Recent Amendments to the North Carolina Business Corporation Act

By Heyward Armstrong, Dave Clement, and Justin Truesdale

The North Carolina General Assembly recently approved Senate Bill 507 (the “Act”),[i] which makes a number of significant changes to the North Carolina Business Corporation Act (“NCBCA”), and the governor signed the Act into law on August 16, 2021.[ii] Certain provisions of the Act were effective immediately, and the remaining provisions of the Act became effective on October 1, 2021.

The bill resulting in the Act was drafted by the Business Corporations Committee of the Business Law Section (the “Committee”) and approved as “Association-sponsored legislation” by the NCBA Board of Governors in January 2021. The North Carolina Bar Association is grateful for the endorsement and support of the North Carolina Chamber and thankful to the bill’s primary sponsor Senator Amy Galey and Representative Destin Hall who ably shepherded the bill through the legislative process to enactment.

The NCBCA is based on the Model Business Corporation Act (the “Model Act”), which is the work of the Corporate Laws Committee of the ABA Business Law Section (the “ABA Committee”).  The Act was recommended by the North Carolina Bar Association to update the NCBCA based on changes made to the Model Act as well as selected changes in state laws in other jurisdictions and to address case law developments from the North Carolina Business Court interpreting the NCBCA.

A summary of the key changes included in the Act is set forth below:

Voting of Shares Held by Subsidiaries (Section 1 of the Act)

Prior to the Act

NCGS § 55-7-21(b) provided that shares of a parent corporation held by a majority owned corporate subsidiary of the parent are not entitled to vote. The reason for this long-standing prohibition is to prevent the parent’s management from creating the subsidiary to entrench itself in power.

As Amended

The Act amended NCGS § 55-7-21(b) to provide that the form of entity of the subsidiary is irrelevant to whether shares held by the subsidiary are entitled to vote. Under the Act, any majority owned subsidiary, regardless of whether it is a corporation, limited liability company or other entity, may not vote the shares of its parent. This change is consistent with the current provisions of the Model Act.

Compensation of Directors (Section 2 of the Act)

Prior to the Act

NCGS § 55-8-11, as amended in 2018 by N.C. Session Law 2018-45, provided that, unless the corporation’s articles of incorporation or bylaws provide otherwise, the corporation’s board of directors may fix the compensation of directors in any capacity regardless of their personal interest in such decision. NCGS § 55-8-11 further provided that, with respect to any compensation established pursuant to such section of directors of a public corporation or a corporation that so provides in its articles of incorporation, such compensation is generally presumed to be fair to the corporation.

In Ehmann v. Medflow, Inc., 2019 NCBC 9 (2019), the North Carolina Business Court interpreted the presumption of fairness under NCGS § 55-8-11 to be limited to compensation that the directors receive for services rendered while acting in their capacities as directors. In so doing, the Business Court rejected the arguments of a director that the compensation he had fixed for himself serving as an officer of the corporation was entitled to the presumption of fairness and therefore the director did not offer any evidence to prove that his officer compensation was fair to the corporation.

As Amended

The Act amends NCGS § 55-8-11 to conform to the decision in Ehmann by limiting NCGS §55-8-11 to “compensation of directors for services in any capacity as a director.” Thus, there is no change to existing law as applied by the Business Court.

Quorum and Voting Requirements for Actions by the Board of Directors (Section 3 of the Act)

Prior to the Act

NCGS § 55-8-24(a) provided that, unless a corporation’s articles of incorporation or bylaws require a greater number, a quorum of a board of directors (i.e., the number of directors that are required to be present at a meeting for action to be taken) depends on whether the corporation has a fixed board size (e.g., “the number of directors shall be X”) or a variable-range size board (e.g., “the number of directors shall not be less than Y or more than Z as determined by the board of directors”). If the corporation has a fixed board size, a quorum consists of a majority of the fixed number of directors. If the corporation has a variable-range board size, a quorum consists of a majority of the prescribed number of directors within such range or, if no number is prescribed, the number of directors in office immediately before the beginning of the applicable board meeting. NCGS § 55-8-24(b) further provided that a corporation’s articles of incorporation or a bylaw adopted by the corporation’s shareholders may authorize a quorum that consists of no fewer than one-third of the fixed or prescribed number of directors determined under NCGS § 55-8-24(a). This provision therefore appeared to conflict with § 55-8-24(a), which indicated that the corporation’s articles of incorporation and bylaws may only increase, and not decrease, the size of the quorum.

As Amended

The Act simplifies NCGS § 55-8-24(a) to eliminate the distinction between fixed and variable-range size boards with respect to quorum requirements. As amended, § 55-8-24(a) provides that, unless the corporation’s articles of incorporation or bylaws provide for a greater or lesser number, or unless otherwise specifically set forth in the NCBCA, a quorum of a board of directors consists of a majority of the number of directors specified in or fixed in accordance with the corporation’s articles of incorporation or bylaws.

The Act also amends NCGS § 55-8-24(b) to provide that any quorum requirement established in the corporation’s articles of incorporation or bylaws under § 55-8-24(a) may not be less than one-third of the number of directors specified in or fixed in accordance with the articles of incorporation or bylaws.

Thus, the Act gives corporations the flexibility to establish their own quorum requirements subject to the one-third limitation. For example, if a corporation sets its quorum size based on the number of directors then in office (instead of based on the fixed or specified number of directors), it should ensure that its articles of incorporation or bylaws clarify that in no event would the quorum at any meeting be less than permitted by NCGS § 55-8-24(b).

Corporate Name Changes (Section 4 of the Act)

Prior to the Act

NCGS § 55-10-02 provided that a corporation’s shareholders generally must approve all corporate name changes. This requirement was more restrictive than the Delaware General Corporation Law, which gives the board of directors of a corporation the authority to change the corporation’s name. Particularly for publicly traded companies, the shareholder approval requirement creates unnecessary complexity and expense.

As Amended

NCGS § 55-10-02 now provides that the corporation’s board of directors may change a corporation’s name without shareholder approval.

Jurisdiction in Appraisal Proceedings Commenced under NCGS § 55-13-30 (Section 5 of the Act)

Prior to the Act

Article 13 of the NCBCA provides “appraisal rights” to shareholders of North Carolina corporations in connection with certain fundamental corporate events. If a shareholder properly exercises its appraisal rights under NCGS § 55-13-23, NCGS § 55-13-25 and NCGS § 55-13-27 generally require the corporation to pay the shareholder the amount the corporation estimates as the fair value of the shareholder’s shares, plus interest. A shareholder that is dissatisfied with the corporation’s fair value determination is entitled to object to such determination under NCGS § 55-13-28. Unless the corporation pays the demanded amount or settles the claim with the shareholder, the corporation must commence a proceeding in Superior Court under NCGS § 55-13-30 to obtain a judicial determination of the value of the shares within 60 days of receiving the shareholder’s demand for additional payment. The corporation is required to make all shareholders with unsettled appraisal demands party to such proceeding so that the court can resolve all outstanding disputes.

In Reynolds American Inc. v. Third Motion Equities Master Fund Ltd., 2019 NCBC 35 (2019), the corporation bringing the appraisal proceeding under § 55-13-30 asserted that the defendant shareholders were required to prove that they had properly perfected their appraisal rights at trial. However, the N.C. Business Court determined that, under the plain language of § 55-13-30, it did not have jurisdiction to review each shareholder’s entitlement to appraisal before making a determination on fair value. The court noted that the North Carolina General Assembly could have enacted a provision similar to Section 262(g) of the Delaware General Corporation Law whereby the court would first review shareholder’s entitlement to appraisal before making a determination on fair value but had clearly not done so, and the court could not write such a provision into the statute.

As Amended

The North Carolina General Assembly accepted the court’s invitation to amend NCGS § 55-13-30 to give the court the jurisdiction to first determine whether a shareholder complied with Article 13 of the NCBCA before determining the fair value of the shares to be paid to such shareholder. The shareholder has the burden of proving that it is entitled to appraisal rights under Article 13.

Maintenance of Corporate Records and Financial Statements (Section 6 of the Act)

Prior to the Act

NCGS § 55-16-01 requires corporations to keep specified corporate records and included a requirement that the corporation keep certain records at the corporation’s principal office. §§ 55-16-02 through 55-16-04 generally give shareholders the right to inspect the corporation’s records for a proper purpose. NCGS § 55-16-20 requires corporations to make available financial statements to its shareholders and required corporations to either mail their annual financial statements or a written notice of their availability to their shareholders within 120 days after the end of the fiscal year.

As Amended

The Act makes a number of welcome changes to the requirements related to the maintenance, inspection and delivery of corporate records and financial statements. These changes were driven by recent changes in the Model Act, a recognition that many corporate records are now maintained electronically, and a desire to provide corporations with greater flexibility and more reasonable compliance obligations.

Maintenance of Corporate Records (Section 6.(a) of the Act)

In particular, the Act amends NCGS § 55-16-01 to require corporations to maintain the following records (which are not required to be maintained at the corporation’s principal offices but instead must only be maintained in a manner so that they may be made available for inspection within a reasonable time):

• The corporation’s articles of incorporation as currently in effect, its bylaws as currently in effect, all written communications within the past three years to shareholders generally, minutes of all meetings of, and records of all actions taken without a meeting by, its shareholders, board of directors and board committees, a list of the names and business addresses of its current directors and officers, and its most recent annual report delivered to the N.C. Secretary of State (§ 55-16-01(a))
• All annual financial statements prepared for the corporation for its last three fiscal years, or each year of its existence if shorter than three years, and any audit or other reports with respect to the financial statements (§ 55-16-01(b))
• A record of the corporation’s current shareholders, in alphabetical order by class of shares showing the number and class of shares held by each shareholder (§ 55-16-01(c))
• Accounting records in a form that permits preparation of the corporation’s financial statements (§ 55-16-01(d))

Inspection of Corporate Records (Sections 6.(b)–(e) of the Act)

The Act amends NCGS §§ 55-16-02 through 55-16-04 and adds a new Section 55-16-01A, which govern the rights of shareholders to inspect and copy the corporation’s records. Most of the amendments are technical in nature. Consistent with prior law, and inconsistent with the Model Act, the right to inspect and copy is limited to “qualified shareholders,” which continue to only include shareholders that have been shareholders in the corporation for at least six months or who hold at least 5% of the corporation’s outstanding shares of any class.

The Act adds a new § 55-16-02(c1), which expressly provides that the corporation may impose reasonable restrictions on the confidentiality, use and distribution of the corporation’s records, other than the corporation’s articles of incorporation, its bylaws, the list of the names and business addresses of the corporation’s directors and officers and the corporation’s most recent annual report. Similar changes were added to the provisions in § 55-16-04 with respect to court-ordered inspections. Thus, the Act recognizes that while qualified shareholders have an absolute right of inspection and use of these enumerated fundamental records (which are not likely to contain confidential information), qualified shareholders have only a limited right of inspection, copying and use of other corporate records where the corporation may have a significant interest in protecting such information.

Financial Statements (Sections 6.(f)–(i) of the Act)

Section 6.(f) of the Act substantially revises NCGS § 55-16-20, which governs the obligations of corporations with respect to providing financial statements to shareholders. Notable revisions include the following:

• The corporation is only required to deliver, or make available to the requesting shareholder, annual financial statements for the most recent fiscal year of the corporation for which annual financial statements have been prepared. Such financial statements can be made available by posting them on the corporation’s website or, if the corporation is a public corporation, filing the financial statements with the Securities and Exchange Commission.
• The Act eliminates the prior requirement that financial statements not reported on by a public accountant be accompanied by a statement by the corporation’s president or the person responsible for the corporation’s accounting records regarding the basis on which the financial statements were prepared and describing changes in the basis of accounting from the prior fiscal year.
• The Act eliminates the obligation to mail the financial statements, or a notice of their availability, to all shareholders within 120 days after the close of each fiscal year.
• The corporation may withhold financial statements if it reasonably determines that the shareholder’s request is not made in good faith or for a proper purpose.
• The corporation may require the requesting shareholder to agree to reasonable restrictions on the confidentiality, use and distribution of the financial statements.

Sections 6.(g) through 6.(i) of the Act include technical changes to Article 13 of the NCBCA and to the North Carolina Limited Liability Company Act for consistency with the amendments to NCGS § 55-16-20.

Committee Members Involved in these NCBCA Amendments

The following are the Committee members who participated in drafting the proposed bill resulting in the Act and/or who represented the North Carolina Bar Association in various committee hearings in the North Carolina General Assembly regarding Senate Bill 507:

Heyward D. Armstrong – Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P., Raleigh

David B. Clement – Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P., Raleigh

Gregory S. Connor – Connor Law Group, Raleigh

Lisa Crandall – PLG Law, Charlotte

Carly Ginley – Mattel, Inc., El Segundo, CA

Amanda A. Hayes – Parker Poe Adams & Bernstein LLP, Raleigh

Seth M. Huffstetler – Robinson, Bradshaw & Hinson, P.A., Charlotte

Stephen M. Lynch – Robinson, Bradshaw & Hinson, P.A., Charlotte

Justin G. Truesdale – Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P., Raleigh

 

[i] N.C. Session Law 2021-106, N.C. Senate Bill 507.

[ii] This blog post does not cover the separate changes to the NCBCA enacted on September 20, 2021, that permit virtual-only shareholders meetings. Those changes will be covered in a future blog post by the Business Corporations Committee.