2001-358 is effective January 1, 2002, and applicable to documents submitted for filing on or after that date.

Effect of Amendments. - Session Laws 2001-358, s. 6(c), effective January 1, 2002, and applicable to documents submitted for filing on or after that date, substituted "chair" for "chairman" in subsection (a).

OFFICIAL COMMENT

Section 8.08(a) accepts the view that since the shareholders are the owners of the corporation, they should normally have the power to change the directors at will. This section reverses the common law position that directors have a statutory entitlement to their office and can be removed only for cause - fraud, criminal conduct, gross abuse of office amounting to a breach of trust, or similar conduct. The power to remove directors is subject to several restrictions set forth in section 8.08:

1. The power to remove a director without cause may be eliminated by a provision in the articles of incorporation. Such a provision in effect guarantees the directors the same entitlement to office that directors enjoyed at common law. It is likely to be used in closely held corporations as an element of an agreed-upon allocation of power and control which ensures directors immunity from removal except for cause. It may also be used in publicly held corporations that fear changes in ownership of the majority of the shares and desire to provide security to the directors.
2. If the articles of incorporation provide that one or more classes of shares constitute a separate voting group entitled to elect a director (see section 8.04), only the shareholders of that voting group may participate in the vote whether or not to remove that director. But that director may be removed by court proceeding under section 8.09 despite this section.
3. If cumulative voting is not authorized, a director is removed (with or without cause) only if the votes cast to remove him exceed the votes cast to retain him at a meeting of the voting group electing him at which a quorum of shares entitled to vote on his election is present.
4. If cumulative voting is authorized, a different standard for removal is involved. Under cumulative voting, a director may be removed (with or without cause) only if the votes cast in favor of retaining him would not have been sufficient to elect him pursuant to cumulative voting at that meeting. This provision guarantees that a minority faction with sufficient votes to guarantee the election of a director under cumulative voting will be able to protect that director from removal by the remaining shareholders. The director, however, may be removed by court proceeding under section 8.09 despite this section. In computing whether or not a director elected by cumulative voting is protected from removal from office by section 8.08(c), the votes should be counted as though (1) the vote to remove the director occurred in an election to elect the number of directors normally elected by the voting group along with the director whose removal is sought, (2) the number of votes cast cumulatively against removal of the director had been cast for his election, and (3) all votes cast for removal of the director had been cast cumulatively in an efficient pattern for the election of a sufficient number of candidates so as to deprive the director whose removal is being sought of his office.

Removal of directors under section 8.08(d) requires the meeting notice to state that removal of specific directors will be proposed.

AMENDED NORTH CAROLINA COMMENTARY

This section is consistent with prior law as contained in former G.S. 55-27(f) with two notable differences. This section does not contain a specific provision allowing removal of the entire board by a majority vote, and the notice requirement of subsection (d) is new. Subsection (d) does not prohibit removal of a director by unanimous consent ( see G.S. 55-7-04) but requires notice if the removal is to be considered at a meeting. The language of the Model Act was modified in this subsection for clarity.

OFFICIAL COMMENT

Section 8.09 authorizes the removal of a director who is found in a judicial proceeding to have engaged in fraudulent or dishonest conduct or gross abuse of office. For example, a judicial proceeding (as contrasted with removal under section 8.08) may be necessary or appropriate in the following situations:

1. In a closely held corporation, the director charged with misconduct is elected by voting group or cumulative voting, and the shareholders with power to prevent his removal exercise that power despite the existence of fraudulent or dishonest conduct. The classic example is where the director charged with misconduct himself possesses sufficient votes to prevent his own removal and exercises his voting power to that end.
2. In a publicly held corporation, the director charged with misconduct declines to resign, though urged to do so, and because of the large number of widely scattered shareholders, a special shareholders' meeting can be held only after a period of delay and at considerable expense.

A shareholder who owns less than 10 percent of the outstanding shares of the corporation may bring suit derivatively in the name of the corporation under this section upon compliance with the requirements of section 7.40. A shareholder who owns at least 10 percent of the outstanding shares of the corporation may maintain suit in his own name and in his own right without compliance with section 7.40. The corporation, however, must be made a party to the proceeding. See section 8.09(c).

The purpose of section 8.09 is to permit the prompt and efficient elimination of dishonest directors. It is not intended to permit judicial resolution of internal corporate struggles for control except in those cases in which a court finds that the director has been guilty of wrongful conduct of the type described.

NORTH CAROLINA COMMENTARY

This section increases from 5% (as in former G.S. 55-27(g)) to 10% the number of shares needed to petition for removal of a director. Otherwise, this section is consistent with the prior law.

OFFICIAL COMMENT

Vacancies on the board of directors may be filled either by the shareholders or by the board of directors. In large corporations the cost of calling a special meeting of shareholders may be prohibitive so that in those corporations filling vacancies by the board of directors is the norm. On the other hand, in a closely held corporation the shareholders may fill vacancies as readily as the board.

Section 8.10(a)(3) allows the directors remaining in office to fill vacancies even though they are fewer than a quorum. The test for the exercise of this power is whether the directors remaining in office are fewer than a quorum, not whether the directors seeking to act are fewer than a quorum. For example, on a board of six directors where a quorum is four, if there are two vacancies, they may not be filled under section 8.10(a)(3) at a "meeting" attended by only three directors. Even though the three directors are fewer than a quorum, section 8.10(a)(3) is not applicable because the number of directors remaining in office - four - is not fewer than a quorum.

Section 8.10(b) provides that if a voting group of shares is entitled to elect a director, only that voting group is entitled to fill a vacant office which was held by a director elected by that voting group. This section is part of the consistent treatment of directors elected by a voting group of shareholders. See sections 1.40, 7.25, 7.26, 7.28, 8.04 and 8.08(b).

Section 8.10(c) permits vacancies that will arise on a specific later date to be filled in advance of that date so long as the designee does not actually take office until the vacancy occurs. The director in the office that will become vacant may participate in the selection of his successor. A vacancy arising at a later date is most likely to arise because of a resignation effective at a later date; it may also arise in connection with retirements or with prospective amendments to bylaws. In a closely held corporation with a balance of power on the board of directors that was reached by agreement, a prospective resignation followed by the appointment of a successor under this section permits the board to act on the replacement before the change in balance caused by the resignation.

AMENDED NORTH CAROLINA COMMENTARY

This section is generally consistent with prior law. However, unlike the present section, former G.S. 55-27(c) permitted the bylaws as well as the articles of incorporation to withhold from directors the power to fill board vacancies and did not permit the directors to fill vacancies created by an increase in the authorized number of directors, except within a minimum-maximum range fixed by the shareholders.

This section expands the comparable Model Act section in subsection (a) by explicitly recognizing a vacancy occurring from failure by the shareholders to elect a full board and in subsection (b) by permitting the remaining directors elected by a voting group to fill a vacancy in that class of directors, both of which are consistent with former G.S. 55-27(c). The Model Act was modified in subsection (c) to conform to the changes made in G.S. 55-8-07(b) regarding the effective date of a resignation.

OFFICIAL COMMENT

This section puts at rest the question whether the board of directors can fix the compensation of its members for serving as directors. The practice of compensating directors is now of long standing, and the establishment of a policy with respect to director compensation is an appropriate function of the board of directors.

In publicly held corporations, compensation is customarily provided to nonmanagement directors. As stated in The Corporate Director's Guidebook, ". . . it is expected that a nonmanagement director will devote substantial attention to the affairs of the corporation and will be compensated accordingly." 33 BUS. LAW. 1591, 1622 (1978).

NORTH CAROLINA COMMENTARY 2018

This section differs from the Model Act by confirming that, in the case of a public corporation or of a private corporation that so provides in its articles of incorporation, if the board of directors fixes the compensation of directors, then regardless of their personal interest in that decision, the amount of compensation is presumed fair to the corporation and the challenger would be required to allege facts, that if proven true, would be sufficient to overcome the presumption in order to avoid dismissal at the summary judgment stage of any proceeding. In effect, the section confirms that the decision of a board regarding its compensation is subject to review under the business judgment rule, but the amendment does not preclude meritorious challenges where a board of directors has awarded itself compensation that is proven not to be fair to the corporation.

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 7, effective October 1, 2018, rewrote the first sentence which formerly read "Unless the articles of incorporation or bylaws provide otherwise, the board of directors may fix the compensation of directors", and added the second sentence.

OFFICIAL COMMENT

This section authorizes meetings of directors anywhere. No distinction is made between meetings in-state and out-of-state. It also authorizes the board of directors to permit any or all directors to participate in a meeting by the use of any means of communication by which all directors participating may simultaneously hear each other. This decision is discretionary with the board of directors, and a person participating in this fashion is deemed to be present in person at the meeting for purposes of quorum and voting requirements.

With the development of modern electronic technology, it is possible that the advantages of the traditional meeting, at which all members are present at a single place, may be obtained even though the members are physically dispersed and no two directors are present at the same place. The advantage of the traditional meeting is the opportunity for interchange that is permitted by a meeting in a single room at which members are physically present. If this opportunity for interchange is thought to be available by the board of directors, a meeting may be conducted by electronic means although no two directors are physically present at the same place and no specific place for the meeting is designated.

NORTH CAROLINA COMMENTARY

By providing that, in the absence of contrary provisions in the articles of incorporation or bylaws, "the board of directors may permit" telephonic participation in its meetings, this section resolves the ambiguity of former G.S. 55-29(c), which provided that a director "may participate" telephonically in such meetings. It is now clear that an individual director may not assert telephonic participation as a right.

OFFICIAL COMMENT

The power of the board of directors to act unanimously without a meeting is based on the pragmatic consideration that in many situations a formal meeting is a waste of time. For example, in a closely held corporation there will often be informal discussion by the manager-owners of the venture before a decision is made. And, of course, if there is only a single director (as is permitted by section 8.03), a written consent is the natural method of signifying director action. Consent may be signified on one or more documents if desirable.

In publicly held corporations, formal meetings of the board of directors may be appropriate for many actions. But there will always be situations where prompt action is necessary and the decision noncontroversial, so that approval without a formal meeting may be appropriate.

Under section 8.21 the requirement of unanimous consent precludes the possibility of stifling or ignoring opposing argument. A director opposed to an action that is proposed to be taken by unanimous consent, or uncertain about the desirability of that action, may compel the holding of a directors' meeting to discuss the matter simply by withholding his consent.

NORTH CAROLINA COMMENTARY

This section is generally consistent with former G.S. 55-29, except that it does not contain the provisions for estoppel of a director who does not object promptly after obtaining knowledge of the action. The drafters believed that little, if any, use was made of the estoppel provisions of former G.S. 55-29(a)(3).

The Model Act was modified in subsection (a) to conform to a corresponding change made in G.S. 55-7-04(a), providing that written consent to action without a meeting can be given before or after the action is taken.

Editor's Note. - Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Effect of Amendments. - Session Laws 2005-268, s. 9, effective October 1, 2005, in subsection (a), inserted "unrevoked" preceding "written consents signed" in the second sentence and "or revocation thereof" in the last sentence; and rewrote subsection (b).

OFFICIAL COMMENT

Regular meetings of the board of directors may be held without notice and special meetings require only two days' notice unless other requirements are imposed by the articles of incorporation or bylaws. The notice may be written or oral. Also, no statement of the purpose of either a regular or special meeting is necessary unless required by the articles of incorporation or bylaws. These requirements differ from the requirements applicable to meetings of shareholders because of fundamental differences in their roles: directors are expected to be more closely involved in corporate affairs than shareholders, and meetings of directors are held more systematically and regularly than meetings of shareholders.

NORTH CAROLINA COMMENTARY

This section is consistent with former G.S. 55-28(c).

The section differs in subsection (b) from the Model Act by requiring five instead of two days' notice of meetings in the absence of a notice provision in the articles of incorporation or bylaws, and by adding "this act" to the last sentence of the subsection.

OFFICIAL COMMENT

Section 8.23(a) reverses the common law rule that invalidates waivers of notice by directors after the date and time of the meeting. In modern practice notice is often a technical requirement and waivers should be freely permitted.

Section 8.23(b) recognizes that the function of notice is to inform directors of a meeting. If a director actually appears at the meeting he has probably had notice of it and generally should not be able to raise a technical objection that he was not given notice.

In cases where actual prejudice occurs because of the lack of notice, as may be indicated by the absence of one or more other directors, the director must call attention to the defect at the outset of the meeting or promptly upon his arrival. That director, or a director who did not receive notice and was not present at the meeting, may then attack the validity of the action taken for want of notice. If a director properly objects to the meeting being held, he is not presumed to have assented to actions taken thereafter, but he waives his objection if he there after votes for or assents to action taken at the meeting. See section 8.24(d).

NORTH CAROLINA COMMENTARY

This section is substantially the same as former G.S. 55-28(c) and 55-172.

OFFICIAL COMMENT TO THE MODEL BUSINESS CORPORATION ACT, =nl 2016 REVISION

In the absence of a provision in the articles of incorporation or bylaws, a quorum is a majority of the total number of directors specified ( e.g., "the number of directors shall be X") in or fixed ( e.g., "the number of directors shall be not less than Y or more than Z as determined by the board of directors") in accordance with the articles of incorporation or the bylaws.

Section 8.24(a) recognizes that the Act itself may provide for a different quorum in certain specified situations. See sections 8.53(c)(1) and 8.55(b)(1).

Section 8.24 allows the articles of incorporation or bylaws to decrease the required quorum (but not below one-third) or to increase the quorum or the vote necessary to take action up to and including unanimity. The articles of incorporation or bylaws may also establish quorum or voting requirements with respect to directors elected by voting groups of shareholders pursuant to section 8.04. The options to increase the quorum and vote requirements might be used, for example, in closely held corporations where a greater degree of participation is thought appropriate or where a minority participant in the venture seeks to obtain a veto power over corporate action.

The phrase "when the vote is taken" in section 8.24(c) is designed to make clear that the board of directors may act only when a quorum is present. If directors leave during the course of a meeting, the board of directors may not act after the number of directors present is reduced to less than a quorum.

If a director who is present at a meeting wishes to object or abstain with respect to action taken by the board of directors or a committee, that director must make his or her position clear in one of the ways described in section 8.24(d). If objection is made in the form of a written dissent under clause (iii) of section 8.24(d), it may be transmitted by any form of delivery authorized by the definition of that term in section 1.40, including electronic transmission, if authorized by section 1.41. Section 8.24(d) serves the important purpose of bringing the position of the dissenting director clearly to the attention of the other directors. The provision that a director who is present is deemed to have assented unless an objection is noted also prevents a director from later seeking to avoid responsibility because of unexpressed doubts about the wisdom of the action taken.

Section 8.24(d) applies only to directors who are present at the meeting. Directors who are not present are not deemed to have assented to any action taken at the meeting in their absence.

NORTH CAROLINA COMMENTARY

This section is generally consistent with prior law but clarifies an ambiguity in former G.S. 55-28(d) by expressly requiring in subsection (c) that a quorum be present when the vote is taken, thus explicitly permitting directors to prevent further action by withdrawing from the meeting to eliminate a quorum.

This section varies from the Model Act in requiring in subsection (b) that a bylaw fixing a low quorum be "adopted by the shareholders." For clarification, the word "files" was substituted in subdivision (d) (3) for the Model Act's ambiguous "delivers."

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 8, effective October 1, 2018, in subsection (d), substituted "committee or subcommittee" for "committee", "unless any of the following requirements are met" for "unless", "The director" for "He", "The director's" for "His", and made minor stylistic changes throughout.

Legal Periodicals. - For note on unanimous approval of corporate bylaws and creation of shareholder agreements, see 1 Campbell L. Rev. 153 (1979).

CASE NOTES

No Cause of Action Stated. - Claim against director of dissolved corporation did not state a cause of action where plaintiff only alleged that director was officer when corporation dissolved and where there was no allegation that corporation's assets were distributed by officers without providing for known or reasonably ascertainable liabilities. Heather Hills Home Owners Ass'n v. Carolina Custom Dev. Co., 100 N.C. App. 263, 395 S.E.2d 154 (1990), decided under former G.S. 55-32.

OFFICIAL COMMENT

Section 8.25 makes explicit the common law power of a board of directors to act through committees of directors and specifies the powers of the board of directors that are nondelegable, that is, powers that only the full board of directors may exercise. Section 8.25 deals only with committees of the board of directors exercising the functions of the board of directors; the board of directors or management, independently of section 8.25, may establish nonboard committees composed of directors, employees, or others to deal with corporate powers not required to be exercised by the board of directors.

Section 8.25(b) provides that a committee of the board of directors may be created only by the affirmative vote of a majority of the board of directors then in office, or, if greater, by the number of directors required to take action by the articles of incorporation or the bylaws. This supermajority requirement reflects the importance of the decision to invest board committees with power to act under section 8.25.

Committees of the board of directors are assuming increasingly important roles in the governance of publicly held corporations. See "The Corporate Director's Guidebook," 33 BUS. LAW. 1591 (1978); "The Overview Committees of the Board of Directors," 35 BUS. LAW. 1335 (1980). Executive committees have long provided guidance to management between meetings of the full board of directors. Audit committees also have a long history of performing essential review and control functions on behalf of the board of directors. In recent years nominating and compensation committees, composed primarily or entirely of nonmanagement directors, have also become more widely used by publicly held corporations.

Section 8.25 establishes the desirable and appropriate role of director committees in light of competing considerations: on the one hand, it seems clear that appropriate board committee action is not only desirable but also is likely to improve the functioning of larger and more diffuse boards of directors; on the other hand, wholesale delegation of authority to a board committee, to the point of abdication of director responsibility as a board of directors, is manifestly inappropriate and undesirable. Overbroad delegation also increase the potential, where the board of directors is divided, for usurpation of basic board functions by means of delegation to a committee dominated by one faction.

The statement of nondelegable functions set out in section 8.25(e) is based on the principle that prohibitions against delegation should be limited generally to actions substantially affecting the rights of shareholders among themselves as shareholders and specifically to (1) those matters that have immediate and irrevocable effect (such as the declaration of a dividend), (2) those matters that may well become irrevocable without swift action, and (3) those matters that will cause changes of position by others that cannot be rectified. As a result, delegation of authority to committees under section 8.25(e) may be broader than mere authority to act with respect to matters arising within the ordinary course of business. The ordinary course of business standard for delegation was rejected as being too narrow and inappropriate for many modern corporations. For example, although section 8.25(e)(8) makes nondelegable the decision whether to issue and sell shares or create a class or series of shares with designated rights and preferences, it permits the board of directors to delegate to a committee (within limits specifically prescribed by the board of directors) the important but more limited functions of fixing the specific terms - including without limitation, the price, the dividend rate, provisions for redemption, sinking fund, conversion, voting or preferential rights, and provisions for other features of a class or series of shares. The committee may also be empowered to adopt any final resolution setting forth the terms and to authorize the appropriate filing with the Secretary of State required by this Act. Thus, terms of the sale of shares may be set quickly and upon the most accurate information without necessarily involving a meeting of the board of directors. The phrase "(or senior executive officer of the corporation)" also permits these functions to be delegated to the chief financial officer or other appropriate officer of the corporation. The subsection also permits delegation to a committee of authority to determine the terms of a contract or option for the sale of shares if the board prescribes specific limits in a stock option plan or otherwise. This delegation avoids requiring involvement of the full board in the details of the administration of stock option or other compensation plans.

Section 8.25(e) prohibits delegation of authority with respect to most mergers, sales of substantially all the assets, amendments to articles of incorporation and voluntary dissolution under section 8.25(e)(2) since these require shareholder action. In addition, section 8.25(e) prohibits delegation to a board committee of authority to declare dividends or distributions, designate director candidates for purposes of proxy solicitation, fill board vacancies, approve a so-called "short-form merger" (where the interests of the minority shareholders warrant special attention), authorize the disposition or reacquisition of shares, or amend the bylaws or the articles of incorporation (without shareholder approval under section 10.02). On the other hand, under section 8.25(e) many actions of a material nature, such as the authorization of long-term debt and capital investment or the pricing of shares, may properly be made the subject of committee delegation.

The statutes of several states make nondelegable certain powers not listed in section 8.25(e) - for example, the power to change the principal corporate office, to appoint or remove officers, to fix director compensation, or to remove agents. These are not prohibited by section 8.25(e) since the whole board of directors may reverse or rescind the committee action taken, if it should wish to do so, without undue risk that implementation of the committee action might be irrevocable or irreversible.

Section 8.25(f) makes clear that although the board of directors may delegate to a committee the authority to take action, the designation of the committee, the delegation of authority to it, and action by the committee will not alone constitute compliance by a noncommittee board member with his responsibility under section 8.30. On the other hand, a noncommittee director also will not automatically incur liability should the action of the particular committee fail to meet the standard of care set out in section 8.30. The noncommittee member's liability in these cases will depend upon whether he failed to comply with section 8.30(b)(3). Factors to be considered in this regard will include the care used in the delegation to and supervision over the committee, and the amount of knowledge regarding the particular matter which the noncommittee director has available to him. Care in delegation and supervision include appraisal of the capabilities and diligence of the committee directors in light of the subject and its relative importance and may be facilitated, in the usual case, by review of minutes and receipt of other reports concerning committee activities. The enumeration of these factors is intended to emphasize that directors may not abdicate their responsibilities and secure exoneration from liability simply by delegating authority to board committees. Rather, a director against whom liability is asserted based upon acts of a committee of which he is not a member avoids liability if the standards contained in section 8.30 are met.

Section 8.25(f) has no application to a member of the committee itself. The standard applicable to a committee member is set forth in section 8.30(a).

AMENDED NORTH CAROLINA COMMENTARY

The powers which may not be delegated to committees, specified in subsection (e) of this section, are different and more extensive than those specified in former G.S. 55-31(a). Also, this section contains no counterpart of former G.S. 55-31(c), which expressly held the board responsible for action of its committees. This difference is moderated by subsection (f) of the present section.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended (i) to permit a committee of the board of directors to consist of a single director, (ii) to permit a committee to approve the corporation's purchase of its own shares, to approve the issuance of shares, and to determine the designation and relative rights, preferences, and limitations of a class or series of shares, and (iii) to recognize the special procedures provided in G.S. 55-7-44(b)(2) for appointment of a committee to make certain determinations in a derivative proceeding.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2007)

The amendment to subsection (e)(1) affected by Session Law 2007-385 permits a board of directors to delegate to a committee the authority to authorize or approve distributions, but only according to a formula or method, or within limits, prescribed by the board of directors. This applies to distributions as defined in G.S. 55-1-40, including but not limited to share reacquisitions and dividends.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2018)

Subsection (a) provides that a board of directors may create committees and appoint one or more members of the board of directors to serve on the committees, but does not address the use of substitute committee members. The change in subsection (h), which is based on Model Act (2016 Revision) Section 8.25(e), empowers board committees to continue operating despite a member's absence or disqualification by allowing the full board to designate another board member who would be available to act without delay in committee meetings if a regular committee member was disqualified or unable to be present at a committee meeting.

Unless otherwise required by committee governing documents, replacement of an absent or disqualified member is not necessary to permit the other committee members to continue to perform their duties (provided that a quorum is present). Rather, appointing alternate committee members in advance is intended as an expedient temporary solution, allowing a committee to continue effectively accomplishing its duties despite an absent or disqualified committee member and without necessity of convening a special meeting of the full board to make a short-fuse replacement. The alternate director owes the same fiduciary duties and is subject to the same liabilities as any other director.

Editor's Note. - Session Laws 2007-385, s. 7, provides: "The Revisor of Statutes may cause to be printed all explanatory comments of the drafters of the act as the Revisor deems appropriate."

The comment under the heading Supplemental North Carolina Commentary (2007) above was printed under authority of Session Laws 2007-385, s. 7. It was provided by the original drafters of Session Laws 2007-385 and was printed as received.

Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2005-268, s. 8, effective October 1, 2005, rewrote subsections (a) and (c); added "unless this chapter provides otherwise" in subsection (b); added subsection (b1); substituted "shall not, however, do any of the following" for "may not, however" in subsection (e); deleted former subdivisions (e)(7) and (e)(8); and made minor punctuation changes.

Session Laws 2007-385, s. 1, effective August 19, 2007, substituted "or approve distributions, except according to a formula or method, or within limits, prescribed by the board of directors" for "distributions" in subdivision (e)(1).

Session Laws 2018-45, s. 9, effective October 1, 2018, in subsection (a), substituted "the committee" for "any such committee" in the first sentence, and added the last sentence; in subsection (b), substituted "shall" for "must", and "greater of either of the following" for "greater of", and made a minor stylistic change; substituted "committees and subcommittees" for "committees" in subsection (c); substituted "committee or subcommittee" for "committee" in subsection (f); and added subsection (g).

Legal Periodicals. - For note, "Alford v. Shaw: North Carolina Adopts a Prophylactic Rule to Prevent Termination of Shareholders' Derivative Suits Through Special Litigation Committees," see 64 N.C.L. Rev. 1228 (1986).

CASE NOTES

Editor's Note. - The case below was decided under the Business Corporation Act adopted in 1955.

Special Litigation Committee. - The fact that the appointing members of a board of directors are acting under the "disability" of potential liability as a result of shareholder allegations does not per se extend to disable them from delegating managerial authority over the litigation to a special litigation committee. Alford v. Shaw, 318 N.C. 289, 349 S.E.2d 41 (1986), modified and aff'd on rehearing, 320 N.C. 465, 358 S.E.2d 323 (1987).

OFFICIAL COMMENTS (2013)

Section 8.26 is intended to clarify that a corporation can enter into an agreement, such as a merger agreement, containing a force the vote provision. Section 8.26 is broader than some analogous state corporation law provisions and applies to several different provisions of the Model Act that require the directors to approve a matter before recommending that the shareholders vote to approve it. Under section 8.26, directors can agree to submit a matter to the shareholders for approval even if they later determine that they no longer recommend it. The provision is not intended to relieve the board of directors of its duty to consider carefully the proposed transaction and the interests of the shareholders.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

OFFICIAL COMMENT

Section 8.30 defines the general standard of conduct for directors. It sets forth the standard by focusing on the manner in which the director performs his duties, not the correctness of his decisions. Section 8.30(a) thus requires a director to perform his duties in good faith, with the care of an ordinarily prudent person in a like position and in a manner he believes to be in the best interests of the corporation. This standard is based on former section 35 of the 1969 Model Act, a number of state statutes and on judicial formulations of the duty of care applicable to directors. Section 8.30 also parallels, to the extent possible, the indemnification provisions of sections 8.50 through 8.58.

In determining whether to impose liability, the courts recognize that boards of directors and corporate managers continuously make decisions that involve the balancing of risks and benefits for the enterprise. Although some decisions turn out to be unwise or the result of a mistake of judgment, it is unreasonable to reexamine these decisions with the benefit of hindsight. Therefore, a director is not liable for injury or damage caused by his decision, no matter how unwise or mistaken it may turn out to be, if in performing his duties he met the requirements of section 8.30.

Even before statutory formulations of directors' duty of care, courts sometimes invoked the business judgment rule in determining whether to impose liability in a particular case. In doing so, courts have sometimes used language similar to the standards set forth in section 8.30(a). The elements of the business judgment rule and the circumstances for its application are continuing to be developed by the courts. In view of that continuing judicial development, section 8.30 does not try to codify the business judgment rule or to delineate the differences, if any, between that rule and the standards of director conduct set forth in this section. That is a task left to the courts and possibly to later revisions of this Model Act.

Section 8.30 should be read in light of the basic duty of directors set forth in section 8.01(b) that the "business and affairs of a corporation [shall be] managed under the direction of" the board. Since the board may delegate or assign to appropriate officers of the corporation the authority or duty to exercise powers that section 8.01 does not require the board to retain, directors are not personally responsible under section 8.30 for actions or omissions of officers, employees, or agents of the corporation so long as the directors, complying with the standard of care set forth in section 8.30, have acted reasonably in delegating responsibility.

1. Section 8.30(a)
2. Section 8.30(b)
3. Section 8.30(c)
4. Section 8.30(d)
5. Application to officers

Section 8.30(a) establishes a general standard of care for all directors. It requires a director to exercise "the care an ordinarily prudent person in a like position would exercise." Some state statutes use the words "diligence," "care," and "skill" to define this duty. E.G., N.C. GEN. STAT. ANN. § 55-35 (1975). There is very little authority as to what "skill" and "diligence," as distinguished from "care," can be required or properly expected of corporate directors in the performance of their duties. "Skill," in the sense of technical competence in a particular field, should not be a qualification for the office of director. The concept of "diligence" is sufficiently subsumed within the concept of "care." Accordingly, the words "diligence" and "skill" were omitted from the standard adopted.

Likewise, section 8.30 does not use the term "fiduciary" in the standard for directors' conduct, because that term could be confused with the unique attributes and obligations of a fiduciary imposed by the law of trusts, some of which are not appropriate for directors of a corporation.

Several of the phrases chosen to define the general standard of care in section 8.30(a) deserve specific mention.

1. The reference to "ordinarily prudent person" embodies long traditions of the common law, in contrast to suggested standards that might call for some undefined degree of expertise, like "ordinarily prudent businessman." The phrase recognizes the need for innovation, essential to profit orientation, and focuses on the basic director attributes of common sense, practical wisdom, and informed judgment.
2. The phrase "in a like position" recognizes that the "care" under consideration is that which would be used by the "ordinarily prudent person" if he were a director of the particular corporation.
3. The combined phrase "in a like position . . . under similar circumstances" is intended to recognize that (a) the nature and extent of responsibilities will vary, depending upon such factors as the size, complexity, urgency, and location of activities carried on by the particular corporation, (b) decisions must be made on the basis of the information known to the directors without the benefit of hindsight, and (c) the special background, qualifications, and management responsibilities of a particular director may be relevant in evaluating his compliance with the standard of care. Even though the quoted phrase takes into account the special background, qualifications and management responsibilities of a particular director, it does not excuse a director lacking business experience or particular expertise from exercising the common sense, practical wisdom, and informed judgment of an "ordinarily prudent person."

The process by which a director informs himself will vary but the duty of care requires every director to take steps to become informed about the background facts and circumstances before taking action on the matter at hand. In relying upon the performance by management of delegated or assigned duties pursuant to section 8.01 (including, for example, matters of law and legal compliance), the director may depend upon the presumption of regularity, absent knowledge or notice to the contrary. A director may also rely on information, opinions, reports, and statements prepared or presented by others as set forth in section 8.30(b). Furthermore, a director should not be expected to anticipate the problems which the corporation may face except in those circumstances where something has occurred to make it obvious to the director that the corporation should be addressing a particular problem.

A director complying with the standards expressed in section 8.30(a) is entitled to rely upon information, opinions, reports or statements, including financial statements and other financial data, prepared or presented by the persons or committees described in section 8.30(b). The right to rely under this section applies to the entire range of matters for which the board of directors is responsible. Under section 8.30(c), however, a director so relying must be without knowledge concerning the matter in question that would cause his reliance to be unwarranted. Also inherent in the concept of good faith is the requirement that, in order to be entitled to rely on a report, statement, opinion, or other matter, the director must have read the report or statement in question, or have been present at a meeting at which it was orally presented, or have taken other steps to become generally familiar with its contents. In short, the director must comply with the general standard of care of section 8.30(a) in making a judgment as to the reliability and competence of the source of information upon which he proposes to rely.

Section 8.30(b) permits reliance upon outside advisers, including not only those in the professional disciplines customarily supervised by state authorities, such as lawyers, accountants, and engineers, but also those in other fields involving special experience and skills, such as investment bankers, geologists, management consultants, actuaries, and real estate appraisers. The concept of "expert competence" in section 8.30(b)(2) embraces a wide variety of qualifications and is not limited to the more precise and narrower recognition of experts under the Securities Act of 1933. In this respect section 8.30(b) goes beyond any existing state business corporation act, although several state statutes permit reliance on reports of appraisers selected with reasonable care by the board of directors and deal with the scope and nature of corporate reports and records generally.

Section 8.30(b) permits reliance upon a committee of the board of directors when performing a supervisory or other functions in instances where neither the full board of directors nor the committee takes dispositive action. For example, there may be reliance upon an investigation undertaken by a board committee and reported to the full board of directors, which forms the basis for action by the board of directors itself. Another example is reliance upon a committee of the board of directors, such as a corporate audit committee, with respect to the ongoing role of oversight of the accounting and auditing functions of the corporation. In addition, where reliance upon information or materials prepared or presented by a board committee is not involved, a director may properly rely on dispositive action by a board committee (of which he is not a member) empowered to act pursuant to authority delegated under section 8.25 or acting with the acquiescence of the board of directors. In this connection, see the Official Comment to section 8.25. A director may similarly rely on committees not created under section 8.25 which have nondirector members.

Section 8.30(b) permits reliance upon a committee of the board of directors when performing a supervisory or other functions in instances where neither the full board of directors nor the committee takes dispositive action. For example, there may be reliance upon an investigation undertaken by a board committee and reported to the full board of directors, which forms the basis for action by the board of directors itself. Another example is reliance upon a committee of the board of directors, such as a corporate audit committee, with respect to the ongoing role of oversight of the accounting and auditing functions of the corporation. In addition, where reliance upon information or materials prepared or presented by a board committee is not involved, a director may properly rely on dispositive action by a board committee (of which he is not a member) empowered to act pursuant to authority delegated under section 8.25 or acting with the acquiescence of the board of directors. In this connection, see the Official Comment to section 8.25. A director may similarly rely on committees not created under section 8.25 which have nondirector members.

In conditioning reliance upon reasonable belief that the board committee merits the director's "confidence," section 8.30(b)(3) recognizes a difference between a board committee and an expert. In sections 8.30(b)(1) and (2) the reference is to "competence of an expert," which recognizes the expectation of experience and in most instances technical skills on the part of those upon whom the director may rely. In section 8.30(b)(3), the concept of "confidence" is substituted for "competence" in order to avoid any inference that technical skills are a prerequisite.

By identifying those upon whom a director may rely in discharging his duties, section 8.30(b) does not limit the ability of directors to delegate their powers under section 8.01(a) to committees of the board of directors or officers of the corporation, except where this delegation is expressly prohibited by the Act. Delegation should be carried out in accordance with the standards set forth in section 8.30(a). See also section 8.25 and its Official Comment with respect to delegation to committees.

Section 8.30(c) expressly prevents a director from "hiding his head in the sand" and relying on information, opinions, reports, or statements when he has actual knowledge which makes reliance unwarranted.

Section 8.30(d) follows former section 35 of the Model Act, which provided that "An individual who performs the duties of his office in accordance with this section is not liable for serving or having served as a director." Thus, both former section 35 and current section 8.30(d) are self-executing, and the individual director's exoneration from liability is automatic. If compliance with the standard of conduct set forth in former section 35 or section 8.30 is established, there is no need to consider possible application of the business judgment rule. The possible application of the business judgment rule need only be considered if compliance with the standard of conduct set forth in former section 35 or section 8.30 is not established.

Section 8.30(d) makes clear that the section will apply whether or not affirmative action was in fact taken. If the board of directors or a committee considers an issue (such as a recommendation of independent auditors concerning the corporation's internal accounting controls) and determines not to take action, the determination not to act is protected by section 8.30. Similarly, if the board of directors or committee delegates responsibility for handling a matter to subordinates, the delegation constitutes "action" under section 8.30. Section 8.30(d) applies (assuming its requirements are satisfied) to any conscious consideration of matters involving the affairs of the corporation. It also applies to the determination by the board of directors of which matters to address and which not to address. Section 8.30(d) does not apply only when the director has failed to consider taking action which under the circumstances he is obliged to consider taking.

Section 8.30 generally deals only with directors. Section 8.42 and its Official Comment explain the extent to which the provisions of section 8.30 apply to officers.

NORTH CAROLINA COMMENTARY

Although the word "fiduciary" is no longer used in describing the duty owed by a director to a corporation, there is no intent to change North Carolina law in this area. The decision not to bring forward the language stating that a director shall "be deemed to stand in a fiduciary relation to the corporation" in former G.S. 55-35 is not intended to modify in any way the duty of directors recognized under the former law. Removal of the word "fiduciary" was solely because of confusion in other jurisdictions between the corporate and the trust standards of fiduciary duty. This Act does not attempt to define the full range of a director's duty, since the language chosen might be used to limit the standards under which directors should act.

Former G.S. 55-35 provided that officers and directors stand in a fiduciary relation "to the corporation and to its shareholders." The drafters decided not to bring forward the words "and to its shareholders" in order to avoid an interpretation that there is a duty running directly from directors to the shareholders that would give shareholders a direct right of action on claims that should be asserted derivatively.

The drafters noted the dictum in Snyder v. Freeman , 300 N.C. 204, 266 S.E.2d 593 (1980), suggesting that directors owe a fiduciary duty to creditors. The drafters considered adding a new section 55-8-34 expressly stating that the directors do not have any such duty to creditors; but, because of the complexities and novelty of such a provision, they finally decided not to add the new section but instead to express in this Comment their opinion that in general no such duty exists.

Subsection (c) of this section is different from the Model Act in two respects. First, it requires "actual" knowledge for a director to be denied the right of reliance under subsection (b); and, second, it says more specifically that a director who has such knowledge is not "entitled to the benefit of subsection (b)" instead of saying that such director is not "acting in good faith."

Subsection (e) of the section was added to the Model Act's provisions to clarify the two points covered. It should be noted that a provision in the articles of incorporation that limits a director's monetary liability for a breach of the duty of due care does not affect the duty of due care itself.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY 2018

Clause (ii) of subsection (d), effective October 1, 2018, provides an affirmative defense to liability where an articles of incorporation provision has been adopted under G.S. 55-2-02(b)(4) that eliminates a director's duties with respect to the applicable business opportunity.

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 10, effective October 1, 2018, substituted "committee or subcommittee, in accordance with all of the following:" for "committee:" in subsection (a); in subsection (b), substituted "the duties of a director's office," for "his duties", "by any of the following:" for "by:", and substituted "committee or subcommittee" for "committee" in subdivision (b)(3); added "of this section" following "subsection (b)" throughout subsection (c); rewrote subsection (d); substituted "the director" for "he" and made minor stylistic changes throughout the section.

Legal Periodicals. - For note on the fiduciary duty of interested directors and the business judgment rule, see 45 N.C.L. Rev. 755 (1967).

For comment on promoters of corporations dealing in condominiums, see 12 Wake Forest L. Rev. 979 (1976).

For note on close corporations and personal liability from execution of shareholder agreements, see 16 Wake Forest L. Rev. 975 (1980).

For article on corporate directors' accountability, see 66 N.C.L. Rev. 171 (1987).

For article discussing derivative suit litigation, see 66 N.C.L. Rev. 565 (1988).

For comment, "Fiduciary Duties of Directors, How Far Do They Go?," see 23 Wake Forest L. Rev. 163 (1988).

For article, "Reliance and Liability Standards for Outside Directors," see 24 Wake Forest L. Rev. 5 (1989).

For article, "The Effect of Statutes Limiting Directors' Due Care Liability on Hostile Takeover Defenses," see 24 Wake Forest L. Rev. 31 (1989).

For article, "Should Corporate Statutes Providing Special Protection for Directors Be Limited to Publicly Traded Corporations?," see 24 Wake Forest L. Rev. 79 (1989).

For article, "Intracorporate Process and the Avoidance of Director Liability," see 24 Wake Forest L. Rev. 97 (1989).

For comment, "North Carolina's Statutory Limitation on Directors' Liability," see 24 Wake Forest L. Rev. 117 (1989).

For comment on corporate law and director liability, see 24 Wake Forest L. Rev. 141 (1989).

For article, "The Duty of Directors to Non-Shareholder Constituencies in Control Transactions - A Comparison of U.S. and U.K. Law," see 25 Wake Forest L. Rev. 61 (1990).

For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For note, "First Union v. Suntrust and The Delaware Experience: An Analysis of Deal Protection Measures," see 80 N.C.L. Rev. 2109 (2002).

For recent development, "In re Wachovia Shareholders Litigation: The Case for the Common Benefit Doctrine," see 84 N.C. L. Rev. 2066 (2006).

For article, "Duties of the Modern Corporate Executive: Article & Essay: Fiduciary Constraints: Correlating Obligation with Liability," see 42 Wake Forest L. Rev. 697 (2007).

For article, "To Incorporate or not to Incorporate - That is the Question: How State v. Custard Clarified Corporate Governance in North Carolina," see 33 N.C. Cent. L. Rev. 175 (2011).

For article, "Duties of Nonprofit Corporate Directors - Emphasizing Oversight Responsibilities," see 90 N.C. L. Rev. 1845 (2012).

For article, "Is the Corporate Director's Duty of Care a 'Fiduciary' Duty? Does it Matter?," see 48 Wake Forest L. Rev. 1027 (2013).

For article, "Holding Out for a Change: Why North Carolina Should Permit Holder Claims," see 92 N.C. L. Rev. 988 (2014).

For article, "Overcoming the Rippy Effect: Why the North Carolina Business Corporations Act Should Allow Permissive Officer Exculpation," see 94 N.C.L. Rev. 2155 (2016).

CASE NOTES

Editor's Note. - Many of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Common Law of Business Judgment Rule Not Abrogated. - This section does not abrogate the common law of the business judgment rule. State ex rel. Long v. ILA Corp., 132 N.C. App. 587, 513 S.E.2d 812 (1999).

Directors Are Trustees of Property of Corporation. - Directors of a corporation are trustees of the property of the corporation for the benefit of the corporate creditors, as well as shareholders. It is their duty to administer the trust assumed by them, not for their own profit, but for the mutual benefit of all interested parties; and, when such directors receive an advantage to themselves not common to all, they are guilty of a plain breach of trust. Meiselman v. Meiselman, 58 N.C. App. 758, 295 S.E.2d 249 (1982), modified and aff'd, 309 N.C. 279, 307 S.E.2d 551 (1983).

Directors owe the corporation fidelity and the duty to use due care in the management of its business. Wilson v. McClenny, 262 N.C. 121, 136 S.E.2d 569 (1964).

Director in Fiduciary Relationship to Shareholder. - Under special circumstances, a director of a corporation stands in a fiduciary relationship to a shareholder or director in the acquisition of the shareholder's stock. Lazenby v. Godwin, 40 N.C. App. 487, 253 S.E.2d 489 (1979).

Director's Fiduciary Duty to Creditors. - As a general rule, directors of a corporation do not owe a fiduciary duty to creditors of the corporation under G.S. 55-8-30, but a corporate director can breach a fiduciary duty to a creditor if the transaction at issue occurs under circumstances amounting to a winding-up or dissolution of the corporation. Oberlin Capital, L.P. v. Slavin, 147 N.C. App. 52, 554 S.E.2d 840 (2001).

General rule under North Carolina law that the fiduciary duties owed by a director of a corporation per G.S. 55-8-30(a) were owed to the corporation and not to its creditors did not foreclose a suit by corporate creditors against directors thereof where the creditors claimed that the directors had continued to operate the corporation despite the fact that it was insolvent for the purposes of obtaining payment of debts owed by the corporation to the directors. In re Bostic Constr., Inc., 435 B.R. 46 (Bankr. M.D.N.C. June 25, 2010).

Officer Not Protected. - The director and chief executive officer of an insolvent insurer and its parent corporation was not protected by the business judgment rule from liability for breach of his fiduciary duties, where the director was a leading participant in a plan to benefit himself and his interests at the expense of the insurer. State ex rel. Long v. ILA Corp., 132 N.C. App. 587, 513 S.E.2d 812 (1999).

Where the former president of a Chapter 11 debtor claimed that his actions were sheltered by the business judgment rule and G.S. 55-8-30(d), the debtor was entitled to summary judgment on its claim against the president for breach of fiduciary duty because the debtor rebutted any presumption that the president acted in good faith and with the care of an ordinarily prudent person by showing that certain transfers of property from the debtor to the president were transactions in which the president had a direct financial interest. Anderson v. Brokers Inc. (In re Brokers, Inc.), 363 B.R. 458 (Bankr. M.D.N.C. 2007).

Duty Owed to Minority Shareholders. - Directors, officers, and majority shareholders owe a fiduciary duty and obligation of good faith to minority shareholders as well as to the corporation. Meiselman v. Meiselman, 58 N.C. App. 758, 295 S.E.2d 249 (1982), modified and aff'd, 309 N.C. 279, 307 S.E.2d 551 (1983); Umstead v. Durham Hosiery Mills, Inc., 578 F. Supp. 342 (M.D.N.C. 1984).

Fiduciary Duty. - Directors of a corporation generally owed a fiduciary duty to their corporation and the complaint adequately stated a cause of action for breach of the fiduciary duty against a corporation's directors. Governor's Club Inc. v. Governors Club Ltd. P'ship, 152 N.C. App. 240, 567 S.E.2d 781 (2002), aff'd sub nom., 357 N.C. 46, 577 S.E.2d 620 (2003).

Evidence was sufficient to establish a breach of defendant's fiduciary duty to plaintiff as a minority shareholder. Freese v. Smith, 110 N.C. App. 28, 428 S.E.2d 841 (1993).

Board of directors of a bank that merged with another bank did not breach its fiduciary duties by employing improper deal protection measures, failing to comply with statutory share exchange requirements, and failing to make material disclosures concerning the merger. Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

Shareholders of an acquired bank could not proceed with their lawsuit as individual shareholders under the "special duty" exception to the general rule as they failed to allege any facts from which it may be inferred that the financial institution owed the shareholders a duty that was personal to the shareholders and distinct from the duty owed to an acquired bank and its shareholders. Rice-Marko v. Wachovia Corp., 398 S.C. 301, 728 S.E.2d 61 (June 27, 2012).

As the former director and officers of an insolvent corporation tried to secure financing for its continued operation up until the point that a lender foreclosed on its secured loans, the directors and officers did not own a fiduciary duty to plaintiff or the corporation's other creditors. United States Trouser, S.A. de C.V. v. Int'l Legwear Group, Inc., - F. Supp. 2d - (W.D.N.C. Dec. 13, 2012).

Director of a corporation, by the director's concealment of the criminal and driving history of the director and the director's adult child, who was also an employee of the corporation, breached a fiduciary duty of loyalty to the corporation and the other directors, who, upon learning of the concealment, terminated the director from the director's position with the corporation. Harris v. Testar, Inc., 243 N.C. App. 33, 777 S.E.2d 776 (2015).

It was error to dismiss a homeowners' association's breach of fiduciary duty claim against the association's directors and officers because (1) the directors and officers owed the association such a duty, and (2) it was alleged that the directors and officers did not act in the association's interests. Conleys Creek Ltd. P'ship v. Smoky Mt. Country Club Prop. Owners Ass'n, - N.C. App. - , 799 S.E.2d 879 (2017), sub. op., 805 S.E.2d 147, 2017 N.C. App. LEXIS 740 (N.C. Ct. App. 2017).

Trial court erred in dismissing a homeowners association's (HOA) counterclaim for breach of fiduciary duty as to a director and officer of the HOA because the HOA made a number of allegations which, if true, tended to show that they acted in their own interests and not in the best interests of the HOA or within the applicable limitations period. Conleys Creek Limited Partnership v. Smoky Mt. Country Club Prop. Owners Ass'n, 370 N.C. 695, 255 N.C. App. 236, 805 S.E.2d 147 (2017), appeal dismissed, 811 S.E.2d 596, 2018 N.C. LEXIS 263 (2018).

This Section Applies to Limited Partnerships. - In a limited partnership the duty of the general partner to the limited partners is a duty to discharge his responsibilities according to the business judgment rule outlined in G.S. 55-8-30. Jackson v. Marshall, 140 N.C. App. 504, 537 S.E.2d 232 (2000).

Fiduciary Duty as Question Where Revolving Fund Certificate Was Issued. - Revolving fund certificate held by plaintiff issued in exchange for stock sold to defendant had some characteristics of a corporation/shareholder relationship; therefore, issue of whether defendants owed plaintiff a fiduciary duty was properly submitted to the jury. HAJMM Co. v. House of Raeford Farms, Inc., 94 N.C. App. 1, 379 S.E.2d 868, reversed on other grounds, HAJMM Co. v. House of Raeford Farms, Inc., 328 N.C. 578, 403 S.E.2d 483 (1991), appeal of right allowed pursuant to Rule 16(b) and petition allowed as to additional issues, 325 N.C. 271, 382 S.E.2d 439 (1989), decided under the former Business Corporation Act.

Balance Sheet Insolvency. - For a corporate director to breach a fiduciary duty to a creditor, the transaction at issue must occur under circumstances amounting to a "winding up" or dissolution of the corporation; balance sheet insolvency, absent such circumstances, is insufficient to give rise to a breach of fiduciary duty to creditors of a corporation. Whitley v. Carolina Clinic, Inc., 118 N.C. App. 523, 455 S.E.2d 896 (1995).

Suit for Breach of Duty Is Derivative. - A suit against corporation's officers and directors for breach of their fiduciary duty on account of mismanagement is clearly derivative. Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980).

Shareholder's claims that corporate officers misrepresented the corporation's financial health, causing the value of its stock to decline, had to be brought in a derivative suit rather than an individual action. The special duty exception did not apply, as the fiduciary duty of disclosure was owed to the corporation itself under North Carolina law and did not give the shareholder a direct right of action. Rivers v. Wachovia Corp., 665 F.3d 610 (4th Cir. 2011).

When Action by Shareholders Is Individual. - Where several officers and directors were alleged to have breached the fiduciary duty owed to shareholders by maintaining the market price of the corporation's shares at artificial levels and in issuing false or misleading financial statements, the shareholder plaintiffs would be entitled to receive any recovery under these allegations and the action was thus individual. Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980).

Shareholder plaintiffs need not demonstrate that all defendants are amenable to suit. Rather, nonofficers and nondirectors may, by North Carolina common-law principles, be held to answer for substantially assisting or encouraging another's breach of fiduciary duty. Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980).

Civil Conspiracy Claim Premised on Statute. - Plaintiff former president's civil conspiracy claim alleged defendants, the directors of the corporation, violated the provisions of three federal criminal statutes relating to witness tampering and obstruction of justice, as set forth in 18 U.S.C.S. §§ 1503, 1512(b), (d), 1513(e), but none of those criminal statutes authorized a private cause of action for money damages, thus, he failed to allege the existence of a "predicate tort" to support the civil conspiracy claim, and further, although he also alleged the directors entered into an agreement to violate G.S. 55-8-30 as to the directors' fiduciary duties, those duties were owed to the corporation and the alleged violation of G.S. 55-8-30 was insufficient to support a claim for civil conspiracy. Feldman v. Law Enforcement Assocs. Corp., 779 F. Supp. 2d 472 (E.D.N.C. 2011).

Stockholders' "Holder" Claim Was Not Recognized in North Carolina. - Stockholders' complaint against the directors of a corporation failed to state a claim because North Carolina did not recognize holder claims. Estate of Browne v. Thompson, 219 N.C. App. 637, 727 S.E.2d 573 (2012), review denied 366 N.C. 426, 736 S.E.2d 495, 2013 N.C. LEXIS 110 (2013).

Creditor's Standing to Assert Violation of Duty. - Plaintiff's claim that former director and officers failed to perform their statutory duties by continuing to operate the corporation during insolvency instead of "winding down" did not survive summary judgment; as directors' and officers' duties under G.S. 55-8-30 and G.S. 55-8-42 were owed to the corporation, not to its creditors, plaintiff lacked standing to assert the claim. United States Trouser, S.A. de C.V. v. Int'l Legwear Group, Inc., - F. Supp. 2d - (W.D.N.C. Dec. 13, 2012).

Genuine Issue of Material Fact Shown. - Where defendants submitted a number of affidavits tending to substantiate their version of the facts and where plaintiff responded with evidence which, if believed, would enable a jury to find in the corporation's favor, the parties' submissions created a genuine issue of material fact as to whether defendants breached their duty of loyalty by diverting a deal from the corporation for which they were directors to another corporation so as to warrant denial of defendants' summary judgment motion. Silverman v. Miller, 155 Bankr. 362 (Bankr. E.D.N.C. 1993).

Issues regarding knowledge, intent and motive, in determining whether directors' actions were taken in good faith in order to further the interests of the corporations, depend upon credibility of witnesses and are therefore not amenable to resolution on summary judgment. Clark v. B.H. Holland Co., 852 F. Supp. 1268 (E.D.N.C. 1994).

Where a Chapter 11 debtor claimed that a former director breached his fiduciary duty in approving or executing transfers of property to the debtor's former president, the debtor was not entitled to summary judgment because there was an issue of material fact as to whether the director acted in good faith because there was evidence that the director honestly believed that a partnership existed between the debtor and the president, and that it was in the best interests of the debtor to pay its indebtedness to the president. Anderson v. Brokers Inc. (In re Brokers, Inc.), 363 B.R. 458 (Bankr. M.D.N.C. 2007).

Where directors of a bankruptcy debtor formed a management company to manage the debtor, genuine issues of material fact remained concerning whether the directors breached fiduciary duties since it was unclear whether the directors caused unnecessary transfer of the debtor's funds and whether the company's contract with the debtor served a legitimate business purpose. Ivey v. McDaniel (In re EBW Laser, Inc.), - Bankr. - (Bankr. M.D.N.C. Jan. 15, 2009).

Failure to Rely on the Advice of Professionals. - The director of an insolvent insurer did not rely on the advice of accounting and legal professionals, and thus, his statutory right to rely on their advice did not protect him from liability for breach of fiduciary duty in connection with loans made by the insurer, where actual advice received made the director aware that the loans were undercollateralized. State ex rel. Long v. ILA Corp., 132 N.C. App. 587, 513 S.E.2d 812 (1999).

Officer Not Personally Liable for Debt. - Where the evidence showed the defendant was an officer of a lawful corporation but had no knowledge, at the time debt was incurred on behalf of the corporation, that the corporate charter was suspended, the defendant had no personal liability for the corporation's debt to the plaintiff. Charles A. Torrence Co. v. Clary, 121 N.C. App. 211, 464 S.E.2d 502 (1995).

Safe Harbor Protection. - Defendant was not entitled to G.S. 55-8-30(b) protection since the plaintiffs' claim was not a derivative action, and defendant's fundraising attempts were neither the product of the company's collective approval nor a business judgment. Piazza v. Kirkbride, 246 N.C. App. 576, 785 S.E.2d 695 (2016), aff'd and modified in part, 372 N.C. 137, 827 S.E.2d 479, 2019 N.C. LEXIS 379 (2019).

Action Untimely. - Summary judgment was granted in favor of a director of a corporation in an action alleging violations of G.S. 55-8-30 and N.Y. Gen. Bus. Law § 717 relating to the sale of certain illegal agreements because the causes of action were time barred. Rich Food Servs., Inc. v. Rich Plan Corp., (E.D.N.C. Nov. 11, 2002).

Applied in Raymond James Capital Partners, L.P. v. Hayes, 248 N.C. App. 574, 789 S.E.2d 695 (2016).

Cited in IRA ex rel. Oppenheimer v. Brenner Cos., 107 N.C. App. 16, 419 S.E.2d 354, cert. denied, 332 N.C. 666, 424 S.E.2d 401 (1992); Howell v. Sykes, 136 N.C. App. 407, 526 S.E.2d 183 (2000); In re Wachovia S'holders Litig., 168 N.C. App. 135, 607 S.E.2d 48 (2005), cert. denied, 359 N.C. 411, 613 S.E.2d 25 (2005); Geitner v. Mullins, 182 N.C. App. 585, 643 S.E.2d 435 (2007); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012); Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262 (2013).

OFFICIAL COMMENT

Historically, the scope of a director's duty of loyalty to a corporation has been defined by judicial decision rather than by statute. The courts have developed and refined this duty based on increasing sophistication and experience with the corporate form, and the need to encourage honest decisions by directors and to discourage direct or indirect devices by which directors may benefit personally at the expense of creditors or shareholders. Over the years, courts have been vigilant to subject novel transactions and devices to scrutiny.

Sections 8.31 and 8.32 deal with various facets of the duty of loyalty. The Model Act, however, does not attempt to define the full range of this duty. Indeed, any such attempt would probably be self-defeating since the language chosen might be used to limit prematurely the standards under which directors should act.

1. Conflict of interest transactions in general
2. Requirements for approval of conflict of interest transactions
   1. Consideration by the directors
   2. Consideration by the shareholders

Section 8.31 deals only with "conflict of interest" transactions by a director with the corporation, that its, transactions in which the director has an interest either (1) directly or (2) indirectly through an entity in which the director has a financial or managerial interest covered by section 8.31(b). A conflict of interest transaction does not include transactions in which the director participates in the transaction only as a shareholder and receives only a proportionate share of the advantage or benefit of the transaction. Section 8.31 deals only with conflict of interest transactions involving directors; it does not address analogous transactions entered into by officers, employees, or substantial or dominating shareholders unless they are also directors.

Section 8.31 rejects the common law view that all conflict of interest transactions entered into by directors are automatically voidable at the option of the corporation without regard to the fairness of the transaction or the manner in which the transaction was approved by the corporation. Section 8.31(a) makes any automatic rule of voidability inapplicable to transactions that are fair or that have been approved by directors or shareholders in the manner provided by the balance of section 8.31. The approval mechanisms set forth in section 8.31(c) and (d) relate only to the elimination of this automatic rule of voidability and do not address the manner in which the transactions must be approved under other sections of this Act. This is made clear by the express limitations in sections 8.31(c) and (d) that they are applicable only "for the purposes of this section" as well as the language of the second and third sentences of section 8.31(d).

The elimination of the automatic rule of voidability does not mean that all transactions that meet one or more of the tests set forth in section 8.31(a) are automatically valid. These transactions may be subject to attack on a variety of grounds independent of section 8.31 - for example, that the transaction constituted waste, that it was not authorized by the appropriate corporate body, that it violated other sections of the Model Business Corporation Act, or that it was unenforceable under other common law principles. The sole purpose of section 8.31 is to sharply limit the common law principle of automatic voidability and in this respect section 8.31 follows earlier versions of the Model Act and the statutes of many states dealing with conflict of interest transactions.

Sections 8.31(c) and (d) provide special rules for determining whether the board of directors (or a committee thereof) or the shareholders have authorized, approved, or ratified a conflict of interest transaction so as to bring subsections (a)(1) or (a)(2) into play. Basically, these subsections require the transaction in question to be approved by an absolute majority of the directors (on the board of directors, or on the committee, as the case may be) or shares whose votes may be counted in determining whether the transaction should be authorized, approved, or ratified. If these votes are not obtained the transaction is tested under the fairness test of subsection (a)(3). The vote required for authorization, approval, or ratification of a conflict of interest transaction is more onerous than the standard applicable to normal voting requirements for approval of corporate actions - i.e., that a quorum be present and only the votes of directors or shares present or represented at that meeting be considered - because of the importance of assuring that conflict of interest transactions receive as broad consideration within the corporation as possible if independent review on the basis of fairness is to be avoided.

Section 8.31(c) provides that if a conflict of interest transaction is to be considered by the board of directors or a committee of the board, only the votes of directors "who have no direct or indirect interest in the transaction" may be counted in determining whether to authorize, approve, or ratify the transaction. A vote mistakenly cast by an interested director, however, does not affect the validity of the authorization, approval, or ratification by a committee or by the board of directors under section 8.31 if it otherwise meets the requirement of this subsection. The presence of the interested director at the meeting similarly does not affect the validity of the action by the disinterested directors. Because of the voting disqualification of interested directors, section 8.31(c) provides that a majority of the disinterested directors on the committee or on the board of directors, as the case may be, constitute a quorum for purposes of authorizing, approving, or ratifying the conflict of interest transaction under section 8.31, subject always, however, to the requirement that more than one director must approve the transaction. This two director minimum is applicable to a committee of the board of directors as well as the board of directors itself.

When a director's conflict of interest transaction is considered by the shareholders, section 8.31(d) applies a similar but somewhat more complex prohibition: votes by shares "owned by or voted under the control of a director who has a direct or indirect interest in the transaction" and votes by shares "owned by or voted under the control of an entity described in subsection (b)(1)" - that is, an entity in which the director has a material financial interest or is a general partner - may not be counted. This prohibition is based on the belief that the same considerations that prevent votes cast be interested directors from being counted in favor of a conflict of interest transaction also compel the conclusion that votes cast by shares owned or controlled by them, or by entities involved in the transaction in which they have a material financial interest, should also not be counted when the issue is the authorization, approval, or ratification of a conflict of interest transaction under section 8.31. A similar prohibition does not appear in section 41 of the 1969 Model Act.

In some situations, the prohibition of section 8.31(d) will result in the conflict of interest issue being resolved by a majority of a minority of the shares. This will occur, for example, whenever a director who is the majority shareholder of the corporation is interested in a transaction. The vote on the conflict of interest issue under section 8.31, however, must be distinguished from the vote on the approval of the transaction itself under other sections of the Model Act, in which there is no prohibition against the voting of shares owned or controlled by an interested director. For example, if a parent corporation wishes to merge its 60-percent-owned subsidiary into itself, and the majority shareholder of the parent is a director of the subsidiary, the votes of the shares owned by the parent corporation may not be counted under section 8.31(d) (since the shares are owned by an entity which is a party to the transaction and which the director controls). The shares nevertheless may be voted on the merger proposal itself under chapter 11 of the Model Act, and the merger will, of course, normally be approved solely by the vote of the shares owned by the parent corporation. On the other hand, the test of section 8.31(a)(2) is not met unless the transaction is approved by at least a majority of the votes cast by the holders of the 40 percent of the shares not owned by the parent corporation. If this requirement is not met, the transaction may be evaluated under the fairness test of section 8.31(a)(3).

3. Indirect Conflicts of Interest

Section 8.31 is applicable to "indirect" as well as direct conflicts; "indirect" is defined in section 8.31(b) to cover transactions between the corporation and an entity in which the director has a material financial interest or is a general partner. Further, section 8.31(b) covers indirect conflicts where the director is an officer or director of another entity (but does not have a material financial interest in the transaction) if the transaction is of sufficient importance that it is or should be considered by the board of directors of the corporation. The purpose of this last clause is to permit normal business transactions between large business entities that may have a common director to go forward without concern about the technical rules relating to conflict of interest unless the transaction is of such importance that it is or should be considered by the board of directors or the director may be deemed to have a material financial interest in the transaction. Thus, section 8.31 covers transactions between corporations with interlocking or common directors as well as the direct "interested director" transaction.

4. "Fairness" of a transaction

The fairness of a transaction for purposes of section 8.31 should be evaluated on the basis of the facts and circumstances as they were known or should have been known at the time the transaction was entered into. For example, the terms of a transaction subject to section 8.31 should normally be deemed "fair" if they are within the range that might have been entered into at arm's-length by disinterested persons.

5. An "interested" director

The Model Act does not attempt to define precisely when a director should be viewed as "interested" for purposes of participating in the decision to adopt, approve, or ratify a conflict of interest transaction. Secton 8.31(b) does, however, define one aspect of this concept - the "indirect" interest. For purposes of section 8.31 a director should normally be viewed as interested in a transaction if he or the immediate members of his family have a financial interest in the transaction or a relationship with the other parties to the transaction such that the relationship might reasonably be expected to affect his judgment in the particular matter in a manner adverse to the corporation.

NORTH CAROLINA COMMENTARY

This section replaces former G.S. 55-30(b); subsection (a) of the prior law is covered by G.S. 55-8-11. The section is more precise than former G.S. 55-30(b) in several respects. First, it says that a conflict of interest transaction "is not voidable by the corporation solely because of the director's interest" if it passes one of the three prescribed tests, thus recognizing that it might be voidable for some other reason. Second, subsection (b) of this section defines "indirect interest." Finally, subsections (c) and (d) define the manner in which the transaction may be approved by the disinterested directors or shareholders, respectively. The specific requirement of "good faith" by the directors in former G.S. 55-30(b)(1) is unnecessary because it is generally imposed by G.S. 55-8-30.

The only change in this section from the Model Act is a minor clarification of the last sentence in subsection (d).

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, subsection (c) is amended to remove the limitation that a conflict of interest transaction may not be approved by a single disinterested director.

Effect of Amendments. - Session Laws 2005-268, s. 11, effective October 1, 2005, in subsection (c), inserted "of this section" following "subsection (a)(1)" twice and deleted "but a transaction may not be authorized, approved, or ratified under this section by a single director" at the end of the first sentence.

Session Laws 2018-45, s. 11, effective October 1, 2018, substituted "committee or subcommittee" for "committee" in subsections (a), and (c); substituted "directors, or the committee or subcommittee of the board of directors," for "directors or committee" in subdivision (a)(1); in subsection (b), substituted "if either of the following is true:" for "if:" and "the director" for "he" throughout; substituted "subdivision" for "subsection" throughout subsection (c); and made minor stylistic changes throughout the section.

Legal Periodicals. - For comment on promoters of corporations dealing in condominiums, see 12 Wake Forest L. Rev. 979 (1976).

For article on corporate directors' accountability, see 66 N.C.L. Rev. 171 (1987).

For article, "Should Corporate Statutes Providing Special Protection for Directors Be Limited to Publicly Traded Corporations?," see 24 Wake Forest L. Rev. 79 (1989).

For comment, "North Carolina's Statutory Limitation on Directors' Liability," see 24 Wake Forest L. Rev. 117 (1989).

For article, "Fairness and Trust in Corporate Law," see 1993 Duke L.J. 425.

CASE NOTES

Editor's Note. - Many of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

"Corporate Transaction" Construed. - The words "corporate transaction" in former G.S. 55-30 were intended to apply to a situation where the corporate director was dealing directly with the corporation. Smith v. Robinson, 343 F.2d 793 (4th Cir. 1965).

Corporate officer acts in a fiduciary capacity and cannot profit at the expense of the corporation. Smith v. Robinson, 343 F.2d 793 (4th Cir. 1965).

Contracts Fixing Compensation Not Void or Voidable Per Se. - Notwithstanding the fiduciary relationship existing between officers and the corporation which they serve, contracts fixing the amount and method of paying compensation for services to be rendered are not void or voidable per se. Fulton v. Talbert, 255 N.C. 183, 120 S.E.2d 410 (1961).

Derivative Action Against Director Does Not Necessarily Make Him "Adversely Interested." - In a derivative action brought by shareholders against directors of a corporation alleging malfeasance in office, former G.S. 55-30 did not operate to prevent former G.S. 55-19(d) from being effective in allowing the corporation to advance any legal fees to the directors, since the advancement of legal fees under former G.S. 55-19(d) was not necessarily a transaction in which a director was adversely interested, and since, even if it were, the disinterested directors of the corporation had approved the advancement. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Adversely Interested Party Must Prove Transaction Was Fair. - While North Carolina law and general law do not prohibit corporate officers from dealing with the corporation, the adversely interested party must prove that the transaction was fair, just and reasonable when entered into. Smith v. Robinson, 343 F.2d 793 (4th Cir. 1965).

When a stockholder in a derivative action seeks to establish self-dealing on the part of a majority of the board, the burden should be upon those directors to establish that the transactions complained of were just and reasonable to the corporation when entered into or approved. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Where officer of corporation engaged in transactions which were not approved by the corporate defendants or shareholders, the burden was on him to prove that the transactions were just and reasonable. Lowder v. All Star Mills, Inc., 103 N.C. App. 479, 405 S.E.2d 794 (1991).

Where the former director and president of a Chapter 11 debtor claimed that he complied with G.S. 55-8-31(a)(1) by having two disinterested directors approve or ratify the transfer of certain property to him, although the president sufficiently established that the two directors were disinterested, the director failed to disclose the material facts of the transactions to the disinterested directors, and could not show that the transactions were fair to the debtor. Anderson v. Brokers Inc. (In re Brokers, Inc.), 363 B.R. 458 (Bankr. M.D.N.C. 2007).

For discussion of the "doctrine of corporate opportunity," see Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983).

Determination of what is "just and reasonable" and thus, whether a corporate opportunity has been usurped, is one in which no hard and fast rule can be formulated. Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983).

Decision of Special Committee Not Binding on Trial Court. - The fact that a special litigation committee appointed by directors charged with self-dealing recommends that derivative action should not proceed, while carrying weight, is not binding upon the trial court. Rather, the court must make a fair assessment of the report of the special committee, along with all the other facts and circumstances in the case, in order to determine whether the defendants will be able to show that the transaction complained of was just and reasonable to the corporation. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323 (1987).

Corporate director and majority shareholder of closely held corporation did not breach a fiduciary duty to minority shareholder and director when the corporate director purchased the corporation's sole property at a foreclosure on a mortgage the corporate director had personally guaranteed without telling the minority shareholder he intended to do so in advance. Boyd v. Howard, 147 N.C. App. 491, 556 S.E.2d 337 (2001).

Approval of Employment Contract by Disinterested Officers. - Execution of employment contract with the former director and president of a Chapter 11 debtor complied with G.S. 55-8-31(a)(1) because the contract was approved by two disinterested directors. Anderson v. Brokers Inc. (In re Brokers, Inc.), 363 B.R. 458 (Bankr. M.D.N.C. 2007).

No Conflict of Interest Based Solely on Familial Relationship. - Shareholders did not establish that corporate directors had a conflict of interest, based solely on a familial relationship, in their actions in electing the officers and managers of the corporation and setting their compensation because G.S. 55-8-31 did not provide for a conflict of interest solely based on a family relationship; also, none of the actions at issue by the board of directors was a "transaction with the corporation." Geitner v. Mullins, 182 N.C. App. 585, 643 S.E.2d 435 (2007), cert. denied, 361 N.C. 692, 652 S.E.2d 263 (2007), Geitner v. Mullins, 182 N.C. App. 585, 643 S.E.2d 435 (2007).

Applied in LeCann v. Cobham (In re Cobham), 551 B.R. 181 (E.D.N.C. 2015), aff'd, 2016 U.S. App. LEXIS 18523 (2016).

Cited in Benchmark Carolina Aggregates, Inc. v. Martin Marietta Materials, Inc., 125 N.C. App. 666, 482 S.E.2d 27 (1997), cert. denied, 346 N.C. 275, 487 S.E.2d 538 (1997).

OFFICIAL COMMENT

Section 8.32 treats specially a second type of conflict of interest transaction: loans by the corporation to directors (including loans obtained by directors from third persons on the basis of the corporation's credit). Early statutes in many states made all these loans unlawful because they were believed to be inherently subject to abuse; the modern view epitomized by section 8.32 recognizes that these loans may be proper and desirable in some situations.

The basic test for validity under section 8.32(a) is that either (1) the particular loan is approved by a majority of the shares or by the board of directors after a specific finding that the loan benefits the corporation, or (2) the loan is pursuant to a general plan approved by the board of directors as being of benefit to the corporation. This type of plan will normally cover at least directors, officers, and high-level employees, and possibly lower level employees as well. Examples of these plans are employee benefit plans, plans authorizing loans of petty cash, and advances for expenses reasonably anticipated to be incurred in the performance of the duties of the director, officer, or employee.

Section 8.32(b) makes clear that an irregular or improper loan is nevertheless legally enforceable by the corporation by the corporation against the borrower.

Section 8.32(c) provides for an exception for loans by banks, savings and loans, and other lending institutions that are authorized by law to make loans to directors in the ordinary course of business. The protections provided by the statutes applicable to these entities render unnecessary the protections provided by section 8.32.

NORTH CAROLINA COMMENTARY

Former G.S. 55-22 required shareholder approval of loans to directors, officers, and dominant shareholders. This section permits the board of directors to authorize loans to directors without shareholder approval if the board determines that the loan benefits the corporation. There are no special limits on loans to officers who are not directors or to dominant shareholders.

This section differs from the Model Act by the addition of the words "directly or indirectly" to the loan prohibition in subsection (a) of this section. These words are then defined in a new subsection (d).

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955.

Grant of Security Interest. - Former G.S. 55-22 was not drafted or designed to prevent a corporation from granting a security interest in its own property to secure its own obligation to another party. Landscaping Servs., Inc. v. Poole, 38 Bankr. 21 (Bankr. E.D.N.C. 1983).

Restriction Imposed. - The language contained in former G.S. 55-22 was very broad and severely restricted the right of a corporation to lend money or property to, or guarantee or otherwise secure the obligation of a dominant shareholder, directors or officers of any corporation of which the officers and directors of the lending or securing corporation owned more than 50% of the outstanding stock of any class; such a restriction was consistent with the fiduciary relationship created by former G.S. 55-35 between the corporation and directors of the corporation. Landscaping Servs., Inc. v. Poole, 38 Bankr. 21 (Bankr. E.D.N.C. 1983).

CASE NOTES

Editor's Note. - Some of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Primary Right to Enforce Liabilities Lies in Corporation. - The primary right of enforcement of liabilities to the corporation lies in the corporation, and as such the corporation is the real party in interest and a necessary party to such action. Underwood v. Stafford, 270 N.C. 700, 155 S.E.2d 211 (1967).

Creditor or Stockholder Cannot Maintain Action Without First Demanding Suit by Corporation. - Where alleged breach or injuries are based on duties owed to the corporation and not to any particular creditor or stockholder, the creditor or stockholder cannot maintain an action without a demand on the corporation, or its receiver if insolvent, to bring suit and a refusal to do so, and a joinder of the corporation as a party. Underwood v. Stafford, 270 N.C. 700, 155 S.E.2d 211 (1967).

Liability of Director for Improper Dividend. - A director of a corporation who has not brought himself within the exemptions to liability for the payment of dividends to the stockholders when the profits of the business did not justify it, or its debts exceeded two thirds of its assets, etc., is liable, in the action of the trustee in bankruptcy of such corporation, for the amount of such debts, and the proper court costs and charges, not exceeding the amount of the dividends unlawfully declared. Claypoole v. McIntosh, 182 N.C. 109, 108 S.E. 433 (1921).

Effect of Charter Provision Exempting Stockholders from Liability. - A charter provision that "no stockholder of the corporation shall be individually liable for debt, liability, contract, tort, omission, or engagement of the corporation or any other stockholder therein" did not interfere with the just and equitable principle embodied in former statute holding stockholders who were directors liable for a joint tort or misfeasance committed by them to the prejudice of creditors. McIver v. Young Hdwe. Co., 144 N.C. 478, 57 S.E. 169 (1907).

Trial court was justified in disregarding the corporate entity and holding defendant personally liable to the extent of plaintiff 's damages under the contract where defendant, who was president and sole shareholder of company, received substantial compensation from the sale of the corporation's assets without informing plaintiff of the sale or making provision for contractual debt to plaintiff. Hudson v. Jim Simmons Pontiac-Buick, Inc., 94 N.C. App. 563, 380 S.E.2d 612 (1989), decided under the former Business Corporation Act.

No Cause of Action Stated. - Claim against director of dissolved corporation did not state a cause of action where plaintiff only alleged that director was officer when corporation dissolved and where there was no allegation that corporation's assets were distributed by officers without providing for known or reasonably ascertainable liabilities. Heather Hills Home Owners Ass'n v. Carolina Custom Dev. Co., 100 N.C. App. 263, 395 S.E.2d 154 (1990), decided under former G.S. 55-32.

Creditors Lacked Standing. - Plaintiffs lacked standing to assert claims (1) that the joinder agreements executed by two defendants were fraudulent transfers in violation of G.S. 39-23.1 and unlawful distributions in violation of G.S. 55-8-33 and G.S. 55-6-40, for which all defendants were liable, or alternatively, (2) for unauthorized execution, because such claims could have been brought by any of the corporation's creditors who, like plaintiffs, were denied timely payment of the corporation's debts when execution of the joinder agreements led to its insolvency. Angell v. Kelly, 336 F. Supp. 2d 540 (M.D.N.C. 2004).

OFFICIAL COMMENT

Section 8.40 permits every corporation to designate the officers it wants. The designation may be made in the bylaws or by the board of directors consistently with the bylaws. This is a departure from earlier versions of the Model Act and most state corporation acts, which require certain officers, usually the president, the secretary, and the treasurer, and generally authorize the corporation to designate additional or assistant officers. Experience has shown, however, that little purpose is served by a statutory requirement that there be certain officers, and statutory requirements may sometimes create problems of implied or apparent authority or confusion with nonstatutory offices the corporation desires to create.

The board of directors may appoint assistant officers pursuant to its general powers under section 8.40(a); duly appointed officers may also appoint assistant officers if authorized by the board under section 8.40(b).

Throughout the Model Act, the act of a board designating an officer is referred to as an "appointment" rather than an "election." The Act also consistently uses the word "elect" when referring to the selection of directors, thus emphasizing the difference in the selection process.

The board of directors, as well as duly appointed corporate officers or other agents, may also appoint agents for the corporation.

The bylaws or the board of directors must also delegate to an officer the responsibility to prepare minutes and authenticate records of the corporation; the person performing this function is referred to as the "secretary" of the corporation throughout the Model Act. See section 1.40. Under this Act a corporation may have this and all other corporate functions performed by a single individual.

The person who is designated by the bylaws or the board as responsible for maintaining minutes of meetings and authenticating records of the corporation thereby has authority to bind the corporation by his authentication under this section. This delegation of authority, traditionally vested in the corporate "secretary," allows third persons to rely on authenticated records without inquiring into their truth or accuracy.

AMENDED NORTH CAROLINA COMMENTARY

This section was adapted from the corresponding section of the Model Act with several changes. The word "required" was deleted from the catchline of the section because it covers officers that are optional as well as those that are required.

No changes were made in subsections (a) and (b). Subsection (b) permits the board of directors to authorize officers to appoint other officers or assistant officers, whereas former G.S. 55-34 was silent on this point. The drafters were in favor of this provision but noted that the appointment should be documented as a practical matter, e.g., in the minute books.

Subsection (c) was changed to designate the secretary or any assistant secretary as the officers who have responsibility and authority to maintain and authenticate corporate records, subject to any other provision in the bylaws, in accordance with existing practice, and subsection (d) was changed by adding the final clause relating to acting in a dual capacity when the action of more than one officer is required, thus conforming to former G.S. 55-34(a). Subsection (e) brings forward the last sentence of former G.S. 55-34(a) with updated terminology.

CASE NOTES

Whether Level of Control and Authority Rose to De Facto Director Status. - In a business dispute involving asserted allegations of breach of a covenant-not-to-compete and other claims, a trial court erred by granting defendants summary judgment on the issue of whether one of defendants' level of control and authority rose to the level of a de facto officer as, although none of plaintiff's corporate records indicated that the defendant was the president of plaintiff, testimony from plaintiff stated that the defendant was promoted to that position when the defendant signed the covenant-not-to-compete and other agreements and that the defendant's own business cards named him as president of plaintiff. Kinesis Adver., Inc. v. Hill, 187 N.C. App. 1, 652 S.E.2d 284 (2007), review denied, appeal dismissed, 362 N.C. 177, 658 S.E.2d 485 (2008).

OFFICIAL COMMENT

Section 8.41 recognizes that persons designated as officers have the formal authority set forth for that position (1) by its description in the bylaws, (2) by specific resolution of the board of directors, or (3) by direction of another officer authorized by the board of directors to prescribe the duties of other officers.

These methods of investing officers with formal authority do not exhaust the sources of an officer's actual or apparent authority. Many cases state that specific corporate officers, particularly the chief executive officer, may have implied authority merely by virtue of their positions. This authority, which may overlap the express authority granted by the bylaws, generally has been viewed as extending only to ordinary business transactions, though some cases have recognized unusually broad implied authority of the chief executive officer or have created a presumption that corporate officers have broad authority, thereby placing on the corporation the burden of showing lack of authority. Corporate officers may also be vested with apparent (or ostensible) authority by reason of corporate conduct on which third persons reasonably rely.

In addition to express, implied, or apparent authority, a corporation is normally bound by unauthorized acts of officers if they are ratified by the board of directors. Generally, ratification extends only to acts that could have been authorized as an original matter. Ratification may itself be express or implied and may in some cases serve as the basis of apparent (or ostensible) authority.

NORTH CAROLINA COMMENTARY

This section was modified by deleting the Model Act's words "shall perform the" before the word "duties" in the first use of that word and by adding the words "authority and" before the word "duties" in the other two uses of that word.

Former G.S. 55-34(c) expressly gave the president of a corporation authority to institute or defend legal proceedings when the directors are deadlocked. See Thomas v. Baker, 227 N.C. 226, 41 S.E.2d 842 (1947). That provision was not brought forward. The drafters concluded that situations involving a deadlocked board of directors should be determined by the courts on a case by case basis rather than having a definitive statutory statement that the president can act in such situations.

Legal Periodicals. - For note on the liability of directors and officers for negligent management, see 45 N.C.L. Rev. 748 (1967).

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Conduct of Day-to-Day Business. - The day-to-day business of a corporation is actually conducted by its officers, employees and other agents under the authority and control of its board of directors. The officers of a corporation have such authority and may perform such duties in the management of the corporation as provided either specifically or generally in the bylaws, or as may be determined by action of the board of directors not inconsistent with the bylaws. Burlington Indus., Inc. v. Foil, 284 N.C. 740, 202 S.E.2d 591 (1974).

President as Head and General Agent of Corporation. - The president of a corporation by the very nature of his position is the head and general agent of the corporation, and accordingly he may act for the corporation, in the business in which the corporation is engaged. Burlington Indus., Inc. v. Foil, 284 N.C. 740, 202 S.E.2d 591 (1974).

But the authority of the president to act for the corporation is limited to those matters that are incidental to the business in which the corporation is engaged, that is, to matters that are within the corporation's ordinary course of business. Burlington Indus., Inc. v. Foil, 284 N.C. 740, 202 S.E.2d 591 (1974).

Necessity for Contract for Compensation. - An officer of a corporation, for services in the course and scope of his official duties, can only recover when compensation therefor has been authoritatively agreed upon in advance. It is not always required that a definite sum be fixed upon, but there must be a previous agreement for compensation existent or in some way expressed so as to bind the company. There can be no recovery on a quantum meruit. Chiles v. United States Furn. Mfg. Co., 167 N.C. 574, 83 S.E. 812 (1914). See Caho v. Norfolk & S. Ry., 147 N.C. 20, 60 S.E. 640 (1908).

Individual Liability of Officers. - Where officers of a corporation knowingly participate in a wrong which is actionable, they are jointly and severally liable therefor. Cone v. United Fruit Growers' Ass'n, 171 N.C. 530, 88 S.E. 860 (1916).

Defense Based on Unwritten Limitation on Powers. - The president of a corporation is not bound by any secret limitation upon the authority usually vested in the chief officer of a corporation; hence a defense to a note, issued by the president of a corporation, that it was unauthorized because of an unwritten bylaw, is untenable. Phillips v. Interstate Land Co., 176 N.C. 514, 97 S.E. 417 (1918).

The president of a corporation under former G.S. 55-49 had implied power to sign a note, and secret limitations on his authority were not binding on the payee. White v. Johnson & Sons, 205 N.C. 773, 172 S.E. 370 (1934).

The secretary of an incorporated garage and automobile repair company had the implied authority to settle claims made for damages upon the corporation, and one so dealing with him therein would not be bound by a secret limitation of his authority; and upon his own testimony that he was the proper one to be dealt with in this respect, the question of the corporation's liability for his promise to pay the claim was properly presented. Beck v. Wilkins-Ricks Co., 186 N.C. 210, 119 S.E. 235 (1923).

The general manager of one of a chain of stores had implied authority to employ clerks by the year, and the corporation was bound by such contract though there existed an undisclosed limitation of the agent's authority to make contracts of employment for more than a month. Strickland v. S.H. Kress & Co., 183 N.C. 534, 112 S.E. 30 (1922).

Suit for Breach of Duty is Derivative. - Dismissal of all claims against a minority shareholder of a closely held corporation, who was also a former corporate officer of a subsidiary corporation, was appropriate because the majority shareholder lacked standing to maintain a direct action seeking individual recovery against the minority shareholder as the majority shareholder's individual claims based upon the minority shareholder's conduct as an officer, which were derivative in nature, did not fall under an exception to the general rule prohibiting individual shareholder suits. Raymond James Capital Partners, L.P. v. Hayes, 248 N.C. App. 574, 789 S.E.2d 695 (2016).

Cited in Ron Medlin Constr. v. Harris, 364 N.C. 577, 704 S.E.2d 486 (2010).

OFFICIAL COMMENT

This section provides that a nondirector officer with discretionary authority must meet the same standards of conduct required of directors under section 8.30. But his ability to rely on information, reports, or statements, may, depending upon the circumstances of the particular case, be more limited than in the case of a director in view of the greater obligation he may have to be familiar with the affairs of the corporation. See section 8.42(b). Nondirector officers with more limited discretionary authority may be judged by a narrower standard, though every corporate officer or agent owes duties of fidelity, honesty, good faith, and fair dealing to the corporation. The Official Comment to section 8.30 is generally applicable to nondirector officers as well as to directors.

NORTH CAROLINA COMMENTARY

Subsection (c) of this section is different from the Model Act, first, in requiring "actual" knowledge and, second, in providing that an officer with such knowledge is not "entitled to the benefit of subsection (b)" instead of not "acting in good faith." This change conforms to the change made in subsection 55-8-30(c). Subsection (e) was added for clarification.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY 2018

Clause (ii) of subsection (d), effective October 1, 2018, provides an affirmative defense to liability where an articles of incorporation provision has been adopted under G.S. 55-2-02(b)(4) that eliminates an officer's duties with respect to the applicable business opportunity.

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2018-45, s. 12, effective October 1, 2018, rewrote subsection (d) which formerly read "An officer is not liable for any action taken as an officer, or any failure to take any action, if he performed the duties of his office in compliance with this section."

Legal Periodicals. - For article, "Is the Corporate Director's Duty of Care a 'Fiduciary' Duty? Does it Matter?," see 48 Wake Forest L. Rev. 1027 (2013).

For article, "Overcoming the Rippy Effect: Why the North Carolina Business Corporations Act Should Allow Permissive Officer Exculpation," see 94 N.C.L. Rev. 2155 (2016).

CASE NOTES

Editor's Note. - Many of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Duty Owed to Minority Shareholders. - Directors, officers, and majority shareholders owe a fiduciary duty and obligation of good faith to minority shareholders as well as to the corporation. Meiselman v. Meiselman, 58 N.C. App. 758, 295 S.E.2d 249 (1982), modified and aff'd, 309 N.C. 279, 307 S.E.2d 551 (1983); Umstead v. Durham Hosiery Mills, Inc., 578 F. Supp. 342 (M.D.N.C. 1984).

Fiduciary Duty. - As the former director and officers of an insolvent corporation tried to secure financing for its continued operation up until the point that a lender foreclosed on its secured loans, the director and officers did not own a fiduciary duty to plaintiff or the corporation's other creditors. United States Trouser, S.A. de C.V. v. Int'l Legwear Group, Inc., - F. Supp. 2d - (W.D.N.C. Dec. 13, 2012).

Trial court erred in concluding that a corporate officer's failure to remit payroll taxes and make 401(k) contributions did not constitute a breach of fiduciary duties where the failure to make the required payments violated both federal and state law, and the officer knew that the payments remained unpaid during his tenure. Seraph Garrison, LLC v. Garrison, 247 N.C. App. 115, - S.E.2d - (Apr. 19, 2016).

Trial court erred in concluding that damages could not be awarded on a shareholder's fraud claim where the court had diminished the legal significance of the officer's concealed execution of a later contract, and the officer had used an initial payment from the contractor for his personal benefit. Seraph Garrison, LLC v. Garrison, 247 N.C. App. 115, - S.E.2d - (Apr. 19, 2016).

Trial court erred in dismissing a homeowners association's (HOA) counterclaim for breach of fiduciary duty as to a director and officer of the HOA because the HOA made a number of allegations which, if true, tended to show that they acted in their own interests and not in the best interests of the HOA or within the applicable limitations period. Conleys Creek Limited Partnership v. Smoky Mt. Country Club Prop. Owners Ass'n, 370 N.C. 695, 255 N.C. App. 236, 805 S.E.2d 147 (2017), appeal dismissed, 811 S.E.2d 596, 2018 N.C. LEXIS 263 (2018).

Fiduciary Duty as Question Where Revolving Fund Certificate Was Issued. - Revolving fund certificate held by plaintiff issued in exchange for stock sold to defendant had some characteristics of a corporation/shareholder relationship; therefore, issue of whether defendants owed plaintiff a fiduciary duty was properly submitted to the jury. HAJMM Co. v. House of Raeford Farms, Inc., 94 N.C. App. 1, 379 S.E.2d 868, rev'd on other grounds, HAJMM Co. v. House of Raeford Farms, Inc., 328 N.C. 578, 403 S.E.2d 483 (1991).

Officers Must Act in Good Faith. - The officers of a company have no right to take advantage of their knowledge of its financial condition to secure a preference for themselves on all its property as to a preexisting debt. Hill v. Pioneer Lumber Co., 113 N.C. 173, 18 S.E. 107 (1893); Thomson-Houston Elec. Light Co. v. Henderson Elec. Light Co., 116 N.C. 112, 21 S.E. 951 (1895); Graham v. Carr, 130 N.C. 271, 41 S.E. 379 (1902); Holshouser v. Copper Co., 138 N.C. 248, 50 S.E. 650 (1905); Edwards v. Hill Supply Co., 150 N.C. 171, 63 S.E. 742 (1909).

An officer may be held liable for the torts committed by agents of the corporation if the officer fails to act with due diligence in their supervision. Air Traffic Conference of Am. v. Marina Travel, Inc., 69 N.C. App. 179, 316 S.E.2d 642 (1984).

Corporate officer cannot take business for himself from the corporation. Brite v. Penny, 157 N.C. 110, 72 S.E. 964 (1911).

The law will not permit corporate officers to create obligations in the name of the corporation, knowing the acts are without authority and invalid, and then be permitted to use the corporate name as shield against creditors. Pierce Concrete, Inc. v. Cannon Realty & Constr. Co., 77 N.C. App. 411, 335 S.E.2d 30 (1985).

Officers Not to Incur Ordinary Business When Charter Suspended. - While corporate officers in North Carolina are not trustees, their fiduciary duty to the corporation is a high one; this includes a duty not to continue to incur ordinary business obligations on behalf of the corporation when they have knowledge that the corporation's charter has been suspended. Pierce Concrete, Inc. v. Cannon Realty & Constr. Co., 77 N.C. App. 411, 335 S.E.2d 30 (1985).

Whether Level of Control and Authority Rose to De Facto Director Status. - In a business dispute involving asserted allegations of breach of a covenant-not-to-compete and other claims, a trial court erred by granting defendants summary judgment on the issue of whether one of defendants' level of control and authority rose to the level of a de facto officer as, although none of plaintiff's corporate records indicated that the defendant was the president of plaintiff, testimony from plaintiff stated that the defendant was promoted to that position when the defendant signed the covenant-not-to-compete and other agreements and that the defendant's own business cards named him as president of plaintiff. Kinesis Adver., Inc. v. Hill, 187 N.C. App. 1, 652 S.E.2d 284 (2007), review denied, appeal dismissed, 362 N.C. 177, 658 S.E.2d 485 (2008).

Contracts Fixing Compensation Not Void or Voidable Per Se. - Notwithstanding the fiduciary relationship existing between officers and the corporation which they serve, contracts fixing the amount and method of paying compensation for services to be rendered are not void or voidable per se. Fulton v. Talbert, 255 N.C. 183, 120 S.E.2d 410 (1961).

Suit for Breach of Duty Is Derivative. - A suit against corporation's officers and directors for breach of their fiduciary duty on account of mismanagement is clearly derivative. Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980).

Shareholder's claims that corporate officers misrepresented the corporation's financial health, causing the value of its stock to decline, had to be brought in a derivative suit rather than an individual action. The special duty exception did not apply, as the fiduciary duty of disclosure was owed to the corporation itself under North Carolina law and did not give the shareholder a direct right of action. Rivers v. Wachovia Corp., 665 F.3d 610 (4th Cir. 2011).

Dismissal of all claims against a minority shareholder of a closely held corporation, who was also a former corporate officer of a subsidiary corporation, was appropriate because the majority shareholder lacked standing to maintain a direct action seeking individual recovery against the minority shareholder as the majority shareholder's individual claims based upon the minority shareholder's conduct as an officer, which were derivative in nature, did not fall under an exception to the general rule prohibiting individual shareholder suits. Raymond James Capital Partners, L.P. v. Hayes, 248 N.C. App. 574, 789 S.E.2d 695 (2016).

When Action by Shareholders Is Individual. - Where several officers and directors were alleged to have breached the fiduciary duty owed to shareholders by maintaining the market price of the corporation's shares at artificial levels and in issuing false or misleading financial statements, the shareholder plaintiffs would be entitled to receive any recovery under these allegations and the action was thus individual. Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980).

Shareholder plaintiffs need not demonstrate that all defendants are amenable to suit. Rather, nonofficers and nondirectors may, by North Carolina common-law principles, be held to answer for substantially assisting or encouraging another's breach of fiduciary duty. Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980).

Creditor's Standing to Assert Violation of Duty. - Plaintiff's claim that former director and officers failed to perform their statutory duties by continuing to operate the corporation during insolvency instead of "winding down" did not survive summary judgment; as directors' and officers' duties under G.S. 55-8-30 and G.S. 55-8-42 were owed to the corporation, not to its creditors, plaintiff lacked standing to assert the claim. United States Trouser, S.A. de C.V. v. Int'l Legwear Group, Inc., - F. Supp. 2d - (W.D.N.C. Dec. 13, 2012).

Action Based on Fraud for Salaries Not Honestly Earned. - The right of action which accrues for the fixing and taking by one in authority of salaries, bonuses, or other moneys not honestly earned and fairly owing is based on fraud. When one seeks to recover for wrongs fraudulently inflicted, he must allege the facts which, if proven, will establish the fraud. It is not sufficient merely to allege as a conclusion that the payments were "exorbitant, unreasonable, and unjust." Fulton v. Talbert, 255 N.C. 183, 120 S.E.2d 410 (1961).

Wrongful Discharge Action for Compliance With Fiduciary Duties. - While plaintiff former president alleged defendant employer terminated him because he discharged his duties as an officer of the corporation as required by G.S. 55-8-42, by reporting possible illegal activities to federal authorities, he failed to specifically allege that he refused to violate the law in the face of a request or an instruction from the employer, as there was no allegation that the employer instructed him not to report the information to federal investigators or that the employer specifically asked or encouraged him to violate his duties as a corporate officer, and thus, the president's wrongful discharge in violation of public policy claim failed. Feldman v. Law Enforcement Assocs. Corp., 779 F. Supp. 2d 472 (E.D.N.C. 2011).

Conversion of Corporate Money Justifying Punitive Damages. - Defendant officers and directors' conversions to their own use of money belonging to corporation held to support an award of punitive damages. Stone v. Martin, 85 N.C. App. 410, 355 S.E.2d 255, appeal dismissed and cert. denied, 320 N.C. 638, 360 S.E.2d 105 (1987).

Cited in IRA ex rel. Oppenheimer v. Brenner Cos., 107 N.C. App. 16, 419 S.E.2d 354, cert. denied, 332 N.C. 666, 424 S.E.2d 401 (1992); Charles A. Torrence Co. v. Clary, 121 N.C. App. 211, 464 S.E.2d 502 (1995); T-Wol Acquisition Co. v. ECDG South, LLC, 220 N.C. App. 189, 725 S.E.2d 605 (2012); Conleys Creek Ltd. P'ship v. Smoky Mt. Country Club Prop. Owners Ass'n, - N.C. App. - , 799 S.E.2d 879 (2017), sub. op., 805 S.E.2d 147, 2017 N.C. App. LEXIS 740 (N.C. Ct. App. 2017).

OFFICIAL COMMENT

Section 8.43(a) is declaratory of current law. It recognizes that corporate officers may resign, that, with the consent of the board of directors, they may resign effective at a later date, and that the board of directors may fill a future vacancy to become effective as of the effective date of the resignation.

In part because of the unlimited power of removal, confirmed by section 8.43(b), a board of directors may grant an officer an employment contract that extends beyond the term of the board of directors. This type of contract is binding on the corporation even if the articles of incorporation or bylaws provide that officers are appointed for a term shorter than the period of the employment contract. If a later board of directors refuses to reappoint that person as an officer, he has the right to sue for damages but not for specific performance of his employment contract.

Section 8.43(b) is also declaratory of current law. The tenure of all corporate officers is subject to the will of the board of directors. If the board of directors loses confidence in a corporate officer, that officer may be removed irrespective of contract rights or the presence or absence of "cause" in a legal sense. Section 8.44 provides that removal of an officer who has contract rights is without prejudice to whatever rights the former officer may assert in a suit for damages for breach of contract.

NORTH CAROLINA COMMENTARY

The reference to an officer "communicating his resignation" is broader language than the reference in the Model Act to "delivering notice" of the resignation. This change parallels the change made in section 55-8-07.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended to provide that an officer may be removed by another officer in certain circumstances.

Effect of Amendments. - Session Laws 2005-268, s. 12, effective October 1, 2005, in subsection (a), substituted "time" for "date" throughout and inserted "or the appointing officer" twice in the second sentence; rewrote subsection (b); and added subsection (c).

CASE NOTES

Editor's Note. - The cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Removal. - The officers of a corporation created for private purposes have no franchise in their offices, and are removable during the term for which they are appointed, when found to be incompetent or faithless. Eliason v. Coleman, 86 N.C. 235 (1882).

Where plaintiff had no written contract, and his employment was indefinite, he was not wrongfully discharged even though his employment was not terminated by the board of directors. While the board of directors may remove an officer, there is no indication that it is mandatory that it do so. Buffaloe v. United Carolina Bank, 89 N.C. App. 693, 366 S.E.2d 918 (1988).

OFFICIAL COMMENT

Section 8.43 makes clear that the appointment of an officer does not itself create contract rights in the officer. The removal of an officer with contract rights is without prejudice to his later enforcement of contract rights in a suit for damages for breach of contract. See the Official Comment to section 8.43. Similarly, an officer with an employment contract who prematurely resigns may be in breach of his employment contract. The mere appointment of an officer for a term does not create a contractual obligation on his part to complete the term.

OFFICIAL COMMENT

The definitions set forth in section 8.50 apply only to subchapter E and have no application elsewhere in the Model Act.

1. Corporation
2. Director
3. Expenses
4. Liability
5. Official capacity
6. Party
7. Proceeding

A special definition of "corporation" is included in subchapter E to make it clear that predecessor entities that have been absorbed in mergers or other transactions are included within the definition. It is probable that the same result would be reached for many transactions under section 11.06 (effect of merger or share exchange), which provides for the assumption of liabilities by operation of law upon a merger. The express responsibility of successor entities for the liabilities of their predecessors under this subchapter is broader than under section 11.06 and may impose liability on a successor although section 11.06 does not. Section 8.50(1) is thus an essential aspect of the protection provided by this subchapter for persons eligible for indemnification.

A special definition of "director" is included in subchapter E to make it clear that a person who is or was a director is covered by this subchapter while serving at the corporation's request in another enterprise. The purpose of this definition is to give directors the benefits of the protection of this subchapter while serving at the corporation's request in a responsible position in employee benefit plans, trade associations, nonprofit or charitable entities, foreign or domestic entities, and other kinds of profit or nonprofit ventures. A director serving at the corporation's request in such a venture is viewed as acting as a director of the corporation for purposes of this subchapter even though he is also acting in some other capacity in the other venture.

The second sentence of section 8.50(2) addresses the question of liabilities arising under the Employee Retirement Income Security Act (ERISA). It makes clear that a director who is serving as a fiduciary of an employee benefit plan is nevertheless viewed as acting as a director for purposes of this subchapter. Special treatment is felt to be necessary because of the broad definition of "fiduciary" in section 3(21) of ERISA, 29 U.S.C. § 1002(21) (1974), and the requirement of section 404 ( § 1104(a)) that a "fiduciary" must discharge his duties "solely in the interest" of the participants and beneficiaries of the employee benefit plan. Decisions by a director serving as a fiduciary under the plan on questions regarding eligibility for benefits, investment decisions, and interpretation of plan provisions regarding qualifying service, years of service, and retroactivity are all subject to the protections of this subchapter. See also sections 8.50(4) and 8.51(b) of this subchapter. Similar provisions appear in the business corporation acts of New York, N.Y. BUS. CORP. LAW ANN. § 723 (McKinney 1963), and Connecticut, CONN. GEN. STAT. ANN. § 33-320a (West Supp. 1981).

The estate or personal representative of a director is entitled to the rights of indemnification possessed by the director himself. See the last sentence of section 8.50(2). The phrase, "unless the context requires otherwise," was added to make clear that the estate or personal representative did not have the right to participate in directoral decisions whether to grant indemnification authorized in this subchapter.

"Expenses" is defined to include counsel fees to avoid repeated references to such fees every time "expenses" appears throughout the subchapter.

"Liability" is defined for convenience, to avoid repeated references to recoverable items throughout the subchapter. Even though the definition of "liability" includes both expenses and amounts paid to satisfy or to settle substantive claims, indemnification against substantive claims is not allowed in several provisions in subchapter E. For example, indemnification in suits brought by or in the name of the corporation is limited to expenses. See section 8.51(e).

The definition of "liability" permits the indemnification only of "reasonable expenses incurred." The intention is that any portion of expenses falling outside the perimeter of reasonableness should not be indemnified, and that, if necessary, an allocation of expenses should be made. By contrast, unlike earlier versions of the Model Act and statutes of many states, section 8.50(4) provides that amounts paid to settle or satisfy substantive claims are not subject to a reasonableness test. Since payment of these amounts is permissive - mandatory indemnification is available under section 8.52 only where the defendant is "wholly successful" - a special limitation of "reasonableness" for settlements is inappropriate. Further, it is undesirable to base the statutory test of power to indemnify on an affirmative finding that a settlement is reasonable. Indeed, the grant of authority to indemnify only those settlements that are "reasonable" would suggest an "all or nothing" approach inconsistent with the basic philosophy of indemnification of "reasonable" expenses.

"Penalties" and "fines" are expressly included within the definition of "liability" so that in appropriate cases these items may also be indemnified. See section 8.51. The purpose of this definition is to cover every type of monetary obligation that may be imposed upon a director, including civil penalties (which have been authorized in a number of recent statutes), restitution, and obligations to give notice (which are proposed as part of the revision of the federal criminal code). This definition also expressly includes the levy of excise taxes under the Internal Revenue Code pursuant to ERISA within the definition of "fines."

The definition of "official capacity" is necessary because the term determines which of the two alternative standards of conduct set forth in section 8.51 applies: if action is taken in an "official capacity," the person to be indemnified must have reasonably believed he was acting in the best interests of the corporation, while if the action in question was not taken in his "official capacity," he need only have reasonably believed that the conduct was not opposed to the best interests of the corporation.

The definition of "party" establishes the basic coverage of the subchapter. The definition includes every individual "who was, is, or is threatened to be made a named defendant or respondent in a proceeding." A person who is only called as a witness is not a "party" within this definition, and as specifically provided in section 8.58(b), indemnification of this person is not limited by this subchapter.

The broad definition of "proceeding" ensures that the benefits of this subchapter will be available to directors in new and unexpected, as well as traditional, types of proceedings whether civil, criminal, administrative, or investigative. It also includes appeals in lawsuits and petitions to review administrative actions.

NORTH CAROLINA COMMENTARY

Subsection (a) of this section contains a policy statement that is not in the Model Act.

The definitions in subsection (b) are essentially the same as in the Model Act, and in the opinion of the drafters they all broaden the scope of prior law. For example, "corporation" includes predecessor entities (e.g., in a merger), whether or not incorporated; "director" broadens the coverage of persons who have responsibilities with respect to employee benefit plans and includes the successors of deceased directors; "party" includes persons who are threatened to be named as a party; and "proceeding" includes any kind of formal or informal proceeding, whether threatened or actual. The drafters do not believe there are any uncertainties or ambiguities in any of these definitions that permit a court to limit their scope, and any contrary restrictive decision by a court of another jurisdiction should be overridden by the broad public policy intent expressed in G.S. 55-8-50(a).

G.S. 55-8-51, 55-8-52, 55-8-54, 55-8-55 and 55-8-56 provide for indemnification of directors, officers, employees and agents. Indemnification in addition to and independent of that statutory indemnification is authorized in G.S. 55-8-57.

Legal Periodicals. - For comment, "North Carolina's Statutory Limitation on Directors' Liability," see 24 Wake Forest L. Rev. 117 (1989).

OFFICIAL COMMENT

1. Section 8.51(a)
2. Section 8.51(b)
3. Section 8.51(c)
4. Section 8.51(d)
5. Section 8.51(e)

The standards for indemnification of directors contained in this subsection define the outer limits for which voluntary indemnification is permitted under the Model Act. Conduct which does not meet these standards is not eligible for voluntary indemnification under the Model Act, although court-ordered indemnification may be available under section 8.54(2). Conduct that falls within these outer limits does not automatically entitle directors to indemnification, although many corporations have adopted bylaw provisions that obligate the corporation to indemnify directors to the maximum extent permitted by statute. Absent such a bylaw provision, section 8.52 defines a much narrower area in which the directors are entitled as a matter of right to indemnification.

Some state statutes provide separate, but usually similarly worded, standards for indemnification in third-party suits and indemnification in suits brought by or in the name of the corporation. The Model Act establishes a single uniform test to make clear that the outer limits of conduct for which indemnification is permitted should not be dependent on the type of proceeding in which the claim arises. To prevent circularity in recovery, however, section 8.51(e) limits indemnification in connection with suits brought by or in the name of the corporation to expenses incurred and excludes amounts paid to settle or satisfy substantive claims.

The standards of conduct described in sections 8.5(a)(1) and 8.5(a)(2)(i) - that a director's conduct in his official capacity was in "good faith" and in the corporation's "best interests" - is closely related to the basic standards of conduct imposed by section 8.30, but the two standards are not identical. No attempt is made to define "good faith," a term used in both section 8.30 and section 8.51. The concept of good faith involves a subjective test, which would include "a mistake of judgment," in the words of the Official Comment to section 8.30, even though made unwisely by objective standards. But the affirmative requirement of section 8.30 - that the "care of an ordinarily prudent person in a like position" be exercised - is not included in the standard of conduct for indemnification. On the other hand, section 8.51 requires that there be a "reasonable" belief on the part of the director in most instances, and in the case of criminal proceedings that there be no "reasonable" cause to believe the conduct was unlawful. Accordingly, it is possible that a director who has not acted "with the care an ordinarily prudent person in a like position would exercise under similar circumstances," as required by section 8.30, could nevertheless be indemnified if the standard of section 8.51 were met. As a corollary, it is clear that a director who has met the section 8.30 standards of conduct would be eligible in virtually every case to be indemnified under section 8.51.

Section 8.5(a)(2)(ii) requires, if a director is not acting in his official capacity, that his action be "at least not opposed to" the corporation's best interests. This standard is applicable to the director when serving another entity at the request of the corporation or when sued simply because he is or was a director. The words "at least" were added to qualify "not opposed to" in order to make it clear that this test is an outer limit for conduct other than in an official capacity.

This section makes clear that a director who is serving as a trustee or fiduciary for an employee benefit plan under ERISA meets the standard for indemnification under section 8.51(a) if he reasonably believes his conduct was in the best interests of the participants in and beneficiaries of the plan. This standard is a specific application of the more general test that conduct not in official corporate capacity is indemnifiable if it is "at least not opposed to" the best interests of the corporation and provides a standard for indemnification that is consistent with the statutory policies embodied in ERISA. See the Official Comment to section 8.50.

The purpose of section 8.51(c) is to reject the argument that indemnification is automatically improper whenever a proceeding has been terminated on a basis that does not exonerate the director claiming indemnification. Even though a final judgment or conviction is not automatically determinative of the issue whether the minimum standard of conduct was met, any judicial determination of substantive liability would in most instances be entitled to considerable weight. By the same token, it is clear that the termination of a proceeding by settlement or plea of nolo contendere should not of itself create a presumption either that conduct met or did not meet the standard of section 8.51. On the other hand, a final determination of nonliability or acquittal automatically entitles the director to indemnification of expenses under section 8.52.

Section 8.51(c) applies expressly to indemnification expenses in derivative actions as well as to indemnification in third party suits. The most likely application of this subsection to derivative actions will be to settlements since a judgment or order would normally result in liability to the corporation and thereby preclude all indemnification under section 8.51(d). In the rare event that a judgment or order entered against the director did not include a determination of liability to the corporation, the entry of the judgment or order would not be determinative that the director failed to meet the requisite standard of conduct.

This subsection makes clear that indemnification is not permissible under section 8.51 in the face of a finding of improper conduct either because liability is imposed in favor of the corporation in a suit brought by or in its name or because there is a finding that the director improperly received a personal benefit as a result of his conduct. Indemnification under this subsection is prohibited if a director is adjudged liable in a derivative suit because it is believed that there should be no indemnification in this situation unless a court first finds it proper. Section 8.54 permits a director found liable to the corporation to petition a court for a judicial determination of entitlement to indemnification. Voluntary indemnification is also prohibited if there has been an adjudication that a director improperly received a personal benefit, even if, for example, he acted in a manner not opposed to the best interests of the corporation. Improper use of inside information for personal benefit should not be an action for which the corporation may provide indemnification, even if the corporation was not thereby harmed. Although it is unlikely that a person found liable for receiving an improper personal benefit would be found to have met the statutory standard of conduct set forth in section 8.51(a)(2)(ii), this limitation is made explicit in section 8.51(d)(2). Recourse to a court under section 8.54 may also be appropriate in some improper benefit cases - for example, where it would be unfair for a small personal benefit to foreclose indemnification in an expensive and complicated matter.

This subsection limits indemnification in suits brought by or in the right of the corporation to expenses incurred in connection with the proceeding. Its purpose is to avoid circularity that would be involved if a corporation seeks to indemnify a director for payments made in settlement by the director to the corporation. This subsection applies only to settlements since all indemnification is prohibited by section 8.5(d)(1) - subject to the right to seek judicially approved indemnification under section 8.54 - in cases where a director is "adjudged" liable to the corporation.

NORTH CAROLINA COMMENTARY

This section differs in two respects from Section 8.51 of the Model Act. First, the qualifying clause "that is concluded without a final adjudication on the issue of liability" was added to subsection (e) to make it clear that the subsection applies only to settlements, as noted in the Official Comment on that subsection, and thus to remove any possible conflict with the prohibition in subdivision (d)(1) against indemnification under this section in a proceeding in which the director was adjudged liable to the corporation. Second, the entire subsection (f) was added.

This section does not limit any additional indemnification that may be payable under G.S. 55-8-57.

Legal Periodicals. - For article, "Overcoming the Rippy Effect: Why the North Carolina Business Corporations Act Should Allow Permissive Officer Exculpation," see 94 N.C.L. Rev. 2155 (2016).

OFFICIAL COMMENT

Section 8.51 determines whether indemnification may be made voluntarily by a corporation if it elects to do so. Section 8.52 determines whether a corporation must indemnify a director for his expenses; in other words, section 8.52 creates a statutory right of indemnification in favor of the director who meets the requirements of that section. Enforcement of this right by judicial proceeding is specifically contemplated by section 8.54(1), which also gives the director a statutory right to recover expenses incurred by him in enforcing his statutory right to indemnification under section 8.52.

The basic standard for mandatory indemnification is that the director has been "wholly successful, on the merits or otherwise," in the defense of the proceeding. The word "wholly" is added to avoid the argument accepted in Merritt-Chapman & Scott Corp. v. Wolfson, 321 A.2d 138 (Del. 1974), that a defendant may be entitled to partial mandatory indemnification if he succeeded by plea bargaining or otherwise to obtain the dismissal of some but not all counts of an indictment. A defendant is "wholly successful" only if the entire proceeding is disposed of on a basis which involves a finding of nonliability. However, the language in earlier versions of the Model Act and in many other state statutes that the basis of success may be "on the merits or otherwise" is retained. While this standard may result in an occasional defendant becoming entitled to indemnification because of procedural defenses not related to the merits - e.g., the statute of limitations or disqualification of the plaintiff, it is unreasonable to require a defendant with a valid procedural defense to undergo a possibly prolonged and expensive trial on the merits in order to establish eligibility for mandatory indemnification.

Legal Periodicals. - For article, "Corporate Director and Officer Indemnification: Alternative Methods for Funding," see 24 Wake Forest L. Rev. 53 (1989).

For article, "Should Corporate Statutes Providing Special Protection for Directors Be Limited to Publicly Traded Corporations?," see 24 Wake Forest L. Rev. 79 (1989).

For comment, "North Carolina's Statutory Limitation on Directors' Liability," see 24 Wake Forest L. Rev. 117 (1989).

OFFICIAL COMMENT

It is often critically important to a director who is made a party to a complex proceeding that the corporation he served have power to make advances for expenses at the beginning of and during the proceeding. Adequate legal representation and adequate preparation of a defense may require substantial payments of expenses before a final determination, and unless the corporation may make advances for expenses, a defendant may be unable to finance his own defense. This problem is complicated by reason of the fact that during the early stages of a proceeding (when advances are often needed) the facts underlying the claim cannot be fully evaluated and the board of directors therefore cannot accurately ascertain the ultimate propriety of indemnification.

Section 8.53 establishes a workable standard: indemnification is permitted if the facts then known to those making the determination do not establish that indemnification would be precluded under section 8.51. The directors (or special legal counsel) making the determination under section 8.53(c) would normally communicate with counsel and the person or persons monitoring the matter for the corporation in order to gain familiarity with the status of the proceeding and the relevant facts that have emerged, but it is not required (or expected) that any form of independent investigation be undertaken for purposes of the determination. Thus, an advance may be made under section 8.53 unless it becomes clear, from the facts at hand, that indemnification under section 8.51 cannot be provided. As additional facts become known, a different determination may be required.

This section is a compromise between the view of some that advances should be made automatically at the claimant's request and at any time before the litigation is terminated and the view of others that a special investigation should be made before each advance.

In addition to the requirement that the facts then known to those acting on the request for an advance do not preclude indemnification, section 8.53(a) requires a written affirmation by the director of his good faith belief that he has met the standard of conduct necessary for indemnification by the corporation and a written undertaking by or on behalf of the director to repay the advance if it is ultimately determined that he has not met the standard of conduct. Under section 8.53(b), the undertaking need not be secured and financial ability to repay is not a prerequisite. The theory underlying this subsection is that, in advancing expenses, wealthy directors should not be favored over directors whose financial resources are modest.

The limitations of section 8.53 apply only to persons who are directors at the time the advance is made. Thus the corporation may advance the expenses of former directors without obtaining the undertaking otherwise required by section 8.53(a)(1) or (2).

NORTH CAROLINA COMMENTARY

The Model Act counterpart of this section was replaced by the less restrictive provisions of former G.S. 55-19(d). See North Carolina Comment to G.S. 55-8-57, supra.

CASE NOTES

Editor's Note. - The case below was decided under the Business Corporation Act adopted in 1955.

"Undertaking" Defined. - The "undertaking" required by former G.S. 55-19(d) for the repayment of fees advanced if the director is unsuccessful is just that: a written promise, not made under seal, given as security for the performance of some act as required in a legal proceeding. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

Legal Fees May Be Advanced for Defense of Derivative Action. - In a derivative action brought by shareholders against directors of a corporation alleging malfeasance in office, former G.S. 55-30 did not operate to prevent former G.S. 55-19(d) from being effective in allowing the corporation to advance any legal fees to the directors, since the advancement of legal fees under that section was not necessarily a transaction in which a director was adversely interested, and since, even if it were, the disinterested directors of the corporation had approved the advancement. Swenson v. Thibaut, 39 N.C. App. 77, 250 S.E.2d 279 (1978), cert. denied and appeal dismissed, 296 N.C. 740, 254 S.E.2d 181, 254 S.E.2d 182, 254 S.E.2d 183 (1979).

OFFICIAL COMMENT

Section 8.54 permits court-ordered indemnification in two situations: (1) a director entitled to mandatory indemnification may enforce that entitlement by judicial proceeding (in which case the court may also order the corporation to pay the reasonable expenses incurred in connection with the proceeding); and (2) indemnification at the court's discretion is permitted in all cases whether or not the director met the requisite standard of conduct in section 8.51 or is otherwise ineligible for indemnification. But indemnification with respect to derivative suits or improper benefit is always limited to expenses by the last clause of section 8.54(2).

Application for indemnification under section 8.54 may be made either to the court in which the proceeding was heard or to another court of appropriate jurisdiction. For example, a defendant in a criminal action who has been convicted but believes that indemnification would be proper could apply either to the court which heard the criminal action or bring an action against the corporation in another court. A decision by the board of directors not to oppose the request for indemnification is governed by the general standards of conduct found in section 8.30. Even if the corporation decided not to oppose the request, the court must satisfy itself that the person seeking indemnification is properly entitled to it.

A corporation may limit the right of a director under section 8.54 by a provision in its articles of incorporation. In the absence of such a provision, however, the court has general power to grant indemnification under this section.

OFFICIAL COMMENT

Section 8.55 provides the method for determining whether a corporation should voluntarily indemnify directors under section 8.51. In this section a distinction is made between a "determination" and an "authorization." A "determination" involves a decision whether under the circumstances the person seeking indemnification has met the requisite standard of conduct under section 8.51 and is therefore eligible for indemnification. This decision may be made by the persons or groups described in section 8.55(b). In addition, after a favorable "determination" is made, the corporation must "authorize" indemnification; this includes a review of the reasonableness of the expenses, the financial ability of the corporation to make the payment, and the judgment whether limited financial resources should be devoted to this or some other use by the corporation. Section 8.55(c) provides that "authorization" of indemnification may be made only by the board of directors, by a committee of the board, or by the shareholders. While special legal counsel may make the "determination" of eligibility for indemnification, he may not "authorize" the indemnification.

Section 8.55(b) establishes a procedure for selecting the person or persons who will make the determination of eligibility for indemnification. Even though directors who are parties to the proceeding may not participate in the decision determining eligibility for indemnification, they may, if necessary to permit valid action by the board of directors, participate in the decision establishing a committee of independent directors or selecting special legal counsel. Directors who are parties may also participate in the decision to "authorize" indemnification on the basis of a favorable "determination" if necessary to permit action by the board of directors. This limited participation of interested directors in the decision is justified by a principle of necessity.

Legal counsel authorized to make the required determination is referred to as "special legal counsel." In earlier versions of the Model Act, and in the statutes of many states, he is referred to as "independent" legal counsel. The word "special" is felt to be more descriptive of the role to be performed and is not intended to indicate that the counsel selected should not be independent in accordance with governing legal precepts. "Special legal counsel" should normally be counsel having no prior professional relationship with those seeking indemnification, should be retained for the specific occasion, and should not be either inside counsel or regular outside counsel. It is important that the selection process be sufficiently flexible to permit selection of counsel in light of the particular circumstances and so that unnecessary expense may be avoided. Hence the phrase "special legal counsel" is not defined in the statute.

Determinations by shareholders rather than by directors or special counsel are permitted by section 8.55(b)(4), but shares owned by or voted under the control of directors seeking indemnification may not be voted on the determination of eligibility for indemnification. This does not affect rules governing the determination of a quorum at the meeting.

OFFICIAL COMMENT

Section 8.56 correlates the general legal principles relating to the indemnification of officers, employees, and agents of the corporation with the limitations on indemnification in subchapter E. This correlation may be summarized in general terms as follows:

1. Subchapter E (except for section 8.56) applies only to, and limits the indemnification of, directors.
2. An officer, agent or employee of a corporation who is not a director may be indemnified by the corporation on a discretionary basis to the same extent as though he were a director, and, in addition, may have additional indemnification rights apart from subchapter E. (Section 8.56(2) and (3).)
3. A director who is also an officer, employee, or agent of the corporation is limited to his indemnification rights under subchapter E and is therefore treated the same way as other directors. (Section 8.56(3) by negative inference.) Such an officer/director is limited to his rights under subchapter E even though he is sued solely in his capacity as an officer.
4. An officer of the corporation (but not employees or agents generally) who is not a director has the mandatory right of indemnification granted to directors under section 8.52 and the right to apply for court-ordered indemnification under section 8.54. (Section 8.56(1).)

1. Officers, employees, or agents who are not directors
2. Directors who are also officers, employees, or agents
3. Officers who are not directors

Section 8.56(3) authorizes indemnification for officers, employees, and agents who are not directors, but neither requires nor prescribes standards for their indemnification and expressly states that their indemnification may be broader than the right of indemnification granted to directors by this subchapter. The rights of employees or agents may derive from principles of agency, the doctrine of respondeat superior, or collective bargaining or other contractual agreement, rather than from the statute. Indemnification of employees or agents may appropriately protect the person indemnified from liabilities incurred while serving at the corporation's request as a director, officer, partner, trustee, or agent of another commercial, charitable, or nonprofit enterprise. See the definition of "director" in section 8.50(2). But indemnification under section 8.56(3) must ultimately be "consistent with law." In effect, this leaves public policy determinations as to what are permissible limits, in a particular case, to the courts. For example, in Koster v. Warren, 297 F.2d 418, 423 (9th Cir. 1961), the court allowed indemnification of an officer and an employee, both of whom pleaded nolo contendere to an antitrust indictment at the corporation's request, the court reasoning that they had foregone their personal right to defend for the corporation's benefit. On the other hand, the court indicated in dictum that an agreement in advance by the corporation to indemnify anyone convicted of antitrust violations would be against public policy.

The broad grant of indemnification in section 8.56(3) may be limited by appropriate provisions in the articles of incorporation.

Section 8.56 provides that officers, employees, or agents who are also directors are subject to the same standards of indemnification as other directors. Consideration was given to whether these officer-directors, if acting in their capacity as an officer but not as a director, should have the benefit of the additional flexibility afforded by section 8.56(3) for officers who are not directors. It was concluded, however, that all directors should be treated alike; complications may be created if directors who are not officers have potentially less protection under the statute than directors who are officers. It would also be difficult in many instances to distinguish in what capacity an officer-director is acting. Finally, this subchapter offers sufficient flexibility in indemnifying directors so that, as a practical matter, foreseeable problems for officer-directors can be handled within the statutory framework.

Section 8.56(1) grants nondirector officers the same mandatory rights to indemnification under section 8.52 (or to petition a court for indemnification under section 8.54) as are granted directors. Thus, the net effect of section 8.56 is to provide officers with no less protection than is provided directors (including protection for service to third parties at the request of the corporation) and, additionally, to permit the corporation to provide broader indemnification for officers who are not directors.

NORTH CAROLINA COMMENTARY

The words "who is not a director" appear after the words "of the corporation" in subdivisions 8.56(1) and (2) of the Model Act. The drafters omitted that language from the North Carolina version, without intending to change the meaning of the section, because they believe the words were unnecessary and confusing. If an officer, employee or agent is also a director, his rights of indemnification in his capacity as director will be defined by the other sections and his indemnification rights in his capacity as officer, employee or agent will be defined by this section. The addition of the unnecessary language in the Model Act might possibly be read as limiting a director's indemnification rights if he is also an officer, which was not intended.

OFFICIAL COMMENT

Section 8.57 authorizes a corporation to purchase and maintain insurance on behalf of directors, officers, employees, or agents against liabilities imposed on them by reason of actions in their official capacity or arising from their service to the corporation or another entity at the corporation's request. Insurance is not limited to claims against which corporations are entitled to indemnify under this subchapter. This insurance, usually referred to as "D&O Liability Insurance," provides a useful supplement to the rights of indemnification created by this subchapter, providing a source of reimbursement for corporations who indemnify directors and others for conduct covered by the insurance, and protecting the insureds against the corporation's failure to pay indemnification required or permitted by this subchapter. On the other hand, policies do not cover uninsurable events like self-dealing, bad faith, knowing violations of the securities acts, or other willful misconduct. See generally Johnston, "Corporate Indemnification and Liability Insurance," 33 BUS. LAW. 1993 (1978); Hinsey, "The New Lloyd's Policy Form for Directors and Officers' Liability Insurance - An Analysis," 33 BUS. LAW. 1961 (1978).

AMENDED NORTH CAROLINA COMMENTARY

Section 8.57 of the Model Act is entitled "Insurance" and deals only with that subject. In the North Carolina version the catchline has been expanded and the section is intended to permit broad nonstatutory indemnification completely in addition to and notwithstanding any other provisions of this Act. G.S. 55-8-50(a) expressly states that purpose and declares it to be the public policy of North Carolina.

This section permits indemnification, insurance and reimbursement of expenses in addition to, and notwithstanding, any other provisions of this Chapter. The section embodies the public policy of this State set forth in G.S. 55-8-50(a) to permit a corporation organized under this Chapter to spread the risk of corporate management, notwithstanding any other general or special law of this State or of any other jurisdiction including the federal government.

Subsection (a) permits and defines the scope of contractual indemnification under which the corporation, essentially as a self-insurer, may commit in advance to indemnify its directors, officers, employees or agents. This provision brings forward and clarifies all of former G.S. 55-19(a), which was added by the 1986 amendments. It adds an express statement, for example, that a corporation may agree in advance to indemnify its personnel even in a corporate or derivative action, subject only to the limitation brought forth from former G.S. 55-19(a).

Similarly, subsection (b) brings forward former G.S. 55-19(b) relating to the conflict of interest rules in G.S. 55-8-31 (which replaced former G.S. 55-30), but the application of the subsection to indemnification plans adopted on or after July 1, 1990 has been limited to public corporations (i.e., those required to file reports under Section 12 of the Securities Exchange Act of 1934). This limitation to public corporations was considered appropriate because (1) former G.S. 55-19(b) was intended to deal with the need to attract qualified outside directors - a need experienced mainly by public corporations, (2) shareholders of public corporations receive current disclosure of material changes in the indemnification scheme, and (3) shareholders have an active market in which they can dispose of their shares if they disapprove of a particular scheme of indemnification. Subsection (b) does not prevent a shareholder from challenging indemnification in a particular case. Instead, its effect is to shift to the shareholder of a public corporation the burden of proving that indemnification constitutes a breach of duty to the corporation under all of the facts and circumstances, including the facts and circumstances existing at the time indemnification was authorized or approved.

Subsection (c) replaces former G.S. 55-19(c) with section 8.57 of the Model Act because the drafters concluded that these insurance provisions of the Model Act are broader and clearer than former G.S. 55-19(c). Subsection (c) applies whether or not a corporation provides additional indemnification pursuant to subsections (a) and (b). As previously noted, former G.S. 55-19(d) was brought forward as G.S. 55-8-53.

CASE NOTES

Indemnification Prohibited. - Law firm was not entitled to fees for representing a bankruptcy debtor and its majority shareholders in an action in state court by a minority shareholder since the firm's claim was derivative of indemnification rights of the majority shareholders as directors of the debtor, and indemnification was precluded since the majority shareholder's actions in looting the debtor and forming a new entity were clearly in conflict with the best interests of the debtor. In re Prot. Sys. Techs., - Bankr. - (Bankr. W.D.N.C. Dec. 24, 2014).

OFFICIAL COMMENT

Section 8.58(a) provides that a provision treating the indemnification of directors by the corporation in articles of incorporation, bylaws, shareholders' or directors' resolution, or contract "is valid only if and to the extent it is consistent with" this subchapter. Earlier versions of the Model Act and the statutes of many states provided that the statutory provisions were not "exclusive" and made no attempt to limit the nonstatutory creation of rights of indemnification. This kind of language is subject to misconstruction, however, since nonstatutory conceptions of public policy limit the power of a corporation to indemnify or to contract to indemnify directors, officers, employees, or agents.

The language of the first sentence of section 8.58(a), "to the extent it is consistent with this subchapter," is believed to be a more accurate description of the limited validity of nonstatutory indemnification provisions than the "nonexclusive" provisions of earlier versions of the Model Act. It is important to recognize that "to the extent it is consistent with" is not synonymous with "exclusive." Situations may well develop from time to time in which indemnification is permissible under section 8.58 but would be precluded if all portions of subchapter E were viewed as exclusive. But indemnification provisions protecting against the consequences of bad faith or willful misconduct are not consistent with this subchapter and would not be valid. Furthermore, they would violate well-understood principles of public policy and doubtless would be invalidated on that ground even under statutes purporting to make "nonexclusive" the statutory provisions for indemnification. To the extent the consistency language may preclude indemnification in circumstances where it is reasonable and violates no statutory policy, an escape valve is provided in section 8.55(2), which authorizes a court to grant indemnification if a director "is fairly and reasonably entitled to indemnification in view of all the relevant circumstances," even though he may not have fully met the standards of conduct set forth in section 8.51.

Section 8.58 does not preclude provisions in articles of incorporation, bylaws, resolutions, or contracts designed to provide procedural machinery different from that provided by section 8.55 or to make mandatory the permissive provisions of subchapter E. For example, a corporation may properly obligate the board of directors to consider and act expeditiously on an application for indemnification or advances, or obligate the board of directors to cooperate in the procedural steps required to obtain a judicial determination under section 8.54.

Some corporations currently commit themselves, in one form or another, to indemnify directors to the fullest extent permitted by applicable law. These commitments are consistent with subchapter E, subject to appropriate interpretation in light of the facts and circumstances of the particular case. Furthermore, a commitment to maintain liability insurance for a director, pursuant to section 8.57, is consistent with this subchapter.

The first sentence of section 8.58(a) applies only to directors; it does not apply to officers, employees, or agents who are not directors. See section 8.56 and its Official Comment. The inherent problems of conflict of interest and the need to encourage persons to serve as directors are not present to the same degree in the case of nondirector officers, employees, or agents. The standard for permissible indemnification of these persons in section 8.56(3) is "consistent with law" without regard to this subchapter.

Section 8.58(b) is designed to make clear that subchapter E deals only with directors who are actual or prospective defendants or respondents in a proceeding, and that expenses incurred in connection with appearance as a witness may be indemnified without regard to the limitations of subchapter E. Indeed, most of the standards described in sections 8.51 and 8.54 by their own terms can have no meaningful application to a director whose only connection with a proceeding is that he has been called as a witness.

NORTH CAROLINA COMMENTARY

This section differs from the Model Act in two respects. First, the first sentence of subsection 8.58(a) of the Model Act, dealing with nonstatutory contractual indemnification, has been omitted because the subject is more broadly covered by G.S. 55-8-57; and second, the new subsection (c) has been added.

Effect of Amendments. - Session Laws 2018-45, s. 13, effective October 1, 2018, substituted "Subject to subsection (d) of this section, if the" for "If" in subsection (a); substituted "the director's" for "his" and "the director" for "he" in subsection (b); and added subsection (d).

OFFICIAL COMMENT

Section 10.01(a) authorizes a corporation to amend its articles of incorporation by adding a new provision to its articles of incorporation, modifying an existing provision, or deleting a provision in its entirety. The sole test for the validity of an amendment is whether the provision could lawfully have been included in (or in the case of a deletion, omitted from) the original articles of incorporation as of the effective date of the amendment.

The power of amendment must be exercised pursuant to the procedures set forth in the rest of this chapter, which require significant amendments to be approved either by a majority of the votes cast on the proposed amendment or by a majority of all of the votes eligible to be cast on the proposed amendment (section 10.03). This majority vote requirement is supplemented by section 10.04, which establishes a right of voting by voting group on amendments that directly affect a single class or series of shares, and by section 7.27, which treats amendments that change the voting requirements for future amendments.

Section 10.01(b) restates explicitly the policy embodied in earlier versions of the Model Act and in all modern state corporation statutes, that a shareholder "does not have a vested property right" in any provision of the articles of incorporation. Corporations and their shareholders are also subject to amendments of the governing statute by the state under section 1.02.

Section 10.01(b) should be construed liberally and without qualification or restriction to achieve the fundamental purpose of this chapter of permitting corporate adjustment and change by majority vote. Section 10.01(b) rejects decisions by a few courts that have applied a "vested rights" or "property right" doctrine to restrict or invalidate amendments to articles of incorporation because they modified particular rights conferred on shareholders by the original articles of incorporation. These holdings are rejected because their effect often is to create a tyranny of the minority: the individual consent of each shareholder becomes necessary to adopt any important change, and each shareholder, no matter how small his holding, can prevent the change.

Section 10.01(b) does not change in any way the purpose of similar provisions in earlier versions of the Model Act, which included, along with general language similar to section 10.01(b), a long list of specific permissible amendments. This list was designed to eliminate the last possible vestige of the "vested rights" theory by expressly referring to and validating all types of amendments to which a vested rights challenge could be made. Section 10.01(b) omits this "laundry list" of permissible amendments as prolix and unnecessary to carry out the policies of the section. Examples of amendments that may be made under section 10.01 include:

1. Amendments to eliminate a narrow or limited purpose clause (thereby authorizing the corporation to engage in any lawful business) or a limited duration clause (thereby authorizing the corporation to have perpetual duration).
2. Amendments increasing or decreasing the number of shares a corporation is authorized to issue.
3. Amendments exchanging, classifying, reclassifying, or cancelling any part of a corporation's shares, whether or not previously issued.
4. Amendments limiting or cancelling the right of holders of a class of shares to receive dividends, whether or not the dividends or rights to receive the dividends had accumulated or accrued in the past.
5. Amendments creating new classes of shares whether superior or inferior to shares already outstanding, or changing the designations of shares, or the preferences, limitations, or rights of classes of shares, whether or not previously issued.
6. Amendments dividing a class of shares into series and authorizing the directors to fix the relative rights and preferences of a class or series.
7. Amendments changing the voting rights of outstanding shares, including elimination of the power to vote cumulatively or assigning multiple or fractional votes per share, or denying the power to vote entirely to classes of shares, whether or not previously issued.

This listing is partial and illustrative only.

A provision in the articles of incorporation is subject to amendment under section 10.01 even though the provision is described, referred to, or stated in a share certificate, information statement, or other document issued by the corporation that reflects provisions of the articles of incorporation. The only exception to this unlimited power of amendment is section 6.27, which provides that share transfer restrictions may not be imposed by amendment on shares that were previously issued without the consent of the holder.

Section 10.01 relates only to amendments to articles of incorporation. It does not relate to the impairment of obligations of a corporation to its shareholders based upon contracts independent of the articles of incorporation. An amendment permitted by this section may constitute a breach of such a contract or of a contract between the shareholders themselves. A shareholder with contractual rights (or who otherwise is concerned about possible onerous amendments) may obtain complete protection against these amendments only by establishing procedures in the articles of incorporation or bylaws that limit the power of amendment without his consent. In appropriate cases, a shareholder may be able to enjoin an amendment that constitutes a breach of a contract.

Minority shareholders are protected from the power of the majority to impose onerous or objectionable amendments by two basic devices: the right to vote on amendments by separate voting groups (section 10.04) and the right to dissent under chapter 13. In addition, courts have held that a decision by majority shareholders to exercise the powers granted by this section in a way that is arguably detrimental or unfair to minority interests may be examined by a court under its inherent equity power to review transactions for good faith and fair dealing. McNulty v. W. & J. Sloane, 184 Misc. 835, 54 N.Y.S.2d 253 (Sup. Ct. 1945); Kamena v. Janssen Dairy Corp., 133 N.J.Eq. 214, 31 A.2d 200, 203 (1943), aff'd, 134 N.J.Eq. 359, 35 A.2d 894 (1944) (where the court stated that it "is more a question of fair dealing between the strong and the weak than it is a question of percentages or proportions of the votes favoring the plan"). See also Teschner v. Chicago Title & Trust Co., 59 Ill.2d 452, 322 N.E.2d 54, 57 (1974), where the court, in upholding a transaction that had a reasonable business purpose, relied partially on the fact that there was "no claim of fraud or deceptive conduct . . . [or] that the exchange offer was unfair or that the price later offered for the shares was inadequate."

Because of the broad power of amendment contained in this section, it is unnecessary and undesirable to make any reference to, or reserve, an express power to amend in articles of incorporation.

NORTH CAROLINA COMMENTARY

This section broadly authorizes a corporation to amend its articles of incorporation to include any provision required or permitted in the articles of incorporation. Former G.S. 55-99 contained a "laundry list" of permissive amendments.

Legal Periodicals. - For note on unanimous approval of corporate bylaws and creation of shareholder agreements, see 1 Campbell L. Rev. 153 (1979).

For article, "Using Alternative Dispute Resolution Techniques To Settle Conflicts Among Shareholders Of Closely Held Corporations," see 22 Wake Forest L. Rev. 105 (1987).

For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For article, "Silencing the Shareholder's Voice," see 80 N.C.L. Rev. 1897 (2002).

CASE NOTES

Editor's Note. - The cases below were decided under prior law.

Amendment Operates Prospectively. - Whether the law itself makes an amendment, or confers the power of amendment on the corporation, the amendment will not be construed to operate retrospectively to the detriment of rights already vested under the old charter. Patterson v. Durham Hosiery Mills, 214 N.C. 806, 200 S.E. 906 (1939).

A charter amendment requiring consent of three fourths in interest of the preferred stockholders to the issuing of bonds or securities of prior or equal rank is prospective in effect, and does not constitute a waiver of the right to the declaration of accrued, accumulated dividends, when earned, by permitting the interposing of new preferred stock by agreement of three fourths of the preferred stockholders, nor does legislative authority to amend the charter extend to authority to defeat the vested right to the declaration of such dividends by amendment of the charter. Patterson v. Durham Hosiery Mills, 214 N.C. 806, 200 S.E. 906 (1939).

Subscriber Released by Fundamental Change. - Any fundamental change in the charter of a corporation relieves a nonassenting subscriber from liability upon his stock. First Nat'l Bank v. City of Charlotte, 85 N.C. 433 (1881).

OFFICIAL COMMENT

The amendments described in clauses (1) through (6) are so routine and "housekeeping" in nature as not to require action by shareholders. None affects substantive rights in any meaningful way. For example, section 10.02(1) authorizes amendments by the board of directors to extend the duration of a corporation that was formed at a time when limited duration was required by law. The extension normally will be in the form of an amendment to delete all reference to the duration of the corporation, which automatically makes the duration perpetual. See section 3.02. Similarly, sections 10.02(2) and (3) authorize the board of directors to delete the names of initial directors, or the name and address of the initial registered agent and registered office, set forth in the original articles if that information is obsolete. Section 10.02(4) authorizes the board of directors to change each issued and unissued share of an outstanding class of shares into a greater number of whole shares if the corporation has only that class of shares outstanding. All shares of the class being changed must be treated identically under this clause. Section 10.02(5) authorizes minor name changes without shareholder approval.

Section 10.02(6) recognizes that other sections of the Model Act expressly permit other amendments to be made by the board of directors without prior shareholder approval. Examples of these include section 6.02 (creation of series of shares pursuant to authority already granted in the articles) and section 6.31 (cancellation of reacquired shares if the articles provide they are not to be reissued).

Amendments provided for in this section may be included in restated articles of incorporation under section 10.07 or in articles of merger under chapter 11.

NORTH CAROLINA COMMENTARY

This section authorizes the board of directors to adopt certain "housekeeping" amendments to the articles of incorporation without shareholder action. Under former G.S. 55-100(b), shareholder action was required for all amendments after the initial issuance of shares. Subdivision 10.02(1) of the Model Act, relating to an amendment to extend the duration of a corporation if it was incorporated at a time when limited duration was required by law, was omitted, because limited duration has not been required by North Carolina law.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended to reflect (i) the relocation to this section from G.S. 55-6-31 of the provision authorizing a board of directors to amend articles of incorporation to reflect a reduction in authorized shares when the corporation is prohibited from reissuing acquired shares and (ii) the addition of a provision authorizing a board of directors to amend the articles of incorporation to increase the number of authorized shares as necessary to permit a share dividend if the corporation has only one class of shares outstanding.

Effect of Amendments. - Session Laws 2005-268, s. 13, effective October 1, 2005, in the introductory language, substituted "any of the following" for "one or more" and "approval" for "action"; made minor stylistic changes in subdivisions (1) through (3) and (5); rewrote subdivision (4); added subdivisions (5a) and (5b); and in subdivision (6), substituted "Chapter" for "act" and "approval" for "action."

CASE NOTES

Shareholders' Prior Authorization of Stock - Share exchange in the merger of two banks did not violate the law when one bank issued a class of preferred stock, representing 39.9 percent of the bank's aggregate voting rights, in exchange for shares of the other bank's common stock because the shareholders had previously authorized the preferred stock. Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

OFFICIAL COMMENT

Significant amendments to articles of incorporation must be approved by the shareholders after being proposed by the board of directors. When proposing an amendment, the board of directors must make a recommendation to the shareholders that the amendment be approved, unless it determines that because of conflict of interest or other special circumstances it should make no recommendation. If the board of directors so determines, it must describe the conflict or circumstance, and communicate the basis for its determination, when presenting the proposed amendment to the shareholders.

Section 10.03(c) codifies existing practice by expressly permitting the board of directors to submit an amendment to the shareholders on a conditional basis. This power of the board of directors does not alter the balance of power between the board of directors and shareholders since the board of directors may always withhold its approval entirely and not submit an amendment. Examples of conditions commonly imposed are that the amendment not be approved unless (1) a favorable vote by a specified proportion (larger than ordinarily required) of the shareholders is obtained, (2) no more than a specified fraction of the shareholders file written dissents, or (3) a class or series of shares must approve the amendment as a separate voting group. These conditions may be used, for example, to discourage unwise depletion of corporate assets by the adoption of the amendment. The board of directors is not limited to conditions of these types, however, and may condition the submission on any basis.

The vote of shareholders needed to approve an amendment depends in part on the voting groups entitled to vote separately on the amendment and in part on whether any of those voting groups would be entitled to dissenters' rights if the amendment were adopted. See section 10.04. However, section 10.03(e) itself establishes a dual requirement for approval by shareholders of each voting group depending on the nature of the amendment: under section 7.25 and 7.26 a majority of the votes cast affirmatively and negatively on the amendment at a meeting at which a quorum is present is necessary to approve most amendments; but if the amendment would give rise to dissenters' rights under chapter 13, section 10.03(e) requires that it be approved by a majority of the votes of the outstanding shares of each voting group that will have dissenters' rights if the amendment were adopted, and by the vote required by sections 7.25 and 7.26 by other voting groups that are entitled to vote on the amendment. This increased voting requirement reflects the importance of these proposals. Of course, the articles of incorporation may specify a greater quorum or voting requirement for a voting group to approve an amendment of any type. See section 7.27.

The articles of incorporation or the board of directors may require that a proposed amendment be approved by a class or series of shares voting as a separate voting group; such a requirement may only be in addition to that otherwise required by section 10.04 of this Act.

NORTH CAROLINA COMMENTARY

This section continues the usual procedure under former G.S. 55-100(b) for adoption of amendments to the articles of incorporation by action of the board of directors and then by the shareholders. It adds two new features. First, the board of directors must recommend the amendment to the shareholders, unless it determines that, because of conflict of interest or other special circumstances, it should make no recommendation and communicates the basis for its lack of a recommendation to the shareholders. Second, the section specifically authorizes the board of directors to condition its submission of a proposed amendment "on any basis."

This section omits the Model Act's requirement that notice of the meeting at which the proposed amendment will be considered and of the proposed amendment itself be given to all shareholders of the corporation whether or not entitled to vote on the proposed amendment. Accordingly, the section continues the procedure under former G.S. 55-100(b)(2) of giving notice only to those shareholders entitled to vote on the proposed amendment.

Under former G.S. 55-100(b)(1), an amendment to the articles of incorporation could be initiated by shareholders entitled to call a shareholders' meeting. There is no similar procedure in this Act.

A clarifying stylistic change was made to the Model Act's language in subsection (b) of this section.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is changed to provide that once shares have been issued generally all amendments to the articles of incorporation must be adopted by the board of directors, including those that must be approved by the shareholders. Prior to this change, a board of directors was only required to propose amendments that required shareholder approval.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2005-268, s. 14, effective October 1, 2005, rewrote subsections (a) through (d).

Session Laws 2011-347, s. 5, effective October 1, 2011, substituted "appraisal rights" for "dissenter's rights" in subdivision (e)(1).

Session Laws 2013-153, s. 8, effective January 1, 2014, in subsection (b), substituted "shall" for "must" twice, and substituted "one of the following circumstances exist, in which event the board of directors shall communicate the basis for not recommending approval of the amendment to the shareholders at the time it submits the amendment to the shareholders" for "the board of directors determines that, because of conflict of interest or other special circumstances, it should not make such a recommendation, in which event the board of directors must communicate the basis for that determination to the shareholders with the amendment" in the second sentence; added subdivisions (b)(1) and (b)(2); added "all of the following" in subsection (e); and made a minor stylistic and punctuation change in subdivision (e)(1).

Session Laws 2018-45, s. 14, effective October 1, 2018, substituted "G.S. 55-7-31(f), 55-10-02," for "G.S. 55-10-02," in subsection (b).

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

CASE NOTES

Shareholders' Prior Authorization of Stock. - Share exchange in the merger of two banks did not violate the law when one bank issued a class of preferred stock, representing 39.9 percent of the bank's aggregate voting rights, in exchange for shares of the other bank's common stock because the shareholders had previously authorized the preferred stock. Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

OFFICIAL COMMENT

A class or series of shares is generally entitled to vote separately as a voting group on any amendment that affects the class or series in the manner described in subdivisions (1) through (9) of section 10.04(a). Shares are entitled to vote as separate voting groups under this section even though they are designated as nonvoting shares in the articles of incorporation, or the articles of incorporation purport to deny them entirely the right to vote on the proposal in question, or purport to allow other classes or series of shares to vote as part of the same voting group. See section 10.04(d). If an amendment would create dissenters' rights with respect to any class or series of shares, the amendment must be approved by each voting group that would have dissenters' rights by a majority of all votes entitled to be cast on the amendment, and by other voting groups by the vote required by sections 7.25 and 7.26. See section 10.04(b). All other amendments are subject to the voting requirements generally applicable to voting groups under sections 7.25 and 7.26.

The right to vote by voting groups under section 10.04 is applicable only if "shareholder voting is otherwise required by this Act." An amendment that does not require shareholder approval, such as the creation of a new series of shares pursuant to authority reserved in the original articles of incorporation (see section 6.02), does not trigger the right to vote by voting groups under this section.

The right to vote as a separate voting group provides a major protection for classes or series of shares with preferential rights or classes or series of limited or nonvoting shares against amendments that are especially burdensome to that class. This section, however, does not make the right to vote by separate voting group dependent on an evaluation of whether the amendment is detrimental to the class or series: if the amendment is one of those described in section 10.04(a), the class or series is automatically entitled to vote as a separate voting group on the amendment. The question whether an amendment is detrimental is often a question of judgment, and approval by the affected class or series is required, irrespective of whether the board or other shareholders believe it is beneficial or detrimental to the affected class or series.

The nine types of changes that give rise to voting by voting groups are essentially the same as in earlier versions of the Model Act, though their number has been reduced based on the conclusion that some of the changes listed in earlier versions were subsumed within other listed changes. Subsections (b) and (c) extend the privilege of voting by separate voting group to one or more series of a class of shares if the series has unique financial or voting provisions and is affected in one or more of the ways described in subsection (a). These subsections must necessarily be phrased in general terms; any significant distinguishing feature of a series, which an amendment affects or alters, should trigger the right of voting by separate voting group for that series.

The application of subsections (b) and (c) may best be illustrated by an example. Assume there is a class of shares with preferential rights comprised of three series, each with different preferential dividend rights. A proposed amendment would reduce the rate of dividend applicable to the "Series A" shares and would change the dividend right of the "Series B" shares from a cumulative to a noncumulative right. The amendment would not affect the preferential dividend right of the "Series C" shares. Both Series A and B would be entitled to vote as separate voting groups on the proposed amendment; the holders of the Series C shares, not directly affected by the amendment, would not be entitled to vote at all unless the shares are otherwise voting shares under the articles of incorporation, in which case they would not vote as a separate voting group but in the voting group consisting of all shares with general voting rights under the articles of incorporation. If the proposed amendment would reduce the dividend right of Series A and change the dividend right of both Series B and C from a cumulative to a noncumulative right, the holders of Series A would be entitled to vote as a single voting group, and the holders of Series B and C would be required to vote together as a single, separate voting group.

Sections 7.25 and 7.26 set forth the mechanics of voting by multiple voting groups.

Section 10.04(d) makes clear that the limited right to vote by separate voting groups provided by section 10.04 may not be narrowed or eliminated by the articles of incorporation. Even if a class or series of shares is described as "nonvoting" and the articles purport to make that class or series nonvoting "for all purposes," that class or series nevertheless has the limited voting right provided by this section. Section 10.04(d) was included because of the ambiguity that would normally arise whenever a class or series of nonvoting shares is created; no inference of any kind should be drawn from section 10.04(d) as to whether other, unrelated sections of the Model Act may be modified by the provisions in the articles of incorporation.

NORTH CAROLINA COMMENTARY

This section differs from the Model Act in providing for class voting in the case of a proposed amendment to the articles of incorporation that would change the corporation into a nonprofit corporation or a cooperative organization. With this addition, the instances in which class voting is required under the Act are the same as under former G.S. 55-101.

CASE NOTES

Cited in Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

OFFICIAL COMMENT

Section 10.05 provides that, before any shares are issued, amendments may be made by the persons empowered to complete the organization of the corporation. Under section 2.04 the organizers may, at the option of the corporation, be either the incorporators or the initial directors named in the articles of incorporation. An amendment to the articles made at this stage of the formation process should involve a minimum of formality.

NORTH CAROLINA COMMENTARY

This section continues the procedure under former G.S. 55-100(a) by which the board of directors and incorporators may amend the articles of incorporation before the issuance of shares.

OFFICIAL COMMENT

The articles of amendment must set forth both the amendment itself and the manner in which it was adopted. In the case of an amendment approved by shareholder vote (sections 10.03 and 10.04), the articles must state either the total vote in favor and against the proposal or the undisputed vote for and a statement that this vote was sufficient to adopt the amendment. The latter tally method is permitted because in many situations the precise vote may depend on the resolution of protracted disputes with respect to proxy votes. The filing of the articles of amendment should not be dependent on the resolution of every dispute if it is certain that a sufficient vote has been obtained without considering the disputed votes. In most situations, of course, the precise vote can be readily determined, and when it can the articles should record it.

Section 10.06(a)(3) requires the articles of amendment to contain a statement of the manner in which an exchange, reclassification, or cancellation of issued shares is to be put into effect if not set forth in the amendment itself. This requirement avoids any possible confusion that may arise as to how the amendment is to be put into effect and also permits the amendment itself to be limited to provisions of permanent applicability, with transitional provisions having no long-range effect appearing only in the articles of amendment.

NORTH CAROLINA COMMENTARY

This section is essentially the same as former G.S. 55-103, except that no special statement is required in the case of an amendment effecting a change in the amount of stated capital and except that no statement is required with respect to dissenters' rights.

OFFICIAL COMMENT

Restated articles of incorporation serve the useful purpose of permitting articles of incorporation that have been amended from time to time to be consolidated into a single document. Such a restatement may also eliminate "historical" or obsolete provisions that have no present relevance.

A restatement of articles of incorporation that does not involve any substantive change in the articles (or that makes only amendments that may be made by the board of directors without shareholder approval) may be approved by the board of directors alone. In order to increase the reliability of restated articles as the definitive governing document of the corporation, section 10.07 authorizes the restated articles of incorporation to be submitted to the shareholders for approval in the same manner as amendments to the articles. If duly submitted to the shareholders, substantive variation between the original articles of incorporation, as amended, and the restated articles becomes academic if the shareholders' vote is the appropriate one required to amend the articles to the extent of the inconsistency.

Substantive amendments may also be adopted as part of a restatement. If substantive amendments are proposed, the same procedure must be followed as for the adoption of amendments under sections 10.02, 10.03, or 10.05.

If restated articles are submitted to the shareholders, the notice of meeting should identify changes in the articles that may reasonably be viewed as more than mere changes of form.

Section 10.07(e) makes it clear that the restated articles of incorporation supersede the original articles of incorporation and all amendments to them, and section 10.07(f) permits the secretary of state to certify the restatement uncluttered by the information set forth in subsection (e).

NORTH CAROLINA COMMENTARY

This section is in substance the same as former G.S. 55-105. The procedure for simultaneously amending and restating the articles of incorporation was clarified. The Model Act uses two terms in its comparable section, "restated articles of incorporation" and "restatement," to refer to the same document. Because the drafters concluded that the use of both could be confusing, they decided to use a single term, "restated articles of incorporation," and made other conforming and stylistic changes in subsections (c), (d), and (f).

Effect of Amendments. - Session Laws 2005-268, s. 15, effective October 1, 2005, substituted "approval, to consolidate all amendments into a single document" for "action" in subsection (a); deleted former subsection (c) which read: "If the board of directors submits restated articles of incorporation for shareholder action, the corporation shall notify each shareholder entitled to vote, of the proposed shareholders' meeting in accordance with G.S. 55-7-05. The notice must also (i) state that the purpose, or one of the purposes, of the meeting is to consider the proposed restated articles of incorporation, (ii) contain or be accompanied by a copy of the proposed restated articles of incorporation, and (iii) identify any amendment or other change they would make in the articles"; rewrote subdivision (d)(3) and (d)(4); substituted "to the original articles of incorporation" for "to them" in subsection (e); inserted "of this section" in subsection (f); and made minor stylistic changes throughout.

OFFICIAL COMMENT

Under section 10.09, amendments to articles of incorporation do not interrupt the corporate existence and do not abate a proceeding by or against the corporation even though the amendment changes the name of the corporation.

Amendments are effective when filed unless a delayed effective date is elected. See section 1.23.

NORTH CAROLINA COMMENTARY

This section is in substance the same as former G.S. 55-104.

OFFICIAL COMMENT

In the absence of a provision in the articles of incorporation, the power to amend or repeal bylaws is shared by the board of directors and shareholders. Amendment of bylaws by the board of directors is often simpler and more convenient than amendment by the shareholders and avoids the expense of calling a shareholders' meeting, a cost that may be significant in publicly held corporations. As used in this subchapter, "amendment" includes the adoption of a bylaw on a new subject as well as the alteration of existing bylaws.

Section 10.20(a) provides, however, that the power to amend or repeal bylaws may be reserved exclusively to the shareholders by an appropriate provision in the articles of incorporation. This option may appropriately be elected by a closely held corporation - for example, where control arrangements appear in the bylaws but one shareholder or group of shareholders has the power to name a majority of the board of directors. In such a corporation, the control arrangements may alternatively be placed in the articles of incorporation rather than the bylaws if there is no objection to making them a matter of public record.

Section 10.20(a)(1) provides that the power to amend or repeal the bylaws may be reserved to the shareholders "in whole or part." This language permits the reservation of power to be limited to specific articles or sections of the bylaws or to specific subjects or topics addressed in the bylaws. It is important that the areas reserved exclusively to the shareholders be delineated clearly and unambiguously.

Section 10.20(a)(2) permits the shareholders to adopt or amend a bylaw and reserve exclusively to themselves the power to amend or repeal it later. This reservation must be expressed in the action by the shareholders adopting or amending the bylaw. This option is also included for the benefit of closely held corporations.

Section 10.20(b) states that the power of shareholders to amend or repeal bylaws exists even though that power is shared with the board of directors. This section makes inapplicable the holdings of a few cases under differently phrased statutes that shareholders do not have a general or residual power to amend bylaws or that the power to amend bylaws may be vested exclusively in the board of directors. Under the Model Act the shareholders always have the power to amend or repeal the bylaws.

Sections 10.21 and 10.22 limit the power of directors to adopt or amend supermajority provisions in bylaws.

NORTH CAROLINA COMMENTARY

The Model Act was modified to provide that a bylaw adopted, amended or repealed by the shareholders may not be readopted, amended or repealed by the board of directors unless authorized by the articles of incorporation or a bylaw adopted by the shareholders. As modified, this section is consistent with former G.S. 55-16(a)(1).

Effect of Amendments. - Session Laws 2018-45, s. 15, effective October 1, 2018, added the last sentence in subsection (a).

Legal Periodicals. - For article discussing shareholder voting rights, see 71 N.C.L. Rev. 1 (1992).

OFFICIAL COMMENT

Supermajority provisions relating to the board of directors may appear in the bylaws of the corporation without specific authorization in the articles of incorporation. See section 8.24(a) and (c). Like other bylaw provisions, they may be adopted either by the board of directors or by the shareholders. See section 10.20. Such provisions, further, may be amended or repealed by the board of directors or shareholders as provided in this section. This treatment of supermajority provisions for the board of directors should be contrasted with the treatment of analagous provisions for shareholders which must either be set forth in the articles of incorporation, section 7.27, or included in the bylaws when expressly authorized by the articles, section 10.21, and their adoption, amendment, or repeal must be approved by the shareholders by the vote specified in sections 7.27 and 10.21.

Supermajority provisions relating to the board of directors are usually part of control arrangements in closely held corporations, and section 10.22 is designed with this end in view. Its basic purpose is to ensure that control arrangements negotiated by shareholders for their own protection will not be prematurely terminated by a majority vote of the shareholders or the board of directors. Thus, section 10.22(a)(1) provides that if a supermajority requirement is originally imposed by a bylaw adopted by the shareholders, only the shareholders may amend or repeal it. Further, under section 10.22(b), that bylaw may impose restrictions on the manner in which it may be thereafter amended or repealed by the shareholders. On the other hand, if a supermajority requirement is originally imposed in a bylaw adopted by the board of directors, that bylaw may be amended either by the board of directors or shareholders (see section 10.22(a)(2)), but if it is to be amended by the board of directors, section 10.22(c) requires approval by the supermajority requirement then being imposed or amended, whichever is greater. This requirement is analogous to that imposed on supermajority amendments appearing in the articles of incorporation. See section 7.27. For an example of the application of this language, see the Official Comment to section 7.27.

NORTH CAROLINA COMMENTARY

The Model Act was modified in this section to conform to the provisions of G.S. 55-7-27.

OFFICIAL COMMENT

1. Statutory mergers
2. Equivalent nonstatutory transactions

Section 11.01(a) authorizes a statutory merger, to be accomplished by the adoption of a plan of merger under section 11.01(b), approval of the transaction by the shareholders (if required by section 11.03), and filing articles of merger under section 11.05. Upon the effective date of the merger, the surviving corporation becomes vested with all the assets of the disappearing corporations and becomes subject to their liabilities.

Under the Model Act there are virtually no restrictions or limitations on the terms of a statutory merger. Shareholders of the disappearing corporations may receive securities of the surviving corporation, securities of a third corporation, e.g., shares issued by the parent of the surviving or disappearing corporation (which may be publicly traded and marketable while the shares of the surviving or disappearing corporation are not), or cash or other property (a "cash" or "cash-out" merger). Some of the holders of a single class of shares may be required to accept securities or properties while the remaining holders may be compelled to accept different securities, property, or cash. The capitalization of the surviving corporation may be restructured in the merger, or its articles of incorporation may be amended by the articles of merger in any way deemed appropriate. Any other provisions considered necessary or desirable with respect to the merger may be included in the plan of merger.

Merger transactions may give rise to voting by separate voting groups of shareholders under section 11.03(f), and dissenting shareholders may have dissenters' rights under chapter 13.

Courts have held that merger transactions that are formally authorized by the procedures set forth in this chapter may in some circumstances constitute a breach of duty to minority shareholders where the effect of the transaction is to eliminate them from further equity participation in the enterprise. See McBride, "Delaware Corporate Law: Judicial Scrutiny of Mergers - The Aftermath of Singer v. Magnavox Co. ," 33 BUS. LAW. 2231 (1978). In Delaware, case law establishes that these transactions must be fully disclosed and entirely fair to the minority shareholders. See Singer v. Magnavox Co. , 380 A.2d 969 (Del. 1977); Weinberger v. UOP, Inc. , 457 A.2d 701 (Del. 1983); Harman v. Masoneilan International, Inc. , 442 A.2d 487 (Del. 1982).

A transaction may have the same economic effect as a statutory merger even though it is cast in the form of a nonstatutory transaction. For example, assets of the disappearing corporations may be sold for consideration in the form of shares of the surviving corporation, followed by the distribution of those shares by the disappearing corporations to their shareholders and their subsequent dissolution. Transactions have sometimes been structured in nonstatutory form for tax reasons or in an effort to avoid some of the consequences of a statutory merger, particularly appraisal rights to dissenting shareholders. Faced with these transactions, a few courts have developed or accepted the "de facto merger" concept which, to some uncertain extent, grants to dissenting shareholders the rights they would have had if the transaction had been structured as a statutory merger. See Folk, "De Facto Mergers in Delaware: Hariton v. Arco Electronics, Inc. ," 49 VA. L. REV. 1261 (1963). These problems should not occur under the Model Act since the procedural requirements for authorization and consequences of various types of transactions are largely standardized. For example, dissenters' rights are granted not only in mergers but also in share exchanges, in sales of all or substantially all the corporate assets, and in amendments to articles of incorporation that significantly affect rights of shareholders.

REVISED NORTH CAROLINA COMMENTARY 2018

Article 11 eliminates all references to statutory consolidation because of the infrequent use of the consolidation form of combination, in which all corporate parties to the combination disappear and an entirely new corporation is created, and because, if a new entity is desirable, it may be created before the merger and the disappearing entities may merge into it.

The third sentence of the second paragraph of the "Official Comment" to Section 11.01 of the Model Act indicates that a plan of merger can discriminate among holders of shares of the same class in the kind of property they receive in a merger. The drafters believed that this sentence does not reflect the current law in North Carolina. They believed that the current law does not permit discrimination among the holders of shares of a single class that are similarly situated in the kind of property that can be received in a merger; all the shares of a single class must be treated the same, both in value and kind, for similarly situated shareholders. Therefore, the drafters note their disagreement with this sentence in the "Official Comment." But see G.S. 55-6-24(b) (which expressly permits discrimination among holders of a single class or series of shares in certain shareholder rights plans).

There are circumstances where shares of a single class are not similarly situated. For example, Corporation A and/r its wholly-owned subsidiaries may own a portion of the shares of common stock of Corporation B, while the remaining shares of common stock of Corporation B are owned by a number of other holders. Corporation A and Corporation B may wish to engage in a merger transaction, pursuant to which Corporation A will acquire all of the shares of Corporation B not already owned by Corporation A and/r its wholly-owned subsidiaries (for example in a triangular merger) and the other holders of Corporation B shares will receive a specified merger consideration for their shares. Under such circumstances, Corporation A (and its wholly-owned subsidiaries) and the other holders of Corporation B stock are not similarly situated and there is no reason for them to be treated the same, so long as all of the other holders are treated equally and do not receive merger consideration that is of lesser value than any received by Corporation A or its wholly-owned subsidiaries. Accordingly, under such circumstances, the plan of merger should properly be able to provide that the shares of Corporation B held by Corporation A and its wholly-owned subsidiaries may be cancelled (and Corporation A and its wholly-owned subsidiaries not receive any merger consideration for such shares) and that the shares held by the other holders of Corporation B shares may receive the specified merger consideration.

This section is not intended to change the current law in North Carolina under which shareholders may elect to receive alternative forms of consideration (e.g. cash or shares) and proration is provided if one of the alternatives is oversubscribed.

Effect of Amendments. - Session Laws 2005-268, s. 16, effective October 1, 2005, added subsection (d).

Session Laws 2018-45, s. 16, effective October 1, 2018, substituted "shall set forth all of the following:" for "must set forth:" in subsection (b); substituted "part, or of cancelling the shares" for "part" in subdivision (b)(3); and made minor stylistic changes throughout subsection (b).

Legal Periodicals. - For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

CASE NOTES

Editor's Note. - Some of the cases below were decided under prior law.

Statute Controls. - Where two corporations enter into an agreement for their union and the continuation of business under the name of one with the combined assets of both, the statute controls as to whether there is a merger or a consolidation. Carolina Coach Co. v. Hartness, 198 N.C. 524, 152 S.E. 489 (1930).

Merger changed the capitalization of a corporation and a corporation's approval of the merger pursuant to G.S. 55-11-01 to 55-11-10 violated the terms of its option agreement with a consultant who had a five-year option to purchase 50 percent of its shares; the corporation's principal was also liable for the breach because he voluntarily participated in the merger knowing that it would extinguish the consultant's stock options, and he was the sole shareholder and director of the corporation. Lee v. Scarborough, 164 N.C. App. 357, 595 S.E.2d 729 (2004).

Breach of Stock Option and Restriction Agreement. - Trial court properly granted partial summary judgment to a businessman against a shareholder and a corporation because the merger of a company into the corporation without any prior notice to or consent by the businessman resulted in a breach of a stock option and restriction agreement between the businessman and the company and its sole shareholder, as the merger clearly effected a change in the capitalization of the company. Lee v. Scarborough, 162 N.C. App. 674, 592 S.E.2d 43 (2004).

Shareholder Vote Not Required for Share Exchange. - Board of directors of a bank was not required to submit a share exchange to the shareholders for a vote when the bank merged with another bank because the transaction was not compulsory on any owners of the acquired shares as they were issued directly to the other bank. There were no prior-owners of the acquired shares, and the other bank provided consideration to the bank in the form of the other bank's shares. Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

Cited in Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

OFFICIAL COMMENT

Section 11.02 establishes a procedure by which a direct exchange of shares for cash or other consideration in corporate combinations may be effected under the same safeguards applicable to statutory mergers or similar transactions. A share exchange under section 11.02 is binding upon all shareholders of the acquired class or series of shares.

It is often desirable to effect a reorganization or combination so that the corporation being acquired does not go out of existence but becomes a subsidiary of the acquiring corporation or holding company, the securities of which are issued as part of the transaction. These objectives often are particularly important in the formation of holding company systems for, or for the acquisition of, insurance companies and banks, but are not limited to these transactions. In the absence of a share exchange procedure, this kind of a transaction often may be accomplished only by the process of a "reverse triangular merger": the formation of a new subsidiary of the acquiring or holding company, followed by a merger of that subsidiary into the corporation to be acquired in which securities of the new subsidiary's parent are exchanged for securities of the corporation to be acquired. Section 11.02 provides a straightforward procedure to accomplish the same end.

Under section 11.02, all shares of a particular class or series of shares must be acquired. However, shares of one or more classes or series may be excluded from the plan or may be included on different bases. After the plan is adopted and approved by the shareholders as required by section 11.03, it is binding on all holders of shares of the class or series to be acquired; members of the class or series, however, have the right to dissent under chapter 13.

It is not necessary that a share exchange under section 11.02 be on a share-for-share basis. The consideration for the shares being acquired may be "shares, obligations, or other securities of the acquiring or any other corporation or . . . cash or other property in whole or part."

Section 11.02(c) is designed to make it clear that the mandatory exchange provided by section 11.02 does not affect the power of corporations to acquire shares by voluntary exchange or otherwise by agreement with the shareholders.

NORTH CAROLINA COMMENTARY

This section introduces a concept that is new to North Carolina, i.e., a share exchange, which is defined as a transaction by which a corporation becomes the owner of all the outstanding shares of one or more classes of another corporation by an exchange that is compulsory on all owners of the acquired shares.

The same kind of transaction that is accomplished by a share exchange has in the past been accomplished by the process of a "reverse triangular merger," which is the formation of a new subsidiary of the acquiring company, followed by a merger of that subsidiary into the corporation to be acquired in which the securities of the new subsidiary's parent are exchanged for securities of the corporation to be acquired.

Effect of Amendments. - Session Laws 2005-268, s. 17, effective October 1, 2005, added subsection (c1); and in subsection (d), substituted "the acquisition of" for "the power of a corporation to acquire" and "a corporation" for "another corporation."

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

OFFICIAL COMMENT

1. Introduction
2. When surviving corporation shareholder approval is not required
3. Voting by multiple voting groups
4. Application of the 20-percent requirement
5. Abandonment of merger or share exchange

Section 11.03 requires mergers or share exchanges to be approved by the shareholders as follows:

In the case of a merger:

1. the transaction must always be approved by the shareholders of the disappearing corporation; and
2. the transaction must be approved by the shareholders of the surviving corporation if the number of voting or participating shares is increased by more than 20 percent as a result of the transaction.

In the case of a share exchange:

(1) the transaction must always be approved by the shareholders of the corporation whose shares are being acquired; and

(2) the transaction need not be approved by the shareholders of the corporation acquiring the shares.

Section 11.03 requires the board of directors to propose the plan of merger or sale exchange and then submit the proposal to the shareholders. When proposing a plan of merger or share exchange, the board of directors must make a recommendation to the shareholders that the plan be approved, unless it determines that because of conflict of interest or other special circumstances it should make no recommendation. If the board of directors so determines, it must describe the conflict or circumstances, and communicate the basis for its determination, when presenting the proposed plan of merger or share exchange to the shareholders.

Section 11.03(c) permits the board of directors to condition its submission of a plan of merger or share exchange on any basis; for example, the board may direct that the plan is approved only if it receives a favorable vote of a specified percentage of the disinterested shareholders voting on the plan or that shareholders holding no more than a specified number or percentage of shares file notice of intent to demand payment under chapter 13. See the discussion of conditional submissions in the Official Comment to section 10.03.

A plan of merger or share exchange, to be approved, must be approved by each voting group entitled to vote on the merger by a majority of all the votes entitled to be cast on the plan. This is a greater vote than that required for ordinary matters under section 7.25. The articles of incorporation of either corporation, however, may require a greater vote by one or more voting groups of that corporation, and if the transaction involves an amendment to the articles of incorporation of the surviving corporation which affects the voting requirements for future amendments, the transaction must also be approved by the vote required by section 7.27. See section 11.03(e). In addition, voting by more than one voting group may be required by section 11.03(f) or by the articles of incorporation. Finally, the board of directors may require a greater vote or a vote by voting groups under their power to make conditional submissions to shareholders described above. The articles of incorporation or the board of directors, however, may only require a vote by separate voting groups in addition to that otherwise required by this Act.

Only shareholders who have the right to vote on a merger or share exchange under section 11.03 have the right to dissent and obtain payment for their shares under chapter 13.

Section 11.03(g) describes when approval by the shareholders of the surviving corporation is not required. The theory behind this subsection is that shareholders' votes should be required only if the transaction fundamentally alters the character of the enterprise or substantially reduces the shareholders' participation in voting or profit distribution. It is believed that the transactions for which shareholder approval is not required by subsection (g) do not alter the investors' prospects any more than many other management decisions, and thus should not require a shareholder vote. In particular, the 20 percent requirement of subsections (g)(3) and (4) is broadly consistent with the statutes of several states, including Delaware (20 percent), Michigan (20 percent), and Pennsylvania (15 percent), and also with the New York Stock Exchange requirement that shareholders must be consulted if the number of outstanding shares is to be increased by more than 18.5 percent.

The requirement that shareholders of the surviving corporation in a statutory merger have a right to vote if the increase in the number of shares exceeds 20 percent may be avoided by arranging the transaction in the form of a merger involving a subsidiary of the acquiring corporation or as a share exchange under section 11.02. This anomaly reflects a compromise among basically conflicting points of view.

The 20 percent requirement is applicable only if the corporation has available enough authorized shares to permit it to issue the shares without amending its articles of incorporation to increase authorized capital. If it must amend its articles of incorporation to authorize the shares necessary to complete the transaction, a shareholder vote on the amendment will be necessary in all cases. See section 10.03.

Section 11.03(f)(1) requires voting by voting groups on a plan of merger if the plan contains a provision that "if contained in a proposed amendment to articles of incorporation, would require action by one or more separate voting groups on the proposed amendment." See section 10.04. Under this provision, voting by voting groups may be required for one or more classes or series of shares of the surviving corporation as well as for one or more classes or series of the disappearing corporation.

Section 11.03(f)(2) requires voting by voting groups in a share exchange, with each class or series of shares that is to be acquired in a share exchange entitled to vote as a separate voting group. This provision protects all classes of shareholders when more than one class or series of shares are being acquired on different terms.

In a merger transaction that involves an increase in shares of more than 20 percent, section 11.03(g) requires a shareholder vote in order to prevent significant dilution without the approval of the shareholders involved. Sections 11.03(g)(3) and (4) separately apply the 20-percent test to increases in the "voting shares" (as defined in section 11.03(h)(2)) and increases in "participating shares" (as defined in section 11.03(h)(1)). If either type of shares is increased by more than 20 percent in the merger transaction, the transaction must be approved by the shareholders.

Under the definitions in subsections (h)(1) and (2), the 20-percent requirement may be applied to shares with preferential rights if they are either voting or fully participating, and to deferred or contingent shares issued as a result of the merger. On the other hand, it is typically not applicable to shares issuable under antidilution clauses to balance share splits or share dividends; these shares would not become issuable "pursuant to the merger," but by virtue of later corporate action authorizing the split or dividend.

Sections 11.03(g)(3) and (4) only determine when a shareholders' vote is required; they do not relate to voting by voting groups. Whether or not a class or series of shares is entitled to vote as a separate voting group is determined by section 11.03(f).

Section 11.03(i) makes it clear that the corporations may abandon without shareholder approval a merger or share exchange even though it has been previously approved by the shareholders. Abandonment under this section does not affect contract rights of third parties. The plan, however, may require that abandonments be approved by shareholders before they are effective.

AMENDED NORTH CAROLINA COMMENTARY

This section essentially follows the same pattern as former G.S. 55-108 and 55-108.1, except it does not carry forward the provision in former G.S. 55-108(b) allowing nonvoting shareholders to vote on mergers. However, the corporation must give nonvoting shareholders notice of the proposed shareholders' meeting so that they can act if their rights will be adversely affected. The Model Act's requirement that notice be given to nonvoting shareholders was retained in this section, in contrast to G.S. 55-10-03, involving shareholders' meetings to consider amendments to the articles of incorporation, because a proposed merger or share exchange is a fundamental change, whereas most amendments to the articles of incorporation are not. It should be noted that the last sentence in the first section of the Official Comment is not correct for this Act. That sentence indicates that nonvoting shareholders have no right to dissent and obtain payment for their shares in a merger or share exchange. G.S. 55-13-02(a)(1) and (2) give nonvoting shareholders this right.

The Model Act was modified in subsection (b) to conform to changes made in G.S. 55-10-03.

The Model Act was modified in subsection (e) by inserting between the word "incorporation" and the word "or" the words "a bylaw adopted by the shareholders." This modification continues the existing concept of allowing a bylaw adopted by the shareholders to impose a higher quorum or voting requirement. The subsection was further amended by inserting at the end a clause providing that for purposes of Article 9 or already existing provisions in articles of incorporation or bylaws, a "merger" includes a share exchange.

Subdivision 11.03(f)(1) of the Model Act requires voting by voting groups on a plan of merger if the plan contains a provision that "if contained in a proposed amendment to articles of incorporation, would require action by one or more separate voting groups on the proposed amendment." Under this provision, voting by voting groups may be required for one or more classes or series of shares of the surviving corporation as well as for one or more classes or series of the disappearing corporation. This provision was modified in subdivision (f)(1) to create an exception where the consideration to be received in exchange for the shares of the voting group consists solely of cash.

The Model Act was modified in subdivision (f)(2) by substituting "to be acquired" for "included."

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended (i) to require the approval of each shareholder who will have personal liability for any corporate obligation solely as a result of owning shares in the surviving corporation, (ii) to allow articles of incorporation to require shareholder approval of a merger for which G.S. 55-11-03(g) would not otherwise require shareholder approval, and (iii) to allow a plan of merger to be amended if the plan of merger makes provision for amendment.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2018)

Subsections (a) and (b) were amended and subsections (j) and (k) were added, effective October 1, 2018, to permit a public company target to enter into a "two-step" merger agreement, where the first step is a tender offer by the acquiror for the public company shares and the second step is a merger in which the public company shares not tendered are converted into the same merger consideration offered in the tender offer. The provisions are based on 2016 changes to Model Act Subsections 11.04(b) and (j). Appraisal rights generally would not be available with respect to a merger involving public company shares pursuant to G.S. 55-13-02(b)(1), but if the transaction was an interested transaction, appraisal rights would be available pursuant to G.S. 55-13-02(b)(4). Under the "two-step" merger agreement procedure, shareholders who do not tender their shares would have the same rights to seek appraisal under Article 13 of this Chapter that they would in a merger that was approved at a meeting of shareholders.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2005-268, ss. 18 through 20, effective October 1, 2005, in subsection (e) substituted "vote" for "vote or a vote by voting groups" and added the last sentence; rewrote subsection (g) and subdivision (g)(1); made minor stylistic changes in subdivisions (g)(2) and (g)(3); and rewrote subsection (i).

Session Laws 2013-153, s. 9, effective January 1, 2014, substituted "The following requirements shall be met for" for "For" in subsection (b); rewrote subdivision (b)(1); added "of merger or share exchange" in subdivision (b)(2); added "for the following" in subsection (f); and made a minor punctuation change in subdivision (f)(1).

Session Laws 2018-45, s. 17, effective October 1, 2018, substituted "subsections (g) and (j) of this section and in G.S. 55-11-04" for "subsection (g)" in subsection (a); rewrote subdivision (b)(1); and added subsections (j) and (k).

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For recent development, "In re Wachovia Shareholders Litigation: The Case for the Common Benefit Doctrine," see 84 N.C. L. Rev. 2066 (2006).

CASE NOTES

Failure to comply with the statutory procedures required for a corporate merger constitutes a breach of a director's fiduciary duty as well as a breach of the majority stockholders' duty to the minority. Clark v. B.H. Holland Co., 852 F. Supp. 1268 (E.D.N.C. 1994).

Board of directors of a bank was not required to submit a share exchange to the shareholders for a vote when the bank merged with another bank because the transaction was not compulsory on any owners of the acquired shares as they were issued directly to the other bank. There were no prior-owners of the acquired shares, and the other bank provided consideration to the bank in the form of the other bank's shares. Ehrenhaus v. Baker, 216 N.C. App. 59, 717 S.E.2d 9 (2011).

OFFICIAL COMMENT

Section 11.04(a) defines a "parent" corporation as one that owns at least 90 percent of the outstanding shares of each class of another corporation, and a "subsidiary" corporation as one whose shares are so owned. Section 11.04 permits merger of a subsidiary into its parent corporation upon adoption of a plan of merger by the board of directors of the parent alone. Separate action by the board of directors of the subsidiary is unnecessary because the share ownership of the parent corporation is normally sufficient to permit it to elect or remove the subsidiary's board of directors.

Further, the merger transaction need not be approved by the shareholders of either corporation. Approval by the shareholders of the subsidiary is meaningless because the parent's share ownership is sufficient to ensure the plan will be approved. Approval by the parent's shareholders is also unnecessary because the transaction does not materially change their rights: the ownership of the parent corporation is being changed only from 90 percent indirect ownership to 100 percent direct ownership of the same assets, and no significant amendment of the parent's articles of incorporation is being made. For the same reason, shareholders of the parent corporation do not have the right to dissent from the transaction under chapter 13.

Minority shareholders of the subsidiary corporation may receive shares, obligations, or other securities of the parent or any other corporation, or cash or other property in whole or in part in exchange for their shares. These shareholders are entitled to 30 days' notice of the plan of merger before it is effectuated.

Shareholders of the subsidiary corporation have a right to dissent from the merger transaction under chapter 13. Courts have held that in some circumstances such a transaction may constitute a breach of duty owed by the parent corporation to the shareholders of the subsidiary. See Roland International Corp. v. Najjar, 407 A.2d 1032 (Del. 1979).

NORTH CAROLINA COMMENTARY

This section is substantially different from former G.S. 55-108.1 in that it permits a parent corporation to merge a 90% subsidiary into the parent without a vote of the minority shareholders of the subsidiary; but such minority shareholders would still have a right of dissent and appraisal. See G.S. 55-13-02(a)(1).

The Model Act was modified in this section by adding an introductory phrase to subsection (a) to provide that the section is subject to Article 9, and by specifying "copy or summary" in subsection (d) to parallel subsection (c).

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended (i) to provide that the articles of incorporation of a parent or subsidiary corporation may require shareholder approval for a merger for which this section would otherwise waive such approval, (ii) to waive approval by the subsidiary corporation's board of directors unless the subsidiary corporation's articles of incorporation require approval of the subsidiary corporation's shareholders, and (iii) to require that notice of the merger be given to the subsidiary corporation's shareholders (if the shareholders are not required to approve the merger) within ten days after the merger instead of providing notice at least 30 days before the merger.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2005-268, s. 21, effective October 1, 2005, rewrote subsections (a) and (b); and deleted subsections (c) through (e).

Session Laws 2006-226, s. 16(a), effective August 10, 2006, substituted "the surviving corporation" for "the parent corporation" in subsection (b).

Session Laws 2013-153, s. 10, effective January 1, 2014, substituted "between parents and subsidiary or between subsidiaries" for "with subsidiary" in the section heading; rewrote subsection (a); and substituted "G.S. 55-13-02(b)" for "G.S. 55-13-02(c)" in subsection (f).

Session Laws 2018-45, s. 18, effective October 1, 2018, inserted "corporation" in the section heading.

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

OFFICIAL COMMENT

The articles of merger or share exchange formally make the terms of the transaction a matter of public record and the effective date of the articles is the effective date of their filing unless a delayed effective date is utilized. See section 1.23. The articles of merger or share exchange must describe whether the plan was submitted to the vote of one or more voting groups of the participating corporations entitled to vote separately on the plan, and, if so, either the total vote in favor and against the plan or a statement that the plan was approved by at least the number of undisputed votes required to approve the merger or share exchange by each voting group of each participating corporation entitled to vote separately on the plan.

NORTH CAROLINA COMMENTARY

Former G.S. 55-109, relating to articles of merger and articles of consolidation, contained a cross-reference to G.S. 47-18.1, requiring the local registration of certificates of merger or consolidation with the register of deeds where title to real property is transferred by operation of law pursuant to the merger or consolidation. A similar cross-reference to G.S. 47-18.1 was therefore added to this section as subsection (c).

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended to delete the requirement that the plan of merger or plan of share exchange be included in the articles of merger or articles of share exchange except that identifying information about the corporations contained in the plan is required to be included in the articles plus, in the case of a merger, any amendments to the articles of incorporation of a surviving domestic corporation that are contained in the plan of merger. Other changes to this section clarify its application to mergers of domestic nonprofit corporations, foreign business corporations, and foreign nonprofit corporations with domestic business corporations and to share exchanges with foreign business corporations. In related changes, provisions requiring certain statements to be included in the articles of merger when a foreign business corporation or foreign nonprofit corporation is the surviving corporation are relocated to this section from G.S. 55-11-07 and 55-11-09, and provisions requiring certain statements to be included in the articles of share exchange when a foreign business corporation is the acquiring corporation are relocated to this section from G.S. 55-11-07.

Editor's Note. - Session Laws 2006-264, s. 44(b), which amended subsection (d), was repealed by Session Laws 2006-259, s. 14.5(a).

Effect of Amendments. - Session Laws 2005-268, s. 22, effective October 1, 2005, rewrote subsection (a); added subsection (a1); in subsection (b), substituted "when" for "upon the effective date of" and added "become effective"; and added subsection (d).

Session Laws 2006-226, s. 16(b), as amended by Session Laws 2006-259, s. 14.5(b), effective August 10, 2006, substituted "merger pursuant to G.S. 55-11-07 or G.S. 55-11-09, or a share exchange pursuant to G.S. 55-11-07, references in subsections (a) and (a1)" for "merger or share exhange pursuant to G.S. 55-11-07 or G.S. 55-11-09, references in subsections (a) and (b)" in subsection (d).

OFFICIAL COMMENT

Section 11.06 describes the legal consequences of a merger or share exchange on its effective date.

Section 11.06(a) describes the effect of a merger. On the effective date every disappearing corporation that is a party to the merger disappears into the surviving corporation and the surviving corporation automatically becomes the owner of all real and personal property and becomes subject to all liabilities, actual or contingent, of each disappearing corporation. A merger is not a conveyance or transfer, and does not give rise to claims of reverter or impairment of title based on a prohibited conveyance or transfer. See section 11.06(a)(2). Further, all pending litigation is continued; the name of the surviving corporation may, but need not be, substituted for the name of a disappearing corporation that is a party to litigation.

Section 11.06(a)(6) provides that if any shareholders to any party to the merger are to receive different shares or cash or property under the plan of merger, the rights of those shareholders after the articles of merger are filed are limited to their rights under the plan of merger or their rights under chapter 13 of this Act.

The articles of incorporation of the surviving corporation are amended as provided in the plan of merger on the effective date of the merger. See section 11.06(a)(5).

Section 11.06(b) describes the effect of a share exchange. On the effective date, the shareholders of the acquired class of shares cease to be shareholders of the acquired corporation. On that date they are entitled to receive only the consideration provided in the plan of share exchange, or the rights of dissenting shareholders under chapter 13.

NORTH CAROLINA COMMENTARY

This section is identical to the comparable section of the Model Act, except for a minor modification to subdivision (a)(6). "Cash" in that subdivision was changed to "right to receive cash" and the word "thereupon" was added to clarify the meaning.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is changed to provide that any amendments to the articles of incorporation of a surviving domestic corporation must be set forth in the articles of merger because G.S. 55-11-05 (as amended effective October 1, 2005) no longer requires the plan of merger to be included in the articles of merger. A provision is added stating that the merger does not affect the liability of a shareholder for obligations of a merging corporation incurred prior to the merger. Other amendments to this section clarify its application to mergers of domestic nonprofit corporations, foreign business corporations, and foreign nonprofit corporations with domestic business corporations and to share exchanges with foreign business corporations. In related changes, provisions applying when the surviving corporation in a merger is a foreign business corporation or foreign nonprofit corporation are relocated to this section from G.S. 55-11-07 and 55-11-09, and provisions applying when the acquiring corporation in a share exchange is a foreign business corporation are relocated to this section from G.S. 55-11-07.

Editor's Note. - This section was amended by Session Laws 2014-102, s. 6(b), in the coded bill drafting format provided by G.S. 120-20.1. However, in the introductory language of subsection (a), the phrase "or 55-11-09" was not struck through on the act to indicate that it had been deleted. The introductory language of subsection (a) has been set out in the form above at the direction of the Revisor of Statutes.

Effect of Amendments. - Session Laws 2005-268, s. 23, effective October 1, 2005, rewrote the section.

Session Laws 2006-264, s. 44(c), effective August 27, 2006, substituted "Each other merging" for "Each merging" at the beginning of subdivision (a)(1).

Session Laws 2011-347, ss. 6 and 7, effective October 1, 2011, in subdivisions (a)(7)a. and (b)(2), deleted "dissenting" preceding "shareholders" and inserted "exercising appraisal rights"; and in subdivisions (a)(7)b. and (b)(3)a., substituted "appraisal rights of shareholders" for "rights of dissenting shareholders."

Session Laws 2014-102, s. 6(b), inserted "55-11-09, or 55-11-11" in the introductory paragraph of subsection (a). For effective date and applicability, see Editor's note.

Session Laws 2018-45, s. 19, effective October 1, 2018, substituted "55-11-20" for "55-11-11" in subsection (a).

Legal Periodicals. - For comment, "Beyond Budd Tire: Examing Corporate Successor Liability in North Carolina," see 30 Wake Forest L. Rev. 889 (1995).

For article, "Legislative Survey: Business & Banking," see 22 Campbell L. Rev. 253 (2000).

CASE NOTES

Editor's Note. - Some of the cases below were decided under the Business Corporation Act adopted in 1955 or under prior law.

Merger does not create new or additional rights. The surviving corporation is vested with all the rights which each party to the merger could exercise, but only those rights. Good Will Distribs. (N.), Inc. v. Shaw, 247 N.C. 157, 100 S.E.2d 334 (1957).

Surviving Corporation Succeeds by Operation of Law. - In the event of a merger between corporations, the surviving corporation succeeds by operation of law to all of the rights, privileges, immunities, franchises and other property of the constituent corporations, without the necessity of a deed, bill of sale, or other form of assignment. Econo-Travel Motor Hotel Corp. v. Taylor, 301 N.C. 200, 271 S.E.2d 54 (1980).

Since a surviving corporation succeeded by operation of law to all of the rights and obligations of a constituent corporation under G.S. 55-11-06(a)(2), a company, which had merged with a former employee's employer, had standing to sue for enforcement of a noncompetition agreement entered into by the employee and his former employer. Philips Elecs. N. Am. Corp. v. Hope, - F. Supp. 2d - (M.D.N.C. June 30, 2009).

Lender's successor's evidence, including a letter from the Comptroller of the Currency officially certifying a merger between the successor and the lender, was sufficient to establish the merger. The successor, as the surviving corporation after the merger, succeeded by operation of law to the lender's status as holder of a note, pursuant to G.S. 55-11-06(a)(2). In re Foreclosure of N.C. Deed of Trust by Carver Pond I L.P., 217 N.C. App. 352, 719 S.E.2d 207 (2011).

Bank presented sufficient evidence to establish all the required elements of G.S. 45-21.16, because the bank showed that it was the holder of a promissory note through a corporate merger, and a default on the debt. In re Foreclosure of the Deed of Trust from Manning, 228 N.C. App. 591, 747 S.E.2d 286 (2013).

Subcontractor that provided labor, materials, and equipment to a general contractor that built condominium units for an LLC before the LLC declared Chapter 11 bankruptcy was entitled to summary judgment on claims the general contractor filed against the subcontractor because the claims had merged with another subcontractor the general contractor used, and the second subcontractor had assumed responsibility for the first subcontractor's acts; G.S. 55-11-06 provided that once the first subcontractor merged with the second subcontractor it ceased to exist, and the second subcontractor, as the surviving business, assumed all liabilities of both businesses. New Bern Riverfront Dev. v. Weaver Cooke Constr., LLC (In re New Bern Riverfront Dev., LLC), - Bankr. - (Bankr. E.D.N.C. Sept. 10, 2014).

Subcontractor was denied summary judgment on a contractor's professional negligence claim based on the subcontractor's allegation that it contracted only to install a post-tension system and that the design was done by another corporation, as the subcontractor and the design corporation merged before the subcontract at issue and, under North Carolina law, the subcontractor, as the surviving corporation, had all of the liabilities of each merging corporation. New Bern Riverfront Dev., LLC v. Weaver Cooke Constr., LLC (In re New Bern Riverfront Dev., LLC), - Bankr. - (Bankr. E.D.N.C. Sept. 30, 2014).

Subcontractor that provided labor, materials, and equipment to a general contractor that built condominium units for an LLC before the LLC declared Chapter 11 bankruptcy did not show there were grounds for reconsideration of an order the court issued on September 10, 2014, which granted the subcontractor's motion for summary judgment on third-party claims the general contractor filed against it because it had merged with another subcontractor the general contractor used, and the second subcontractor had assumed responsibility for the first subcontractor's acts; the court's order was correct under G.S. 55-11-06. New Bern Riverfront Dev., LLC v. Weaver Cooke Constr. LLC (In re New Bern Riverfront Dev., LLC), - Bankr. - (Bankr. E.D.N.C. Mar. 12, 2015).

Application of Statute of Limitations Against Surviving Corporation. - The six-year statute of limitations of G.S. 1-50 did not apply to an action for fraud arising out of the collapse of the floor of a building where the corporate tenant of the building merged into the corporate plaintiff after the building collapsed. Since the plaintiff succeeded to the rights of the corporate tenant and thus was in possession of the building as tenant at the time of the injury, it came within the exception under G.S. 1-50(5) (see now G.S. 1-50(a)(5). Feibus & Co. v. Godley Constr. Co., 301 N.C. 294, 271 S.E.2d 385 (1980), rehearing denied, 301 N.C. 727, 274 S.E.2d 228 (1981).

Nevada limited liability company could not amend its suit to allege a tort claim of a North Carolina limited liability company after the Nevada company succeeded to the rights of the North Carolina company following a merger under G.S. 55-11-06(a)(4) as it did not assert its right to file the tort claim before the claim became time-barred under G.S. 1-15(c); the Nevada company's suit clearly alleged violations of patent rights that had been assigned to it, and did not give notice that the suit was intended to be a re-filing of a malpractice case by the North Carolina company that had been dismissed under G.S. 1A-1, N.C. R. Civ. P. 41. Even if the amendment were allowed, it would not relate back under G.S. 1A-1, N.C. R. Civ. P. 15(c). Revolutionary Concepts, Inc. v. Clements Walker PLLC, 2012 NCBC 14 (2012).

Successor Not Real Party In Interest. - Nevada limited liability company did not become the real party in interest under G.S. 1A-1, N.C. Gen. R. Civ. P. 17 to bring a malpractice case previously dismissed by a North Carolina limited liability company after the Nevada company succeeded to the rights of the North Carolina company following a merger under G.S. 55-11-06(a)(4) as the Nevada company did not bring the North Carolina company's tort claim before they became time-barred under G.S. 1-15(c). Revolutionary Concepts, Inc. v. Clements Walker PLLC, 2012 NCBC 14 (2012).

Successor's action could not be converted to action by acquired limited liability company. - Claim alleging that two attorneys failed to detect and supervise the activities of a patent agent in filing or failing to file documents associated with a patent application and Patent Cooperation Treaty Application was barred by G.S. 57C-3-30 (now repealed) as a Nevada limited liability company did not show that the attorneys were on notice that the employee was in need of supervision or that the attorneys were assigned or accepted responsibility for supervising the patent agent in a member's absence. Revolutionary Concepts, Inc. v. Clements Walker PLLC, 2012 NCBC 14 (2012).

Breach of Stock Option and Restriction Agreement. - Trial court properly granted partial summary judgment to a businessman against a shareholder and a corporation because the merger of a company into a corporation without any prior notice to or consent by the businessman resulted in a breach of a stock option and restriction agreement between the businessman and the company and its sole shareholder, as the merger clearly effected a change in the capitalization of the company. Lee v. Scarborough, 162 N.C. App. 674, 592 S.E.2d 43 (2004).

Surviving corporation was liable, pursuant to G.S. 55-11-06(a)(3), for a breach of an option agreement by a merged corporation that had given a consultant a five-year option to purchase 50 percent of its shares; because the merger could not have been accomplished without the actions of the sole shareholder and director, who was the only person could vote for and approve the merger, he was also personally liable. Lee v. Scarborough, 164 N.C. App. 357, 595 S.E.2d 729 (2004).

Effect of Merger on Subcontractor. - In a developer's negligence action against a subcontractor, the subcontractor was not entitled to summary judgment based on the division of duties between the subcontractor and another company. Based on the merger between the subcontractor and the other company, which occurred before the subcontractor had contracted to perform any work on the project, the subcontractor was responsible for the work of the other company. New Bern Riverfront Dev., LLC v. Weaver Cooke Constr., LLC (In re New Bern Riverfront Dev.), - Bankr. - (Bankr. E.D.N.C. Sept. 23, 2014).

Statute Did Not Apply. - Trial court did not err in granting a law firm and attorneys summary judgment on the ground that a corporation did not have standing to assert malpractice claims because the corporation did not acquire the claims as a result of an inventor's assignment and did not take any action post-merger to assert those claims as the surviving entity of the merger; G.S. 55-11-06(a)(4) did not apply because there were no pending claims asserted against the law firm and attorneys by the corporation at the time of the merger. Revolutionary Concepts, Inc. v. Clements Walker PLLC, 227 N.C. App. 102, 744 S.E.2d 130 (2013).

OFFICIAL COMMENT

Section 11.07 permits mergers or share exchanges between domestic and foreign corporations.

In connection with a plan of merger, the plan must be permitted under the law of the state or country of incorporation of the foreign corporation as well as under the law of the domestic state. The surviving corporation, if it is a foreign corporation, must file articles of merger to accomplish the disappearance of the domestic corporation or corporations, and thereby irrevocably appoints the secretary of state as agent for service of process and agrees to pay dissenters in accordance with chapter 13.

A plan of share exchange, unlike a plan of merger, need not be authorized by the state or country of incorporation of the acquiring foreign corporation. If the domestic law authorizes a compulsory share exchange to acquire a class or series of shares of a domestic corporation, it makes no difference whether the acquiring corporation is foreign or domestic. This kind of transaction does not affect the separate corporate existence of, or impose the liabilities of the disappearing corporation on, the acquiring foreign corporation.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section is amended to provide that if the corporation whose shares are to be acquired in a share exchange is a foreign business corporation, the laws of the state or country of incorporation of the foreign business corporation must permit the share exchange and both the foreign business corporation and the acquiring domestic business corporation must comply with those laws. In the case of a merger involving a foreign business corporation, the merging domestic business corporation must comply with the laws of the state or country of incorporation of the merging foreign business corporation to the extent applicable in addition to the merging foreign business corporation complying with those laws. Other amendments reflect the relocation to G.S. 55-11-05 and 55-11-06 from this section of certain provisions applying if a foreign business corporation is the surviving corporation in a merger or the acquiring corporation in a share exchange.

Editor's Note. - Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Effect of Amendments. - Session Laws 2005-268, s. 24, effective October 1, 2005, rewrote the section.

CASE NOTES

Cited in Lee v. Scarborough, 162 N.C. App. 674, 592 S.E.2d 43 (2004).

§ 55-11-11: Recodified as G.S. 55-11-20 by Session Laws 2018-45, s. 22, effective October 1, 2018.

OFFICIAL COMMENT

A sale of "all or substantially all" the corporate assets in the regular course of business is governed by section 12.01. Mortgages of all of the corporation's assets or redeployment of those assets through a wholly owned subsidiary are also covered by section 12.01. All other sales of "all or substantially all" the corporate assets are governed by section 12.02. Dispositions or transfers of property that do not involve "all or substantially all" the property of the corporation are not controlled by statute and may be approved by the board of directors (or authorized corporate officer) in the same manner as any other corporate transaction.

1. The meaning of "all or substantially all"
2. Transfers of "all or substantially all" of a corporation's assets that do not require shareholder approval
   1. Mortgages or pledges
   2. Sales in the usual and regular course of business
   3. Transfers to a subsidiary

The phrase "all or substantially all," chosen by the draftsmen of the Model Act, is intended to mean what it literally says, "all or substantially all." The phrase "substantially all" is synonymous with "nearly all" and was added merely to make it clear that the statutory requirements could not be avoided by retention of some minimal or nominal residue of the original assets. A sale of all the corporate assets other than cash or cash equivalents is normally the sale of "all or substantially all" of the corporation's property. A sale of several distinct manufacturing lines while retaining one or more lines is normally not a sale of "all or substantially all" even though the lines being sold are substantial and include a significant fraction of the corporation's former business. If the lines retained are viewed only as a temporary operation or as a pretext to avoid the "all or substantially all" requirements, however, the statutory requirements of chapter 12 must be complied with. Similarly, a sale of a plant but retention of operating assets (e.g., machinery and equipment), accounts receivable, good will, and the like with a view toward continuing the operation at another location is not a sale of "all or substantially all" the corporation's property.

Some court decisions have adopted a narrower construction of somewhat similar statutory language. These decisions should be viewed as resting on the diverse statutory language involved in those cases and should not be viewed as illustrating the meaning of "all or substantially all" intended by the draftsmen of the Model Act.

Section 12.01 describes transfers or dispositions of "all or substantially all" the corporate assets that do not require shareholder approval unless the articles of incorporation require it. These transactions consist of (1) mortgages or pledges of all the corporation's property, whether or not the loan they secure is in the ordinary course of business, (2) transactions within the usual and regular course of business, and (3) transfers to wholly owned subsidiaries.

Mortgages or pledges of all the corporate assets may be demanded by lenders. They are essentially and substantively different from a sale or other disposition of assets even though they may take the form of a formal transfer of title to the mortgagee for security purposes, or of a dedication of assets to the repayment of indebtedness, as in the case of oil and gas production payments. The corporation remains in possession of the mortgaged property, may continue to use it for corporate purposes, in most cases must continue to manage the property, and may recover full title to the property by discharging the indebtedness.

Most transfers of "all or substantially all" the corporate property (as defined above) are, almost by definition, not in the usual and regular course of business; sales by real estate corporations and by corporations organized to liquidate a business are examples of sales that may be included in this part of section 12.01(a). Typically, sales falling within the usual and regular course of business do not involve the sale of the corporate name or good will.

Section 12.01 provides that a transfer of property to a wholly owned subsidiary does not require a vote of shareholders. This provision, however, may not be used as a device to avoid a vote of shareholders by a multiple-step transaction.

NORTH CAROLINA COMMENTARY

Subsection (a) is identical to former G.S. 55-112(a) and was substituted for the comparable provision in the Model Act (subdivision 12.01(a)(2)) to avoid an unintended implication that all mortgages or security interests require express approval by the board of directors. Subsection (b) consists of subsection 12.01(a) of the Model Act, except for an introductory phrase taken from former G.S. 55-112(b) and the omission of the Model Act's subdivision 12.01(a)(2). Because the Model Act's subsection 12.02(b) serves the same function as the language taken from former G.S. 55-112(b), that subsection was omitted.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2013-153, s. 12, effective January 1, 2014, rewrote the section heading, which formerly read "Sale of assets in regular course of business and mortgage of assets"; added ", do any of the following" in subsection (b); made a minor stylistic and punctuation change in subdivision (b)(1); and added subdivision (b)(3).

Legal Periodicals. - For comment on the disposition of corporate assets, see 43 N.C.L. Rev. 957 (1965).

For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

CASE NOTES

Editor's Note. - The case below was decided under the Business Corporation Act adopted in 1955.

Noncompliance with Statute as Breach of Duty. - Failure to conform to the mandates of former G.S. 55-112 constituted a breach of director's fiduciary duty as well as a breach of the majority stockholders' duty to the minority. Loy v. Lorm Corp., 52 N.C. App. 428, 278 S.E.2d 897 (1981).

OFFICIAL COMMENT

The scope of the phrase "all or substantially all" is discussed in the Official Comment to section 12.01. All transactions that involve the sale or transfer of "all or substantially all" the corporate property must be approved by the shareholders unless they fall within one of the exceptions of section 12.01.

Section 12.02 requires the board of directors to propose the sale and then submit the proposal to the shareholders. The board of directors must make a recommendation to the shareholders that the transaction be approved, unless the board determines that because of conflict of interest or other special circumstances it should make no recommendation. If the board so determines, it must describe the conflict or circumstances, and communicate the basis for its determination, to the shareholders when it presents the proposed sale.

The proposed sale, to be approved, must receive the vote of a majority of the outstanding votes entitled by the articles of incorporation to be cast on the proposal. This is a greater vote than that required for ordinary matters under section 7.25. Nonvoting classes of shares are not given a statutory right to vote on proposed sales (either as separate voting groups or together with voting shares) by the revised Model Act on the theory that classes or series of shares that are made nonvoting by the articles of incorporation generally did not retain a voice in the areas of business the corporation may engage in the future. The articles of incorporation, however, may stipulate that specified classes or series of shares are entitled to vote by separate voting groups. Thus, in the absence of special provision in the articles of incorporation, only the shares of the corporation entitled to vote generally by the articles of incorporation are entitled to vote on sales of substantially all the assets of the corporation. The articles of incorporation may also specify that a greater percentage of votes is required to approve the proposal than specified in section 12.02.

The board of directors may condition its submission of a proposal to the shareholders under subsection (c) on any basis - for example, on its receiving a certain percentage of shareholders' affirmative votes or that specified classes or series of shares, voting by separate voting groups, must approve the transaction or on some other basis; see the discussion of conditional submissions in the Official Comment to section 10.03.

The approval of most sales of "all or substantially all" of the corporation's assets gives rise to dissenters' rights under chapter 13 to shareholders who are entitled to vote on the transaction and avail themselves of the procedures described in that chapter. Sales subject to section 12.02 that do not give rise to dissenters' rights even for voting shares include (1) sales pursuant to a court order and (2) sales that require all or substantially all of the net proceeds to be distributed to the shareholders in accordance with their respective interests within one year after the date of sale. See section 13.02. Shares not entitled to vote on the transaction do not have dissenters' rights by statute; the articles of incorporation may grant those rights or the board of directors may elect to make them available.

Section 12.02(f) authorizes a board of directors to abandon a proposed sale without shareholder approval after it has been previously approved by the shareholders. An abandonment does not affect contractual rights that third persons may have against the corporation.

Certain corporate divisions, often called "spin offs," "split offs," or "split ups," sometimes involve transactions that may be formally characterized as sales of "all or substantially all" the corporate assets when in fact they are only a step in a corporate division that does not give rise to the problem of a major change in corporate direction and therefore does not need shareholder approval. Section 12.02(g) is designed to make clear that transactions like this, which actually constitute a distribution, are not subject to section 12.02. See Siegal, "When Corporations Divide: A Statutory and Financial Analysis," 79 HARV. L. REV. 534 (1966).

NORTH CAROLINA COMMENTARY

Article 12 changes the former law by requiring a simple majority of the shares entitled to vote instead of a two-thirds majority of all shares outstanding, whether or not otherwise entitled to vote, for the sale of substantially all of the assets of a corporation.

The Model Act's subsection 12.02(a) provides that a corporation may sell, lease, exchange, or otherwise dispose of all, or substantially all, of its property "(with or without the good will)." Because the drafters believed that the language in parentheses is unclear and probably adds nothing to the subsection, it was not included in subsection (a).

The Model Act was modified in subsection (b) to conform to changes made in G.S. 55-10-03.

The phrase "a bylaw adopted by the shareholders" was inserted in subsection (e) to preserve the practice under prior law.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2013-153, s. 13, effective January 1, 2014, rewrote the section heading, which formerly read "Sale of assets other than in regular course of business"; substituted "The following requirements shall be met for" for "For" in subsection (b); rewrote subdivision (b)(1), which formerly read "The board of directors must recommend the proposed transaction to the shareholders unless the board of directors determines that because of conflict of interest or other special circumstances it should make no recommendation, in which event the board of directors must communicate the basis for its lack of recommendation to the shareholders with the submission of the proposed transaction; and"; added sub-subdivisions (b)(1)a. and (b)(1)b.; and added "proposed" in subdivision (b)(2).

Legal Periodicals. - For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

1. Overview

Chapter 13 deals with the tension between the desire of the corporate leadership to be able to enter new fields, acquire new enterprises, and rearrange investor rights, and the desire of investors to adhere to the rights and the risks on the basis of which they invested. Contemporary corporation statutes in the United States attempt to resolve this tension through a combination of two devices. On the one hand, through their approval of an amendment to the articles of incorporation, a merger, share exchange or disposition of assets, the majority may change the nature and shape of the enterprise and the rights of all its shareholders. On the other hand, shareholders who object to these changes may withdraw the fair value of their investment in cash through their exercise of appraisal rights.

The traditional accommodation has been sharply criticized from two directions. From the viewpoint of investors who object to the transaction, the appraisal process is criticized for providing little help to the ordinary investor because its technicalities make its use difficult, expensive, and risky. From the viewpoint of the corporate leadership, the appraisal process is criticized because it fails to protect the corporation from demands that are motivated by the hope of a nuisance settlement or by fanciful conceptions of value. See generally Bayless Manning, "The Shareholders' Appraisal Remedy: An Essay for Frank Coker," 72 Yale L.J. 223 (1962).

Chapter 13 is a compromise between these opposing points of view. It is designed to increase the frequency with which assertion of appraisal rights leads to economical and satisfying solutions, and to decrease the frequency with which such assertion leads to delay, expense, and dissatisfaction. It seeks to achieve these goals primarily by simplifying and clarifying the appraisal process, as well as by motivating the parties to settle their differences in private negotiations without resort to judicial appraisal proceedings.

Chapter 13 proceeds from the premise that judicial appraisal should be provided by statute only when two conditions co-exist. First, the proposed corporate action as approved by the majority will result in a fundamental change in the shares to be affected by the action. Second, uncertainty concerning the fair value of the affected shares may cause reasonable persons to differ about the fairness of the terms of the corporate action. Uncertainty is greatly reduced, however, in the case of publicly-traded shares. This explains both the market exception described below and the limits provided to the exception.

Appraisal rights in connection with mergers and share exchanges under chapter 11 and dispositions of assets requiring shareholder approval under chapter 12 are provided when these two conditions co-exist. Each of these actions will result in a fundamental change in the shares that a disapproving shareholder may feel was not adequately compensated by the terms approved by the majority. Except for shareholders of a subsidiary corporation that is merged under section 11.05 (the "short-form" merger), only those shareholders who are entitled to vote on a transaction are entitled to appraisal rights. The linkage between voting and appraisal rights is justified because the right to a shareholder vote is a good proxy for assessing the seriousness of the change contemplated by the corporate action. This is especially true where the action triggers group-voting provisions.

Notwithstanding this linkage, amended chapter 13 eliminates appraisal for voting shareholders in several instances where it would have been available under the 1984 Act. Shareholders who are entitled to vote on a corporate action, whether because such shareholders have general voting rights or because group voting provisions are triggered, are not entitled to appraisal if the change will not alter the terms of the class or series of securities that they hold. Thus, statutory appraisal rights are not available for shares of any class of the surviving corporation in a merger or any class of shares that is not included in a share exchange. Appraisal is also not triggered by a voluntary dissolution under chapter 14 because that action does not affect liquidation rights - the only rights that are relevant following a shareholder vote to dissolve.

With the exception of reverse stock splits that result in cashing out some of the shares of a class or series, amended chapter 13 also eliminates appraisal in connection with all amendments to the articles of incorporation. This change in amended chapter 13 does not reflect a judgment that an amendment changing the terms of a particular class or series may not have significant economic effects. Rather, it reflects a judgment that distinguishing among different types of amendments for the purposes of statutory appraisal is necessarily arbitrary and thus may not accurately reflect the actual demand of shareholders for appraisal in specific instances. Instead, amended chapter 13 permits a high degree of private-ordering by delineating a list of transactions for which the corporation may voluntarily choose to provide appraisal and by permitting a provision in the articles of incorporation that eliminates, in whole or in part, statutory appraisal rights for preferred shares.

Chapter 13 also is unique in its approach to appraisal rights for publicly-traded shares. Approximately half of the general corporation statutes in the United States provide exceptions to appraisal for publicly-traded shares, on the theory that it is not productive to expose the corporation to the time, expense and cash drain imposed by appraisal demands when shareholders who are dissatisfied with the consideration offered in an appraisal-triggering transaction could sell their shares and obtain cash from the market. This exception to appraisal is generally known as the "market-out" and is referred to here as the "market exception." Opponents of the market exception argue that it results in unfairness where neither the consideration offered in connection with the transaction nor the market price reflects the fair value of the shares, particularly if the corporate decision-makers have a conflict of interest.

Chapter 13 seeks to accommodate both views by providing a market exception that is limited to those situations where shareholders are likely to receive fair value when they sell their shares in the market after the announcement of an appraisal-triggering transaction. For the market exception to apply under chapter 13, there must first be a liquid market. Second, unique to chapter 13, the market exception does not apply in specified circumstances where the appraisal-triggering action is deemed to be a conflict-of-interest transaction.

2. D efinitions

Section 13.01 contains specialized definitions applicable only to chapter 13.

Beneficial shareholder

The definition of "beneficial shareholder" means a person who owns the beneficial interest in shares; "shares" is defined in section 1.40(22) to include, without limitation, a holder of a depository receipt for shares. Similar definitions are found in section 7.40(2) (derivative proceedings) and section 16.02(f) (inspection of records by a shareholder). In the context of chapter 13, beneficial shareholder means a person having a direct economic interest in the shares. The definition is not intended to adopt the broad definition of beneficial ownership in SEC Rule 13d-2, which includes persons with a right to vote or dispose of the shares even though they have no economic interest in them. However, section 13.02(b)(5) includes the concept of the right to vote in determining whether the event represents a conflict transaction that renders the market exception unavailable.

Corporation

The definition of "corporation"" in section 13.01(3) includes, for purposes of the post-transaction matters covered in section 13.22 through 13.31, a successor entity in a merger where the corporation is not the surviving entity. The definition does not include a domestic acquiring corporation in a share exchange or disposition of assets because the corporation whose shares or assets were acquired continues in existence in both of these instances and remains responsible for the appraisal obligations. Whether a foreign corporation or other form of domestic or foreign entity is subject to appraisal rights in connection with any of these transactions depends upon the corporation or other applicable law of the relevant jurisdiction.

Fair value

Subsection (i) of the definition of "fair value" in section 13.01(4) makes clear that fair value is to be determined immediately before the effectuation of the corporate action, rather than, as is the case under most state statutes that address the issue, the date of the shareholders' vote. This comports with the purpose of this chapter to preserve the shareholder's prior rights as a shareholder until the effective date of the corporate action, rather than leaving the shareholder in an ambiguous state with neither rights as a shareholder nor perfected appraisal rights. The corporation and, as relevant, its shares are valued as they exist immediately before the effectuation of the corporate action requiring appraisal. Accordingly, section 13.01(4) permits consideration of changes in the market price of the corporation's shares in anticipation of the transaction, to the extent such changes are relevant. Similarly, in a two-step transaction culminating in a merger, the corporation is valued immediately before the second step merger, taking into account any interim changes in value. Cf. Cede & Co. v. Technicolor, Inc. , 684 A.2d 289 (Del. 1996).

The definition of "fair value" in section 13.01(4) makes several changes from the prior version. The 1984 Model Act's definition of "fair value" was silent on how fair value was to be determined, except for a concluding clause that excluded from the valuation "any appreciation or depreciation in anticipation of the corporate action, unless exclusion would be inequitable." The Official Comment provided that the section left to the courts "the details by which 'fair value' is to be determined within the broad outlines of the definition." While the logic of the prior Official Comment continues to apply, the exclusionary clause in the prior Model Act definition, including the qualification for cases where the exclusion would be inequitable, has been deleted. Those provisions have not been susceptible to meaningful judicial interpretation and have been set aside in favor of the broader concept in subsection (ii).

The new formulation in paragraph (ii), which is patterned on section 7.22 of the Principles of Corporate Governance promulgated by the American Law Institute, directs courts to keep the methodology chosen in appraisal proceedings consistent with evolving economic concepts and adopts that part of section 7.22 which provides that fair value should be determined using "customary valuation concepts and techniques generally employed . . . for similar businesses in the context of the transaction requiring appraisal." Subsection (ii) adopts the accepted view that different transactions and different contexts may warrant different valuation methodologies. Customary valuation concepts and techniques will typically take into account numerous relevant factors, including assigning a higher valuation to corporate assets that would be more productive if acquired in a comparable transaction but excluding any element of value attributable to the unique synergies of the actual purchaser of the corporation or its assets. For example, if the corporation's assets include undeveloped real estate that is located in a prime commercial area, the court should consider the value that would be attributed to the real estate as commercial development property in a comparable transaction. The court should not, however, assign any additional value based upon the specific plans or special use of the actual purchaser.

Modern valuation methods will normally result in a range of values, not a particular single value. When a transaction falls within that range, "fair value" has been established. Absent unusual circumstances, it is expected that the consideration in an arm's-length transaction will fall within the range of "fair value" for purposes of section 13.01(4). Section 7.22 of the ALI Principles of Corporate Governance also provides that in situations that do not involve certain types of specified conflicts of interest, "the aggregate price accepted by the board of directors of the subject corporation should be presumed to represent the fair value of the corporation, or of the assets sold in the case of an asset sale, unless the plaintiff can prove otherwise by clear and convincing evidence." That presumption has not been included in the definition of "fair value" in section 13.01(4) because the framework of defined types of conflict transactions which is a predicate for the ALI"s presumption is not contained in the Model Act. Nonetheless, under section 13.01(4), a court determining fair value should give great deference to the aggregate consideration accepted or approved by a disinterested board of directors for an appraisal-triggering transaction.

Subsection (iii) of the definition of "fair value" establishes that valuation discounts for lack of marketability or minority status are inappropriate in most appraisal actions, both because most transactions that trigger appraisal rights affect the corporation as a whole and because such discounts give the majority the opportunity to take advantage of minority shareholders who have been forced against their will to accept the appraisal-triggering transaction. Subsection (iii), in conjunction with the lead-in language to the definition, is also designed to adopt the more modern view that appraisal should generally award a shareholder his or her proportional interest in the corporation after valuing the corporation as a whole, rather than the value of the shareholder's shares when valued alone. If, however, the corporation voluntarily grants appraisal rights for transactions that do not affect the entire corporation - such as certain amendments to the articles of incorporation - the court should use its discretion in applying discounts if appropriate. As the introductory clause of section 13.01 notes, the definition of "fair value" applies only to chapter 13. See the Official Comment to section 14.34 which recognizes that a minority discount may be appropriate under that section.

Interest

The definition of "interest" in section 13.01(5) is included to apprise the parties of their respective rights and obligations. The right to receive interest is based on the elementary consideration that the corporation, rather than the shareholder demanding appraisal, has the use of the shareholder's money from the effective date of the corporate action (when those shareholders who do not demand appraisal rights have the right to receive their consideration from the transaction) until the date of payment. Section 13.01(5) thus requires interest to be paid at the rate of interest on judgments from the effective date of the corporate action until the date of payment. The specification of the rate of interest on judgments, rather than a more subjective rate, eliminates a possible issue of contention and should facilitate voluntary settlements. Each state determines whether interest is compound or simple.

Senior executive

The definition of "senior executive" in section 13.01(8) encompasses the group of individuals in control of corporate information and the day-to-day operations. An employee of a subsidiary organization is a "senior executive" of the parent if the employee is "in charge of a principal business unit or function" of the parent and its subsidiaries on a combined or consolidated basis.

Shareholder

The definition of "shareholder" in section 13.01(9) for purposes of chapter 13 differs from the definition of that term used elsewhere in the Model Act. Section 1.40(21) defines "shareholder" as used generally in the Act to mean only a "record shareholder"; that term is specifically defined in section 13.01(7). Section 13.01(9), on the other hand, defines "shareholder" to include not only a "record shareholder" but also a "beneficial shareholder," a term that is itself defined in section 13.01(2). The specially defined terms "record shareholder" and "beneficial shareholder" appear primarily in section 13.03, which establishes the manner in which beneficial shareholders, and record shareholders who are acting on behalf of beneficial shareholders, perfect appraisal rights. The word "shareholder" is used generally throughout chapter 13 in order to permit both record and beneficial shareholders to take advantage of the provisions of this chapter, subject to their fulfilling the applicable requirements of this chapter.

NORTH CAROLINA COMMENTARY

The reference in the definition of "fair value" (in subdivision (3)) to "the effectuation of the corporate action" means the actual merger or other transaction that will occur after the shareholders vote on the transaction.

Subdivision 13.01(4) of the Model Act fixes the interest on fair value at the average rate currently paid by the corporation on its principal bank loans or, if none, at a rate that is fair and equitable under all the circumstances. This section differs from that provision in fixing the statutory "legal rate" as a floor and allows the court more flexibility in fixing a fair interest rate by providing that it should be fair and equitable under the circumstances and that the rate currently paid by the corporation on its principal bank loans, if any, is just one of those circumstances.

Editor's Note. - Session Laws 2011-347, s. 21, provides: "The Revisor of Statutes shall cause to be printed along with this act all relevant portions of the Official Comments to the 2002 Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor may deem appropriate."

Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the Article 13 heading and the Part 1 heading.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the section.

Session Laws 2018-45, s. 24, effective October 1, 2018, substituted "G.S. 55-11-04 or G.S. 55-11-12" for "G.S. 55-11-04" in subdivision (7).

Legal Periodicals. - For article, "The Exclusivity of the Appraisal Remedy Under the New North Carolina Business Corporation Act: Deciding the Standard of Review for Cash-Out Mergers," see 69 N.C.L. Rev. 501 (1991).

For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For article, "Legislative Survey: Business & Banking," see 22 Campbell L. Rev. 253 (2000).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

1. Transactions Requiring Appraisal Rights

Section 13.02(a) establishes the scope of appraisal rights by identifying those transactions which afford this right. In view of the significant degree of private ordering permitted by section 13.02(a)(5), the scope of statutory appraisal provided is somewhat narrower than that provided in the 1984 Model Act. As discussed in the first section of the Official Comment to section 13.01, statutory appraisal is made available only for corporate actions that will result in a fundamental change in the shares to be affected by the action and then only when uncertainty concerning the fair value of the affected shares may cause reasonable differences about the fairness of the terms of the corporate action. The transactions that satisfy both of these criteria are:

1. A merger pursuant to section 11.04 or a short-form merger pursuant to section 11.05. Holders of any class or series that is to be exchanged or converted in connection with a merger under section 11.04 are entitled both to a vote under section 11.04(f) and to appraisal under section 13.02(a)(1). Although shareholders of a subsidiary that is a party to a merger under section 11.05 are not entitled to a vote, they are entitled to appraisal under 13.02(a)(1) because their interests will be extinguished by the merger. Section 13.02(a)(1)(i) denies appraisal rights to any class or series of shares in the surviving corporation if such class or series remains outstanding.
2. A share exchange under section 11.03 if the corporation is a party whose shares are being acquired in the exchange. Consistent with the treatment in section 13.02(a)(1) of mergers requiring shareholder approval, subsection (2) provides appraisal only for those shares that will be exchanged.
3. A disposition of assets requiring shareholder approval under section 12.02. Minimally, shareholders of all classes or series of the corporation that are generally entitled to vote on matters requiring shareholder approval will be entitled to assert appraisal rights. Whether shares of a class or series that do not have general voting rights will be entitled to vote on the asset disposition and thus become entitled to appraisal rights depends on the form of the transaction disposing of the corporation's assets. In the usual form of this transaction, which is governed by chapter 12, the acquirer purchases substantially all of the assets and assumes substantially all of the liabilities of the corporation, which then liquidates pursuant to a plan of dissolution approved by the shareholders as part of the transaction and distributes the consideration received from the acquirer to its shareholders. If the transaction provides a non-voting class of preferred with its liquidation preference, there is no change in the contractual terms of the preferred and it is entitled neither to vote nor to appraisal rights. By the same token, a preferred class cannot be required to accept any consideration different from that called for in its liquidation preference without amending the terms of the class. For example, a plan that called for the preferred to accept securities of the acquirer in lieu of its cash liquidation preference would trigger both group voting and appraisal rights on behalf of the class. In the unusual event that the asset disposition plan contemplated that the corporation would continue in existence, the terms of a nonvoting class would not have been changed as a result of the transaction, and appraisal rights would not be available. As provided in section 12.02(g), a disposition of assets by a corporation in the course of dissolution under chapter 14 is governed by that chapter, not chapter 12, and thus does not implicate appraisal rights.
4. Amendments to the articles of incorporation that effectuate a reverse stock split which reduces the number of shares that a shareholder owns of a class or series to a fractional share if the corporation has the obligation or right to repurchase the fractional share so created. The reasons for granting appraisal rights in this situation are similar to those granting such rights in cases of cash-out mergers, as both transactions could compel affected shareholders to accept cash for their investment in an amount established by the corporation. Appraisal is afforded only for those shareholders of a class or series whose interest is so affected.
5. Any other merger, share exchange, disposition of assets or amendment to the articles to the extent the articles, bylaws, or a resolution of the board of directors grants appraisal rights to a particular class or series of stock. A corporation may voluntarily wish to grant to the holders of one or more of its classes or series of shares appraisal rights in connection with these important transactions whenever the Act does not provide statutory appraisal rights. The grant of appraisal rights may satisfy shareholders who might, in the absence of appraisal rights, seek other remedies. Moreover, in situations where the existence of appraisal rights may otherwise be disputed, the voluntary offer of those rights under this section may avoid litigation. Obviously, an express grant of voluntary appraisal rights under section 13.02(a)(5) is intended to override any of the exceptions to the availability of appraisal rights in section 13.02(a). Any voluntary grant of appraisal rights by the corporation to the holders of one or more of its classes or series of shares will thereby automatically make all of the provisions of chapter 13 applicable to the corporation and such holders regarding this corporate action.
6. A domestication in which the shares held by a shareholder are reclassified in a manner that results in the shareholder holding shares either with terms that are not as favorable in all materials respects or representing a smaller percentage of the total outstanding voting rights in the corporation as those held before the domestication. Appraisal rights are not provided if the shares of a shareholder are otherwise reclassified so long as the foregoing restrictions are satisfied.
7. A conversion to nonprofit status pursuant to subchapter 9C. Such a conversion involves such a fundamental change in the nature of the corporation that appraisal rights are provided to all of the shareholders.
8. A conversion of the corporation to an unincorporated entity pursuant to subchapter 9E. As with the previous type of transaction, this form of conversion is so fundamental that appraisal rights are provided to all of the shareholders.

2. Market Exception to Appraisal Rights

Chapter 13 provides a limited exception to appraisal rights for those situations where shareholders can either accept the consideration offered in the appraisal-triggering transaction or can obtain the fair value of their shares by selling them in the market. This provision is predicated on the theory that where an efficient market exists, the market price will be an adequate proxy for the fair value of the corporation's shares, thus making appraisal unnecessary. Furthermore, after the corporation announces an appraisal-triggering action, the market operates at maximum efficiency with respect to that corporation's shares because interested parties and market professionals evaluate the offer and competing offers may be generated if the original offer is deemed inadequate.

Moreover, the market exception reflects an evaluation that the uncertainty, costs and time commitment involved in any appraisal proceeding are not warranted where shareholders can sell their shares in an efficient, fair and liquid market. For these reasons, approximately half of the states have enacted market exceptions to their appraisal statutes.

For purposes of this chapter, the market exception is provided for a class or series if two criteria are met: the market in which the class or series is traded must be "liquid" and the value of the shares established by the appraisal-triggering event must be "reliable." Liquidity is defined in section 13.02(b)(1) and requires the class or series of stock to satisfy either of two requirements: the class or series is either listed on the New York Stock Exchange or the American Stock Exchange or is designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc.; or, although not so listed or designated, the class or series has at least 2,000 record or beneficial shareholders, provided that using both concepts does not result in duplication. In this instance, the outstanding class or series must also have a market value of at least $20 million, excluding the value of shares held by the corporation's subsidiaries, senior executives, directors and beneficial shareholders owning more than 10 percent of the class or series.

Because section 13.02(b)(3) excludes from the market exception those transactions that require shareholders to accept anything other than cash or securities that also meet the liquidity tests of section 13.02(b)(1), shareholders are assured of receiving either appraisal rights, cash from the transaction, or shares or other proprietary interests in the survivor entity that are liquid. Section 13.02(b)(2) provides that the corporation generally must satisfy the requirements of section 13.02(b)(1) on the record date for a shareholder vote on the appraisal-triggering transaction. For purposes of subsection 13.02(a)(1)(ii), the requirements of section 13.02(b)(1) must be met as of the day before the corporate action becomes effective.

3. Appraisal Rights in Conflict Transactions

The premise of the market exception is that the market must be liquid and the valuation assigned to the relevant shares must be "reliable." Section 13.02(b)(1) is designed to assure liquidity. For purposes of these provisions, section 13.02(b)(4) is designed to assure reliability by recognizing that the market price of, or consideration for, shares of a corporation that proposes to engage in a section 13.02(a) transaction may be subject to influences where a corporation's management, controlling shareholders or directors have conflicting interests that could, if not dealt with appropriately, adversely affect the consideration that otherwise could have been expected. Section 13.02(b)(4) addresses two groups of conflict transactions: those in clause (i), which involve controlling shareholders; and those in clause (ii), which involve senior executives and directors.

Section 13.02(b)(4)(i) covers two possible conflict situations: subsection (A) covers the acquisition or exchange of shares or assets of the corporation by a shareholder or an affiliate of the shareholder that could be considered controlling by virtue of ownership of a substantial amount of voting stock (20 percent); and subsection (B) covers the acquisition or exchange of shares or assets of the corporation by an individual or group, or by an affiliate of such individual or group, that has the ability to exercise control, through contract, stock ownership, or some other means, over at least one fourth of the board's membership. The definition of "beneficial owner" in section 13.02(b)(5) serves to identify possible conflict situations by deeming each member of a group that agrees to vote in tandem to be a beneficial owner of all the voting shares owned by the group. In contrast, the term "beneficial shareholder," as defined in section 13.01(2), is used to identify those persons entitled to appraisal rights. The last portion of subsection (A) recognizes that an acquisition effected in two steps (a tender offer followed by a merger) within one year, where the two steps are either on the same terms or the second step is on terms that are more favorable to target shareholders, is properly considered a single transaction for purposes of identifying conflict transactions, regardless of whether the second-step merger is governed by sections 11.04 or 11.05.

Section 13.02(b)(4)(ii) covers the acquisition or exchange of shares or assets of the corporation by a person, or an affiliate of a person, who is, or in the year leading up to the transaction was, a senior executive or director of the corporation. The section eliminates the market exception for management buyouts because participation in the buyout group is itself "a financial benefit not available to other shareholders as such." The market exception is also not available for transactions involving other types of economic benefits (in addition to benefits afforded to shareholders generally, as such) afforded to senior executives (as defined in section 13.01(8)) and directors in specified conflict situations, unless specific objective or procedural standards are met. Section 13.01(1) specially defines the term "affiliate" for purposes of section 13.02(b)(4) to include an entity of which a person is a senior executive. Due to this specialized definition, if a senior executive of the corporation is to continue and is to receive enumerated employment and other financial benefits after the transaction, the availability of the market exception will depend on meeting one of the three conditions specified in clauses (A), (B) and (C) of section 13.02(b)(4)(ii).

First, under section 13.02(b)(4)(ii)(A), the market exception is not lost if financial benefits that result from the transaction consist of employment, consulting, retirement or similar benefits established separately and not in contemplation of the transaction. For example, if an individual has an arrangement under which benefits will be triggered on a "change of control," such as accelerated vesting of options, retirement benefits, deferred compensation and similar items, or is afforded the opportunity to retire or leave the employ of the enterprise with more favorable economic results than would be the case absent a change of control, the existence of these arrangements would not disqualify the transaction from the market exception if the arrangements had been established as a general condition of the individual's employment or continued employment, rather than in contemplation of the particular transaction. Second, under section 13.02(b)(4)(ii)(B), if such arrangements are established as part of, or as a condition of, the transaction, the market exception will not be lost if the arrangements are either not more favorable than those already in existence or, if more favorable, are approved by "qualified" directors ( i.e. , meeting the standard of independence specified in section 8.62(d)), in the same manner as is provided for conflicting interest transactions generally with the corporation under section 8.62. This category would include arrangements with the corporation which have been negotiated as part of, or as a condition of, the transaction or arrangements with the acquiring company or one or more of its other subsidiaries. The third situation, delineated in section 13.02(b)(4)(ii)(C), addresses a person who is a director of the issuer and, in connection with the transaction, is to become a director of the acquiring entity or its parent, or to continue as a director of the corporation when it becomes a subsidiary of the acquiring entity. In this situation, the market exception is not lost as long as that person will not be treated more favorably as a director than are other persons who are serving in the same director positions.

4. Elimination of Appraisal Rights for Preferred Shares

Section 13.02(c) permits the corporation to eliminate or limit appraisal rights for the holders of one or more series or classes of preferred shares. The operative provisions may be set forth in the corporation's articles of incorporation as originally filed or in any amendment thereto, but any such amendment will not become effective for one year with respect to outstanding shares or shares which the corporation is or may be required to issue or sell at some later date pursuant to any rights outstanding prior to such amendment becoming effective. Shareholders who have not yet acquired, or do not have a right to acquire from the corporation, any shares of preferred stock, should have the ability either not to acquire any shares of preferred stock or to have appraisal rights granted or restored for such shares, if such shareholders so desire, before purchasing them. In contrast, because the terms of common shares are rarely negotiated, section 13.02 does not permit the corporation to eliminate or limit the appraisal rights of common shares.

5. Exclusivity of Appraisal Rights

With two exceptions, section 13.02(d) provides that the appraisal is the exclusive remedy for corporate action that has been completed. The theory underlying this section is that when a majority of shareholders has approved a corporate change, the corporation should be permitted to proceed even if a minority considers the change unwise or disadvantageous. The very existence of the appraisal remedy recognizes that shareholders may disagree about the value of consequences of a corporate action and that some may hold such strong views that they will want to vindicate them in a judicial proceeding. Since a judicial proceeding is insulated from the dynamics of an actual negotiation, it is not surprising that the two processes could produce different valuations. Accordingly, if such a proceeding results in an award of additional consideration to the shareholders who pursued appraisal, no inference should be drawn that the judgment of the majority was wrong or that compensation is now owed to shareholders who did not seek appraisal. Thus, an exclusivity principle is generally justified. Nevertheless, there may be exceptional circumstances where the process by which the corporate action was approved was so flawed that it is appropriate to provide more general relief on behalf of all affected shareholders. Thus, section 13.02(d)(1) does not preclude challenges to serious procedural defects in approving the action, such as a failure to obtain the votes required by statute or by the corporation's own articles, bylaws, or board resolution authorizing the transaction. Similarly, subsection (2) creates an exception for cases where fraud or material misrepresentation have affected the shareholder vote to such an extent as to have caused the corporate action to be approved mistakenly. The concept of misrepresentation includes the omission of a material fact necessary to make statements made not misleading.

Although section 13.02(d) does not address the question of remedies, such as injunctive relief, that may be available before the corporate action is effected, it should be noted that a complaint based solely on adequacy of consideration is not actionable unless accompanied by credible allegations of wrongdoing. Section 13.02(d) is concerned with challenges only to the corporate action and does not address remedies, if any, that shareholders may have against directors or other persons as a result of the corporate action. See section 8.31 and Official Comment.

AMENDED NORTH CAROLINA COMMENTARY

Subdivisions (a)(1), (a)(2), and (a)(3) give a right of dissent for all shares, whether voting or nonvoting, in the case of a merger or sale or exchange of assets; the corresponding provisions in the Model Act give the right of dissent only to voting shareholders.

The right of dissent under this section, however, does not apply in a merger to shares of a corporation when approval by the shareholders of that corporation is not required under G.S. 55-11-03(g) or to shares of a parent corporation in a merger under G.S. 55-11-04. In addition, the right of dissent does not apply in a merger or share exchange to shares that are redeemable by the corporation at the time of the transaction at a price not greater than the cash to be received in exchange for such shares. The Model Act was modified in clause (i) of subdivision (a)(1) to clarify that the absence of a right of dissent applies only to the shares of the corporation covered by G.S. 55-11-03(g) and not to shares of a corporation if approval by its shareholders is required.

The Model Act was also modified in subdivision (a)(3) to provide that a right of dissent will not be available if the sale of property is pursuant to a plan by which all or substantially all of the net proceeds of the sale will be distributed in cash to the shareholders within one year after the date of the sale. This is different from the Model Act, which requires the sale itself to be in cash. This subdivision thus allows more flexibility in permitting, for example, the sale to be for promissory notes or other property that will be converted to cash for distribution within the one-year period.

The language of the Model Act which excepts from the operation of the section "a limitation by dilution through issuance of shares or other securities with similar voting rights" was eliminated from the end of clause (iv) of subdivision (a)(4). The only reason for this elimination was the drafters' opinion that the language is unnecessary; if it were necessary, it should also have been added to the end of G.S. 55-10-04(a)(4).

Clause (vi) of subdivision (a)(4), which is not in the Model Act, brings forward the same provisions in former G.S. 55-101(b). However, the drafters decided not to bring forward the unusual provision in former G.S. 55-102(a) that gave a right of dissent to the holders of any class of preferred shares with dividend arrearages if the corporation offered to exchange such shares for shares with a prior preference and that offer was accepted by any of the preferred shareholders. Such a situation may be covered by clause (i) of subdivision (a)(4).

The introductory language of subsection 13.02(a) of the Model Act was modified to provide that the rights provided by this section are in addition to any rights provided by Article 9.

By making the appraisal remedy exclusive unless the transaction is "unlawful" or "fraudulent," subsection (b) effects a change from former G.S. 55-113(b), which provided that such remedy was "in addition to any other right [the shareholder] may have in law or in equity."

Language was added to the Model Act provision to make it clear that subsection (b) covers a cash merger and that, in determining whether a merger was "unlawful" or "fraudulent," the same standard applies, regardless of whether the consideration received was cash, other property, or shares of a surviving corporation.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2011)

Effective October 1, 2011, this section was amended to limit appraisal rights under subdivision (a)(1), (2) and (3) to voting shares in the case of a merger or share exchange or sale of assets. The prior statute gave a right of appraisal for all shares, whether voting or non-voting, in such transactions. Subdivision (d), which is not in the Model Act, grandfathers the appraisal rights of a shareholder holding shares of a class or series that were issued and outstanding as of the effective date of the Act but that did not as of that date entitle the shareholder to vote on a corporate action described in subdivision (a)(1), (2) or (3) of this section; such shareholder shall be entitled to appraisal rights to the same extent as if such shares did entitle the shareholder to vote on such corporate action.

Corporations are afforded flexibility under Article 13 to deviate from the specified corporate actions that give rise to appraisal rights and the shareholders entitled to such rights. Under subdivision (a)(5) appraisal rights can be extended to any shareholders in connection with any amendment to the articles of incorporation, merger, share exchange or disposition of assets to the extent provided in the articles, bylaws or a resolution of the board of directors.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2018)

Effective as of October 1, 2018, this section was amended to provide appraisal rights to voting and non-voting shareholders on an equal basis, including (i) to minority shareholders of a subsidiary corporation in a short-form merger with an unincorporated parent company under G.S. 55-11-12, and (ii) to non-tendering shareholders in second-step mergers following a tender offer in which offeror gains control under G.S. 55-11-03(j).

Editor's Note. - Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Session Laws 2011-347, s. 22(a) provides: "This section is effective only if Senate Bill 26 of the 2011 Regular Session of the General Assembly becomes law." Senate Bill 26 did not become law; therefore, the amendments made by Session Laws 2011-347, s. 22(c) and (d), which would have added subdivision (a)(9) and substituted "(8), and (9)" for "and (8)" in subsection (b), did not take effect.

Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, substituted "appraisal" for "dissent" in the section catchline; and rewrote the section.

Session Laws 2018-45, s. 25, effective October 1, 2018, substituted "Article 9 of this Chapter" for "Article 9" in the lead-in language of subsection (a); in subdivision (a)(1), substituted "or would be required but for the provisions of G.S. 55-11-03(j)" for "and the shareholder is entitled to vote on the merger" near the middle, and added "or G.S. 55-11-12" at the end; in subdivision (a)(2), deleted "if the shareholder is entitled to vote on the exchange" following "acquired" near the middle; deleted "if the shareholder is entitled to vote on the disposition" following "G.S. 55-12-02" in subdivision (a)(3); in subdivision (b)(2), inserted "or, in the case of an offer made pursuant to G.S. 55-11-03(j), the date of the offer" near the middle, added "shareholders and no offer made pursuant to G.S. 55-11-03(j)" at the end, and made minor stylistic changes; rewrote subsection (c); and deleted subsection (d).

Legal Periodicals. - For note as to bad faith of the majority in close corporations, see 35 N.C.L. Rev. 271 (1957).

For article, "The Exclusivity of the Appraisal Remedy Under the New North Carolina Business Corporation Act: Deciding the Standard of Review for Cash-Out Mergers," see 69 N.C.L. Rev. 501 (1991).

For 1997 legislative survey, see 20 Campbell L. Rev. 389.

For article on the evolution of corporate combination law, see 76 N.C.L. Rev. 687 (1998).

For article, "Legislative Survey: Business & Banking," see 22 Campbell L. Rev. 253 (2000).

For article, "Silencing the Shareholder's Voice," see 80 N.C.L. Rev. 1897 (2002).

CASE NOTES

Editor's Note. - Some of the cases below were decided under the Business Corporation Act adopted in 1955.

A statutory appraisal is shareholder's exclusive remedy to redress what the minority shareholders perceived to be as an inadequate price for their shares. IRA ex rel. Oppenheimer v. Brenner Cos., 107 N.C. App. 16, 419 S.E.2d 354, cert. denied, 332 N.C. 666, 424 S.E.2d 401 (1992).

A statutory appraisal is not a dissenting shareholder's exclusive remedy when the shareholder has presented claims of breach of fiduciary duty, fraud, self-dealing, securities violations, or similar claims based on allegations other than solely the inadequacy of the stock price. IRA ex rel. Oppenheimer v. Brenner Cos., 107 N.C. App. 16, 419 S.E.2d 354, cert. denied, 332 N.C. 666, 424 S.E.2d 401 (1992).

When Statutory Appraisal Is Appropriate Remedy. - A statutory appraisal is a dissenting shareholder's exclusive remedy when the shareholder challenges only the fair value or price of the stock. IRA ex rel. Oppenheimer v. Brenner Cos., 107 N.C. App. 16, 419 S.E.2d 354, cert. denied, 332 N.C. 666, 424 S.E.2d 401 (1992).

Exclusivity of Shareholders's Remedy. - Subsection (b) of this section now establishes the exclusivity of a dissenting shareholder's remedy in challenging a corporation's actions. The remedy is the exclusive remedy unless the transaction is unlawful or fraudulent. IRA ex rel. Oppenheimer v. Brenner Cos., 107 N.C. App. 16, 419 S.E.2d 354, cert. denied, 332 N.C. 666, 424 S.E.2d 401 (1992).

Dissent and appraisal was the exclusive remedy for shareholders aggrieved by the price offered and the method by which the price was set in a cash-out merger of a North Carolina corporation; where a minority shareholder's complaint centered around an allegation that a corporation's directors and a buyer had engaged in a course of conduct designed to enable them to buy the shares of the minority at an unfair price, the complaint failed to adequately allege an unlawful or fraudulent transaction, and the complaint was properly dismissed. Osher v. Ridinger, 162 N.C. App. 155, 589 S.E.2d 905 (2004).

Legislative Intent to Increase Available Remedies. - The language "In addition to any other right he may have in law or equity" in former G.S. 55-113(b) showed that the legislature intended to increase the remedies available to a dissenting shareholder, not to supplant any other remedies that the shareholder might have. Austell v. Smith, 634 F. Supp. 326 (W.D.N.C.), appeal dismissed, 801 F.2d 393 (4th Cir. 1986).

Plaintiffs in derivative shareholders' action were not required to pursue statutory dissenters' rights under former G.S. 55-113 (see now Art. 13 of ch. 55) to oppose merger during litigation in order to maintain standing. Subdivision (c) of former G.S. 55-113 would have deprived them of all interest in defendant corporation. Alford v. Shaw, 327 N.C. 526, 398 S.E.2d 445 (1990).

Assertion of Claims in Federal Court. - Pending dissent and appraisal petitions did not bar minority stockholders from asserting damage claims in federal court. Austell v. Smith, 634 F. Supp. 326 (W.D.N.C.), appeal dismissed, 801 F.2d 393 (4th Cir. 1986).

Allegations of Fraud or Misrepresentation. - Minority shareholder's allegations failed to state a fraud claim, where they alleged that the majority stockholders intentionally engaged in a course of conduct designed to reduce the value of the corporation's assets, which would diminish the value of minority shares and thereby allow those shares to be purchased at a reduced price. Werner v. Alexander, 130 N.C. App. 435, 502 S.E.2d 897 (1998).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.03 addresses the relationship between those who are entitled to assert appraisal rights and the widespread practice of nominee or street name ownership of publicly-held shares. Generally, a shareholder must demand appraisal for all the shares of a class or series which the shareholder owns. If a record shareholder is a nominee for several beneficial shareholders, some of whom wish to demand appraisal and some of whom do not, section 13.03(a) permits the record shareholder to assert appraisal rights with respect to a portion of the shares held of record by the record shareholder but only with respect to all the shares beneficially owned by a single person. This limitation is necessary to prevent abuse by a single beneficial shareholder who is not fundamentally opposed to the proposed corporate action but who may wish to speculate on the appraisal process, as to some of that shareholder's shares, on the possibility of a high payment. On the other hand, a shareholder who owns shares in more than one class or series may assert appraisal rights for only some but not all classes or series that the shareholder owns. This is permitted because fair treatment of one class or series does not guarantee fair treatment of other classes or series.

Section 13.03(a) also requires a record shareholder who demands appraisal with respect to a portion of the shares held by the record shareholder to notify the corporation of the name and address of the beneficial owner on whose behalf the record shareholder has demanded appraisal rights.

Section 13.03(b) permits a beneficial shareholder to assert appraisal rights directly if the beneficial shareholder submits the record shareholder's written consent. Although generally the record shareholder is treated as the owner of shares, this section recognizes that sometimes the record shareholders are holding shares on behalf of beneficial shareholders. It would be foreign to the premises underlying nominee and street name ownership to require these record shareholders to forward demands and participate in litigation on behalf of their clients. In order to make appraisal rights effective without burdening record shareholders, beneficial shareholders should be allowed to assert their own claims as provided in this subsection. The beneficial shareholder is required to submit, no later than the date specified in section 13.22(b)(2)(ii), a written consent by the record shareholder to the assertion of appraisal rights to verify the beneficial shareholder's entitlement and to permit the protection of any security interest in the shares. In practice, a broker's customer who wishes to assert appraisal rights may request the broker to supply the customer with the name of the record shareholder (which may be a house nominee or a nominee of the Depository Trust Company), and a form of consent signed by the record shareholder. At the same time, the customer may want to obtain certificates for the shares so that they may be deposited pursuant to section 13.23. After the corporation has received the form of consent, the corporation must deal with the beneficial shareholder.

NORTH CAROLINA COMMENTARY

The drafters did not include the language at the end of subsection 13.03(b)(3) of the Model Act requiring a beneficial owner to dissent with respect to all shares "over which he has power to direct the vote" because they concluded that it could be construed to include shares which that person did not own either as beneficial or record holder but for which he or she was a proxy or could exercise a power of attorney. That result was not deemed desirable.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the section catchline, which formerly read: "Dissent by nominees and beneficial owners"; and rewrote the section.

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Before a vote is taken on a corporate action, the corporation is required by section 13.20(a) to notify record shareholders that a transaction is proposed and that the corporation has concluded either that appraisal rights are or are not available; alternatively, if the corporation is unsure about the availability of appraisal rights, it may state that appraisal rights may be available. Notice of appraisal rights is needed because many shareholders do not know what appraisal rights they may have or how to assert them. If the corporation has concluded appraisal rights are or may be available, the notice must be accompanied by a copy of this chapter.

Section 13.20(b) provides that notice be given by the parent corporation within ten days after the effective date of a merger of its subsidiary under section 11.05. This notice may be combined with the notice required by section 13.22.

NORTH CAROLINA COMMENTARY

This section adds to the Model Act's provisions the 10-day requirement in subsection (b) and the new subsection (c). A similar 10-day requirement is included in G.S. 55-13-22(b) and in section 13.22(b) of the Model Act. The new subsection (c) was adapted from former G.S. 55-113(f), except that the period within which the damage action may be brought was increased from one to three years, thus increasing the burden on the corporation to comply with the statute. The shareholder must bring the damage action "in his own name," and not as a class or derivative action.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, substituted "appraisal rights" for "dissenters' rights" in the section catchline; and rewrote the section.

Session Laws 2018-45, s. 26, effective October 1, 2018, in subsection (a), inserted "or where no approval of the action is required pursuant to G.S. 55-11-03(j)" near the beginning, inserted "or, if applicable, the offer made pursuant to G.S. 55-11-03(j)" near the middle, inserted "or offer" near the end, and made minor stylistic changes; in subsection (b), inserted "or G.S. 55-11-12" near the beginning, deleted the former second sentence, which read: "In the case of any other corporate action specified in G.S. 55-13-02(a) with respect to which shareholders of a class or series do not have the right to vote, but with respect to which those shareholders are entitled to assert appraisal rights, the corporation must notify in writing all record shareholders of such class or series that the corporate action became effective.", and made minor stylistic changes; rewrote former subsection (d) as present subsection (d) and (e); and substituted "subsection (d) of this section" for "this subsection" in present subsection (e).

Legal Periodicals. - For article, "The Exclusivity of the Appraisal Remedy Under the New North Carolina Business Corporation Act: Deciding the Standard of Review for Cash-Out Mergers," see 69 N.C.L. Rev. 501 (1991).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.21 applies to all transactions requiring appraisal, except short-form mergers under section 11.05. In the latter case, shareholders of the subsidiary do not vote on the transaction but are nevertheless entitled to appraisal.

Section 13.21(a) requires the shareholder to give notice of an intent to demand payment before the vote on the corporate action is taken. This notice enables the corporation to determine how much of a cash payment may be required. It also serves to limit the number of persons to whom the corporation must give further notice during the remainder of the appraisal process.

In order for a shareholder to remain eligible to demand payment, section 13.21(a)(2) mandates that the shareholder must not vote (or, in the case of a beneficial shareholder, cause or permit to be voted) any shares of any class or series for which the shareholder is demanding appraisal in favor of the proposal.

NORTH CAROLINA COMMENTARY

This section is substantially the same as section 13.21 of the Model Act with minor clarifying changes.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY 2018

Effective as of October 1, 2018, this section was amended to facilitate the determination of how much of a cash payment may be required by the exercise of appraisal rights upon closing a corporate action that is approved by shareholder written consent. The amendments provide that the shareholder must provide a notice of intent to demand an appraisal rights payment before the corporate action becomes effective provided notice of the corporate action was given to the shareholder at least 25 days before the effective time. The amendments also provide procedures for exercising appraisal rights to non-tendering shareholders in second-step mergers following a tender offer in which offeror gains control under G.S. 55-11-03(j).

Editor's Note. - Session Laws 2018-45, s. 33, provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, added "and consequences of voting or consenting" in the section catchline; and rewrote the section.

Session Laws 2018-45, s. 27, effective October 1, 2018, deleted "who is entitled to vote on the corporate action and" following "a shareholder" in the lead-in language of subsection (a); rewrote subsection (b); added subsection (b1); and substituted "subsection (a), (b), or (b1)" for "subsection (a) or (b)" in subsection (c).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

The purpose of section 13.22 is to require the corporation to provide shareholders with information and a form for perfecting appraisal rights. The content of this notice and form are spelled out in detail to ensure that they accomplish this purpose.

When an action is submitted to the vote of shareholders, the appraisal notice must be sent only to those persons who gave notice of their intention to demand appraisal under section 13.21 and did not vote (or permit or cause to be voted) such shares in favor of the proposed action. In a short-form merger under section 11.05, the notice must be sent to all persons who may be eligible for appraisal rights no earlier than the effective date of the merger and no later than ten days thereafter. In either case, the notice must be accompanied by a copy of this chapter.

The notice must supply a form to be used by the person asserting appraisal rights in order to complete the exercise of those rights. Under section 13.22(b)(2)(ii), the notice must specify the date by which the shareholder's executed form must be received by the corporation, which date must be at least 40 days but not more than 60 days after the appraisal notice is sent.

Under section 13.22(b)(2)(i), the notice must also specify where and when share certificates must be deposited; the time for deposit may not be set at a date earlier than the date for receiving the required form under section 13.22(b)(2)(ii).

Sections 13.22(b)(1) and (2)(i) require the corporation to specify in the form supplied for demanding payment where the form must be sent as well as the date of the first announcement of the terms of the proposed corporate action. This is the critical date for determining the rights of shareholder-transferees: persons who became shareholders prior to that date are entitled to full appraisal rights, while persons who became shareholders on or after that date are entitled only to the more limited rights provided by section 13.25. See the Official Comments to sections 13.23 and 13.25. The date set forth in the form should be the date the principal terms of the transaction were announced by the corporation to shareholders. This may be the day the terms were communicated directly to the shareholders, included in a public filing with the Securities and Exchange Commission, published in a newspaper of general circulation that can be expected to reach the financial community, or any earlier date on which such terms were first announced by any other person or entity to such persons or sources. Any announcement to news media or to shareholders that relates to the proposed transaction but does not contain the principal terms of the transaction to be authorized at the shareholders' meeting is not considered to be an announcement for the purposes of section 13.22.

Sections 13.22(b)(2)(iii) and (b)(2)(iv) require the corporation to state its estimate of the fair value of the shares and how shareholders may obtain the number of shareholders and number of shares demanding appraisal rights. The information required by sections 13.22(b)(2)(iii) and (b)(2)(iv) is intended to help shareholders assess whether they wish to demand payment or to withdraw their demand for appraisal, but the information under section 13.22(b)(2)(iv) is required to be sent only to those shareholders from whom the corporation has received a written request. If such request is received, the corporation must respond within ten days after forms are due pursuant to section 13.22(b)(2)(ii). Finally, section 13.22(b)(2)(v) requires the corporation to specify the date by which the shareholder's notice to withdraw under section 13.23 must be received.

NORTH CAROLINA COMMENTARY

This section is substantially the same as section 13.22 of the Model Act with minor clarifying changes, except that the specified contents of the form required by subdivision (b)(3) were omitted in light of the changes in G.S. 55-13-25.

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2001)

Effective January 1, 2002, subsection (a) was amended in light of changes in G.S. 55-7-04 to permit less than unanimous shareholder action without meeting for corporation other than public corporations and to clarify that a shareholder who consents to action without meeting is not entitled to payment for the shareholder's shares under this Article.

Editor's Note. - Session Laws 2001-387, s. 154(a), authorizes the Revisor of Statutes to cause to be printed all explanatory comments of the drafters of the act as the Revisor deems appropriate.

Session Laws 2001-387, s. 154(b) provides that nothing in this act shall supersede the provisions of Article 10 or 65 of Chapter 58 of the General Statutes, and this act does not create an alternate means for an entity governed by Article 65 of Chapter 58 of the General Statutes to convert to a different business form.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the section catchline, which formerly read: "Dissenters' notice"; and rewrote the section.

Session Laws 2018-45, s. 28, effective October 1, 2018, in subsection (a), substituted "G.S. 55-11-04 or G.S. 55-11-12" for "G.S. 55-11-04," and deleted the former last sentence, which read: "In the case of any other corporate action specified in G.S. 55-13-02(a) that becomes effective and with respect to which shareholders of a class or series do not have the right to vote but with respect to which such shareholders are entitled to assert appraisal rights, the corporation must deliver a written appraisal notice and form to all record shareholders of such class or series who may be entitled to assert appraisal rights."

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.23 permits shareholders to perfect their appraisal rights under subsection (a), subject to their right to withdraw under subsection (b). In the case of a transaction involving a vote by shareholders, returning the executed form and, in the case of certificated shares, depositing the shares are the shareholder's confirmation of the shareholder's intention expressed earlier under section 13.21(a) to pursue appraisal rights; in the case of a merger of a subsidiary under section 11.05, it is the shareholder's first statement of this position.

The shareholder should include on the appraisal form a certification as to whether the date on which the beneficial shareholder acquired beneficial ownership of the shares was before (or on or after) the date the transaction was announced. See section 13.22(b)(1). This information permits the corporation to exercise its right under section 13.25 to defer payment of compensation for certain shares. The corporation may elect to proceed under section 13.25 with respect to those shareholders who fail to make the required certification.

Section 13.23(a) also requires persons with certificated shares who file the required form to deposit their share certificates as directed by the corporation in its appraisal notice. Once a shareholder deposits that shareholder's shares, that shareholder loses all rights as a shareholder unless the shareholder withdraws from the appraisal process pursuant to section 13.23(b).

With respect to certificated shares, this provision differs from many statutes in that the certificates are deposited for retention, rather than "submitted for notation." This difference reflects the requirement in section 13.22(b)(2)(i) for deposit only after the corporate action became effective; in contrast, many state statutes require shareholders to send in their certificates in anticipation of the effectuation of the proposed corporate action.

Alternatively, under section 13.23(b), a shareholder may withdraw from the appraisal process by so notifying the corporation in writing by the deadline set forth in the appraisal notice. After that date, however, a shareholder who has complied with the requirements to execute and return the form and, in the case of certificated shares, deposit the share certificates may not withdraw from the process without the corporation's written consent.

Under section 13.23(c), a shareholder who fails to execute and return the form with respect to the shares of a class or series for which the shareholder is demanding appraisal or does not deposit that shareholder's share certificates as required by section 13.23(a) loses all rights to pursue appraisal and obtain payment under this chapter. If a beneficial shareholder wishes to assert appraisal rights in place of the record shareholder, the beneficial shareholder must also comply with section 13.03(b).

NORTH CAROLINA COMMENTARY

This section makes minor changes from subsection 13.22(a) of the Model Act to conform it to the modifications made in G.S. 55-13-25.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the section catchline, which formerly read: "Duty to demand payment"; and rewrote the section.

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.24 is applicable both to shareholders who have complied with section 13.23(a), as well as to shareholders who are described in section 13.25(a) if the corporation so chooses. The corporation must, however, elect to treat all shareholders described in section 13.25(a) either under section 13.24 or under section 13.25; it may not elect to treat some shareholders from this group under section 13.24 but treat others under section 13.25. Considerations of simplicity and harmony may prompt the corporation to elect to treat all shareholders under section 13.24.

Section 13.24 changes the relative balance between the corporation and shareholders demanding appraisal by requiring the corporation to pay in cash within 30 days after the required form is due the corporation's estimate of the fair value of the stock plus interest. Section 13.24(b)(2) requires that estimate to at least equal the corporation's estimate of fair value given pursuant to section 13.22(b)(2)(iii). Since under section 13.23(a) all rights as a shareholder are terminated with the deposit of that shareholder's shares, the former shareholder should have immediate use of such money. A difference of opinion over the total amount to be paid should not delay payment of the amount that is undisputed. Thus, the corporation must pay its estimate of fair value, plus interest from the effective date of the corporate action, without waiting for the conclusion of the appraisal proceeding.

Since the former shareholder must decide whether or not to accept the payment in full satisfaction, the corporation must at this time furnish the former shareholder with the information specified in section 13.24(b), with a reminder of the former shareholder's further rights and liabilities.

NORTH CAROLINA COMMENTARY

This section differs from the Model Act by requiring the corporation to send its offer of payment, rather than payment itself, to the dissenter upon completion of the transaction or (if the transaction did not need shareholder approval and has been completed) upon receipt of payment demand. Payment is made to the dissenter upon his acceptance of the corporation's offer in writing. Payment is made to the nonaccepting dissenter at the commencement of the court proceeding under G.S. 55-13-30.

Subdivision (b)(1) was further modified to refer to a "statement of cash flows" instead of a "statement of changes in shareholders' equity," in accordance with the provisions of FASB-95.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the section.

Legal Periodicals. - For 1997 legislative survey, see 20 Campbell L. Rev. 389.

CASE NOTES

Subsection (b) is Mandatory. - G.S. 55-13-25(b) made the inclusion of the required information in that subsection mandatory for a payment to be complete; a letter sent to a shareholder by merging banks failed to offer an explanation as to how the fair value of the stock was calculated, so the bank's proffered payment was incomplete, and the proper date for the determination of the shareholder's 60-day filing period was the date of the shareholder's payment demand. Foard v. Avery County Bank, 169 N.C. App. 625, 610 S.E.2d 460 (2005).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.25(a) gives the corporation the option to treat differently shares acquired on or after the date of public announcement of the proposed corporate action; this date is specified by the corporation in its appraisal notice under section 13.22(b)(1). At the corporation's option, holders of shares acquired on or after this date, or shareholders who fail to certify otherwise under section 13.23(a), are not entitled to immediate payment under section 13.24. Instead, shareholders described in subsection (a) may receive only an offer of payment which is conditioned on their agreement to accept it in full satisfaction of their claim. If the right of unconditional immediate payment were granted as to all after-acquired shares, speculators and others might be tempted to buy shares merely for the purpose of demanding appraisal. Since the function of appraisal rights is to protect investors against unforeseen changes, there is no need to give equally favorable treatment to purchasers who knew or should have known about the proposed changes.

The date used as a cut-off for determining the application of this section is when "the principal terms" of the transaction are first announced to shareholders or to a newspaper of general circulation that can be expected to reach the financial community or included in a public filing with the Securities and Exchange Commission. The cut-off should not be set at an earlier date, such as when the first public statement that the corporate action was under consideration was made, because the goal of this section is to prevent use of appraisal rights as a speculative device after the terms of the transaction are announced. See the Official Comment to section 13.22.

Section 13.25(b) requires the corporation to furnish specified information to all shareholders described in subsection (a) and offer them the option of accepting the corporation's estimate of fair value plus interest, in full satisfaction of their claims, provided that such shareholders so accept and notify the corporation within ten days of receiving this offer. Within ten days after receiving a shareholder's acceptance, the corporation must pay that shareholder in cash the stated fair value plus interest.

A shareholder may accept the offered payment in full satisfaction of that shareholder's claim; alternatively, a shareholder may reject the corporation's offer and demand a judicial determination under section 13.26 and payment of the amount so determined at the termination of the proceeding. A shareholder who does not satisfy the requirements of section 13.26 shall be deemed to have accepted the corporation's offer.

NORTH CAROLINA COMMENTARY

Section 13.27 of the Model Act has been omitted as unnecessary in light of G.S. 55-13-25.

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

A shareholder who is not content with the corporation's remittance under section 13.24, or offer of remittance under section 13.25, and wishes to pursue appraisal rights further must state in writing the amount the shareholder is willing to accept. A shareholder whose demand is deemed arbitrary, unreasonable or not in good faith, however, runs the risk of being assessed litigation expenses under section 13.31. These provisions are designed to encourage settlement without a judicial proceeding.

A shareholder to whom the corporation has made payment (or who has been offered payment under section 13.25) must make a supplemental demand within 30 days after receipt of the payment or offer of payment in order to permit the corporation to make an early decision on initiating appraisal proceedings. A failure to make such demand causes the shareholder to relinquish under section 13.26(b) anything beyond the amount the corporation paid or offered to pay.

NORTH CAROLINA COMMENTARY

The Model Act was modified in this section to reflect the fact that under G.S. 55-13-25, a dissenter who has not accepted the corporation's offer has not yet received payment. A dissenter who fails to notify the corporation of his demand under this section resumes the status of a nondissenting shareholder.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, substituted "with payment or offer" for "with corporation's payment or failure to perform" in the section catchline; and rewrote the section.

Legal Periodicals. - For 1997 legislative survey, see 20 Campbell L. Rev. 389.

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.30 retains the concept of judicial appraisal as the ultimate means of determining fair value. The proceeding is to be commenced by the corporation within 60 days after a timely demand for payment under section 13.26 was received. If the proceeding is not commenced within this period, the corporation must pay the additional amounts demanded by the shareholders under section 13.26. See the Official Comment to section 13.26.

All demands for payment made under section 13.26 are to be resolved in a single proceeding brought in the county in the state where the corporation's principal office is located or, if it is a foreign corporation, where its registered office is located, or if it has no registered office, where the principal office of the corporation which issued the shares to be appraised was located. All shareholders making section 13.26 demands must be made parties, with service by publication authorized if necessary. Appraisers may be appointed within the discretion of the court. Since the nature of the proceeding is similar to a proceeding in equity or for an accounting, section 13.30(d) provides that there is no right to a jury trial. The final judgment establishes not only the fair value of the shares in the abstract but also determines how much each shareholder who made a section 13.26 demand should actually receive.

NORTH CAROLINA COMMENTARY

This section differs from the Model Act in several respects. The North Carolina version provides for the court proceeding to be commenced by the dissenter rather than the corporation. At the commencement of the proceeding, the corporation must pay the amount of its offer to the dissenter. A dissenter who does not commence a timely court proceeding may either accept the corporation's offer or resume his status as a nondissenting shareholder. A dissenter who takes no action resumes the status of a nondissenting shareholder.

Subsection 13.30(b) of the Model Act contains special venue provisions for proceedings under this section. That provision was omitted, and general venue rules apply.

This section expressly provides in subsection (d) that dissenters in a public corporation are not entitled to a jury trial in the appraisal of the "fair value" of their shares.

Editor's Note. - This section was amended by both S.L. 1997-202, s. 4 (amending subsection (a) and repealing subsection (a1)), and S.L. 1997-485, ss. 5 and 5.1 (amending subsections (a), (c), and (d)). The effective date provisions of the two acts differed. S.L. 1997-202 applied to corporate actions to which shareholders could dissent occurring on or after October 1, 1997. S.L. 1997-485, s. 5, applied to proceedings commenced on or after October 1, 1997.

To fill a potential gap between the two acts, S.L. 1997-485, s. 5.1, amended subsection (a), as amended by s. 5 of that act, to read:

"(a) If a demand for payment under G.S. 55-13-28 remains unsettled, the dissenter may commence a proceeding within 60 days after the date of his payment demand under G.S. 55-13-28 by filing a complaint with the Superior Court Division of the General Court of Justice to determine the fair value of the shares and accrued interest. Within 10 days after service upon it of [the] complaint, the corporation shall pay to the dissenter the amount offered by the corporation under G.S. 55-13-25."

This version of subsection (a) applied to proceedings commenced on or after October 1, 1997, by dissenters to corporate actions that occurred before October 1, 1997.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, rewrote the section.

Legal Periodicals. - For 1997 legislative survey, see 20 Campbell L. Rev. 389.

CASE NOTES

Determination of 60-Day Filing Period. - G.S. 55-13-25(b) made the inclusion of the required information in that subsection mandatory for a payment to be complete; a letter sent to a shareholder by merging banks failed to offer an explanation as to how the fair value of the stock was calculated, so the bank's proffered payment was incomplete, and the proper date for the determination of the shareholder's 60-day filing period was the date of the shareholder's payment demand. Foard v. Avery County Bank, 169 N.C. App. 625, 610 S.E.2d 460 (2005).

OFFICIAL COMMENT TO THE 2002 MODEL BUSINESS CORPORATION ACT

Section 13.31(a) provides a general rule that the costs of the appraisal proceeding should be assessed against the corporation. Nevertheless, the court is authorized to assess these costs, in whole or in part, against all or some of the shareholders demanding appraisal if it concludes they acted arbitrarily, vexatiously, or not in good faith regarding the rights provided by this chapter. Similarly, under section 13.31(b), the court may assess fees and expenses of counsel and experts against the corporation or against all or some of the shareholders demanding appraisal for the reasons stated in this subsection. Under section 13.31(c), if the corporation is not required to pay the counsel fees for the shareholders demanding appraisal, the court may require all shareholders who benefitted from the services of counsel to share in the payment of such fees. The purpose of all these grants of discretion with respect to costs and counsel fees is to increase the incentives of both sides to proceed in good faith under this chapter to attempt to resolve their disagreement without the need of a formal judicial appraisal of the value of shares.

While subsections (a)-(c) allocate costs and expenses in an appraisal proceeding, subsection (d) covers the situation where the corporation was obligated to make payment and did not meet this obligation. In that event, the shareholder may sue the corporation directly for the amount owed. In such an action, subsection (d) requires the court, to the extent the shareholder was successful, to impose all costs and expenses, including counsel fees, on the corporation.

NORTH CAROLINA COMMENTARY

Subsection (a) of this section differs from the Model Act by providing simply that "the court shall assess the costs as it finds equitable." This language was adapted from former G.S. 55-113(e). The words "either or" were inserted before "any other" in subdivision (b)(2) to clarify a possible ambiguity.

Effect of Amendments. - Session Laws 2011-347, s. 1, effective October 1, 2011, substituted "expenses" for "counsel fees" in the section catchline; and rewrote the section.

OFFICIAL COMMENT

Section 14.01 provides a simple method of voluntary dissolution for a corporation that has not issued shares or commenced business. These provisions are alternative: a corporation may utilize section 14.01 if it has not issued shares (even though it has commenced business) or if it has issued shares but has not commenced business. Dissolution may be accomplished in either of these situations simply by a majority vote of the incorporators or initial directors. (See section 2.05 and its Official Comment for a discussion of the roles of "incorporators" or "initial directors" in the organization of a corporation.)

This simple method of dissolution is likely to be used by name-holding corporations or by corporations formed for the initiation of a new venture when the reasons for the initial creation of the corporation have been completely realized or will never come to fruition.

The form of articles of dissolution provided in section 14.01 takes account of the fact that a corporation may utilize this section even though it has received capital from the issuance of shares or has incurred liabilities either from the commencement of business without issuing shares or from its organization; hence the articles must state that no debts remain unpaid, and that the net assets of the corporation remaining after winding up have been distributed to the shareholders.

AMENDED NORTH CAROLINA COMMENTARY

This section modifies the Model Act in that dissolution by the directors or incorporators is authorized only in the case of a corporation that has not issued shares. In addition, the incorporators are authorized to act only if the corporation has no directors, and the articles of dissolution must identify the officers and directors or, if none, the incorporators.

Subsection (b) was added for clarification; it parallels G.S. 55-14-03(b).

Legal Periodicals. - For article, "The Creation of North Carolina's Limited Liability Corporation Act," see 32 Wake Forest L. Rev. 179 (1997).

OFFICIAL COMMENT

A corporation that has issued shares and commenced business may dissolve voluntarily only with the approval of its shareholders. Section 14.02 requires the board of directors to propose dissolution and then submit the proposal to the shareholders. The board of directors must make a recommendation to the shareholders that the proposal to dissolve be approved, unless it determines that because of conflict of interest or other special circumstances it should make no recommendation. If the board of directors so determines, it must describe the conflict or circumstances, and communicate the basis for its determination, to the shareholders when presenting the proposal to dissolve to the shareholders.

Dissolution, to be approved, must receive the vote of a majority of the outstanding votes entitled by the articles of incorporation to vote on the proposal. This is a greater vote than that required for ordinary matters under section 7.25. Nonvoting classes of shares are not given a statutory right to vote on proposals to dissolve (either as separate voting groups or together with voting shares) by the Revised Model Act on the theory that, upon dissolution, the rights of all classes or series of shares are fixed by the articles of incorporation. The articles of incorporation, however, may stipulate that specified classes or series of shares are entitled to vote by separate voting groups. Thus, in the absence of specific provision in the articles of incorporation, only the shares of the corporation entitled to vote generally by the articles of incorporation are entitled to vote on dissolution. The articles of incorporation may also specify that a greater percentage of votes is required to approve the proposal than is required by section 14.02.

The board of directors may condition its submission of a proposal to the shareholders under subsection (c) on its receiving a specified percentage of the votes of shareholders of one or more classes or series, voting by separate voting groups, or on some other basis. See the discussion of conditional submissions in the Official Comment to section 10.03.

Section 14.04 permits the corporation to revoke the dissolution under the circumstances described.

NORTH CAROLINA COMMENTARY

This section differs from former G.S. 55-118(a) in that only voting shares are entitled to vote on a proposal to dissolve and, unless otherwise provided in the articles of incorporation, a bylaw adopted by the shareholders, or the resolution of the board of directors approving the dissolution, only a majority of the voting shares is required to adopt the proposal. It should be noted that all shareholders, whether or not entitled to vote, are still entitled to notice of the shareholders' meeting at which the dissolution proposal will be considered. Under prior law, the board of directors was required to recommend the dissolution; under this section, the board must recommend the dissolution proposal to the shareholders unless it determines that, because of conflict of interest or other special circumstances, it should make no recommendation to the shareholders. In addition, the board of directors may now condition its submission of a dissolution proposal "on any basis."

The language of the Model Act was modified in subsection (b) to conform to changes made in G.S. 55-10-03.

Under former G.S. 55-117, a corporation could be dissolved by written consent of all of the shareholders, without action by the board of directors. This provision was not brought forward.

Editor's Note. - Session Laws 2013-153, s. 15 provides: "The Revisor of Statutes may cause to be printed all relevant portions of the Official Comments to the Model Business Corporation Act and all explanatory comments of the drafters of this act as the Revisor deems appropriate."

Effect of Amendments. - Session Laws 2013-153, s. 14, effective January 1, 2014, substituted "The following requirements shall be met for" for "For" in subsection (b); rewrote subdivision (b)(1), which formerly read "The board of directors must recommend dissolution to the shareholders unless the board of directors determines that because of conflict of interest or other special circumstances it should make no recommendation, in which event the board of directors must communicate the proposal and the basis for its lack of recommendation to the shareholders; and"; and added sub-subdivisions (b)(1)a. and (b)(1)b.

CASE NOTES

Editor's Note. - The cases below were decided under prior law.

Statute Settles Question as to When Dissolution Allowed. - Former G.S. 55-121 settled the question formerly much mooted in the courts as to whether, and under what circumstances, a corporation could be dissolved by the stockholders, when no time was fixed for its duration, upholding and extending this power of voluntary dissolution as established by the better considered decisions on the subject. White v. Kincaid, 149 N.C. 415, 63 S.E. 109 (1908).

Part of Every Charter. - The provision of the statute enters into every charter, and unless otherwise enacted by the legislature, every stockholder takes and holds his stock subject to the power of voluntary dissolution, by resolution of the directors concurred in by two thirds in interest of the stockholders. White v. Kincaid, 149 N.C. 415, 63 S.E. 109 (1908).

Directors Are Trustees in Dissolution Proceedings. - The directors of a corporation in proceedings for dissolution are trustees in the sense that they must act faithfully in their judgment for the benefit of the corporation and in furtherance of its interest, and not for the purpose of unjustly oppressing the holders of the minority stock, or to attain their own personal ends. White v. Kincaid, 149 N.C. 415, 63 S.E. 109 (1908).

Motive for Dissolution Generally Immaterial. - When a corporation lawfully proceeds to wind up its affairs in accordance with the statute, the motive prompting the act, however reprehensible or malicious, is not, as a rule, relevant to the inquiry; and the courts will not undertake to interfere with the honest exercise of discretionary powers vested by statute in the management of a corporation, however unwise or improvident it may seem in a given instance. White v. Kincaid, 149 N.C. 415, 63 S.E. 109 (1908).

Liquidation to Escape Judgment. - An attempted liquidation by a corporation, to escape judgment for the refund of money wrongfully distributed, is in fraud of creditors. Chatham v. Mecklenburg Realty Co., 180 N.C. 500, 105 S.E. 329 (1920).

Suits Pending Dissolution. - Where it appears in an action that the indebtedness sought to be recovered was claimed to be due a corporation, and that the suit was instituted by the individual stockholders, a judgment as of nonsuit is properly entered, though proceedings in dissolution of the corporation were being had under the statute, the proper party plaintiff being the corporation or a receiver appointed therefor. Worthington v. Gilmers, Inc., 190 N.C. 128, 129 S.E. 153 (1925).

OFFICIAL COMMENT

The act of filing the articles of dissolution makes the decision to dissolve a matter of public record and establishes the time when the corporation must begin the process of winding up and cease carrying on its business except to the extent necessary for winding-up. The articles of dissolution must describe the manner in which the proposal to dissolve was submitted to the shareholders and describe the vote taken.

Under the Model Act, articles of dissolution may be filed at the commencement of winding-up or at any time thereafter. This is the only filing required for voluntary dissolution; no filing is required to mark the completion of winding-up since the existence of the corporation continues for certain purposes even after the business is wound up and the assets remaining after satisfaction of all creditors are distributed to the shareholders. No time limit for filing the articles is specified, and it often may be desirable to postpone filing until winding up is far along or even complete.

A corporation is dissolved on the date the articles of dissolution are effective. After this date the corporation is referred to as a "dissolved corporation," although its existence continues under section 14.05 for purposes of winding up.

NORTH CAROLINA COMMENTARY

Articles of dissolution are the only required filing under this Act, and a corporation is dissolved on the effective date of its articles of dissolution. There is no filing comparable to the certificate of completed liquidation required under former G.S. 55-121. Articles of dissolution may be filed at any time after dissolution is authorized.

This section modifies the Model Act by providing that the articles of dissolution shall contain the names and addresses of the corporation's officers and directors, so that creditors and other interested parties can identify the persons responsible for winding up the affairs of the corporation. Minor clarifying changes were also made in subsection (a).

SUPPLEMENTAL NORTH CAROLINA COMMENTARY (2005)

Effective October 1, 2005, this section adds a definition of "dissolved corporation" for purposes of the North Carolina Business Corporation Act.

Effect of Amendments. - Session Laws 2005-268, s. 31, effective October 1, 2005, added subsection (c).

CASE NOTES

Cited in Storr Office Supply Div. v. Radar Bus. Sys., 832 F. Supp. 154 (E.D.N.C. 1993).