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Since the mid-1970s, the California General Corporation Law has contained an unusual provision that purports to require non-exempt corporations (but not other kinds of entities like LLPs) with a specified nexus to California to comply with a large number of California’s statutory corporate law provisions.  This provision holds sway even when these “quasi-California” corporations are organized under the laws of another state, or even another country. 

Indeed, this provision – Section 2115 – goes so far as to provide that it operates “to the exclusion of the law of the jurisdiction in which [the company] is incorporated.”  Even publicly traded companies can fall within Section 2115’s net unless their shares are listed on the New York Stock Exchange or the American Stock Exchange or quoted on the NASDAQ National Market System.

Outcomes Can Be Contrary to Corporate Law of Original Jurisdiction

Section 2115 can produce outcomes disconcertingly contrary to the corporate law of the corporation’s jurisdiction of incorporation.  For instance, a corporation formed under the law of a state like Delaware that does not compel cumulative voting in the election of directors (and has not opted to provide for cumulative voting in its charter documents where the state of incorporation would permit that optional choice) is nevertheless, under Section 2115, required to allow shareholders to cumulate their votes if the corporation meets the Section 2115 tests.  This was precisely the situation addressed by an intermediate California appeal court in 1982 in Wilson, where the court held that Section 2115 did not violate the United States constitution in applying mandatory cumulative voting to a Utah corporation.¹

In the context of a merger in which a quasi-California corporation is one of the merging entities, Section 2115 can produce equally contradictory results.  For instance, unless a Delaware corporation’s certificate of incorporation otherwise provides (as it is permitted to do), its merger with another corporation requires the adoption of the merger agreement by a majority of the outstanding shares of the Delaware corporation entitled to vote; preferred shares have no separate class vote absent express provision otherwise.  In contrast, one of the statutory provisions made applicable to quasi-California corporations by Section 2115 generally requires the principal terms of a reorganization to be approved by the outstanding shares of each class, and, where that provision applies, Section 2115 will afford a mandatory class vote to preferred shares.

This was exactly the situation that the Delaware Supreme Court recently addressed, and decided against the preferred having a class vote, in Examen.²   In this overview we will briefly review the applicability of Section 2115, the basic holding in Examen, and its implications for corporate practice.

The Applicability of Section 2115

Section 2115 generally provides that if:

»    a foreign corporation conducts a certain amount of its business in California  (determined by mathematical factors based on property, payroll, and sales); and

  »   more than 50 percent of a foreign corporation's outstanding voting securities are held by record by persons having California  addresses (as disclosed on the books of the corporation on the record date),

then, subject to technical provisions for determining the exact date of applicability, certain enumerated provisions of the California General Corporation Law apply to the foreign corporation to the exclusion of the law of the jurisdiction in which it is incorporated. 

Thus, for example, where a foreign corporation meets the requirements of a "quasi-California” corporation, Section 2115 purports to state that California  law supersedes the law of the jurisdiction of incorporation with respect to:

• the annual election of directors;
• removal of directors for cause or by court proceedings;
• a director's standard of care;
• officers and directors indemnification;
• the liability of directors and shareholders for unlawful distributions;
• cumulative shareholder voting;
• class votes with respect to the approval of mergers;
• dissenters’ rights;
• shareholders rights of inspection;

and a number of other provisions.

As previously noted, corporations which are listed on the New York Stock Exchange or the American Stock Exchange or quoted on the NASDAQ National Market System are exempt from Section 2115.  In addition, wholly-owned subsidiaries of an exempt corporation are also exempt. 

The Examen Decision

The issue in Examen was whether VantagePoint, a venture capital firm that owned 83 percent of Examen’s preferred stock but none of its common, was entitled to a class vote on the pending merger in which Examen was to be acquired by Reed Elsevier.  By its express terms, the preferred was entitled to vote the number of common shares into which it was convertible, but those as-converted shares voted as a single class with the common.  On that basis, VantagePoint controlled approximately 13.5 percent of the total vote of the merger.  However, if the preferred voted as a single class, VantagePoint could block the merger.

To date there has been no judicial finding that Examen was in fact a quasi-California corporation.  Indeed, five days after Examen filed in Delaware for a declaration that California law did not apply to the voting rights of its stockholders, VantagePoint sued in California Superior Court seeking a declaration that Examen was a quasi-California corporation under Section 2115 and was required, under that section, to disclose that fact to its stockholders.³  However, at Examen’s request, the California court stayed the action pending the Delaware Chancery Court’s ruling. 

The Delaware Chancery Court granted the declarative relief requested by Examen.⁴  It held that, since the company was incorporated in Delaware , only Delaware law applied to its internal affairs, including the voting rights of the preferred.  The court rejected VantagePoint’s argument that the class voting provisions of California law were “additive” and could apply side by side with the Delaware provision for all outstanding shares to vote as a single class.  The court found an irreconcilable conflict between the two sets of voting requirements and held that this conflict had to be resolved in favor of the exclusive application of Delaware law.

The Delaware Supreme Court affirmed this judgment.⁵   Like the Chancery Court, the state’s Supreme Court relied on the internal affairs doctrine as applicable to matters pertaining to the relationship among a Delaware corporation and its officers, directors and stockholders.  The Supreme Court reasoned that the principle that a corporation’s internal affairs should be governed only by one single uniform set of legal requirements was grounded not only in choice of law rules but constitutional principles (except in the rarest situations, such as when the law of the state of incorporation was inconsistent with national policy on foreign or interstate commerce). 

Of particular importance to an assessment of Examen’s implications is the Delaware Supreme Court’s conclusion that the California courts themselves would today reject Wilson as superseded by subsequent U.S. Supreme Court decisions recognizing the internal affairs doctrine as constitutionally mandated.

Where Does That Leave Section 2115?

It is important to note that VantagePoint’s California lawsuit is still pending.  Vantage Point is apparently still seeking a California judicial determination that Examen was a quasi-California corporation. 

On the day after it had ruled on the substantive Section 2115 issue, the Delaware Chancery Court granted Examen’s application for a temporary restraining order and preliminary injunction against litigation in any other court concerning the subject matter of the Delaware action, including the already pending filed California action.  VantagePoint appealed the Delaware Chancery Court decision.  While the appeal was pending, in April 2005, the individuals who comprised the Examen board of directors at the time of the merger, together with the resulting corporation and its parent company, filed a separate complaint in the Delaware Chancery Court,⁶ naming VantagePoint as the defendant and seeking a judicial declaration that (i) the directors and officers of Examen did not breach their fiduciary duties in connection with the merger and (ii) there is no basis to unwind the merger; and (iii) they are not liable to VantagePoint in connection with the merger.  In May 2005, the Delaware Supreme Court affirmed the original Chancery Court decision.  In July 2005, the Delaware Chancery Court denied Examen’s application for a permanent injunction and granted VantagePoint’s request to dissolve the temporary restraining order that had prevented VantagePoint from proceeding further in the California action.  As a result, VantagePoint reactivated its action in the California Superior Court.  However, in November 2005, the California Superior Court stayed the California action pending resolution of the second Delaware action.  As a result, there remains the intriguing possibility that VantagePoint could still obtain a ruling from a California court that, as a matter of California law, it was wrongfully deprived of a class vote on the merger.

While the “full faith and credit” clause of the United States Constitution may require the California courts to give effect to the Delaware Chancery Court’s order enjoining further litigation in California on the Section 2115 issues, it is a separate question whether they are required to respect a Delaware judicial declaration as to the substantive effect of Section 2115.   But, whatever the outcome of final litigation on the complex constitutional issues, and even if the Delaware decision is binding in California as between the parties in the case, Section 2115 is still on the books in California.  The Delaware Supreme Court’s prediction of how a California court would rule remains just that – a prediction (albeit from one of the most influential courts in the country on matters of corporate law).  We still face the ever-present possibility that a corporation which meets the Section 2115 tests could be held by a California court to have violated California law if it bases its decisions regarding its internal affairs solely on the law of its state of incorporation. 

Indeed, the ultimate disposition of the Examen litigation may ultimately prove to have turned on the fact that Examen sued in Delaware before VantagePoint sued in California .  If that happens, Section 2115 issues may spawn a “race to the courthouse,” exacerbating uncertainty over which set of corporate provisions applies to the internal affairs of a quasi-California corporation. 

What Should Quasi-California Corporations Do?

So where does that leave quasi-California corporations?   Despite the strong ruling by one of the nation’s most influential courts, should they continue acting as if they are burdened by dueling sets of legal requirements?  Should they follow Examen’s lead and file for declaratory relief, but this time in California to test the Delaware prediction that Section 2115 would be held inapplicable?  Is there a middle ground where they can safely reject those California rules that are directly contrary to the law of their state of incorporation but not those that are arguably “additive?”  If so, how do they safely identify that middle ground? 

Don’t Regard Section 2115 as Dead

The answer is: we don’t really know.  Pending the California Supreme Court definitive ruling that is so clearly needed, companies should not view Examen as a reliable basis for treating Section 2115 as dead.  So long as corporations with meaningful connections to California , and no NYSE or NASDAQ NMS listing, prefer to incorporate in other states, they will continue to wrestle with the vagaries of Section 2115.⁷

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¹   Wilson v. Louisiana-Pacific Resources, Inc., 138 Cal.App.3d 216 (1982).

²   VantagePoint Ventures Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005).

³   VantagePoint Venture Partners v. Examen, Inc., CA. 05AS00982 (Cal.Super.Ct. March 21, 2005).

⁴   Examen, Inc. v. VantagePoint Venture Partners 1996, 873 A.2d 318 (Del Ch. 2005).

⁵   VantagePoint Ventures Partners 1996 v. Examen, Inc.,871 A.2d 1108 (Del. 2005).

⁶   Johnson, et al. v. VantagePoint Venture Partners 1996, C.A. 1260-N (Del. Ch. April 13, 2005).

⁷   Note that, however, in a different context, a California court has cited Examen with apparent approval of the Delaware court’s reliance on the internal affairs doctrine, holding that the issue of standing to bring a shareholder derivative action against the Delaware corporation was dispositively governed by Delaware law notwithstanding California Corporation Code Section 800 attempting to apply a substantive shareholder derivative standing requirement contrary to Delaware’s.  Grosset v. Wenaas, 35 Cal. Rptr. 3d 58 (2005).