On March 20, 2020, Colorado Gov. Jared Polis signed into law House Bill 20-1013 (the “Act”). The Act provides for the addition of CRS 7-103-106 to the Colorado Business Corporation Act (the “CBCA”), which will create a statutory procedure to remedy defective corporate actions. In passing the Act, Colorado joins Delaware,1 North Carolina,2 Washington,3 and a handful of other states in providing such a statutory procedure. The Act mirrors the defective corporate action provisions of the American Bar Association’s Model Business Corporations Act, and will take effect 90 days after the final adjournment of the Colorado General Assembly in 2020.
Defective Corporate Actions
Actions taken by directors, officers, incorporators, agents and shareholders must comply with a corporation’s articles of incorporation, bylaws, corporate resolutions and third-party agreements (collectively, “Governing Documents”) to the extent such Governing Documents are applicable to the particular action being taken. A defective corporate action is an action taken by a corporation that is within the corporation’s power but is void or voidable because the action lacked authorization required by the corporation’s Governing Documents. Examples of defective corporations include issuing shares without proper authorization, failing to obtain requisite shareholder approval of a corporate action, taking corporate action in the absence of a requisite board resolution authorizing the action, and failing to validly appoint an initial board of directors. Such actions can have serious negative consequences that are difficult to remedy. For example, if a corporation issued unauthorized shares of its stock to investors, that stock issuance would be considered putative stock4 and deemed invalid. In turn, such stockholders’ votes would consequently be deemed invalid since they are not considered owners of the company. The initial over-issuance of stock could create a domino effect of invalid acts that could make capital raising, being acquired or engaging in other major corporate actions difficult. The Act provides a remedy for this issue by establishing a non-exclusive,5 statutory procedure to ratify defective corporate actions, rendering such actions no longer void or voidable. The Act provides corporations with two alternative methods to ratify or validate defective corporate action: (i) a process of remedial action undertaken by the corporation through approval by its board of directors and, if necessary, by the shareholders of the corporation, or (ii) a judicial process for the ratification of the defective act.
Ratification Procedure and Notice Requirements
Generally, in order to ratify a defective corporate action under the Act without judicial involvement, a corporation’s board of directors must adopt resolutions stating the following:6
- the defective corporate action to be ratified and, if the defective corporate action involved the issuance of putative shares, the number and type of putative shares purportedly issued;
- the date of the defective corporate action;
- the nature of the failure of authorization with respect to the defective corporate action to be ratified; and
- the board of directors approves the ratification of the defective corporate action.
Following adoption of such resolutions by the board of directors, the corporation must notify shareholders of the ratification. The notification must be given to holders of both valid and putative shares in each case as of both the date of ratification and the date of the defective corporate action. The Act requires that the shareholder notification must (1) include a copy of the ratifying board resolutions and (2) alert shareholders that they have 120 days from the Validation Effective Time7 to challenge the ratification (the “Challenge Window”).
If any provision of the CBCA or any Governing Document requires shareholder approval or would have required shareholder approval at the date of the defective corporate action, the ratification must also be submitted to the shareholders for approval. If the ratification is to be authorized at a shareholder meeting, the corporation must notify all shareholders of the meeting, including voting and nonvoting shareholders both as of the record date of notice and as of the date of the defective corporate action. The meeting notification must (1) state that ratification is one of the purposes of the meeting, (2) include a copy of the board resolutions regarding ratification, and (3) inform shareholders of the Challenge Window.
Voting and Quorum Requirements
The quorum and voting requirements applicable to a ratifying action by the board are the quorum and voting requirements applicable to the relevant corporate action at the time such ratifying action is taken (not the requirements as of the time of the defective corporate action). Likewise, other than with respect to an election of directors, the quorum and voting requirements for shareholder approval are the shareholder approval requirements at the time of ratification (not the requirements as of the time of the defective corporate action).8 Only valid shares are entitled to vote on the ratification action or counted for quorum purposes.
In the event any filing is or would have been required under the CBCA to effect the defective corporate action, the corporation must file Articles of Amendment with the Colorado Secretary of State. The Articles of Amendment must include an attachment setting forth the following information:
- the defective corporate action that is the subject of the Articles of Amendment;
- the date of the defective corporate action;
- the nature of the failure of authorization;
- a statement that the defective corporate action was ratified in accordance with the Act; and
- certain information relating to the original filing that may or may not need to be corrected or, if a required filing was never made, the information that should have been filed with respect to the defective corporate action and the date and time such filing is deemed effective.
Effect of Ratification
Defective corporate actions ratified pursuant to the Act are no longer void or voidable as of the Validation Effective Time (notwithstanding the Challenge Period). Additionally, the ratification has the effect of ratifying corporate actions that were defective as a result of the original defective corporate action. For example, if an overissue of shares resulted in subsequent invalid director elections, ratification of the overissue would cure the related defects with such elections.
As an alternative to the self-help remedy described above, the Act confers plenary jurisdiction on the applicable Colorado district court9 to hear and determine claims regarding the validity of any corporate action or any shares, rights, options or warrants. The corporation, any successor entity to the corporation, a director of the corporation, any shareholder of the corporation or any other person claiming to be substantially and adversely affected by a ratification under the Act may initiate a judicial proceeding. The court’s jurisdiction is not limited to reviewing corporate actions ratified or purportedly ratified under the Act 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 ratification, the court may take into account any factors or considerations it deems proper under the circumstances, such as whether the person originally taking the defective corporate action believed that the action complied with corporate requirements, whether the corporation and board of directors have treated the defective corporate action as a valid action, and whether any person will be or was harmed by the ratification of the defective corporate action.
As discussed above, the Act makes significant changes to the CBCA by providing Colorado corporations with a non-exclusive, statutory ratification procedure to remedy defective corporate actions. While the Act will not take effect until later in 2020, Brownstein recommends that Colorado corporations and their directors, officers and shareholders understand the Act’s impact as it provides a useful tool to cure defective corporate actions. If a corporation is aware of an existing defective corporate action, it should strongly consider preparing materials for a statutory ratification as soon as possible, so it can carry out such ratification promptly after the effective date of the Act.
This document is intended to provide you with general information regarding the Colorado Business Corporation Act. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions.
1 8 Del. C. §§ 204–205.
2 N.C. Gen. Stat. § 55-1-60 et seq.
3 RCW 23B.20.010 et seq.
4 Putative shares are corporate shares or interests (e.g., stock options or warrants) that could have been validly issued, but there was a failure of authorization or proper authorization cannot be proven.
5 Ratification may also be accomplished via common law.
6 If the defective corporate action was a failure to elect the corporation’s initial board of directors, the majority of the persons who, at the time of ratification, are exercising the powers of directors, must adopt resolutions stating: (1) the name of the person or persons who first took action in the name of the corporation as the initial board of directors; (2) the earlier of the date on which the persons first took the action or were purported to have been elected as the initial board of directors; and (3) that the ratification of the election of the person or persons as the initial board of directors is approved.
7 The “Validation Effective Time” is the later of: (1) when the shareholders approve the ratification; (2) if shareholder approval is not required, when the shareholders are notified of the ratification; or (3) when the articles of validation are filed, if such a filing is necessary.
8 Shareholder approval with respect to ratification of director elections requires that the votes cast within the voting group favoring the ratification exceed the votes cast opposing the ratification of the election at a meeting at which a quorum is present.
9 The applicable court is the district court for the county in Colorado where the corporation’s principal office is located or, if the corporation has no principal office in Colorado, the district court for the county in which the street address of its registered agent is located or, if the corporation has no registered agent, the district court for the city and county of Denver.